UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

SCHEDULE 14A

(Rule 14a-101)

SCHEDULE 14A INFORMATION

Proxy Statement Pursuant to Section 14(a) of the Securities
Exchange Act of 1934 (Amendment No.  )

Filed by the Registrant þ
Filed by a Party other than the Registrant o

Check the appropriate box:

o		Preliminary Proxy Statement
o		Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2))
þ		Definitive Proxy Statement
o		Definitive Additional Materials
o		Soliciting Material Pursuant to §240.14a-12

 

Kansas City Southern

(Name of Registrant as Specified In Its Charter)

 

Not Applicable

(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

Payment of Filing Fee (Check the appropriate box):

þ		No fee required.
o		Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.

	(1)		Title of each class of securities to which transaction applies:
	(2)		Aggregate number of securities to which transaction applies:
	(3)		Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined):
	(4)		Proposed maximum aggregate value of transaction:
	(5)		Total fee paid:

Persons who are to respond to the collection of information contained in this form are not required to respond unless the form displays a current valid OMB control number.

SEC 1913 (04-05)

o		Fee paid previously with preliminary materials.
o		Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing.

	(1)		Amount Previously Paid:
	(2)		Form, Schedule or Registration Statement No.:
	(3)		Filing Party:
	(4)		Date Filed:

 

427 West 12th Street

Kansas City, Missouri 64105

 

KANSAS CITY SOUTHERN

NOTICE AND PROXY STATEMENT
for
Annual Meeting of Stockholders
to be held
May 3, 2007

 

 

 

We commenced mailing this Notice and Proxy Statement,

the enclosed proxy card and the accompanying 2006 Annual Report

on or about March 30, 2007

KANSAS CITY SOUTHERN
427 West 12th Street
Kansas City, Missouri 64105

 

March 30, 2007

 

To Our Stockholders:

 

You are cordially invited to attend the Annual Meeting of Stockholders of Kansas City Southern, at Liberty Memorial, J.C. Nichols Auditorium, 100 West 26th Street, Kansas City, Missouri, at 10:00 a.m. Central Time, on Thursday, May 3, 2007. The purposes of this meeting are described in the accompanying Notice of Annual Meeting and Proxy Statement.

 

We urge you to read these proxy materials and our Annual Report and to participate in the Annual Meeting either in person or by proxy. Whether or not you plan to attend the meeting in person, please sign and return promptly the accompanying proxy card, in the envelope provided, to ensure that your shares will be represented. Alternatively, you may cast your votes by telephone or through the Internet as described on the accompanying proxy card.

 

Sincerely,

 

Michael R. Haverty

Chairman of the Board
and Chief Executive Officer

KANSAS CITY SOUTHERN
427 West 12th Street
Kansas City, Missouri 64105

 

 

NOTICE OF ANNUAL MEETING OF STOCKHOLDERS

 

 

The Annual Meeting of Stockholders of Kansas City Southern will be held at Liberty Memorial, J.C. Nichols Auditorium, 100 West 26th Street, Kansas City, Missouri, at 10:00 a.m. Central Time, on Thursday, May 3, 2007.

 

Stockholders will consider and vote on the following matters:

 

1. Election of three directors;

 

2. Ratification of the Audit Committee’s selection of KPMG LLP as our independent registered public accounting firm for 2007; and

 

3. Such other matters as may properly come before the Annual Meeting or any adjournment thereof.

 

Only stockholders of record at the close of business on March 5, 2007, are entitled to notice of and to vote at the Annual Meeting or any adjournment thereof.

 

By Order of the Board of Directors,

 

Michael R. Haverty

Chairman of the Board
and Chief Executive Officer

 

The date of this Notice is March 30, 2007.

 

Please date, sign and promptly return the enclosed proxy card, regardless of the number of shares you may own and whether or not you plan to attend the meeting in person. Alternatively, you may cast your votes by telephone or through the Internet as described on the proxy card. You may revoke your proxy and vote your shares in person in accordance with the procedures described in this Notice and Proxy Statement. Please also indicate on your proxy card whether you plan to attend the Annual Meeting.

KANSAS CITY SOUTHERN
427 West 12th Street
Kansas City, Missouri 64105

PROXY STATEMENT

 

TABLE OF CONTENTS

 

 

Why were you sent this Proxy Statement?

 

On or about March 30, 2007, we began mailing this Proxy Statement to our stockholders of record on March 5, 2007 (the “Record Date”) in connection with our Board of Directors’ solicitation of proxies for use at the 2007 Annual Meeting of Stockholders and any adjournment thereof (the “Annual Meeting”). We will hold the Annual Meeting at Liberty Memorial, J.C. Nichols Auditorium, 100 West 26th Street, Kansas City, Missouri, on Thursday, May 3, 2007 at 10:00 a.m. Central Time. The Notice of Annual Meeting of Stockholders, our 2006 Annual Report to Stockholders (the “Annual Report”), and a proxy card and voting instructions accompany this Proxy Statement.

 

We will pay for the Annual Meeting, including the cost of mailing the proxy materials and any supplemental materials. Directors, officers and employees of Kansas City Southern (“KCS”) may, either in person, by telephone or otherwise, solicit proxy cards. They have not been specifically engaged for that purpose, however, nor will they be compensated for their efforts. We have engaged Morrow & Co., Inc. to assist in the solicitation of proxies and provide related informational support, for a services fee and the reimbursement of customary disbursements that are not expected to exceed $15,000 in the aggregate. We will pay these fees and expenses. In addition, we may reimburse brokerage firms and other persons representing beneficial owners of our shares for their expenses in forwarding this Proxy Statement, the Annual Report and other soliciting materials to the beneficial owners.

 

Brokers, dealers, banks, voting trustees, other custodians and their nominees are asked to forward this Notice and Proxy Statement, the proxy card and the Annual Report to the beneficial owners of our stock held of record by them. Upon request, we will reimburse them for their reasonable expenses in mailing these materials to beneficial owners of our stock.

 

Who may attend the Annual Meeting?

 

Only KCS stockholders or their proxies and guests of KCS may attend the Annual Meeting. Any stockholder or stockholder’s representative who, because of a disability, may need special assistance or accommodation to allow him or her to participate in the Annual Meeting may request reasonable assistance or accommodation from us by contacting the office of the Corporate Secretary at our principal executive offices, (816) 983-1538. If written requests are made to the Corporate Secretary of KCS, they should be mailed to P.O. Box 219335, Kansas City, Missouri 64121-9335 (or by express delivery to 427 West 12th Street, Kansas City, Missouri 64105). To provide us sufficient time to arrange for reasonable assistance, please submit all requests by April 26, 2007.

 

What matters will be considered at the Annual Meeting?

 

At the Annual Meeting, stockholders will consider and vote upon: (1) the election of three directors; (2) ratification of the Audit Committee’s selection of KPMG LLP as our independent registered public accounting firm for 2007; and (3) such other matters as may properly come before the Annual Meeting or any adjournment thereof. Stockholders do not have dissenters’ rights of appraisal in connection with these proposals. These proposals have been made by the Board of Directors, and neither of them is related to or contingent upon the other. The Board of Directors knows of no other matters that will be presented or voted on at the Annual Meeting.

 

Who may vote at the Annual Meeting?

 

Only the holders of our common stock, par value $0.01 per share (the “Common Stock”), and 4% Noncumulative Preferred Stock, par value $25.00 per share (the “4% Preferred Stock”), of record at the close of business on the Record Date are entitled to notice of and to vote at the Annual Meeting. On the Record Date, we had outstanding 242,170 shares of 4% Preferred Stock (excluding 407,566 shares held in treasury) and 76,775,677 shares of Common Stock (excluding 16,087,908 shares held in treasury) for a total of 77,017,847 shares eligible to vote at the Annual Meeting.

 

How many votes does each Voting Share have?

 

The Common Stock and the 4% Preferred Stock (collectively, the “Voting Stock”) constitute our only voting securities and will vote together as a single class on all matters to be considered at the Annual Meeting. Each holder of Voting Stock is entitled to cast one vote for each share of Voting Stock held on the Record Date on all matters other than the election of directors. You may vote cumulatively for the election of directors. For this purpose, each stockholder has votes equal to the number of shares of Voting Stock held on the Record Date multiplied by the number of directors to be elected. You may cast all of your votes for a single nominee or distribute your votes among the nominees in such manner as you elect. This Proxy Statement solicits discretionary authority to vote cumulatively for the election of directors. The accompanying form of proxy or telephone or Internet vote also grants that authority.

 

How can you vote by proxy?

 

You can vote by proxy in three ways, each of which is valid under Delaware law:

 

 

How do we decide whether our stockholders have approved the proposals?

 

Stockholders owning at least a majority of the shares of Voting Stock entitled to vote must be present in person or represented by proxy to constitute a quorum for the transaction of business at the Annual Meeting. The shares of a stockholder who is present and entitled to vote at the Annual Meeting, either in person or by proxy, are counted for purposes of determining whether there is a quorum, regardless of whether the stockholder votes the shares. Abstentions and broker non-votes (defined below) are counted as present and entitled to vote for purposes of determining a quorum.

 

The directors are elected by the affirmative vote of a plurality of shares of Voting Stock present at the Annual Meeting and entitled to vote, provided a quorum exists. A plurality means receiving the largest number of votes. Where, as here, there are three director vacancies, the three nominees with the highest number of affirmative votes are elected. On any proposal other than the election of directors, the percentage of shares required to pass a proposal depends on the proposal. In most proposals, including ratification of the Audit Committee’s selection of KPMG LLP as our independent registered public accounting firm for 2007, the affirmative vote of a majority of the shares of Voting Stock present at the Annual Meeting in person or by proxy and entitled to vote on the subject matter, provided a quorum is present, is required for the adoption of the proposal.

 

Voting ceases when the chairman of the Annual Meeting closes the polls. The votes are counted and certified by three inspectors appointed by the Board of Directors in advance of the Annual Meeting. In determining whether a majority of shares have been affirmatively voted for a particular proposal, the affirmative votes for the proposal are measured against the votes for and against the proposal plus the abstentions from voting on the proposal. You may abstain from voting on any proposal other than the election of directors. Abstentions from voting are not considered as votes affirmatively cast. Abstaining will, therefore, have the effect of a vote against a proposal. With regard to the election of directors, votes may be cast in favor or withheld. Votes that are withheld will be excluded entirely from the vote and will have no effect.

