Unless otherwise indicated or the context otherwise requires, all references in this Annual Report to “KCSM,” “TFM,” “we,” “ours,” “us,” “the Company,” or similar terms refer to Kansas City Southern de México, S.A. de C.V. (formerly known as TFM, S.A. de C.V.) together with its subsidiaries, and references to “KCS” means Kansas City Southern, a Delaware corporation that, as of September 12, 2005, became our sole shareholder. References to “Grupo TFM” means Grupo Transportación Ferroviaria Mexicana, S.A. de C.V.

Cautionary Statement Regarding Forward-Looking Statements

     You should carefully review the information contained in this Annual Report and in other reports or documents that we file from time to time with the Securities and Exchange Commission (the “SEC”). In this Annual Report, we state our beliefs of future events and of our future financial performance. In some cases, you can identify those so-called “forward-looking statements” by words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of those words and other comparable words. You should be aware that those statements are only our predictions. Actual events or results may differ materially. In evaluating those statements, you should specifically consider various factors, including the risks discussed in this Annual Report and other reports or documents that we file from time to time with the SEC. Those factors may cause our actual results to differ materially from any of our forward-looking statements. All forward-looking statements attributable to us or a person acting on our behalf are expressly qualified in their entirety by this cautionary statement.

BUSINESS OVERVIEW

     We operate the primary commercial corridor of the Mexican railroad system, which allows us to participate significantly in the growing freight traffic between Mexico, the U.S. and Canada. Our rail lines consist of 2,639 miles of main track. In addition, we have trackage rights entitling us to run our trains over 541 miles of track of other Mexican railroad operators. We provide freight transportation services under our 50-year concession, during the first 30 years of which we are the exclusive provider, subject to certain trackage rights of other freight carriers. Our concession is renewable for additional periods of up to 50 years subject to certain conditions.

     We believe our rail lines comprise the most strategically significant and most actively traveled rail corridor in Mexico. Our rail lines connect the most populated and industrialized regions of Mexico with the principal border gateway between Mexico and the U.S. at Nuevo Laredo (Tamaulipas) and Laredo (Texas). In addition, we serve three of Mexico’s most important seaports at Veracruz and Tampico on the Gulf of Mexico and Lázaro Cárdenas on the Pacific Ocean. As a result, we believe our routes are integral to Mexico’s foreign trade.

     We seek to establish our railroad as the primary inland freight transporter linking Mexico with the U.S. and Canadian markets. As the operator of the primary and most direct rail corridor from the U.S. border to Mexico City, our route structure enables us to benefit from continuing growth resulting from the North American Free Trade Agreement (“NAFTA”). We are the only Mexican railroad that serves the Mexico-U.S. border crossing at Nuevo Laredo-Laredo, which is the largest freight exchange point between Mexico and the U.S. Through KCS’s U.S. rail subsidiaries, as well as through interchanges with other major U.S. railroads, we provide customers with access to an extensive network through which they may distribute products throughout North America and overseas.

     Our revenues are derived from the movement of a diversified mix of commodities and products predominantly attributable to cross-border traffic with the U.S. We transport agro-industrial products, industrial products and manufactured products, cement, metals and minerals, chemical and petrochemical products, automotive products, and intermodal freight. Our customers include leading international and Mexican corporations.

The Concession

     We hold a 50-year concession, which took effect in June 1997 and is renewable under certain conditions for up to 50 years, to provide freight transportation services over rail lines serving the northern and central portions of Mexico, and connecting three of Mexico’s main ports with Mexico City, Monterrey and the Nuevo Laredo-Laredo border crossing. Our concession is exclusive for the first 30 years of our operations, subject to certain mandatory trackage rights granted to Ferrocarril Mexicano, S.A. de C.V. (“Ferromex”), Ferrosur, S.A. de C.V. (“Ferrosur”), two short line railroads and Ferrocarril y Terminal del Valle de México, S.A de C.V. (Mexico Valley Railroad and Terminal) (“FTVM”). In 1997, Grupo TFM paid a total of $1,464.5 million to acquire 80.0% of our shares (which represent all of our shares with full voting rights) and certain railroad equipment and related assets, and a 25.0% interest in FTVM. We have the right to use, during the full term of the concession, all track and buildings that are necessary for our rail lines’ operation. Under the terms of the concession, we are required to pay the Mexican government a concession duty equal to 0.5% of our gross revenues during the first 15 years of the concession period and 1.25% of such revenues during the remainder of the period.

     Under the concession and the Mexican railroad services law and regulations, we may freely set our rates unless the Secretaria de Comunicaciones y Transportes (“Ministry of Communications and Transportation” or “SCT”), in consultation with the Mexican Antitrust Commission, determines that there is no effective competition in Mexico’s rail industry, taking into account alternative rail routes and modes of transportation. If the Mexican Antitrust Commission determines that there is a lack of competition, the SCT will establish the basis for our rates. Our rates must be registered and applied in accordance with the Mexican railroad services law and regulations. In applying our rates, we must not make cross-subsidies, engage in tied sales or engage in other discriminatory pricing tactics. We are required to provide railroad services to all users on a fair and non-discriminatory basis and in accordance with efficiency and safety standards approved periodically by the SCT. In the event that we collect from customers rates higher than the registered rates, we must reimburse those customers with interest, and risk the revocation of the concession.

     Mexican railroad services law and regulations and the concession establish several circumstances under which the concession will terminate, including revocation by the SCT, voluntary surrender of our rights under the concession, statutory appropriation, and our liquidation or bankruptcy. Specifically, the Mexican government, acting through the SCT, may revoke the concession for the following reasons: (1) unjustified interruption of the operation of our rail lines; (2) any act or omission that restricts the ability of other Mexican rail railway concession holders to use our rail lines; (3) failure to make payments for damages caused during the performance of services; (4) repeatedly charging rates higher than the registered rates; (5) a change in our nationality; (6) our assignment of, or creation of liens on, the concession without the prior approval of the SCT; (7) failure to maintain a performance bond and adequate insurance coverage as required by the Mexican railroad services law and regulations; and (8) noncompliance with any term or condition of Mexican railroad services law and regulations or the concession. In the cases of (5) or (6) above, the concession will be automatically revoked. In the cases (1) or (4) the concession shall be revoked following the imposition of a sanction by SCT on three occasions. In the cases (2), (3) or (7) the concession shall be revoked following the imposition of a sanction by SCT on five occasions. In the event that the concession is revoked by the SCT, we will receive no compensation, and our rail lines and all other fixtures covered by the concession, as well as all improvements made by us, will revert to the Mexican government. All other property not covered by the concession, including movable railroad property we purchased from the Mexican government, as well as all locomotives and railcars we otherwise acquired, will remain our property. However, if we attempt to sell more than 15.0% of our equipment to a third party within 90 days of termination or revocation of our concession, the Mexican government will have a right of first refusal to purchase the equipment on the same terms offered by the third party if no other concessionaire is likely to provide rail services over our rail lines and the equipment being sold is indispensable to the continuation of our rail services. After the Mexican government receives notice from us of our intention to sell the equipment, it will have 30 days to exercise its right of first refusal. In addition, the Mexican government will have the right to cause us to lease all of our service-related assets to the SCT for a term of at least one year, automatically renewable for additional one-year terms up to five years. The Mexican government must exercise this right within four months after revocation of the concession.

     The concession requires us to make investments and undertake capital projects, including capital projects described in a business plan filed every five years with the Mexican government. We filed our second business plan with the Mexican government in 2003. Under the terms of the plan, we have committed to certain minimum investment and capital improvement goals, which may be waived by the SCT upon our application for relief for good cause. We are also responsible for compliance with efficiency and safety standards set forth in the concession, which are based on standards of the Association of American Railroads (“AAR”).

     Under the concession, we are responsible for all ecological and environmental damage that we may cause from and after the date of commencement of operations. The Mexican government has agreed to indemnify us for any environmental liability relating to soil, subsoil or groundwater contamination attributable to the Mexican government’s operations occurring prior to the commencement of operations in accordance with the concession title in 1997. We assumed full responsibility for the operation of supply depots and shops and the supervision of infrastructure projects, as well as compliance with present and future environmental protection laws and regulations.

     We are required by the concession to obtain and maintain insurance policies in accordance with the terms of the Mexican railroad services law and regulations. Except under specific circumstances, we are responsible for damage caused to cargo transported by us over our lines, as well as for damage caused to third parties and such parties’ property as a result of our activities.