 

What if you hold shares in a brokerage account?

 

The Voting Stock is traded on the New York Stock Exchange, Inc. (the “NYSE”). Under the rules of the NYSE, member stockbrokers who hold shares of Voting Stock in their name for customers are required to obtain directions from their customers on how to vote the shares. NYSE rules permit brokers to vote shares on certain proposals when they have not received any directions. The Staff of the NYSE, prior to the Annual Meeting, informs brokers of those proposals on which they are entitled to vote the undirected shares.

 

A “broker non-vote” occurs when a broker holding shares of Voting Stock for a beneficial owner does not vote on a particular proposal because the broker does not have discretionary voting authority for that proposal and has not received instructions from the beneficial owner (customer directed abstentions are not broker non-votes). Broker non-votes generally do not affect the determination of whether a quorum is present at the Annual Meeting because, in most cases, some of the shares held in the broker’s name have been voted, and, therefore, all of those shares are considered present at the Annual Meeting. Under applicable law, a broker non-vote will not be considered present and entitled to vote on non-discretionary items and will have no effect on the vote.

 

How are your shares voted if you submit a proxy?

 

If you return a properly executed proxy card or properly vote via the Internet or telephone, you are appointing the Proxy Committee to vote your shares of Voting Stock covered by the proxy. The Proxy Committee consists of the three directors of KCS whose names are listed on the proxy card. If you wish to name someone other than the Proxy Committee as your proxy, you may do so by crossing out the names of the designated proxies and inserting the name of another person. In that case, it will be necessary for you to sign the proxy card and deliver it to the person so named and for that person to be present and vote at the Annual Meeting. Proxy cards so marked should not be mailed directly to us.

 

The Proxy Committee will vote the shares of Voting Stock covered by a proxy in accordance with the instructions given by the stockholder(s) executing the proxy or authorizing the proxy and voting via the Internet or telephone. If a properly executed, or authorized, and unrevoked proxy does not specify how the shares represented thereby are to be voted, the Proxy Committee intends to vote the shares FOR the election of the persons nominated by the Board for Directors, FOR ratification of the Audit Committee’s selection of KPMG LLP as our independent registered public accounting firm for 2007, and in accordance with their discretion upon such other matters as may properly come before the Annual Meeting. The Proxy Committee reserves the right to vote such proxies cumulatively for the election of less than all of the nominees for director, but does not intend to do so unless other persons are nominated and such a vote appears necessary to ensure the election of the persons nominated by the Board.

 

May you revoke your proxy or voting instruction card?

 

At any time before the polls for the Annual Meeting are closed, if you hold Voting Stock in your name, you may revoke a properly executed or authorized proxy by (a) an Internet or telephone vote subsequent to the date shown on a previously executed and delivered proxy or the date of a prior electronic or telephonic vote, or (b) with a later-dated, properly executed and delivered proxy, or (c) a written revocation delivered to our Corporate Secretary. If you hold Voting Stock in a brokerage account, you must contact the broker and comply with the broker’s procedures if you want to revoke or change the instructions previously given to the broker. Participants in certain employee benefit plans, as discussed below, must contact the plan trustee and comply with its procedures if they wish to revoke or change their voting instructions. Attendance at the Annual Meeting will not have the effect of revoking your properly executed or authorized proxy unless you deliver a written revocation to our Corporate Secretary before your proxy is voted.

 

How do participants in our Employee Stock Ownership Plan, 401(k) and Profit Sharing Plan, and Union 401(k) Plans vote?

 

If you participate in our employee stock ownership plan (“ESOP”), 401(k) and Profit Sharing Plan (“401(k) Plan”) or union 401(k) plans (“Union Plans”) you have received a separate voting instruction card (accompanying this Proxy Statement) to instruct the trustee of the ESOP, 401(k) Plan or Union Plans how to vote the shares of Common Stock held on your behalf.¹ The trustee is required under the trust agreements to vote the shares in accordance with the instructions given on the voting instruction card.¹ If a voting instruction card is not returned by a participant, the trustee must vote those shares, as well as any unallocated shares, in the same proportions as the shares for which voting instructions were received from plan participants. Voting instructions by Internet or telephone must be given by 5:00 a.m., Central Time, on May 1, 2007. Unless you give voting instructions by Internet or telephone, the voting instruction card should be returned in the envelope provided to Corporate Election Services, P.O. Box 535450, Pittsburgh, Pennsylvania 15253-9846. The voting instruction card should not be returned to us. ESOP participants, 401(k) Plan participants and Union Plan participants who wish to revoke their voting instructions must contact the trustee and follow its procedures.

 

Are the votes of participants in the ESOP, 401(k) Plan and Union Plans confidential?

 

Under the terms of the ESOP, 401(k) Plan and Union Plans, the trustee is required to establish procedures to ensure that the instructions received from participants are held in confidence and not divulged, released or otherwise utilized in a manner that might influence the participants’ free exercise of their voting rights.

 

 

¹ Voting instructions may also be given by Internet or telephone by participants in the ESOP, the 401(k) Plan and the Union Plans. The accompanying voting instruction card relating to such plans contains the Internet address and toll-free number.

 

The following table contains information concerning the beneficial ownership of our Common Stock as of the Record Date by:

 

 

We are not aware of any beneficial owner of more than five percent of the 4% Preferred Stock. None of our directors, executive officers or the nominee for director owns any shares of 4% Preferred Stock, 4.25% Redeemable Cumulative Convertible Perpetual Preferred Stock, Series C (“Series C Preferred Stock”), or 5.125% Cumulative Convertible Perpetual Preferred Stock, Series D (“Series D Preferred Stock”). No officer, director or the nominee for director of KCS owns any equity securities of any subsidiary of KCS. Holders of our Series C Preferred Stock do not have voting rights except under certain limited circumstances or as otherwise from time to time required by law, and do not currently have the right to vote at the Annual Meeting. Holders of our Series D Preferred Stock do not have voting rights except under certain limited circumstances or as otherwise from time to time required by law, and do not currently have the right to vote at the Annual Meeting. Beneficial ownership is generally defined as either the sole or shared power to vote or dispose of the shares. Except as otherwise noted, the beneficial owners have sole power to vote and dispose of their shares. We are not aware of any arrangement which would at a subsequent date result in a change in control of KCS.

 

 

 

 

 

 

The Board of Directors of KCS is divided into three classes. The members of each class serve staggered three-year terms of office, which results in one class standing for election at each annual meeting of stockholders. The term of office for the directors elected at the Annual Meeting will expire in 2010 or when their successors are elected and qualified.

 

Three persons have been nominated by the Board of Directors, following the recommendation of the Nominating and Corporate Governance Committee, for election as directors. Two of these nominees (Ambassador Jones and Ms. Pletz) are presently directors of KCS. The third nominee (Mr. Dunn) has been nominated by the Board of Directors. All nominees have indicated they are willing and able to serve as directors if elected, and all have consented to being named as nominees in this Proxy Statement. If any nominee should become unable or unwilling to serve, the Proxy Committee intends to vote for one or more substitute nominees chosen by them in their sole discretion.

 

As explained above in “How do we decide whether our stockholders have approved the proposals?” directors are elected by the affirmative vote of a plurality of the shares of Voting Stock present at the Annual Meeting and entitled to vote on the election of directors, assuming a quorum is present.

 

 

YOUR BOARD RECOMMENDS THAT YOU VOTE
“FOR”
THE ELECTION OF THE BOARD’S NOMINEES

 

The Board of Directors met five times in 2006. The Board meets regularly to review significant developments affecting KCS and to act on matters requiring Board approval. The Board reserves certain powers and functions to itself; in addition, it has requested that the Chief Executive Officer refer certain matters to it. During 2006, all directors attended at least 75% of the aggregate of (1) the total number of meetings of the Board and (2) the total number of meetings held by all committees of the Board on which they served.

 

 

The Corporate Governance Guidelines of Kansas City Southern (the “Guidelines”) are available for review in the “Corporate Governance” section under the “Investors” tab of our website at www.kcsouthern.com. In addition, this section of our website makes available all of our corporate governance materials, including our Bylaws, board committee charters, code of business conduct and ethics and our anti-harassment and equal employment opportunity policies. Our Board of Directors regularly reviews corporate governance developments and modifies the Guidelines, committee charters, and key practices as it believes warranted. The “Investors” section of our website also includes a copy of the brochure for our Speak Up! report line in portable document format (i.e., PDF). Our Speak Up! line is a means for employees, customers, suppliers, stockholders and other interested parties to submit confidential and anonymous reports of suspected or actual actions they believe may violate our corporate policies or the law including, but not limited to, the following:

 

Our Speak Up! line is operated by an independent outside vendor 24 hours a day, seven days a week. Any employee, stockholder, or other interested party can call the following toll-free number to submit a report:

 

1-800-727-2615

 

Code of Business Conduct and Ethics

 

Our Code of Business Conduct and Ethics is applicable to all directors, officers and employees of KCS and its subsidiaries and embodies our principles and practices relating to the ethical conduct of our business and our commitment to honesty, fair dealing and compliance with applicable laws and regulations. Our Code of Business Conduct and Ethics is available in the “Corporate Governance” section under the “Investors” tab of our website at www.kcsouthern.com and in print to any stockholder who requests it.

 

Policy on Director Attendance at Annual Stockholder Meetings

 

Our directors are encouraged to attend annual stockholder meetings. All directors other than Mr. Slater serving at the time of the 2006 annual stockholder meeting attended that meeting.

 

Director Qualifications, Qualities and Skills

 

The Guidelines establish certain qualifications, qualities and skills that directors and nominees must meet to be eligible to serve on our Board of Directors. Under the Guidelines, directors and nominees must be committed to representing the long-term interests of our stockholders and meet, at a minimum, the following qualifications:

 

 

Additionally, it is considered desirable that directors and nominees possess the following qualities and skills:

 

 

Our Bylaws also provide that no one who is 72 years old shall be eligible to be nominated or to serve as a member of the Board of Directors, but any person who attains the age of 72 during the term of directorship to which he or she was elected shall be eligible to serve the remainder of that term. A. Edward Allinson, a director of KCS since 1990, attained the age of 72 during his current term as a director of KCS. Mr. Allinson will retire from the Board on the date of the Annual Meeting. Mr. Dunn has been nominated by the Board for election at the Annual Meeting to fill the vacancy created by the retirement of Mr. Allinson. Our Certificate of Incorporation and Bylaws do not have any other eligibility requirements for directors.

 

Michael G. Fitt retired from the Board on the date of our 2006 annual meeting of stockholders. Following Mr. Fitt’s retirement, the directors remaining in office appointed Mr. Shoener to the Board on June 13, 2006, in the class of directors serving until the annual meeting of stockholders in 2008.

 

Non-Management Director Independence

 

The Guidelines require that a majority of the Board of Directors must be independent, as determined affirmatively by the Board in accordance with the listing standards of the NYSE, although our goal is to have two-

thirds of the members of the Board meet these requirements. We refer to directors who do not serve as executive officers of KCS or any of its subsidiaries as the “Non-Management Directors.” The Non-Management Directors constitute a majority of our Board of Directors. Our Board has affirmatively determined that Mr. Dunn and each Non-Management Director, other than Ambassador Jones, are independent in accordance with applicable NYSE listing standards (see “Insider Disclosures-Certain Relationships and Related Transactions”). In determining the independence of Mr. Dunn and each Non-Management Director, the Board of Directors applied categorical standards of independence contained in the Guidelines and applicable NYSE listing standards. These standards assist the Board in determining that a director or nominee has no material relationship with KCS, either directly or as a partner, shareholder or officer of an organization that has a relationship with KCS. Under the standards, to be considered independent, a member of the Board may not:

 

 

Executive Sessions

 

Our Non-Management Directors meet regularly in executive session without management. Thomas A. McDonnell (the “Presiding Director”) serves as Presiding Director in such sessions.

 

Stockholder/Interested Person Communication with the Board

 

Any stockholder or interested person may communicate with the Non-Management Directors or the Presiding Director by sending such communication in writing to the office of the Corporate Secretary, Kansas City Southern, P.O. Box 219335, Kansas City, Missouri, 64121-9335, or by express carrier to the Corporate Secretary, Kansas City Southern, 427 West 12th Street, Kansas City, Missouri 64105. In its capacity as the agent for the Non-Management

Directors and Presiding Director, the office of the Corporate Secretary may review, sort and summarize the communications and, in accordance with the directions provided by and procedures established by the Non-Management Directors, forward such communications to the Non-Management Directors and the Presiding Director, as appropriate. The Non-Management Directors or the Presiding Director shall review such communication with the Board, or the group addressed in the communication, for the purpose of determining an appropriate response and any appropriate action that should be taken. Any communications received may be shared with management on the instruction of the Non-Management Directors or the Presiding Director.

 

The Board of Directors has established an Executive Committee, an Audit Committee, a Finance Committee, a Compensation and Organization Committee (referred to in this Proxy Statement as the “Compensation Committee”), and a Nominating and Corporate Governance Committee (referred to in this Proxy Statement as the “Nominating Committee”). Committee members are elected at the Board’s annual meeting immediately following our annual meeting of stockholders. Mr. Allinson’s successors for the committees on which he serves will be elected at this meeting.

 

The following number of committee meetings were held during 2006:

 

 

 

 

The Executive Committee

 

The Executive Committee consists of our Chairman and Chief Executive Officer, and two Non-Management Directors elected by the Board to serve one-year terms. The current members of the Executive Committee are Mr. McDonnell (Chairman), Mr. Allinson and Mr. Haverty. When the Board is not in session, the Executive Committee has all the powers of the Board in all cases in which specific directions have not been given by the Board.

 

The Audit Committee

 

The Audit Committee consists of three Non-Management Directors elected by the Board, taking into consideration the recommendations of the Nominating Committee, to serve staggered three-year terms. The current members of the Audit Committee are Mr. Druten (Chairman), Mr. McDonnell and Ms. Pletz. The members of the Audit Committee are independent (as defined in the NYSE’s listing standards) and meet the additional independence standards in Rule 10A-3 of the Securities and Exchange Commission (“SEC”). In determining independence, the Board of Directors concluded that each member of the Audit Committee has no material relationship with KCS under the standards set forth in the Guidelines.

 

The Audit Committee’s duties and responsibilities include the following: (a) appoint and pre-approve the fees of our independent registered public accounting firm and pre-approve fees for other non-audit services provided by our independent registered public accounting firm; (b) monitor the integrity of our financial reporting process and systems of internal controls; (c) monitor the independence, qualifications and performance of our independent registered public accounting firm and internal audit department; (d) provide an avenue of communication among the independent registered public accounting firm, management, the internal audit department and the Board of Directors; (e) monitor compliance with legal and regulatory requirements; (f) review areas of potential significant financial risk to the Company; (g) prepare the report included in our annual meeting Proxy Statement; and (h) review

with management and the independent registered public accounting firm our annual audited financial statements and quarterly financial statements.

 

The Guidelines do not limit the number of public company audit committees on which the members of our Audit Committee may serve. However, for any director to simultaneously serve on our Audit Committee and the audit committees of more than three other public companies, the Board must affirmatively determine that such simultaneous service will not impair the director’s ability to effectively serve on our Audit Committee. The Board of Directors has affirmatively determined that Mr. McDonnell’s simultaneous service on more than three public company audit committees (including ours) will not impair his ability to effectively serve on our Audit Committee.

 

The Board of Directors has adopted a written charter for the Audit Committee, a copy of which is available in the “Corporate Governance” section under the “Investors” tab of our website at www.kcsouthern.com.

 

The Board has determined that Robert J. Druten and Thomas A. McDonnell are “audit committee financial experts” as that term is defined in applicable securities regulations. The Board determined that Mr. Druten qualifies as an audit committee financial expert based upon his prior experience as Executive Vice President and Chief Financial Officer of Hallmark Cards, Inc. and previously at Crown Media, Inc., as well as his prior experience as a certified public accountant with Arthur Young & Co. The Board of Directors determined that Mr. McDonnell qualifies as an audit committee financial expert based upon his experience as the Chief Executive Officer of DST, his accounting and financial education, his experience actively supervising others performing accounting or auditing functions, and his past and current memberships on audit committees of other public companies.

 

The Audit Committee’s report is provided below.

 

The Finance Committee

 

The Finance Committee consists of three Non-Management Directors elected by the Board, taking into consideration the recommendations of the Nominating Committee, to serve one year terms. The current members of the Finance Committee are Mr. Druten (Chairman), Mr. McDonnell and Ambassador Jones. The Finance Committee has the following duties and responsibilities: (a) review and approve financial transactions exceeding $25 million, but not exceeding $100 million, including, but not limited to, the filing of registration statements, issuance of debt or equity securities, and entrance into new credit facilities, leases and other forms of financing; (b) at the request of the Board, review and approve the terms and conditions of financial transactions exceeding $100 million for which the Board has given prior general approval; (c) review management’s financing plans and reports and make recommendations to the Board with respect to any matter affecting our financing plans and capital structure; and (d) review such other matters within the scope of its responsibilities as the Committee determines from time to time, and make such recommendations to the Board with respect thereto as the Committee deems appropriate. In addition to the foregoing, the Committee shall have such other powers and duties as may be delegated to it from time to time by the Board with respect to a particular financial transaction or type of financial transaction.

 

The Board of Directors has adopted a written charter for the Finance Committee, a copy of which is available in the “Corporate Governance” section under the “Investors” tab of our website at www.kcsouthern.com.

 

The Compensation Committee

 

The Compensation Committee consists of three Non-Management Directors elected by the Board, taking into consideration the recommendations of the Nominating Committee, to serve one year terms. The current members of the Compensation Committee are Mr. Allinson (Chairman), Ms. Pletz and Mr. Slater. Each member of the Compensation Committee is independent (as defined in the NYSE’s listing standards), is considered an outside director under Section 162(m) of the Internal Revenue Code of 1986, as amended (the “Code”), and is considered a non-employee director under Rule 16b-3 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

 

The Compensation Committee’s duties and responsibilities include the following: (a) review and approve guidelines for base, annual incentive and long-term compensation programs for management employees of KCS and, as prescribed by resolution of the Board, subsidiaries, consistent with the compensation philosophy of the

Compensation Committee; (b) review and approve corporate goals and objectives relevant to the compensation of our Chief Executive Officer (“CEO”), evaluate and review with our CEO his performance in light of those goals and objectives, and set our CEO’s compensation level based on that evaluation; (c) review and approve our CEO’s recommendations concerning the compensation of other senior management of KCS; (d) in consultation with our CEO, Chief Financial Officer (“CFO”), and personnel officers and, if deemed appropriate by the Chairperson of the Compensation Committee, an independent outside consultant, review and recommend to the Board the compensation of directors, including equity awards, fees and benefits; (e) establish and communicate to senior management the Board’s expectations concerning KCS stock ownership, with the goal of promoting long-term ownership of our stock and aligning the interests of senior management with our stockholders; (f) review and make recommendations to the Board with respect to non-CEO compensation, incentive compensation plans and equity-based plans; (g) administer the compensation plans of KCS and certain subsidiaries for which the Compensation Committee has been granted administrative responsibility in accordance with the terms of those plans, including, as applicable, approving all stock option and restricted stock grants and pools, establishing performance goals and targets under incentive plans, and determining whether or not those goals have been attained (the Compensation Committee has the authority to delegate that responsibility in accordance with the terms of the applicable plan); (h) review succession planning for key officers of KCS and subsidiaries; (i) review and approve our compensation disclosures with the SEC and other regulatory filings, including the disclosure of executive compensation in our annual Proxy Statement; (j) retain and terminate any compensation consultant used to assist in evaluating the compensation of directors, our CEO or executive officers, including the sole authority to select the consultant and to approve its fees and other material engagement terms; (k) obtain advice and assistance from internal or external legal, accounting or other advisors as required for the performance of its duties; (1) monitor compliance with legal prohibitions on loans to directors and executive officers of KCS; (m) annually participate in a self-assessment of its performance and, in conjunction with the Nominating Committee, undertake an annual evaluation of the qualifications of the members of the Compensation Committee; (n) prepare the report included in our annual meeting Proxy Statement; and (o) perform such other duties and exercise such other powers as directed by resolution of the Board not inconsistent with the Compensation Committee charter or as required by applicable laws, rules, regulations and NYSE listing standards.