     The concession prohibits us from refusing to transport water to communities in need of such service because of geographical or demographical characteristics, provided that we are paid at the prescribed tariff rate. We are also required to transport mail, emergency supplies necessary for rescue and salvage operations, and members of the Mexican government’s armed forces. We must also grant a right of passage for all railroad equipment of the Mexican government’s armed forces. The concession also requires us under certain circumstances to establish reserves to cover contingent labor liabilities that arise during the term of the concession.

     If the Mexican government legally terminates the concession, public domain assets used in the operation of our rail lines would be owned, controlled and managed by the Mexican government. The Mexican government may also temporarily seize our rail lines and our assets used in operating our rail lines in the event of a natural disaster, war, significant public disturbances, or imminent danger to the domestic peace or economy. In such events, the SCT may restrict our ability to exploit the concession fully for such time and in such manner as the SCT deems necessary under the circumstances but only for the duration of any of the foregoing events.

     Mexican law requires that the Mexican government pay us compensation if it effects a statutory appropriation for reasons of the public interest. With respect to a temporary seizure due to any cause other than international war, the Mexican railroad services law and regulations provides that the Mexican government will indemnify an affected concessionaire for an amount equal to damages caused and losses suffered. These payments may not be sufficient to compensate us for our losses and may not be timely made.

     Under the concession, the Mexican government has specifically reserved the right to grant exclusive rights to provide passenger service over our rail lines to a concessionaire other than us. Since we commenced operations, the Mexican government has provided a minimal level of passenger train service to certain areas within our service territory under an arrangement in which Ferrocarriles Nacionales de México, en Liquidación (“FNM”) is responsible for the management of all passenger cars and related personnel necessary for the provision of such service. Our obligation with respect to the provision of passenger service by FNM is limited to providing FNM with locomotive power, engineers and dispatching services for which we are reimbursed.

Network

     Our rail lines extend from Mexico City, Toluca and Aguascalientes to the U.S. border crossings at Nuevo Laredo and Matamoros and to seaports on the Gulf of Mexico and the Pacific Ocean. Our main track consists of core and feeder routes. Our core routes serve the principal industrial and population centers of Mexico while our feeder lines connect with the ports of Veracruz, Lázaro Cárdenas and Tampico, three of Mexico’s four most important seaports.

     We currently have intermodal terminals located in Monterrey, Toluca, San Luís Potosí, and also access to intermodal terminals at Querétaro, Guadalajara, Ramos Arizpe and Encantada. In addition, we have direct access to intermodal terminals at the ports of Tampico, Veracruz and Lázaro Cárdenas and to intermodal terminals at Altamira and Manzanillo through interline service with Ferromex, and in Mexico City through the FTVM. We also have access to intermodal terminals at Laredo operated by the Texas Mexican Railway Company (“Tex-Mex”, another wholly owned subsidiary of KCS) and the Union Pacific Railroad Company, which we are using to develop international intermodal business.

Core Routes and Traffic

     Our rail lines comprise five core routes. We believe these core routes are integral to Mexico’s foreign trade, as they connect Mexico’s most industrialized and populated regions with its principal border and seaport gateways.

      Mexico City — Nuevo Laredo. Our rail lines provide exclusive rail access to the U.S.-Mexico border crossing at Nuevo Laredo, the most important interchange for freight between the U.S. and Mexico, through our 797-mile route from Mexico City to Nuevo Laredo. We operate the southern half of the international rail bridge, which spans the Rio Grande to connect Nuevo Laredo with Laredo. Our affiliate Tex-Mex operates the northern half of the international rail bridge. In 2004 and 2005, 62.7% and 63.7%, respectively, of Mexico’s total imports and exports carried by rail passed through Nuevo Laredo. The Mexico City — Nuevo Laredo route is the shortest rail route between Mexico City and the U.S. border. This route has the lowest grades of any rail route between the U.S. border and Mexico City, which

translates into savings of both fuel and locomotive power. Movements over the Mexico City — Nuevo Laredo route accounted for, 63.2%, 64.2% and 63.7% of our total revenues in 2003, 2004 and 2005, respectively.

     Products transported through Nuevo Laredo include finished vehicles and auto parts, grain, appliances, beer, chemicals, scrap paper and plastics. In 2003, 2004 and 2005, rail traffic representing $405.2 million, $426.5 million and $455.6 million in revenues, respectively, was transported through Nuevo Laredo on our rail lines, of which approximately 65.2%, 67.5% and 63.7%, respectively, consisted of import traffic.

      Mexico City — Lazaro Cardenas. We provide exclusive access to the port of Lazaro Cardenas on the Pacific Ocean over our 491-mile route from Mexico City. In 2003, 2004 and 2005, we transported rail traffic representing $44.1 million, $61.1 million and $62.0 million in revenues, respectively, through Lazaro Cardenas. Traffic at Lázaro Cárdenas is both domestic and import traffic, consisting of minerals, iron, steel slabs, wire rods, fertilizers and intermodal containers. The tunnels along this route are cleared for double-stack intermodal containers. The port of Lázaro Cárdenas also handles traffic for export to Pacific Rim nations. The Mexican government is developing the port at Lázaro Cárdenas on the Pacific Ocean as an alternate to the congested U.S. West Coast ports of Los Angeles/Long Beach. Through our rail service to this port, we plan to provide an alternate route for Asian traffic bound for destinations in Mexico and in the eastern, southern and midwestern United States.

      Mexico City — Veracruz. Both KCSM and Ferrosur serve the port of Veracruz in the Gulf of Mexico. We serve Veracruz through a 288-mile route from Mexico City. In 2003, 2004 and 2005, we transported rail traffic representing $36.6 million, $32.9 million and $29.4 million in revenues, respectively, through Veracruz, of which approximately 68.2%, 66.1% and 74.0%, respectively, was derived from import traffic. The rail freight we transport to and from the port of Veracruz includes autos, grains, steel and mineral products, chemicals and containers.

      Monterrey — Matamoros. Our rail lines include a 203-mile line from Monterrey to Matamoros. We are the exclusive provider of rail service to Matamoros, which is an alternative to the Nuevo Laredo border crossing to the U.S. We interchange rail freight at the Matamoros border crossing at Brownsville, Texas with both the Union Pacific Railroad Company and the BNSF Railway Company. At Matamoros, we have access to the port of Brownsville, the nearest seaport to Monterrey, through our interchange with the Union Pacific Railroad Company. In 2003, 2004 and 2005, we transported rail traffic representing $46.1 million, $43.3 million and $46.2 million in revenues, respectively, through Matamoros, of which 73.2%, 77.5% and 80.4%, respectively, consisted of import traffic. Freight traffic through Matamoros includes grains, steel coils, metal scrap, chemicals and iron slabs.

      Tampico — Altamira. These ports situated in the Gulf of Mexico generated 5.2%, 5.6% and 6.0% of our total revenues in 2005, 2004, and 2003, respectively. In 2003, 2004 and 2005, we transported rail traffic representing $38.5 million, $37.2 million and $37.4 million in revenues, respectively, through these ports.

Kansas City Southern

     KCS is our controlling stockholder. KCS’s principal U.S. subsidiary, The Kansas City Southern Railway Company (“KCSR”), is one of seven Class I railroads in the U.S. The rail network of KCSR, Tex-Mex and KCSM together comprises approximately 6,000 miles of main and branch lines extending from the midwest portions of the United States south into Mexico. In addition, through a strategic alliance with Canadian National Railway Company (“CN”) and Illinois Central Corporation (“IC”), our rail network covers approximately 25,000 miles of main and branch lines connecting Canada, the United States and Mexico. The CN and IC alliance connects Canadian markets with major midwestern and southern markets in the United States, as well as with major markets in Mexico through KCSR’s connections with Tex-Mex and us. We and KCS believe that we are poised to continue to benefit from the growing north/south trade between the United States, Mexico, and Canada promoted by NAFTA.

     KCS’s rail network, of which we are a part, is further expanded through marketing agreements between KCSR and Norfolk Southern Railway Company (“Norfolk Southern”), the BNSF Railway Company, and the Iowa, Chicago & Eastern Railroad Corporation (“IC&E”). This rail network interconnects with all other Class I railroads and provides shippers with an effective alternative to other railroad routes, giving direct access to Mexico and the southeastern and midwestern United States through less congested traffic hubs. As a result of KCS’s acquisition of control over us, we

expect to become more fully integrated into KCS’s NAFTA growth strategy, which includes KCSR’s established strategic alliances and marketing agreements with other railroads.