 

The Board of Directors has adopted a written charter for the Compensation Committee, a copy of which is available in the “Corporate Governance” section under the “Investors” tab of our website at www.kcsouthern.com.

 

The Compensation Committee’s report is provided below.

 

Compensation Committee Processes and Procedures

 

Executive Compensation Practices

 

The Compensation Committee follows the processes and procedures established in its charter with respect to the determination of executive compensation.

 

The Compensation Committee has sole authority to set the compensation of our CEO and other executive officers, and to recommend for Board approval the compensation provided to our Non-Management Directors. The Compensation Committee does not share this authority with, or delegate this authority to, any other person. The Compensation Committee recommends each component of Non-Management Director compensation to our Board. The Compensation Committee assists the Board in fulfilling its responsibility to maximize long-term stockholder value by ensuring that officers, directors and employees are compensated in accordance with our compensation philosophy, objectives and policies; competitive practice; and the requirements of applicable laws, rules and regulations.

 

In fulfilling its responsibilities, the Compensation Committee has direct access to our officers and employees and consults with our CEO, our CFO, our personnel officers and other members of senior management as the Chairperson of the Committee deems necessary.

 

The Compensation Committee reviews executive officer compensation on an annual basis. For each review, the Compensation Committee may consider, and decide the weight it will give to, the following factors:

 

 

NYSE listing standards require the Compensation Committee, in determining the long-term incentive component of our CEO’s compensation, to consider:

 

 

The Compensation Committee may retain at the Company’s expense a compensation consultant to advise the Committee on executive compensation practices and trends. The Committee selects, engages and instructs the consultant. The Compensation Committee engaged Towers Perrin, an independent compensation consultant, to advise the Committee on its executive compensation policies and assist the Committee in making executive compensation decisions in 2006 and 2007. Towers Perrin was engaged directly by the Compensation Committee and reports to the Compensation Committee.

 

As part of its processes and procedures, the Compensation Committee used tally sheets in setting the compensation of our most highly compensated executive officers. The Committee also used benchmark analyses of compensation provided by a peer group of companies selected by the Compensation Committee with the assistance of Towers Perrin.

 

The Compensation Committee may request that management recommend compensation package components, discuss hiring and retention concerns and personnel requirements, and provide information with respect to such matters as executive, Company and business unit performance; market analysis; benefit plan terms and conditions; financial, accounting and tax considerations; legal requirements; and value of outstanding awards. The Compensation Committee may rely on our CEO and other executives for these purposes.

 

The Compensation Committee develops the criteria for evaluating the performance of our CEO and privately reviews his performance against these criteria on at least an annual basis. The CEO periodically discusses the performance of other executive officers with the Compensation Committee. The Committee may review human resources and business unit records. The Compensation Committee may discuss with the Audit Committee the executive officers’ compliance with our Code of Ethics.

 

Non-Management Director Compensation Practices

 

The Compensation Committee recommends each component of Non-Management Director compensation to the Board. The Committee seeks to recommend competitive compensation packages that include both short-term

cash and long-term stock components. The Board of Directors does not delegate its authority for determining Non-Management Director compensation to any other person.

 

In recommending Non-Management Director compensation, the Compensation Committee may consider, and determine the weight it will give to, any combination of the following:

 

 

The Compensation Committee may retain at the Company’s expense a compensation consultant to advise the Committee on director compensation practices and trends. The Compensation Committee engaged Towers Perrin for this purpose in 2006 and 2007.

 

Compensation Committee Interlocks and Insider Participation

 

During 2006:

 

 

The Nominating Committee

 

The Nominating Committee consists of three Non-Management Directors elected by the Board to serve staggered three year terms. The current members of the Nominating Committee are Mr. Slater (Chairman), Mr. Allinson and Ms. Pletz. The members of the Nominating Committee are independent (as defined in the NYSE’s listing standards). The Nominating Committee recommends to the Board of Directors suitable nominees for election to the Board or to fill newly created directorships or vacancies on the Board. The Nominating Committee’s duties and responsibilities include the following: (a) ensure that (i) the Board has the benefit of qualified and experienced directors who meet the requirements of applicable laws, rules and regulations and the criteria established in the Committee’s charter, (ii) the Company maintains appropriate corporate governance practices and procedures, and (iii) the performance of the Board, committees of the Board and management is periodically evaluated; (b) adopt and apply criteria for the selection of director nominees; (c) establish and publish on our website a policy concerning the treatment of shareholder-recommended nominees to the Board; (d) develop and implement a procedure to annually evaluate the performance of the Board and its committees and compliance with corporate governance procedures of KCS; (e) establish and maintain an orientation program for new directors and a continuing education program for all directors; (f) annually review and reassess the adequacy of the Nominating Committee’s charter and recommend any proposed changes to the Board for approval; (g) make recommendations to the Board with respect to the selection of Board committee members; and (h) perform any other activities

consistent with its charter, our Bylaws and governing law as the Nominating Committee or the Board of Directors deems appropriate.

 

The Nominating Committee has the authority to obtain advice and seek assistance from internal or external legal, accounting or other advisors, and has the sole authority to retain and terminate any search firm used to identify director candidates, including sole authority to approve such firm’s fees and other engagement terms.

 

The Board of Directors has adopted a written charter for the Nominating Committee, a copy of which is available in the “Corporate Governance” section under the “Investors” tab of our website at www.kcsouthern.com.

 

The Nominating Committee generally will consider director nominees recommended by stockholders. Nominees recommended by stockholders in compliance with our Bylaws will be evaluated on the same basis as other nominees considered by the Nominating Committee. Stockholders should see “Stockholder Proposals” below for information relating to the submission by stockholders of nominees and matters for consideration at a meeting of our stockholders.

 

Certain Relationships and Related Transactions

 

On September 29, 2000, we entered into an agreement with the law firm of Manatt, Phelps & Phillips, of which Ambassador Jones is Senior Counsel. The agreement expired on October 31, 2004, but has been extended on a month-to-month basis since that date. Under the agreement, Manatt, Phelps & Phillips, Manatt Jones Global Strategies, a wholly-owned subsidiary of Manatt, Phelps & Phillips, and/or Ambassador Jones have provided us with advice and assistance on issues and transactions in Mexico and other international venues. As compensation for these services, we have paid Manatt, Phelps & Phillips or Manatt Jones Global Strategies, as applicable, approximately $10,000 per month. Ambassador Jones receives a salary from his law firm for his services as Senior Counsel and serves as Co-Chairman and CEO of Manatt Jones Global Strategies. The fees paid by us did not exceed 5% of either firm’s gross revenues for its last full fiscal year.

 

On March 30, 2001, at our request, Mr. Allinson entered into an Agreement to Forego Compensation pursuant to which he agreed to forego all of the balance payable to him under his retirement plan account in the KCS Directors’ Retirement Plan. As part of that transaction, we made a loan in the amount of $523,662 (the amount of compensation foregone by Mr. Allinson) to The A. Edward Allinson Irrevocable Trust, Courtney Ann Arnot, A. Edward Allinson III and Bradford J. Allinson, Trustees (the “Allinson Trust”) with interest at the rate of 5.49% per annum, compounded semi-annually, and with the principal amount used by the Allinson Trust to pay the premium on a life insurance policy on the life of Mr. Allinson. The Allinson Trust is designated as beneficiary to receive the policy death benefit or any benefit paid at policy maturity. The entire principal sum of the note plus accrued interest thereon is due and payable within 90 days following the death of Mr. Allinson (or immediately due and payable upon the occurrence of certain specific events). Under the terms of the note, the Allinson Trust may elect to reset the interest rate in accordance with the Applicable Federal Rate established under Section 7872(f)(2)(A) of the Code in effect on the reset date. Only one reset of the interest rate is allowed. The loan was made prior to the enactment of the Sarbanes-Oxley Act of 2002 and no reset of the interest rate has occurred. The trustees and beneficiaries of the Allinson Trust are members of Mr. Allinson’s immediate family.

 

On March 30, 2001, at our request, Mr. Fitt entered into an Agreement to Forego Compensation pursuant to which he agreed to forego all of the balance payable to him under his retirement plan account in the KCS Directors’ Retirement Plan. As part of that transaction, we made a loan in the amount of $975,346 (the amount of compensation foregone by Mr. Fitt) to The Michael G. Fitt and Doreen E. Fitt Irrevocable Insurance Trust, Ann E. Skye, Colin M.D. Fitt and Ian D.G. Fitt, Trustees (the “Fitt Trust”), with interest at the rate of 5.49% per annum, compounded semi-annually, and with the principal amount used by the Fitt Trust to pay the premium on a life insurance policy on the lives of Mr. Fitt and his wife. The Fitt Trust is designated as beneficiary to receive the policy death benefit or any benefit paid at policy maturity. The entire principal sum of the note plus accrued interest thereon is due and payable within 90 days following the death of the last survivor of Mr. Fitt and his wife (or immediately due and payable upon the occurrence of any of certain specified events). Under the terms of the note,

the Fitt Trust may elect to reset the interest rate in accordance with the Applicable Federal Rate established under Section 7872(f)(2)(A) of the Code in effect on the reset date. Only one reset of the interest rate is allowed. The loan was made prior to the passage of the Sarbanes-Oxley Act of 2002. The trustees and beneficiaries of the Fitt Trust are members of Mr. Fitt’s immediate family.