Product Categories

     We believe that we have succeeded in converting customers from trucking transport to rail because we offer reliable rail service at competitive prices. We believe that our service is safer, more punctual and more efficient than that provided prior to the privatization of the Mexican railroad system and that, as a result, we are able to better serve certain shippers in the agro-industrial, chemical, automotive and intermodal sectors that have time-sensitive transportation needs because their products may be valuable, perishable or hazardous, or, in the case of intermodal freight, because they must connect with other transportation facilities at a predetermined date. Having substantially reduced cargo theft and vandalism, improved transit times and on-time performance and focused on customer service, we believe that we are well positioned to continue to capture traffic from the trucking sector.

     The following table sets forth, by product category, our revenues and traffic volumes by carloads for 2005 and 2004.

   Agro-industrial Products

     For the year 2005, $163.0 million, or 22.7% of our total transportation revenues, was derived from the movement of agro-industrial products. Our revenues generated from our agro-industrial sector increased by 13.7% from 2004.

     Movement of corn experienced a major increase as a result of higher import volumes during this period. Movement of sugar maintained a more regular rate of volume increase during this period. Price improvements also favorably impacted this period. This increase was partially offset by a reduction in import shipments of soybeans, sorghum and wheat products during the year 2005.

     The U.S. and Canada are the dominant suppliers of agricultural products to Mexico and a significant amount of the agro-industrial products carried over our rail lines are imports, consisting primarily of grains, grain products (principally corn, soybeans and wheat), as well as seeds and feed grains, imported to Mexico from the U.S. and Canada. In Mexico these grains are used principally for human consumption and for feed. These products enter Mexico by rail at the U.S. border crossings at Nuevo Laredo and Matamoros and by ship at the ports of Tampico, Altamira, Veracruz and

Lázaro Cárdenas from where they are transported by rail to storage and processing facilities in Mexico City, Monterrey, Puebla, Torreon, Veracruz and other cities. Our key customers are Pilgrims Pride de Mexico, S.A. de C.V., CP Ingredients, Ragasa Industrias, S.A. de C. V., Comercializadora Internacional Vali, S.A. de C. V. and Grupo Altex, S.A. de C.V.

   Cement, Metals and Minerals

     In 2005, $142.1 million, or 19.8% of our total transportation revenues, was derived from the movement of cement, metals and minerals. Our revenues generated in this product category increased by 2.8% from 2004. Domestic revenues increased during the year 2005 as a result of an increase in the production volumes of construction materials such as billets, bar and wire, cement and minerals as a result of the continuing strong performance in the construction and mining industries. Steel slab and steel coils revenue increased as a result of higher international traffic flows for both imports and exports due to higher consumption of manufacturing industries, as well as targeted rate increases during the year 2005.

     This product category includes metals, minerals and ores such as iron, steel, zinc and copper, as well as cement. The majority of metals, minerals and ores mined, and steel produced, in Mexico is used for domestic consumption. The volume of Mexican steel exports fluctuates based on global market conditions and prices.

     Most of Mexico’s major steel plants and mills are located along our rail lines, and a large amount of finished products from these mills are exported to manufacturers in the U.S., while the remainder is used domestically. We also seek to convert the traffic flowing from the mines, quarries and smelters within Mexico to our rail lines. We currently transport iron, steel and other metals, minerals and ore products from mills at Lázaro Cárdenas to steel plants and mills in northern Mexico. Finished products such as steel coil used in the production of higher-end finished products such as automobiles, household appliances and other consumer goods, are imported through Nuevo Laredo and through seaports served by our rail lines, as well as the port of Brownsville. Our customers include IMSA-MEX, S.A. de C. V., Hylsa, S.A. de C. V., Siderúrgica Lázaro Cárdenas Las Truchas, S.A. de C. V. and Cementos Apasco, S.A. de C. V.

     Cement is one of the most widely used commodities in construction in Mexico and is produced throughout the country for both domestic use and export to the U.S. Two major companies in Mexico which move their products with us are CEMEX and Cementos Apasco, S.A. de C. V. Due to its bulk and density, cement is ill-suited for road transport and, as a result, is hauled almost exclusively by rail.

   Chemical and Petrochemical Products

     In 2005, $126.6 million, or 17.6 % of our total transportation revenues, was derived from the movement of chemical and petrochemical products. For the year 2005, our revenues increased by 0.7% from 2004. Domestic revenues increased as a result of a higher consumption of diesel and gasoline during 2005.

     The chemical and petrochemical products we transport consist of petrochemical products imported from the U.S. into Mexico and domestic traffic consisting of fuel transported from PEMEX Refinanción (“PEMEX”) refineries to regional distribution centers and power plants owned by the Comisión Federal de Electricidad (the Mexican Federal Electricity Commission (“CFE”), the Mexican government-owned electric utility. CFE is a major user of fuel oil, much of which is transported from PEMEX refineries to CFE power generating plants near our rail lines. We operate a unit train dedicated to transporting these fuels for CFE. We transport fuel oil from PEMEX refineries located in Salamanca and Tula to Lázaro Cárdenas.

     Transportation of plastics for M&G Polimeros S.A. de México , Exxon Mobil S.A., Dow Chemicals and Bulkmatic S.A. , and transportation of soda ash for Vitro, Quimir, Modelo contributed to our revenue growth in 2005.

   Automotive Products

     Our automotive revenues during 2005 were $115.7 million, or 16.1% of our total transportation revenues.

     During 2005, the automotive revenues decreased by 3.4% from 2004. This revenue reduction is a consequence of the decline in production due to the continued recession in the North American automotive industry and the closure of the DaimlerChrysler plant in Lago Alberto, and the subsequent relocation of its production facilities to Encantada in Coahuila.

     The automotive products we transport consist primarily of automotive parts imported into Mexico for assembly in Mexican auto plants, and finished vehicles exported to the U.S. and Canada, and to some extent imported finished vehicles. We have started to convert the potential for growth in the domestic automobile distribution market through automotive ramps at Aguascalientes, Monterrey, Toluca and Veracruz. We believe that we will enhance our ability to move finished automobiles cost-effectively in the international and domestic markets and to convert this traffic from truck to rail transport by providing service superior to that provided by our predecessor and that provided by the trucking industry.

   Manufactured Products and Industrial Products

     For the year 2005, $100.2 million, or 14.0%, of our total transportation revenues were derived from the movement of manufactured products and industrial products. Our revenues generated in this product category increased by 7.1% from 2004. Growth in this segment was a consequence of the strong transportation of beer, paper and pulpwood and recovery of traffic from barge movements, as well as new traffic. Additionally, beer showed an increase of 47.0% in export traffics due to higher production to cover demand in the U.S. market. Home appliances revenue increased, driven mainly by higher exports to the U.S. market. Revenue related to scrap paper also increased due to a recovery of traffic that was lost in 2004 to barge traffic and obtaining new traffic.

     The manufactured and consumer products that we transport include home appliances, textiles, ceramic tile, scrap paper, glass, paper, beer and pulp. We also transport a variety of industrial products such as machinery, including boilers, generators, turbines, tanks and transformers, processed foods and nonperishable products. Processed food products produced in Mexico are both exported for consumption abroad and consumed domestically. Currently, trucks transport a significant percentage of processed foods and nonperishable products. We believe there are opportunities for revenue growth in the industrial products segment, including manufactured products and paper products, mainly through the conversion of cargo from Mexican and U.S. companies from truck to rail transport.

     We have a long-term contract with Mabe S.A. de C. V. (“Mabe”) to transport all the appliances it exports to the U.S. and most of the products it distributes domestically. Mabe is the largest Mexican home appliance manufacturer, 49.0% of which is owned by the General Electric Company (GE). Mabe produces most of the gas and electric ranges sold in the U.S. under the “GE” brand and refrigerators exported to the U.S.

     We believe that bulk products such as paper, including tissue paper, corrugated paper, brown paper, newsprint and others packaging paper, and pulp can be shipped at cost-effective rates by rail from manufacturing plants located near our rail lines to regional distribution centers and directly to the retailer. The majority of the paper and forest products presently carried on our rail lines consist of scrap paper, printing paper, brown paper and wood pulp imported from the southeastern U.S., Canada and Texas to paper mills, newspaper publishers, and printers in major population centers in Mexico.

     Large volumes of paper products are manufactured in Mexico at plants near our rail lines by companies such as Kimberly-Clark de Mexico, S.A. de C. V., Smurfit, S.A., Grupo Pipsamex, S.A. de C. V., Copamex and SCA for domestic

and international consumption, or are imported into Mexico by U.S. paper companies such as MeadWestvaco, International Paper, Rayonier, Weyerhaeuser, Bowater, and Koch Cellulose.

   Intermodal Freight

     For the year 2005, $57.3 million, or 8.0%, of our total transportation revenues were derived from intermodal freight, which entails hauling products in freight containers in combination with transport by water, rail and/or motor carriers, with rail carriers serving as the link between the other modes of transportation. During the year 2005, our revenues in this product category increased by 13.5% from 2004. This increase was mainly attributable to the consolidation of steamship service at the port of Lázaro Cárdenas.

Sales and Marketing

     Our marketing and sales efforts are designed to grow and expand our current business base by focusing on truck conversion up the supply chain and securing existing traffic with current customers through long-term contracts. Emphasis is placed on attracting new business in the U.S., Canada and Mexico. We believe these efforts will continue to benefit from NAFTA as well as the development of the port of Lázaro Cárdenas.

     With respect to intermodal customers, we will be working in conjunction with the rest of the KCS rail lines in offering single line services between Lázaro Cárdenas and the U.S., Mexico City proper and the U.S., and Monterrey proper and the U.S. We will also develop services for Lázaro Cárdenas into Mexico City proper and Monterrey proper.

     To meet the needs of customers shipping commodities in carload units, such as agricultural products, chemicals and automotive products, we will work with our affiliates, Tex-Mex and KCSR in capitalizing upon our strategic advantage resulting from our direct access to key ports and interchange points through our rail lines, which connect with the extensive route structures of Tex-Mex, KCSR, the Union Pacific Railroad and other major U.S. and Canadian rail carriers.

     A significant portion of our contracts are both quoted and settled in U.S. dollars, and the vast majority of additional freight services are quoted in U.S. dollars and settled at a U.S. dollar-Mexican peso exchange rate which approximates a U.S. dollar-denominated contract. We are continuing to move forward with executing dollar-denominated contracts, and we believe that a majority of our contracts are currently denominated in U.S. dollars.

SICOTRA

     We have a license to use SICOTRA, a Union Pacific Technologies system, for among other purposes, the reporting of car movements in train and yard operations and the processing of bill of lading information.

Management Control System (“MCS”)

     In 2005, we proceeded with plans to upgrade our communication infrastructure and systems in anticipation of installing KCS’s computerized MCS management control system in 2006. This state-of-the-art system will replace SICOTRA and is designed to provide better analytical tools for management to use in its decision-making processes. MCS, among other things, delivers work orders to yard and train crews to ensure that the service being provided reflects what was sold to the customer. The system also tracks individual shipments as they move across the rail system, compares that movement to the service sold to the customer and automatically reports the shipment’s status to the

customer and to operations management. If a shipment falls behind schedule, MCS automatically generates alerts and action recommendations so that corrective action can be promptly initiated.

     We expect MCS to provide better analytical tools for management to use in its decision-making process. We anticipate that MCS will provide more accurate and timely information on, among other things, terminal dwell time, car velocity through terminals and priority of switching to meet schedules. A data warehouse is expected to provide an improved decision support infrastructure. By making decisions based upon that information, we expect to improve service quality and utilization of locomotives, rolling stock, crews, yards, and line of road and thereby reduce cycle times and costs. With the implementation of service scheduling, we also expect MCS to provide improved customer service through improved advanced planning and real-time decision support. By designing all new business processes around workflow technology, we expect to more effectively follow key operating statistics to measure productivity and improve our operating performance.

     We expect MCS to improve clerical and information technology group efficiencies. We believe that information technology and other support groups will be able to reduce maintenance costs, increase their flexibility to respond to new requests and improve productivity. By using a layered design approach, MCS is expected to have the ability to extend to new technology as it becomes available. MCS can be further modified to connect customers with additional applications via the Internet and is intended to be constructed to support multiple railroads, permit modifications to accommodate the local language requirements of the area and operate across multiple time zones. A later enhancement of MCS is expected to also include revenue and car accounting systems.

Train Dispatching System

     We are presently utilizing two types of train dispatching systems:

	•		A radio-based track warrant control system is in place over approximately 1,747 miles of track, representing approximately 66% of our rail lines. It utilizes direct radio communication between dispatchers and engineers combined with specific track assignments to coordinate train movements and dispatching.
	•		A centralized traffic control system, or CTC system, which allows a central dispatcher in Monterrey to manage track operations between Mexico City and Nuevo Laredo, is in place over an aggregate distance of 892 track miles, representing approximately 34% of our rail lines.

     To improve operating efficiencies, the dispatchers covering all portions of our rail lines, under both the radio-based track warrant control and CTC systems, are now using the same computer system. This computer system is scheduled for replacement as part of a KCS company-wide initiative to have all KCS rail lines on the same computerized dispatching system in 2006.

Documentation and Billing System

     We have developed, tested and fully implemented a state-of-the-art documentation and billing system that allows our customers to use the Internet to track and trace their railcars, access online documentation and use predetermined templates to expedite the process and ensure consistency and quality of information.

Online Customer Service

     In the customer service area, we have converted our Internet home page into a comprehensive tool permitting customers to track the delivery of their shipments and obtain a wide range of information regarding our services. Besides providing information about our business areas and services, our website provides customers with access to multiple services including:

•

electronic waybilling;

	•		“Track and Trace”;
	•		AEI (Automatic Equipment Identification) readouts;
	•		our graphical rail network;
	•		equipment order monitoring;
	•		rate inquiries;
	•		equipment historical information;
	•		an automatic delivery reporting feature which can be customized by the user based on the day of the week and delivery time and can handle up to 10 delivery recipients;
	•		invoice inquiries; and
	•		train schedule and other information.

Subsidiaries and Principal Affiliates

   Arrendadora TFM

     Arrendadora TFM, our 98%-owned subsidiary, was incorporated on September 27, 2002 as a sociedad anónima de capital variable (variable capital corporation), under the laws of Mexico, and its only operation is the leasing to us of the locomotives and cars acquired by us through the privatization and subsequently transferred by us to Arrendadora TFM.

   Mexico Valley Railroad and Terminal (FTVM)

     FTVM was incorporated as a sociedad anónima de capital variable (variable capital corporation), under the laws of Mexico. The corporate purpose of the company is to provide railroad services as well as ancillary services, including those related to interconnection, switching and haulage services. We hold 25.0% of the share capital of this company. The other shareholders of FTVM, each holding 25.0%, are Ferromex, Ferrosur and the Mexican government. Ferromex and Ferrosur are currently under the common control of Grupo Mexico, S.A. de C.V. (“Grupo Mexico”).

   Mexrail

     Mexrail, which is also a wholly owned subsidiary of KCS, owns 100% of Tex Mex, which in turn operates a 157-mile rail line extending from Laredo to the port city of Corpus Christi, Texas. Tex-Mex connects with our rail lines at the U.S./Mexico border at Laredo and connects to KCSR through trackage rights at Beaumont, Texas. Mexrail owns the northern half of the rail-bridge at Laredo, Texas, while we operate the southern, or Mexican, portion of the international rail bridge at Nuevo Laredo, which spans the Rio Grande River between the U.S. and Mexico. Laredo is a principal international gateway through which more than 50% of all rail and truck traffic between the U.S. and Mexico crosses the border.

     On March 27, 2002, we acquired from Grupo TMM and KCS all of the outstanding stock of Mexrail. On August 16, 2004, we entered into an agreement with KCS to sell to KCS Mexrail shares representing 51% ownership of Mexrail for approximately $32.7 million. The Mexrail shares were placed in a voting trust pending regulatory approval by the United States SurfaceTransportation Board (“STB”) of KCS’s common control of Tex-Mex, KCSR and the Gateway Eastern Railway Company (“Gateway Eastern”). On November 29, 2004, the STB approved KCS’s application for authority to control Tex-Mex and the U.S. portion of the international rail bridge at Laredo, Texas. On January 1, 2005, the shares representing 51% of Mexrail were released from the voting trust to KCS, and KCS took control of Tex-Mex. We continue to own 49% of the stock of Mexrail.

Competition

     We face significant competition from trucks and other railroads and expect such competition to continue to be significant. In general, most freight in Mexico is transported by truck or rail. Freight terminating or originating in our service territory is primarily transported by truck. Competition with other modes of transportation is generally based on rates charged, as well as the quality and reliability of the service provided. We believe that other competitive factors for freight transport are lead time for orders, protection of goods, transit time, adequacy of the equipment and the provision of other value added services such as traceability of shipments and availability of rates through the Internet.

     Some segments of our freight traffic, notably intermodal freight, experience price competition from trucks, although the operating efficiencies we are achieving may lessen the impact of price competition. Although truck transport has generally been more expensive than rail transport, in some circumstances, the trucking industry can provide effective rate and service competition, because trucking requires smaller capital investments and maintenance expenditures and allows for more frequent and flexible scheduling.