 

A 50% owned affiliate of a wholly-owned subsidiary of DST leases to KCSR the headquarters building occupied by KCS and KCSR, and leases to a subsidiary of KCSR a floor in another building. Thomas A. McDonnell is the President, Chief Executive Officer and a director of DST and Chairman of the Board of Directors of the DST subsidiary. Rent and expenses paid by KCSR under these leases aggregated approximately $3.5 million in 2006. DST’s indirect 50% interest in those lease payments amounted to less than 1% of DST’s consolidated gross revenues in 2006. The leases expire in 2019. The aggregate rentals payable under the leases from January 1, 2006 until the end of the lease terms total approximately $34.0 million. Mr. McDonnell does not receive any salary from the DST subsidiary or affiliate, owns no stock in either entity, owns less than 1% of the outstanding common stock of DST, and receives no direct financial benefit from these lease payments.

 

Related Person Transaction Policies and Procedures

 

The Board of Directors is empowered to review, approve and ratify any transactions between KCS and any of our officers or directors or their affiliates or immediate family members (referred to in this Proxy Statement as “Related Persons”). The Board reviews responses to annual director and officer questionnaires to determine whether any Related Person has, or has had, a direct or indirect material interest in any transaction with KCS or its subsidiaries, other than the receipt of ordinary director or officer compensation. For any such transaction, the Board may consider whether the Related Person serves on a committee of the Board and, if so, whether that service is appropriate in light of the committee’s charter, the Guidelines and NYSE listing standards. The Board may decide whether to ratify the transaction considering such matters as the significance of the transaction to us, the best interest of our stockholders, the materiality of the transaction to us and the Related Person, and whether the transaction is likely to affect the judgments made by the affected officer or director on behalf of the Company.

 

This section describes the compensation paid to our Non-Management Directors. Michael R. Haverty, our Chairman and CEO, and Arthur L. Shoener, our President and Chief Operating Officer, serve on our Board of Directors but are not paid any compensation for their service on the Board. Their compensation is described in the Summary Compensation Table.

 

Director Fees

 

The following fees are paid to our Non-Management Directors:

 

Annual Retainers for Board and Committee Membership

 

Fees per Meeting Attended

 

 

We also reimburse directors for their expenses in attending Board and committee meetings.

 

Restricted Stock Awards

 

Each Non-Management Director is awarded 5,000 shares of restricted Common Stock each year immediately following the annual meeting of stockholders. Newly appointed Non-Management Directors are awarded 10,000 shares of restricted Common Stock upon their appointment to the Board. The Non-Management Directors may also be granted awards of restricted Common Stock and performance shares under our 1991 Amended and Restated Stock Option and Performance Award Plan (the “1991 Plan”), as determined by the Compensation Committee. Restricted shares awarded to Non-Management Directors vest upon the earlier of (a) one year from the date of grant or (b) the day prior to the next annual meeting of stockholders. The restricted shares are forfeited if there is a termination of affiliation for any reason other than death, disability or change of control. The restricted shares vest upon termination due to death, disability or change of control.

 

Director Stock Ownership Guidelines

 

The Board has adopted stock ownership guidelines for Non-Management Directors. These guidelines provide that each Non-Management Director is required to beneficially own at least 20,000 shares of our Common Stock within five years from the later of May 4, 2005 or the date on which the Non-Management Director first joined the Board. Restricted stock granted to a Non-Management Director will count toward this requirement.

 

Directors’ Deferred Fee Plan

 

Non-Management Directors are permitted to defer receipt of directors’ fees under an unfunded Directors’ Deferred Fee Plan (which we refer to as the “Deferred Fee Plan”) adopted by the Board of Directors. Earnings for time periods prior to June 1, 2002 accrue interest on deferred fees from the date the fees are credited to the director’s account, and on the earnings on deferred fees from the date the earnings are credited to the account. The rate of earnings is determined annually and is one percentage point less than the prime rate in effect at Chemical Bank on the last day of the calendar year. A director may request that the rate of earnings be determined pursuant to a formula based on the performance of certain mutual funds advised by Janus Capital Management LLC; however, the plan administrator is not obligated to follow such request and may at its sole discretion continue to determine earnings by reference to the prime rate of Chemical Bank. Earnings on the amount credited to a director’s account as of May 31, 2002, earnings on deferred fees and earnings credited to the director’s account on and after June 1, 2002, are determined by the hypothetical “investment” of deferred fees based on the director’s election among investment options designated by us from time to time for the Deferred Fee Plan. An underlying investment rate determined from time to time by the Board (currently the rate on U.S. Treasury securities with a maturity of 10 years plus one percentage point, adjusted annually on July 1) is used to credit with interest any part of a director’s account for which a mutual fund has not been designated as the hypothetical “investment.” A director’s account value will be paid after the director ceases to be a director of KCS. Amounts deferred prior to January 1, 2005, including related earnings, will be distributed either in annual installments over a 10-year period or in a lump sum, whichever the Board decides in its sole discretion. Amounts deferred after December 31, 2004, including related earnings, will be paid either in installments or a lump sum, as elected by the director. Distributions under the plan are allowed prior to cessation as a director in certain instances as approved by the Board. The Board may designate a plan administrator, but in the absence of such designation, the Secretary of KCS will administer the plan.

 

The following table shows the balance in each Non-Management Director’s account in the Deferred Fee Plan as of December 31, 2006.

 

 

 

 

2006 Compensation

 

The following table shows the compensation paid to our Non-Management Directors in 2006.

 

DIRECTOR COMPENSATION

 

 

 

 

 

 

 

 

 

 

 

 

In accordance with the Audit Committee’s written charter duly adopted by the Board of Directors, we have reviewed and discussed with management the Company’s audited financial statements as of and for the year ended December 31, 2006.

 

Management is responsible for the Company’s internal controls and the financial reporting process. KPMG LLP, the Company’s independent registered public accounting firm, is responsible for performing an independent audit of the Company’s consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board and to issue a report thereon. Our responsibility is to monitor and oversee these processes on behalf of the Board of Directors.

 

We have discussed with the independent registered public accounting firm the matters required to be discussed by Statement on Auditing Standards No. 61, Communication with Audit Committees.

 

We discussed with the Company’s independent registered public accounting firm the overall scope and plans for their audit. We met with the independent registered public accounting firm, with and without management present, to discuss the results of their examinations, their evaluations of the Company’s internal controls, and the overall quality of the Company’s financial reporting.

 

We have received and reviewed the written disclosures and the letter from the independent registered public accounting firm required by Independence Standard No. 1, Independence Discussions with Audit Committees, and have discussed with the registered public accounting firm its independence from management.

 

Based on the reviews and discussions referred to above, we recommended to the Board of Directors that the financial statements referred to above be included in the Company’s annual report on Form 10-K for the year ended December 31, 2006 for filing with the SEC.

 

The Audit Committee

 

Robert J. Druten, Chairperson

Thomas A. McDonnell

Karen L. Pletz

 

This Audit Committee Report is not deemed “soliciting material”
and is not deemed filed with the SEC or subject to Regulation 14A
or the liabilities under Section 18 of the Exchange Act.

 

Engagement

 

KPMG LLP (“KPMG”) served as our independent registered public accounting firm for the year ended December 31, 2006. KPMG performed professional services in connection with the audit of our consolidated financial statements and the review of reports we filed with the SEC under the Exchange Act, registration statements we filed with the SEC under the Securities Act of 1933, as amended (the “Securities Act”), and private offering documents. KPMG also reviewed management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006 and issued an attestation report on that review.

 

Independent Registered Public Accounting Firm Fees

 

The following table lists the aggregate fees billed to us by KPMG for the fiscal years ended December 31, 2005 and 2006:

 

 

 

 

Pre-Approved Policy

 

The Audit Committee must pre-approve the engagement of the independent registered public accounting firm to audit our consolidated financial statements.

 

The Audit Committee’s pre-approval policies and procedures, as described in its charter, provide that the Audit Committee will approve all fees for audit and non-audit services prior to engagement. Fees that are reasonably expected to fall below $100,000 may be approved by the Chairperson of the Audit Committee. Fees that are reasonably expected to equal or exceed $100,000 must be approved by the Audit Committee.

 

The Audit Committee pre-approved all services provided by KPMG for 2006.

 

Selection of KPMG as our Independent Registered Public Accounting Firm for 2007

 

The Audit Committee has selected KPMG as our independent registered public accounting firm to audit our 2007 consolidated financial statements.

 

On July 26, 2005, KCSM and Grupo KCSM dismissed PricewaterhouseCoopers (“PwC”) as principal accountant to audit their financial statements. On the same date, KCSM and Grupo KCSM engaged KPMG Cárdenas Dosal, S.C. as the principal accountant to audit the financial statements of KCSM and Grupo KCSM. PwC has continued and will continue to perform services on behalf of KCSM and Grupo KCSM, but such services will not involve auditing financial statements covering periods subsequent to December 31, 2004.

 

PwC’s report on the financial statements of each of KCSM and Grupo KCSM for the fiscal years ended December 31, 2004 and 2003 did not contain an adverse opinion or a disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope or accounting principles. Each of the audit committee of KCSM and the

board of directors of Grupo KCSM approved the change in principal accountant to audit the respective financial statements of KCSM and Grupo KCSM.

 

During the two fiscal years ended December 31, 2004, there were no disagreements between PwC and either of KCSM or Grupo KCSM on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures which, if not resolved to the satisfaction of PwC, would have caused it to make a reference to the subject matter of any such disagreement in this proxy statement. No reportable events, as defined in Item 304(a)(1)(v) of Regulation S-K, occurred within the fiscal year ended December 31, 2004 for KCSM or Grupo KCSM.

SELECTION OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Audit Committee has selected KPMG as our independent registered public accounting firm to audit our 2007 consolidated financial statements and provide an attestation report on management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2007. KPMG served as our independent registered public accounting firm in 2006. No relationship exists between KCS and KPMG other than that of client and independent registered public accounting firm. We are seeking our stockholders’ ratification of the Audit Committee’s selection of our independent registered public accounting firm even though we are not legally required to do so. If our stockholders ratify the Audit Committee’s selection, the Audit Committee nonetheless may, in its discretion, retain another independent registered public accounting firm at any time during the year if the Audit Committee feels that such change would be in the best interest of KCS and its stockholders. Alternatively, if this proposal is not approved by stockholders, the Audit Committee may re-evaluate its decision. One or more representatives of KPMG are expected to be present at the Annual Meeting and will have the opportunity, if desired, to make a statement and are expected to be available to respond to appropriate questions from stockholders. As explained above in “How do we decide whether our stockholders have approved the proposals?” approval of this proposal requires the affirmative vote of a majority of the shares of Voting Stock present at the Annual Meeting that are entitled to vote on the proposal, assuming a quorum is present.