     We believe that we may be able to capture freight traffic currently being carried by truck in part as a result of the following factors:

	•		Rail transport prices are generally lower than truck prices. This is due in part to the fact that less labor is required to haul cargo by rail.
	•		With our customer service structure and substantial capital improvements, we believe that we have created a customer oriented business which, together with our other competitive advantages, is making our freight services more attractive than those presently offered by trucking concerns.

     We also face competition from the other privatized railroads in Mexico, particularly from Ferromex. Ferromex and Ferrosur, which are currently under the common control of Grupo Mexico, together provide rail coverage nationwide (except for Laredo and Lázaro Cárdenas), and together own 50% of the share capital of FTVM and the Mexico City terminal. We have experienced, and continue to experience, competition from Ferromex. Ferromex’s rail lines link Mexico City with U.S. border crossings at Piedras Negras, Ciudad Juárez, Nogales and Mexicali and also serve the city of Guadalajara and the ports of Tampico on the Gulf of Mexico and Manzanillo on the Pacific Ocean. The Union Pacific Railroad owns a minority interest in Ferromex. Ferromex directly competes with us in some areas of our service territory, including Tampico and Mexico City. We experience aggressive price competition with Ferromex in freight rates. This rate competition has adversely affected and may continue to adversely affect our financial results. In addition, we encounter direct competition from Ferrosur on the Mexico City to Veracruz route.

     Under our concession, we are required to grant trackage rights to Ferromex, Ferrosur, two short line railroads and FTVM. These rights will give Ferromex more direct access to the Querétaro and Mexico City markets. In turn, the other railroads are required to grant rights to KCSM which will allow us to directly access the Guadalajara market, Mexico’s third largest industrial and commercial center, via Ferromex routes.

     The Mexican railroad services law and regulations and the concession contain various other provisions designed to introduce competition in the provision of railroad services. While the Mexican railroad services law and regulations allow us to establish our operating policies and freight service rates, we are subject to limited rate regulation in certain circumstances. With respect to freight services over our rail lines, the SCT may grant concessions to third parties or rights to other rail carriers additional to those set forth in the concession beginning in June 2027.

     Although we believe that services provided within our service territory by maritime transportation are generally complementary to our operations, we do face limited competition from the shipping industry with respect to certain products, including chemicals transported by barges.

     In February 2001, a NAFTA tribunal ruled in an arbitration between the U.S. and Mexico that the U.S. must allow Mexican trucks to cross the border and operate on U.S. highways. Under NAFTA, Mexican trucks were to have unrestricted access to highways in the U.S. border states by 1995 and full access to all U.S. highways by January 2000. However, the U.S. did not follow the timetable because of concerns over Mexico’s trucking safety standards. On March 14, 2002, as part of its agreement under NAFTA, the U.S. Department of Transportation issued safety rules that allow Mexican truckers to apply for operating authority to transport goods beyond the 20-mile commercial zones along the U.S.-Mexico border. These safety rules require Mexican carriers seeking to operate in the U.S. to pass, among other things, safety inspections, obtain valid insurance with a U.S. registered insurance company, conduct alcohol and drug testing for drivers and obtain a U.S. Department of Transportation identification number. Under the rules issued by the U.S. Department of Transportation, it was expected that the border would have been opened to Mexican carriers in 2002. However, in January 2003, in response to a lawsuit filed in May 2002 by a coalition of environmental, consumer and labor groups, the U.S. Court of Appeals for the Ninth Circuit in San Francisco issued a ruling which held that the rules issued by the U.S. Department of Transportation violated federal environmental laws because it had failed to adequately review the impact on air quality in the U.S. of rules allowing Mexican carriers to transport beyond the 20-mile commercial zones along the U.S.-Mexico border. The Court of Appeals ruling required the U.S. Department of Transportation to perform an Environmental Impact Statement of the Mexican truck plan and to certify compliance with the U.S. Clean Air Act requirements. The U.S. Department of Transportation subsequently requested the U.S. Supreme Court to review the Court of Appeals ruling and, on December 15, 2003, the U.S. Supreme Court granted the U.S. Department of Transportation’s request. On June 7, 2004, the U.S. Supreme Court unanimously overturned the Court of Appeals ruling. Although the U.S. Department of Transportation is no longer required to perform an Environmental Impact Statement under the U.S. Supreme Court’s ruling, the U.S. and Mexico must still complete negotiations regarding safety inspections before the border is opened. We cannot predict when these negotiations will be completed.

Government Regulation

   Railroad Regulation

     The Mexican railroad services law and regulations provide the overall general legal framework for the regulation of railroad services in Mexico. Under the Mexican railroad services law and regulations, a provider of railroad services, such as us, must operate under a concession granted by the SCT. Such a concession may only be granted to a Mexican corporation and may not be transferred or assigned without the approval of the SCT. The law permits foreign investors to hold up to 49.0% of the capital stock of such a corporation, unless a greater percentage of foreign investment is authorized by the Mexican Foreign Investment Commission. On October 5, 2004, KCS was notified by the Mexican Foreign Investment Commission of its approval of KCS’s acquisition of our indirect controlling owner. We are also subject to the Ley General de Bienes Nacionales (the General Law on National Assets), which regulates all assets that fall within the public domain and by various other laws and regulations.

     The SCT is principally responsible for regulating railroad services in Mexico. The SCT has broad powers to monitor our compliance with the concession and it can require us to supply it with any technical, administrative and financial information it requests. We must comply with the investment commitments established in our business plan, which forms an integral part of the concession, and must update the plan every five years. The SCT treats our business plans confidentially. The SCT monitors our compliance with efficiency and safety standards as set forth in the concession. The SCT reviews, and may amend, these standards every five years.

     The Mexican railroad services law and regulations provides the Mexican government certain rights in its relations with us under the concession, including the right to take over the management of KCSM and our railroad in certain extraordinary cases, such as imminent danger to national security. In the past, the Mexican government has used such a

power with respect to other privatized industries, including the telecommunications industry, to ensure continued service during labor disputes.

     In addition, under the concession and the Mexican railroad services law and regulations, the SCT, in consultation with the Mexican Antitrust Commission, under certain circumstances may determine that there is a lack of competition in the railroad industry, in which case the SCT would have the authority to set our rates for rail freight services.

   Environmental Regulation

     Our operations are subject to Mexican federal laws and regulations relating to the protection of the environment. The primary environmental law in Mexico is the General Law of Ecological Balance and Environmental Protection. The Mexican federal agency in charge of overseeing compliance with, and enforcing the federal environmental laws, is the Secretaría del Medio Ambiente y Recursos Naturales (Ministry of Environmental Protection and Natural Resources). The Procuraduría Federal de Protección al Ambiente (Attorney General for Environmental Protection) has the power to bring administrative proceedings and impose corrective actions and economic sanctions against companies that violate environmental laws, and temporarily or permanently close non-complying facilities. The Ministry of the Environment and Natural Resources and other authorized ministries have promulgated standards for, among other things, water discharge, water supply, emissions, noise pollution, hazardous substances, and transportation and handling of hazardous and solid waste. In addition, we are subject to the environmental laws and regulations issued by the governments of each of the states of Mexico where our facilities are located. The terms of the concession also impose on us certain environmental law compliance obligations.

     Noncompliance with applicable legal provisions may result in the imposition of fines, temporary or permanent shutdown of operations or other injunctive relief, criminal prosecution or the termination of our concession. We believe that all facilities that we operate are in substantial compliance with applicable environmental laws, regulations and agency agreements. There are currently no material legal or administrative proceedings pending against us with respect to any environmental matters, and management does not believe that continued compliance with environmental laws will have a material adverse effect on our financial condition or results of operations. We cannot predict the effect, if any, that the adoption of additional or more stringent environmental laws and regulations would have on our results of operations, cash flows or financial condition.

   Improvements, Maintenance and Repair

     We have entered into locomotive maintenance agreements with Alstom Transporte, S.A. de C.V. (“Alstom”), GE Transportation Systems México, S.A. de C.V. (“GE”) , GETS Locomotive Services, S.A. de C.V., and MPI Noreste, S.A. de C.V. (“MPI”) (which was acquired by GE), under which these contractors provide both routine maintenance and major overhauls. Routine maintenance includes periodic inspections, oils and lubricants, filters, maintenance of wheel profiles, compression and other engine checks and all repairs. Our locomotives are inspected in full compliance with those regulations as required by the U.S. Federal Railroad Administration (“FRA”), which enables our locomotives to operate in the U.S. pursuant to interchanges with major U.S. railroads. Major overhauls are performed every 600,000 to 1,000,000 miles for rebuilt locomotives, and every 756,000 to 1,000,000 miles or 26,000 to 28,000 Megawatts-Hour for new locomotives. Our maintenance contracts require that our locomotives be available for freight service 93.0% to 95% of the time.