 

YOUR BOARD RECOMMENDS THAT YOU VOTE
“FOR”
RATIFICATION OF THE AUDIT COMMITTEE’S
SELECTION OF KPMG LLP

 

The Compensation Committee has received and discussed with management the disclosures contained in “Compensation Discussion and Analysis” in this Proxy Statement. Based on that review and analysis, we recommended to the Board of Directors that the Compensation Discussion and Analysis section be included in this Proxy Statement.

 

The Compensation Committee

 

A. Edward Allinson, Chairperson

Karen L. Pletz

Rodney E. Slater

 

This Compensation Committee Report is not deemed “soliciting material”
and is not deemed filed with the SEC or subject to Regulation 14A
or the liabilities under Section 18 of the Exchange Act.

 

 

Introduction

 

The Compensation Committee is responsible for establishing our executive compensation policies and overseeing our executive compensation practices. The Compensation Committee is comprised solely of Non-Management Directors, all of whom meet the independence requirements of the NYSE.

 

For assistance in fulfilling its responsibilities, the Compensation Committee retained Towers Perrin, an independent consulting firm. Towers Perrin is engaged by and reports to the Compensation Committee. Towers Perrin’s primary role is to work with the Compensation Committee and management to develop recommendations related to various aspects of executive rewards.

 

The creation of stockholder value is the most important responsibility of our Board of Directors and executive officers. With our acquisition of the controlling interest in KCSM on April 1, 2005, we now own and operate a coordinated end-to-end railway linking vital commercial and industrial centers in the United States and Mexico. We believe we are well-positioned to operate a rapidly growing, highly profitable, long-haul, cross-border railway network. To achieve this goal, our executives will be required to execute consistently, efficiently, and well. Our Compensation Committee believes our compensation practices and programs are appropriately designed to incent our executives to meet this goal and to hold them accountable for our performance, with the ultimate objective of promoting long-term stockholder value and the strength and leadership position of our Company.

 

Philosophy

 

The Compensation Committee has adopted an executive compensation philosophy consisting of the following elements:

 

Market competitive positioning

 

Role of incentive compensation

 

 

Primary comparative market

We periodically perform benchmarking analyses of our executives’ base salaries, annual incentive compensation, and long-term incentive compensation. In connection with these analyses, we have defined our primary competitive market as transportation and mature, capital-intensive companies with annual revenues of less than $3 billion that participate in Towers Perrin’s Executive Compensation Database. Most recently, this group was comprised of the following companies:

 

 

The Compensation Committee believes our executive compensation philosophy will achieve the following objectives:

 

 

Elements Of Compensation

 

The primary elements of our 2006 executive officer compensation package are described below.

 

 

Detail regarding these elements, as well as other components and considerations of our executive compensation strategy, are described below.

Compensation Determination and Implementation

 

Pay packages for the top executives are recommended by our CEO to the Compensation Committee early each year. The CEO and the Compensation Committee consider competitive market data on salaries, target annual incentives and long-term incentives, as well as internal equity and each executive’s individual responsibility, experience, and overall performance. The Compensation Committee does not give any specific weighting to any of these factors. The Compensation Committee reserves the right to materially change compensation for situations such as a material change in an executive’s responsibilities. The amount of compensation realized or potentially realizable by our executives does not directly impact the level at which future pay opportunities are set or the programs in which they participate.

 

The targeted total direct compensation levels for our executives are, generally, somewhat below the median of observed market practices as determined by compensation surveys. The Compensation Committee’s intent is to transition, on average, to market median levels for total direct compensation by 2007.

 

Each year, management provides recommended base salary adjustments and equity award grants for the Named Executive Officers to the Compensation Committee. The grant date for all equity awards is the date on which the Compensation Committee approves the grant or the date on which the grant is ratified by the Board of Directors.

 

Special one-time equity awards, generally in the form of stock options and/or restricted stock, are granted to newly-hired executives and executives receiving promotions. The grant date for these awards is the later of the Compensation Committee approval date or the new hire’s start date or executive’s promotion date, as applicable. The number of options granted to newly-hired or promoted executives are recommended by management and set by the Compensation Committee.

 

We do not time stock option grants or other equity awards to our executives with the release of material non-public information.

 

Base Salary

 

Named Executive Officers are paid a base salary to provide a basic level of regular income for services rendered during the year. The Compensation Committee determines the level of base salaries for the Named Executive Officers and other senior executives for whom the Compensation Committee has responsibility. The Compensation Committee generally targets the 50th percentile of the primary comparative market in setting base salary levels. Actual executive salaries vary from this targeted positioning based on individual contribution and performance, level of responsibility, experience, our performance, and internal equity considerations. The Compensation Committee does not give specific weightings to any of these factors.

 

Annual Incentive Awards

 

The Compensation Committee utilized an annual cash incentive program (the “AIP”) for 2006 with bonus amounts based on Company-wide and/or business unit financial performance goals and, in some cases, individual performance goals. The Company and business unit financial goals were operating income (70% weight) and cash flow (30% weight). In order for any awards to be earned under the AIP (for either financial or individual performance), our operating income and cash flow must at least equal the specified threshold performance goals. The Compensation Committee has the discretion to modify the award amounts based on any criteria it determines, including, but not limited to, factors tied to the success of the Company or any of its business units.

 

The table below shows the threshold, target and maximum goals for the Named Executive Officers for 2006.

 

For the year ended December 31, 2006, our operating income (after general and administrative expenses) was approximately $304 million, and our consolidated cash flow was approximately $58 million.

 

Awards made to Named Executive Officers under the AIP for performance in 2006 are reflected in the Non-Equity Incentive Plan Compensation column in the Summary Compensation Table.

 

If our financial results are restated after the payment of incentive awards to executives, the Compensation Committee will review any repayment actions to be taken on a case-by-case basis.

 

Each year, the Compensation Committee will determine whether an annual cash incentive program will be adopted for that year and will establish participation, award opportunities and corresponding performance measures and goals.

 

Long-Term Incentives

 

1991 Amended and Restated Stock Option and Performance Award Plan (the “1991 Plan”).  The purpose of the 1991 Plan is to allow employees, directors and consultants of KCS and its subsidiaries to acquire or increase equity ownership in the Company. The 1991 Plan provides for the award of stock options (including incentive stock options), restricted shares, bonus shares, stock appreciation rights (“SARs”), limited stock appreciation rights (“LSARs”), performance units and/or performance shares to officers, directors and employees. Awards under the 1991 Plan are made in the discretion of the Compensation Committee, which is empowered to determine the terms and conditions of each award. Specific awards may be granted singly or in combination with other awards. The stock options and restricted share awards described in the Director Compensation Table and Summary Compensation Table were awarded under the 1991 Plan.

 

Long-Term Incentive Grants.  The Compensation Committee’s strategy is to emphasize stock-based incentives as a portion of our executives’ total compensation package. Prior to 2005, long-term incentive award opportunities were delivered primarily through stock options. In 2005, based upon the Compensation Committee’s consideration of the unique challenges resulting from our acquisition of KCSM, we began providing long-term incentive opportunities to executives primarily through restricted stock grants. For 2006, the total number of shares of restricted stock granted was based on consideration of each individual’s targeted total direct compensation (salary, target annual incentive and long-term incentive award opportunities). The restricted stock “cliff” vests after five years, providing what we believe is a strong retention incentive to our executive team and facilitating a long-term stock ownership commitment.

 

The Compensation Committee awarded stock options to Messrs. Ottensmeyer and Avramovich as new hire grants in 2006.

 

The Compensation Committee intends to periodically review the grant strategy to ensure that the long-term incentive awards granted balance the objectives of increasing stockholder value, motivating and retaining key executives and facilitating stock ownership in a cost effective manner. The Committee adopted a new long-term incentive program in 2007 (see “2007-2009 Executive Long-Term Incentive Program” below).

 

Perquisites

 

Minimal perquisites are provided to the Named Executive Officers. Specifically, we pay country club initiation fees (with monthly dues paid by the executive) and provide an annual physical exam through our medical plan. In addition, all employees are given the opportunity to use our stadium suites to the extent the suites are not being used for business purposes. Also, spouses of our executives may at times travel with the executives on chartered or commercial flights to the extent the spouse’s presence is requested for a business event. Executives may also use the services of their administrative assistants for limited personal matters. Our charitable matching gift program may also be considered a perquisite. The Compensation Committee does not plan to materially increase the perquisites currently provided.

 

Benefits

 

KCS 401(k) and Profit Sharing Plan (the “401(k) Plan”).  Our 401(k) Plan is a qualified defined contribution plan. Eligible employees may elect to make pre-tax deferral contributions, called 401(k) contributions, to the 401(k) Plan of up to 75% of Compensation (as defined in the 401(k) Plan) (10% maximum deferred percentage for such contributions with respect to Compensation paid prior to July 1, 2002, unless the employee elects catch-up contributions in accordance with the 401(k) Plan) subject to certain limits under the Code. We will make matching contributions to the 401(k) Plan equal to 100% of a participant’s 401(k) contributions and up to a maximum of 5% of a participant’s Compensation. Our matching contributions for the 401(k) Plan vest over five years as follows:

 

 

We may, in our discretion, make special contributions on behalf of participants to satisfy certain nondiscrimination requirements imposed by the Code. These contributions are 100% vested when made.

 

We may also make, in our discretion, annual profit sharing contributions to the 401(k) Plan in an amount not to exceed the maximum allowable deduction for federal income tax purposes and certain limits under the Code. Only employees who have met certain standards as to hours of service are eligible to receive profit sharing contributions. No minimum contribution is required. Each eligible participant, subject to maximum allocation limitations under the Code, is allocated the same percentage of the total contribution as the participant’s Compensation bears to the total Compensation of all participants. Profit sharing contributions are 100% vested when made.