     We believe that the outsourcing of our locomotive maintenance provides us with significant advantages by relieving us of locomotive maintenance requirements while allowing us to focus on implementing our operating initiatives in order to provide efficient and reliable rail service. By outsourcing we also avoid the need to incur the significant expenditures associated with locomotive maintenance facilities. Our locomotive maintenance contract with MPI expires in 2014, our maintenance contract with Alstom expires in 2009 and our contracts with GE expire in 2018.

     Our maintenance-of-way personnel coordinate the maintenance of our track, hiring third parties primarily to perform roadway repairs and track laying and surfacing. We may also purchase other maintenance-of-way services

from time to time, including when we lack in-house expertise to perform services or when the nature or location of the required maintenance work makes the hiring of third parties a cost-effective alternative to utilizing our personnel to perform such maintenance.

   Refurbishing of Our Route

     In May 2000, we entered into a track maintenance and rehabilitation agreement with Alstom pursuant to which it is providing both routine and major rehabilitation of our Celaya-Lázaro Cárdenas line, which comprises approximately 350 miles of track. In each of 2005 and 2004, our maintenance and rehabilitation expenses under this contract amounted to $3.4 million. Under this agreement, we are committed to paying a total of approximately $101.9 million for maintenance and rehabilitation of this route over a period of 12 years. As of December 31, 2005, we have paid $76.7 million under this agreement.

     Our capital improvements program is described in more detail under the caption “ Failure to make capital expenditures could result in the revocation of our concession and adversely affect our financial condition” under Item 1A, “Risk Factors,” and in the discussion of “Capital Expenditures and Divestitures” under Item 7, “Management’s Discussion and Analysis of Financial Conditions and Results of Operations,” of this Annual Report.

Insurance

     Our business is subject to a number of risks, including: (i) mechanical failure, (ii) collision, (iii) property loss, (iv) cargo loss or damage, and (v) business interruption due to natural disasters, political circumstances, hostilities and labor strikes. In addition, the operation of any railroad is subject to the inherent possibility of catastrophic disaster, including chemical spills and other environmental mishaps.

     Our present insurance coverage insures against the accident-related risks involved in the conduct of our business, and is consistent with industry practice and the requirements of the concession and the Mexican railroad services law and regulations. Our insurance policy also provides for “per-incident” maximum amounts which vary depending upon the nature of the risk insured against. Our policy is renewable on an annual basis and expires in June, 2006. The Mexican railroad services law and regulations provide that, if we receive insurance proceeds in respect of any damage to our rail lines, those proceeds shall be applied to the repair or remediation of such damage or, in the event that we elect not to undertake such repairs, these proceeds must be paid to the Mexican government.

Item 1A. Risk Factors.

Risk Factors Relating to Our Debt

Our substantial indebtedness could adversely affect our financial position and our ability to meet our obligations under our debt instruments.

     We have a substantial amount of debt and significant debt service obligations. As of December 31, 2005, we had total outstanding indebtedness of $908.2 million, consisting of (i) $102.1 million under a new credit facility dated October 24, 2005, or the New Credit Agreement, (ii) $788.4 million of senior unsecured indebtedness, (iii) $1.3 million of secured indebtedness, and (iv) $16.4 million fair value adjustment resulting from the push down accounting. Our stockholders’ equity was $1,155.7 million as of December 31, 2005, resulting in a debt to total capitalization ratio of 44.0%. On October 28, 2005, we refinanced our existing term loan indebtedness outstanding under a credit agreement dated June 24, 2004, or the 2004 Credit Agreement, by replacing the 2004 Credit Agreement with the New Credit Agreement. This transaction is

described in more detail in the discussion of “Recent Developments” under Item 7 of this Annual Report, “Management’s Discussion and Analysis of Financial Conditions and Results of Operations.”

     Our substantial indebtedness could interfere with our ability to pay interest and principal on our debt, and may have important consequences for our operations and capital expenditure requirements, including the following:

	•		we will have to dedicate a substantial portion of our cash flow from operations to the payment of principal, premium, if any, or interest on our debt, which will reduce funds available for other purposes;
	•		we may not be able to fund capital expenditures, working capital and other corporate requirements;
	•		we may not be able to obtain additional financing, or to obtain it at acceptable rates;
	•		our ability to adjust to changing market conditions and to withstand competitive pressures could be limited, and we may be vulnerable to additional risk if there is a downturn in general economic conditions or in our business;
	•		we may be exposed to risks in exchange rate fluctuations because any fluctuation of the Mexican peso relative to the dollar could impact our ability to service debt; and
	•		we may be at a competitive disadvantage compared to our competitors that have less leverage and greater operating and financing flexibility than we do.

Failure to comply with restrictive covenants in our existing contractual arrangements could accelerate our repayment obligations under our debt.

     The indentures relating to our outstanding debt securities and our New Credit Agreement contain a number of restrictive covenants, and any additional financing arrangements we enter into may contain additional restrictive covenants. Our New Credit Agreement contains covenants that are more restrictive than those contained in the indentures relating to our securities, including, but not limited to, certain financial covenants which require us to maintain specified financial ratios. These covenants restrict or prohibit many actions, including, but not limited to, our ability to incur debt, create or suffer to exist liens, make prepayments of particular debt, pay dividends, make investments, engage in transactions with stockholders and affiliates, issue capital stock, sell certain assets, and engage in mergers and consolidations or in sale-leaseback transactions.

     As a result of the covenants and restrictions contained in the indentures and in our New Credit Agreement, we are limited in how we conduct our business and we may be unable to compete effectively or to take advantage of new business opportunities. Any breach of these covenants could result in a default under the indentures and our New Credit Agreement.

     We cannot assure you that we will be able to remain in compliance with these covenants in the future and, if we fail to do so, that we will be able to obtain waivers from the appropriate parties and/or amend the covenants. At the same time, there are exceptions to many of these restrictive covenants, and we cannot give assurances that the limitations referred to above will apply in all circumstances.

Risk Factors Relating to Our Business

We may not be successful at reducing our operating costs and increasing our operating efficiencies.

     We must continue to reduce our operating costs and increase our operating efficiencies to achieve further cost savings in future periods. We cannot assure you that we will be able to achieve all of the cost savings that we expect to realize from current initiatives. In particular, we may be unable to implement one or more of our initiatives successfully or we may experience unexpected cost increases that offset the savings that we achieve. Our failure to realize cost savings may adversely affect our results of operations.

The Mexican government may revoke or limit our concession under a number of circumstances.

      We operate under a 50-year concession granted by the Mexican government. The Mexican government may terminate the concession if, among other things, there is an unjustified interruption of the operation of our rail lines, we charge tariffs higher than the tariffs we have registered, we restrict the ability of other Mexican rail operators to use our rail lines, we fail to make payments for damages caused during the performance of services, we fail to comply with any term or condition of the Ley Reglamentaria del Servicio Ferroviaria (Law Regulating Railroad Services, or Mexican railroad services laws and regulations), we fail to make the capital investments required under our five-year plan filed with the Mexican Secretaria de Comunicaciones y Transportes (Ministry of Communications and Transportation), or the SCT, or we fail to maintain an obligations compliance bond and the insurance coverage specified in the Mexican railroad services laws and regulations. In addition, the concession revokes automatically in the event we change our nationality or we assign, or create any lien on, the concession without the SCT’s approval.

      On April 6, 2006 and April 7, 2006, the SCT initiated sanction proceedings against us, claiming that we have failed in the years 2004 and 2005 to make the minimum capital investment projected under our five-year business plan filed with the SCT. We must answer the SCT’s letter of April 6 before May 2, and the letter of April 7 by May 4, 2006. In each case, we anticipate providing the SCT with arguments explaining our capital investment program and arguing that sanctions are not appropriate. If these proceedings are determined adversely to us and sanctions imposed, we would be subject to fines or possible revocation of the concession if the SCT imposes sanctions on three additional occasions over the remaining term of the concession.

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

      Mexican law requires that the Mexican government pay us compensation if it effects a statutory appropriation for reasons of the public interest. With respect to a temporary seizure due to any cause other than international war, the Mexican railroad services law and regulations provide that the Mexican government will indemnify an affected concessionaire for an amount equal to damages caused and losses suffered. However, these payments may not be sufficient to compensate us for our losses and may not be timely made.

Failure to make capital expenditures could result in the revocation of our concession and adversely affect our financial condition.