 

Participants may direct the investment of their accounts in the 401(k) Plan by selecting from one or more of the diversified investment funds available under the 401(k) Plan, including a fund consisting of our Common Stock.

 

Employee Stock Ownership Plan (“ESOP”).  The ESOP is designed to be a qualified employee stock ownership plan under the Code for purposes of investing in shares of our Common Stock and, as of January 1, 2001, a qualified stock bonus plan with respect to the remainder of the ESOP not invested in our Common Stock. In connection with the spin-off of Stillwell Financial in July 2002 (the “Stillwell Spin-off”), holders of KCS Common Stock (including employees owning KCS shares through the ESOP) were issued two shares of common stock of Stillwell Financial for each share of KCS Common Stock held. On December 31, 2002, Janus Capital Corporation merged into Stillwell, and effective January 1, 2003, Stillwell was renamed Janus Capital Group, Inc. and the Stillwell common stock became Janus Capital Group Inc. common stock (we refer to the Janus Capital Group Inc. common stock as “Janus shares”). With respect to the Janus shares held in a participant’s ESOP account, the participant may: (a) keep the Janus shares in the account, (b) dispose of the Janus shares and reinvest the proceeds in one or more of the diversified investment funds available under the ESOP, (c) dispose of the Janus shares and reinvest the proceeds in our Common Stock, or (d) select any combination of the foregoing. Allocations of shares of our Common Stock, if any, to participant accounts in the ESOP for any plan year are based upon each participant’s proportionate share of the total eligible compensation paid during the plan year to all participants in the ESOP, subject to Code-prescribed maximum allocation limitations. Forfeitures are similarly allocated. For this purpose, compensation includes only compensation received during the period the individual was actually a participant in the ESOP. As of the date of this Proxy Statement, all shares held by the ESOP have been allocated to participants’ accounts.

 

Executive Plan.  Our Executive Plan provides a benefit equal to 10% of the excess of (a) an executive’s base salary times the percentage specified in his or her employment agreement (ranging from 145% to 175%) over (b) the maximum compensation that can be considered for benefit purposes in a qualified retirement plan. Payments are generally made annually under this plan and executives may elect to receive such payments in cash or restricted stock with 5-year graded vesting.

 

Other Benefits.  We also pay premiums for medical, disability, AD&D and group life insurance for our employees. Additionally, we provide employees with the opportunity to purchase KCS Common Stock at a discount. These benefits are provided to all employees in the United States.

 

Pay Mix

 

The percentage of a Named Executive Officer’s total compensation that is comprised by each of the compensation elements is not specifically determined, but instead is a result of the targeted competitive positioning for each element (i.e., market median for base salaries, annual incentives, and long-term incentives and below market median for perquisites and benefits). Typically, long-term incentives comprise a significant portion of a Named Executive Officer’s total compensation. This is consistent with the Compensation Committee’s desire to reward long-term performance in a way that is aligned with stockholders’ interests.

 

Executive Stock Ownership Guidelines

 

In 2006, we implemented stock ownership guidelines for approximately forty executives, including our Named Executive Officers. A fixed share approach is used, with the number of shares based on the salary multiples shown in the table below and a specified “constant” share price used for the divisor.

 

 

The Compensation Committee will periodically review the continued appropriateness of the fixed share ownership guidelines.

 

Executives are given five years, commencing on the later of the date the guidelines were implemented or their start date, to meet the required share holdings. If an executive fails to timely comply with the ownership guidelines, then not less than 50% of any future annual incentives will be paid in restricted shares until compliance is achieved.

 

Shares that count in determining compliance with the stock ownership guidelines are shares beneficially owned by the executive, shares held by the executive in any KCS benefit plan, restricted shares at the time of grant, performance shares when earned (even if not yet vested), and shares issued on exercise of stock options.

 

Change in Control Benefits

 

Purpose.  Various compensation arrangements provide for award and account vesting and separation pay upon a change in control (see the discussion of change in control triggers below) or the occurrence of certain events after a change in control. These arrangements are designed to:

 

 

Summary of Benefits.  In the event of a termination without “cause” or a resignation for “good reason” (as defined below) within a three year period after a change in control, Named Executive Officers receive the following benefits:

 

 

Definition of “cause” and “good reason.”  Our Named Executive Officers’ employment agreements generally define “cause” in the context of a termination prior to a change in control to include:

 

 

The employment agreements generally define “cause” in the context of a termination after a change in control to mean commission of a felony or a willful breach of duty, but excluding:

 

 

 

The employment agreements generally define “good reason” in the context of a resignation by the executive after a change in control to include:

 

 

Triggering Events.  Our Named Executive Officers’ employment agreements generally provide that the following events (which we refer to as “triggering events”) constitute a “change in control”:

 

 

Severance benefits (other than accelerated vesting of awards under the 1991 Plan) do not become due upon a mere change in control. Requiring that a termination without cause or a resignation for good reason occur within a three year period after a change in control before certain compensation and benefits are available is called a “double trigger.” We believe a double trigger is in the best interest of our stockholders because it:

 

 

Severance Compensation

 

Each Named Executive Officer’s employment agreement provides that in the event of termination without cause for any reason other than a change in control, death, disability or retirement, such Named Executive Officer will receive one year of salary at the rate in effect immediately prior to his or her termination. Additionally, Mr. Haverty receives reimbursement of health and life insurance costs for fifteen months and Messrs. Shoener, Ottensmeyer, Zuza and Avramovich receive reimbursement of health and life insurance costs for twelve months. Executives must waive any claims against us in return for receiving these severance benefits.

 

On May 12, 2006, our former Chief Financial Officer, Ronald G. Russ, ceased employment with KCS. Mr. Russ’s severance payments are disclosed in the Summary Compensation Table.

 

Other compensatory plans that provide benefits on retirement or termination

 

Described below are the portions of our compensation plans in which the accounts of Named Executive Officers become vested as a result of (a) their retirement, death, disability or termination of employment, (b) a change in control of us, or (c) a change in the Named Executive Officer’s responsibilities following a change in control.

 

ESOP.  A participant with less than five years of service is not vested in the ESOP’s contributions or earnings. However, a participant becomes 100% vested upon completion of five years of service. In addition, a participant becomes 100% vested at his or her retirement at age 65, death or disability or upon a change in control (as defined in the ESOP). Distributions of benefits under the ESOP may be made in connection with a participant’s death, disability, retirement or other termination of employment. A participant in the ESOP has the right to select whether payment of his or her benefit will take the form of whole shares of our Common Stock or a combination of cash and whole shares of our Common Stock. Any remaining balance in a participant’s account will be paid in cash, except that the participant may elect to have such balance applied to provide whole shares of our Common Stock for distribution at the then fair market value. In addition to these distribution options, a participant may elect to receive a distribution in the form of whole Janus shares (to the extent Janus shares are held in the participant’s account). If no election is made, the plan provides that the payment shall be made in cash. A participant may further opt to receive payment in a lump sum or in installments.

 

1991 Plan.  Subject to the terms of the specific award agreements, under the 1991 Plan, the retirement, death or disability (as such terms are defined in the 1991 Plan) of a grantee of an award or a change in control of KCS (as defined in the 1991 Plan) may accelerate the ability to exercise an award. Upon the death or disability of a grantee of an award under the 1991 Plan, (a) the grantee’s restricted shares, if any, that were forfeitable will become nonforfeitable, (b) any options or SARs not exercisable at that time become exercisable and the grantee (or his or her personal representative or transferee under a will or the laws of descent and distribution) may exercise such options or SARs up to the earlier of the expiration of the option or SAR term or 12 months, and (c) the benefits payable with respect to any performance share or performance unit for which the performance period has not ended will be determined based upon a formula described in the 1991 Plan. Upon the retirement of a grantee of an award under the 1991 Plan, (i) the grantee’s restricted shares, if any, that were forfeitable will become nonforfeitable unless otherwise provided in the specific award agreement, (ii) any options or SARs not exercisable at that time become exercisable and the grantee (or his or her personal representative or transferee under a will or the laws of descent and distribution) may exercise such options or SARs up to the earlier of the expiration of the option or SAR term or five years from the date of retirement, and (iii) the benefits payable with respect to any performance share or performance unit for which the performance period has not ended will be determined based upon a formula described in the 1991 Plan. If a grantee has a Termination of Affiliation (as defined in the 1991 Plan) for any reason other than for Cause (as defined in the 1991 Plan), death, disability or retirement, then (i) the grantee’s restricted shares, if any, to the extent forfeitable on the date of the grantee’s Termination of Affiliation, are forfeited on that date, (ii) any unexercised options or SARs, to the extent exercisable immediately before the grantee’s Termination of Affiliation, may be exercised in whole or in part, up to the earlier of the expiration of the option or SAR term or three months after the Termination of Affiliation, and (iii) any performance shares or performance units for which the performance period has not ended as of the Termination of Affiliation will terminate immediately upon that date. Upon a change in control of us (as defined in the 1991 Plan), (x) a grantee’s restricted shares, if any, that were

forfeitable become nonforfeitable, (y) any options or SARs not exercisable at that time become immediately exercisable, and (z) we will immediately pay to the grantee, for any performance share or performance unit for which the performance period has not ended as of the date of the change in control, a cash payment based on a formula described in the 1991 Plan. LSARs may be granted in tandem with options awarded under the 1991 Plan. All of the LSARs are automatically exercised upon a change in control that is not approved by the incumbent board of KCS (as such terms are defined in the 1991 Plan). Upon exercise of an LSAR, the grantee may receive a cash payment based upon the difference between the fair market value on the date of the change in control or other specified date and the per share exercise price of the related option.

 

401(k) Plan.  A participant becomes 100% vested upon retirement at age 65, death or disability or upon a change in control of us (as defined in the 401(k) Plan). Distribution of benefits under the 401(k) Plan will be made in connection with a participant’s death, disability, retirement or other termination of employment. Subject to certain restrictions, a participant may elect whether payment of his or her benefits will be in a lump sum or installments. A participant may elect to receive distributions of benefits under the 401(k) Plan in whole shares of our Common Stock, or in a combination of cash and whole shares of our Common Stock, to the extent of whole shares of our Common Stock allocated to such participant’s account. Absent such election, distributions of benefits will be made in cash.