      Our business is capital intensive and requires substantial ongoing expenditures for, among other things, improvements to roadway, structures, technology, acquisitions, leases and repair of equipment and maintenance of our rail system. Our failure to make necessary capital expenditures could impair our ability to service our existing customers or accommodate increases in traffic volumes. In addition, our railroad concession from the Mexican government requires us to make ongoing investments and undertake capital projects in accordance with successive five-year business plans approved by the Mexican government.

      We have funded, and expect to continue to fund, capital expenditures with funds from operating cash flows, leases and, to a lesser extent, vendor financing. We may not be able to generate sufficient cash flows from our operations or obtain sufficient funds from external sources to fund our capital expenditure requirements. If financing is available, it may not be obtainable on terms acceptable to us and within the limitations contained in the indentures and other agreements relating to our debt. If we are unable to complete our planned capital improvement projects, our ability to service our existing customers or accommodate increases in our traffic volumes may be limited or impaired and our business plan commitments with the Mexican government may be at risk, requiring us to seek waivers to the business plan. We may defer capital expenditures with respect to such business plan with the permission of the SCT. However, the SCT might not grant this permission, and our failure to comply with our commitments in our business plan could result in the Mexican government revoking the concession. We cannot assure you that the Mexican government would grant us such waivers. If such waivers are not obtained and our concession is revoked, this would adversely affect our financial condition.

Significant competition from other railroads could adversely affect our financial condition.

      We face significant competition in some industry segments from other railroads, in particular Ferrocarril Mexicano, S.A. de C.V. , or Ferromex, the operator of the largest railway system in Mexico, which are in close proximity to our rail lines. In particular, we have experienced and continue to experience competition from Ferromex with respect to the transport of a variety of products. The rail lines operated by Ferromex run from Guadalajara and Mexico City to four

U.S. border crossings west of the Nuevo Laredo-Laredo crossing, providing an alternative to our routes for the transport of freight from those cities to the U.S. border. In addition, Ferromex directly competes with us in some areas of our service territory, including Tampico, Saltillo, Monterrey and Mexico City. Ferrosur S.A. de C.V. , or Ferrosur, which operates the Southeast Rail Lines, competes directly with us for traffic to and from southeastern Mexico. Ferrosur, like us, also serves Mexico City, Puebla and Veracruz.

     In November 2005, Grupo Mexico, the controlling shareholder of Ferromex, acquired all of the shares of Ferrosur. Grupo Mexico’s control of Ferromex and Ferrosur remains subject to approval of the Mexican Competition Commission. The common control of Ferromex and Ferrosur would give Grupo Mexico control over a nationwide railway system and ownership of 50% of the shares of the Mexico Valley Terminal and Railway Company.

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

     In recent years, there has also been significant consolidation among major North American rail carriers. The resulting merged railroads may attempt to use their size and pricing power to affect our access to efficient gateways and routing options that are currently and have been historically available. We cannot guarantee that further consolidation will not have an adverse effect on our financial condition.

Significant competition from trucks could adversely affect our financial condition.

     We also face significant competition from trucks. In the past, the trucking industry has significantly eroded the railroad’s market share of Mexico’s total overland freight transportation by providing effective rate and service competition. Trucking requires substantially smaller capital investments and maintenance expenditures than railroads and allows for more frequent and flexible scheduling. In addition, Mexican truckers are able to deliver to points in the U.S. under relaxed NAFTA rules. We cannot give assurances that we will not lose business in the future due to our inability to respond to competitive pressures by decreasing our prices without adversely affecting our gross margins and operational results.

     A material part of our projected revenue growth during the next few years is expected to result from increased truck-to-rail traffic conversion. There can be no assurance that we will have the ability to continue to convert traffic from truck to rail transport or that we will retain the customers that we have already converted. If the railroad industry, in general, and we, in particular, are unable to preserve competitive advantages vis-à-vis the trucking industry, our business plan may not be achieved and our financial condition could be adversely affected.

A significant percentage of our transportation revenues has historically been derived from the automotive industry, which has had difficulties in recent years.

     Our transportation revenues derived from the transport of automotive products declined to $115.7 million in 2005 from $119.8 million in 2004. General Motors, DaimlerChrysler and Ford Motor Co. were among our most significant customers, together representing approximately 14.4% of our total revenues in 2005. Our automotive revenues in 2005 decreased due to the continued recession in the North American automotive industry and the lack of demand for those automobile models manufactured in Mexico.

The rates for trackage rights set by the SCT may not adequately compensate us.

     Pursuant to our concession, we are required to grant rights to use portions of our tracks to Ferromex, Ferrosur and FTVM. The concession stipulates that Ferromex, Ferrosur and FTVM are required to grant to us rights to use portions of their tracks.

     Our concession classifies trackage rights as short trackage rights and long-distance trackage rights. Although all of these trackage rights have been granted under our concession, no railroad has actually operated under the long-distance trackage rights because the means of setting rates for usage and other related terms of usage have not been agreed upon.

Under the Mexican railroad services law and regulations, the rates that we may charge for rights to use our tracks must be agreed upon in writing between us and the party to which those rights are granted. However, if we cannot reach an agreement on rates with rail carriers entitled to trackage rights on our rail lines, the Mexican government is entitled to set the rates in accordance with Mexican law and regulations, which rates may not adequately compensate us.

     We have not been able to reach an agreement with Ferromex regarding rates each of us is required to pay the other for trackage rights, interline services and haulage rights. We and Ferromex are involved in civil, judicial and administrative proceedings in connection with the amounts payable to each other for interline services, haulage and trackage rights. Some of those procedures continue under litigation and therefore are pending final resolution. Any resolution of such procedures adverse to us could have a negative impact on our business and operations. See Item 3, “Legal Proceedings — Other Litigation — Disputes with Ferromex .” In addition, under the Mexican railroad services laws and regulations, acts or omissions that impede the activities of other concessionaires, including the use of trackage rights, may result in the revocation of our concession.

Downturns in the U.S. economy, Mexican economy, U.S.-Mexico trade, certain cyclical industries in which our customers operate, the global economy or fluctuations in the peso-dollar exchange rate could have adverse effects on our financial condition.

     Downturns in the U.S. or Mexican economy or in trade between the U.S. and Mexico will likely have adverse effects on our business and results of operations. Mexican exports to the U.S. of manufactured goods, beer, metals and minerals, automobiles, chemical and petrochemical products and other products, many of which we transport, are an important element of U.S.-Mexico trade. In addition, a significant portion of our business consists of imports into Mexico from the U.S. The level of our business activity depends heavily on the U.S. and Mexican economies and markets, the relative competitiveness of Mexican and U.S. products at any given time and on existing and new tariffs or other barriers to trade. For example, the recent downturn in the U.S. economy has had an adverse effect on our revenues in all product categories, particularly in the automotive segment. Future economic downturns may have a material adverse effect on our results of operations and our ability to meet our debt service obligations.

     Some of our customers operate in industries that experience cyclicality, including the agricultural, automotive, manufacturing and construction sectors. Any downturn in these sectors due to the effects of cyclicality or otherwise could have a material adverse effect on our operating results. Also, some of the products we transport have had a historical pattern of price cyclicality which has typically been influenced by the general economic environment and by supply and demand factors in the relevant markets. For example, global steel and petrochemical prices have decreased in the past. We cannot give assurances you that prices and demand for these products will not decline in the future, adversely affecting those industries and, in turn, our financial condition.

     Our business may also be adversely affected by downturns in the global economy or in particular regions of the global economy. In addition, fluctuations in the peso-dollar exchange rate could lead to shifts in the types and volumes of Mexican imports and exports as manufacturers and raw material suppliers seek to minimize the effect of exchange rate movements by seeking other markets for their business.

     Although a decrease in the level of exports of some of the commodities that we transport to the U.S. may be offset by a subsequent increase in imports of other commodities we haul into Mexico and vice versa, any offsetting increase might not occur on a timely basis, if at all. The level of U.S.-Mexico trade and the development of U.S.-Mexican trade negotiations or agreements in the future are beyond our control, and may result in a reduction of freight volumes or in an unfavorable shift in the mix of products and commodities we transport.

The Mexican government may restrict our ability to operate our concession on a profitable basis by setting tariffs for rail freight services.

     Under the concession and Mexican law, we may freely set our tariffs for rail freight services, but we must register our tariffs with the SCT before they become effective. Under the Mexican railroad services law and regulations, the SCT reserves the right to set tariffs if, in consultation with the Comisión Federal de Competencia (the Mexican Antitrust Commission), it determines that effective competition does not exist. The Mexican Antitrust Commission, however, has not published guidelines regarding the factors that constitute a lack

of competition. It is therefore unclear under what particular circumstances the Mexican Antitrust Commission would deem a lack of competition to exist. If the SCT intervenes and sets tariffs, the rates it sets may be too low to allow us to operate profitably.