 

Tax and Accounting Considerations

 

Section 162(m) of the Code generally limits the deduction by publicly held corporations for federal income tax purposes of compensation in excess of $1 million paid to any of the named executive officers listed in the Summary Compensation Table, unless it is “performance-based.”

 

Except as otherwise described in this section, the Compensation Committee intends to qualify compensation expense as deductible for federal income tax purposes.

 

The compensation packages of the Named Executive Officers for 2006 included base salary, annual incentives, and restricted shares. The highest total base salary was within the $1 million limit. The annual incentive payment was determined based upon the achievement of performance measures established at the beginning of the year. The annual incentive arrangement permits the Compensation Committee to exercise discretion in the determination of the award amounts and is not intended to be a performance-based plan under Section 162(m) of the Code. The restricted shares were awarded under the provisions of the 1991 Plan. These restricted stock awards do not qualify as performance-based compensation under Section 162(m) since the vesting of the awards is time-based. The restricted shares awarded to the Named Executive Officers have the potential to result in total compensation in excess of the $1 million limit under Section 162(m).

 

Prior to 2005, we awarded our executives stock options under the 1991 Plan. These stock options may result in taxable compensation upon exercise. Except with respect to certain stock options granted in 2000 to Mr. Haverty as part of his executive compensation package, we believe we have taken all steps necessary, including obtaining stockholder approval, so that any compensation expense we may incur as a result of awards of stock options under the 1991 Plan, with respect to those Named Executive Officers whose total compensation might exceed the $1 million limit, qualifies as performance-based compensation for purposes of Section 162(m) so that any portion of this component of our executive compensation packages will be deductible for federal income tax purposes. Mr. Haverty has indicated that he intends to manage the exercise of his options granted in 2000 so that the number of any options he exercises in any given year will not result in his total compensation exceeding the $1 million limit of Section 162(m).

 

The Compensation Committee will review from time to time in the future the potential impact of Section 162(m) on the deductibility of executive compensation. However, the Compensation Committee intends to maintain the flexibility to take actions it considers to be in the best interests of KCS and our stockholders and which may be based on considerations in addition to tax deductibility.

 

The Compensation Committee reviews projections of the estimated accounting (pro forma expense) and tax impact of all material elements of the executive compensation program. Generally, an accounting expense is

accrued over the requisite service period of the particular pay element and we realize a tax deduction upon the payment to/realization by the executive.

 

The Compensation Committee intends to review our executive employment agreements and benefit plans upon the adoption of final regulations under Section 409A of the Code (“Section 409A”) and to make any changes it considers necessary to comply with Section 409A and such regulations, to the extent such changes are agreeable to the executives and do not adversely affect the Company.

 

Compensation Decisions Made for 2007

 

In 2006, the Compensation Committee, assisted by Towers Perrin, conducted a review of a number of components of our executive compensation program, including:

 

 

The Compensation Committee made the following changes in its compensation policies and practices for 2007:

 

 

 

2007-2009 Executive Long-Term Incentive Program

 

Prior to March 2005, we relied on stock option grants as the primary long-term incentive award vehicle for our executives. Starting with the March 2005 long-term incentive grants to executives, we adopted a strategy of awarding service-based restricted shares as our sole long-term incentive award vehicle in an effort to enhance executive retention and increase executive stock ownership. These awards vest at the completion of five years of service by the executive.

 

In 2006, our Board of Directors and Compensation Committee expressed an interest in linking our long-term incentive stock awards more closely to our performance in order to provide an incentive to executives to meet or exceed our performance goals.

 

Accordingly, on September 19, 2006, the Compensation Committee adopted a new Executive Long-Term Incentive Grant program (the “LTI Program”) under the 1991 Plan. On January 17, 2007, pursuant to the terms of the LTI Program, the Compensation Committee granted our executives a one-time stock grant comprised of performance shares (60% weighting) and restricted shares (40% weighting) to cover the performance period of 2007 through 2009. The performance shares must be earned by executives over the three-year period based on our meeting the performance goals discussed below. Performance shares are earned on a pro rata basis, conditioned upon achievement of predetermined one-, two- and three-year performance goals. The earned performance share awards and restricted stock awards will not vest or be delivered until the end of the three-year program period (December 31, 2009). The performance metrics in the LTI Program are operating ratio (50% weighting), earnings

before interest, taxes, depreciation and amortization (“EBITDA”) (25% weighting), and return on capital employed (“ROCE”) (25% weighting).

 

Based on the recommendation of our senior management, the Compensation Committee adopted the following performance goals as the performance metrics for the 2007-2009 performance period:

 

 

In 2007, we must meet the performance goals related to the threshold performance level in order for our executives to earn 50% of the first third of their performance share awards. If we meet or exceed the performance goals for the target performance level or the maximum performance level in 2007, then our executives may earn 100% to 200% of the first third of their performance share awards. In 2008 and 2009, we must exceed the performance goals for the threshold performance level in order for our executives to earn any percentage of the second third or final third of their performance share awards, respectively. If we meet or exceed performance goals for the target or maximum performance levels in 2008 or 2009, the executives may earn 100% to 200% of the second third or final third of their performance share awards, respectively. If our actual performance is between performance levels, the percentage of the performance share awards earned by the executives will be prorated between such performance levels.

 

2007 Annual Incentive Plan

 

In February 2007, the Compensation Committee approved the financial performance incentive targets for our 2007 AIP. In order for there to be any payout under the 2007 AIP, our consolidated operating ratio must be 79.9% or lower and our consolidated cash flows must be $50 million or higher. In addition, our cash flow both in the United States and Mexico must be positive. There are three performance goals in our 2007 AIP payout model: (i) financial performance goals (50% weighting), (ii) department performance goals (20% weighting) and individual performance goals (30% weighting). In addition, each executive is assigned incentive targets at the threshold, target and maximum incentive performance levels that are a percentage of the executive’s 2007 base salary. The percentage assigned for each performance level depends on the executive’s salary grade.

 

Financial Performance Goals.  The weighting of the financial performance goals is split equally between our consolidated operating income for the year ending December 31, 2007 and our consolidated operating ratio for the

year ending December 31, 2007. Following are the 2007 financial performance incentive targets for each of these metrics, as well as the percentage payout of the executive’s total incentive target for these metrics:

 

 

Department Performance Goals.  For our Named Executive Officers, the weighting of the department performance goals is split among three sub-categories that will be measured in determining 2007 AIP payouts:

 

 

Individual Performance Goals.  Each executive will set and be required to meet individual safety, financial, strategic project, quality of service/customer service and leadership performance goals. The weightings of each of these goals will vary by department and by each executive’s job responsibilities.

 

2007 Salary Adjustments

 

In February 2007, the Compensation Committee approved 4% salary increases for each of our Named Executive Officers for the 2007 fiscal year.

 

The following table and narrative disclose compensation earned in 2006 by the Named Executive Officers as well as our former Executive Vice President and Chief Financial Officer. The table shows amounts earned by such persons for all services rendered in all capacities to KCS and its subsidiaries during the past year.

 

 

 

 

 

 

 

 

Narrative to Summary Compensation Table

 

Employment Agreements.  Each of the Named Executive Officers (other than Mr. Russ) is a party to an employment agreement with KCS, KCSR, or KCS and KCSR, which remains in effect until terminated or modified.

 

Pursuant to their respective employment agreements, Messrs. Haverty, Ottensmeyer, Shoener, Zuza and Avramovich receive as compensation for their services an annual base salary at the rate approved by the Compensation Committee, which for 2006 was $700,000 for Mr. Haverty, $300,000 for Mr. Ottensmeyer, $500,000 for Mr. Shoener, $215,004 for Mr. Zuza, and $310,000 for Mr. Avramovich. The salaries for these executive officers shall not be reduced except as agreed to by the parties or as part of a general salary reduction by KCSR applicable to all officers of KCSR, with respect to Messrs. Haverty and Shoener. Messrs. Haverty, Ottensmeyer, Shoener, Zuza and Avramovich are eligible to participate in benefit plans or programs generally available to executive employees of KCSR. Each of the employment agreements provides that the value of the respective Named Executive Officer’s annual compensation is fixed at a percentage of base salary for purposes of determining contributions, coverage and benefits under any disability insurance policy and under any cash compensation benefit plan provided to the Named Executive Officer as follows: 167.67% for Mr. Haverty; 175% for Mr. Ottensmeyer, 175% for Mr. Shoener, 145% for Mr. Zuza, and 175% for Mr. Avramovich.

 

For information regarding potential payments to the Named Executive Officers upon termination or change in control, see “Potential Payments Upon Termination or Change in Control” below.

 

Indemnification Agreements.  We have entered into indemnification agreements with our officers and directors. These agreements are intended to supplement our officer and director liability insurance and to provide the officers and directors with specific contractual assurance that the protection provided by our Bylaws will continue to be available regardless of, among other things, an amendment to the Bylaws or a change in management or control of KCS. The indemnification agreements provide for indemnification to the fullest extent permitted by the Delaware General Corporation Law and for the prompt advancement of expenses, including attorneys’ fees and all other costs and expenses incurred in connection with any action, suit or proceeding in which the director or officer was or is a party, is threatened to be made a party or is otherwise involved, or to which the director or officer was or is a party, is threatened to be made a party or is otherwise involved by reason of service in certain capacities. Under the indemnification agreements, if required by the Delaware General Corporation Law, an advancement of expenses incurred will be made upon delivery to us of an undertaking to repay all advanced amounts if it is ultimately determined by final adjudication that the officer or director is not entitled to be indemnified for such expenses. The indemnification agreements allow directors and officers to seek court relief if indemnification or expense advances are not received within specified periods, and obligate us to reimburse them for their expenses in pursuing such relief in good faith.

 

GRANTS OF PLAN-BASED AWARDS

 

The following table provides information for each of the Named Executive Officers regarding 2006 grants of annual incentive awards, restricted shares and stock options.