Traffic congestion or similar problems experienced in the U.S. or Mexican railroad system may adversely affect our operations.

     Traffic congestion experienced in the U.S. railroad system may result in overall traffic congestion which would impact the ability to move traffic to and from Mexico and adversely affect our operations. This system congestion may also result in certain equipment shortages. Any similar congestion experienced by railroads in Mexico could have an adverse effect on our business and results of operations. In addition, the growth of cross-border traffic in recent years has contributed to congestion on the international bridge at the Nuevo Laredo-Laredo border gateway, which is expected to continue in the near future. This may adversely affect our business and results of operations.

Our business strategy, operations and growth rely significantly on third parties.

     Our operations are dependent on interchange agreements that we have negotiated with major U.S. railroads in the north, Ferromex in the west of Mexico and Ferrosur in the south of Mexico. We also have a terminal operations agreement with FTVM. In addition, we and each of the concessionaires of Ferromex and Ferrosur have a 25.0% interest in FTVM, and Ferromex and Ferrosur are currently under the common control of Grupo Mexico. These agreements enable us to exchange traffic and utilize trackage which is not part of our rail system, extending our network and providing us with strategically important rail links to the U.S. and to areas of Mexico that we do not directly serve. Our ability to provide comprehensive service to our customers depends in part on our ability to maintain these agreements with other railroads and third parties and our ability to take legal action in the Mexican Federal Courts to enforce such agreements on the grounds that the railroads are a public service governed by public interest laws. Our failure to maintain these agreements, the termination of these agreements, or failure to obtain the corresponding legal relief in due course, could adversely affect our business, financial condition and results of operations. The other parties to these agreements may not faithfully fulfill their obligations under their agreements or arrangements with us, and many of these other parties are or may become our competitors. Further, the failure of any of these parties to fulfill its obligations to us could adversely affect our financial condition and results of operations. In addition, we may not be able to coordinate our interchange and switching activities with these other concessionaires and railroads in an efficient manner. Inefficient coordination of our interchange and switching activities would negatively impact our operating results.

If our primary fuel supply contract is terminated, or if fuel prices substantially increase, our financial condition could be materially adversely affected.

     The locomotives we operate are diesel-powered, and our fuel expenses are a significant portion of our operating expenses. We meet, and expect to continue to meet, our fuel requirements almost exclusively through purchases at market prices from PEMEX. The contract with PEMEX may be terminated at any time by either party upon thirty days’ written notice to the other. If the contract is terminated and we are unable to acquire diesel fuel from alternative sources on acceptable terms, our financial condition could be materially adversely affected. In addition, since our fuel expense represents a significant portion of our operating expenses, significant increases in the price of diesel fuel could have a material adverse effect on our financial condition. In 2005, our average price of fuel per gallon increased by 43.9% from 2004, which in turn had increased 30.1% from 2003.

We face possible catastrophic loss and liability, and our insurance may not be sufficient to cover our damages or damages to others.

     The operation of any railroad carries with it an inherent risk of catastrophe, mechanical failure, collision and property loss. In the course of our operations, spills or other environmental mishaps, cargo loss or damage, business interruption due to political developments, as well as labor disputes, strikes and adverse weather conditions, could result in a loss of revenues or increased liabilities and costs. Collisions, environmental mishaps or other accidents can cause serious bodily injury, death and extensive property damage, particularly when such accidents occur in heavily populated areas. Additionally, our operations may be affected from time to time by natural disasters such as earthquakes, volcanoes, hurricanes or other storms. The occurrence of a major natural disaster, especially in the Mexico City area,

which is the site of FTVM and significant portions of our customer base, could have a material adverse effect on our operations and our financial condition. We have acquired insurance that is consistent with industry practice and consistent with the requirements of our concession against the accident-related risks involved in the conduct of our business and business interruption due to natural disaster. However, this insurance is subject to a number of limitations on coverage, depending on the nature of the risk insured against. This insurance may not be sufficient to cover our damages or damages to others, and this insurance may not continue to be available at commercially reasonable rates. Even with insurance, if any catastrophic interruption of service occurs, we may not be able to restore service without a significant interruption to operations and an adverse effect on our financial condition.

We face potential environmental liabilities.

     Our operations are subject to general Mexican federal and state laws and regulations relating to the protection of the environment. The Procuraduría Federal de Protección al Ambiente (Mexican Attorney General for Environmental Protection) is empowered to bring administrative proceedings and impose corrective actions and economic sanctions against companies that violate environmental laws, and temporarily or permanently close non-complying facilities. The Secretaría del Medio Ambiente y Recursos Naturales (Mexican Ministry of Environmental Protection and Natural Resources) and other ministries have promulgated compliance standards for, among other things, water discharge, water supply, air emissions, noise pollution, hazardous substances transportation and handling, and hazardous and solid waste generation.

     We are responsible for the costs of environmental compliance, associated with our ongoing operations. Pursuant to our concession, FNM is responsible for any environmental damage caused before the commencement of our operations, and both the Mexican government and FNM are required to indemnify us for any environmental liability relating to soil, subsoil or groundwater contamination arising from acts or omissions attributable to FNM that occurred before KCSM initiated operations in accordance with the concession title. However, the Mexican government is not obligated to compensate us for any expenses that we incur in complying with any amended environmental laws or regulations relating to our ongoing operations or activities that impose higher regulatory standards than those in effect on the date the concession was granted. We cannot predict the effect, if any, that the adoption of additional or more stringent environmental laws and regulations would have on our financial condition. Failure to comply with environmental obligations may result in the termination of our concession.

Terrorist activities and geopolitical events and their consequences could adversely affect our financial condition.

     Terrorist attacks may negatively affect our operations. The continued threat of terrorism within Mexico, the U.S. and elsewhere and the potential for military action and heightened security measures in response to such threat may cause significant disruption to commerce throughout the world, including restrictions on cross-border transport and trade. In addition, related political events may cause a lengthy period of uncertainty that may adversely affect our business. Political and economic instability in other regions of the world, including the U.S. and Canada, could negatively impact our operations. The consequences of terrorism and the responses are unpredictable and could have an adverse effect on our financial condition.

Renegotiation of terms of the labor agreement and any potential labor disruptions could adversely affect our financial condition.

     Approximately 71.0% of our employees are covered by a labor agreement, which was recently renewed and is effective for a two-year term ending in July 2007. The compensation terms of the labor agreement are subject to renegotiation on an annual basis and all other terms are renegotiated every two years. We may not be able to favorably negotiate the provisions of our labor agreement in the future and strikes, boycotts or other disruptions could occur.

     These renegotiated terms and any potential disruptions could have a material adverse effect on our financial condition and results of operations.

Risk Factors Relating to Mexico

Governmental policies and economic developments in Mexico and elsewhere may adversely affect our financial condition.

     All of our operations and assets are located in Mexico. As a result, our business is affected by the general condition of the economy, inflation, interest rates, political and other developments and events in Mexico. Mexico has experienced a period of slow economic growth in recent years, primarily as a result of the downturn in the U.S. economy. In 2001, Mexico’s gross domestic product, or GDP, decreased 0.2% while it increased in 2002, 2003 and 2004 by 0.8%, 1.4% and 4.4%, respectively. Mexico’s economy grew 3.3% in 2005 compared to 2004. We believe that economic slowdowns could negatively affect our financial condition.

Currency fluctuations may adversely affect our financial condition.

     Approximately 99% of our total consolidated indebtedness as of December 31, 2005, was U.S. dollar-denominated, whereas approximately 46% of our consolidated revenues were peso-denominated. Accordingly, we are affected by fluctuations in the value of the Mexican peso against the U.S. dollar and any depreciation or devaluation of the Mexican peso against the U.S. dollar results in net foreign exchange losses. In 2005, the Mexican peso appreciated against the U.S. dollar by approximately 4.5%. In 2004, the Mexican peso appreciated against the U.S. dollar by approximately 0.8%. In 2003, the Mexican peso depreciated by approximately 7.4% against the U.S. dollar, compared to depreciation of approximately 13.9% in 2002.

     Severe devaluation or depreciation of the Mexican peso may result in disruption of the international foreign exchange markets and may limit our ability to transfer or to convert Mexican pesos into U.S. dollars for the purpose of making timely payments of interest and principal on our non-peso-denominated indebtedness. Although the Mexican government currently does not restrict, and for many years has not restricted, the right or ability of Mexican or foreign persons or entities to convert Mexican pesos into U.S. dollars or transfer foreign currencies out of Mexico, the Mexican government could, as in the past, institute restrictive exchange rate policies that could limit our ability to transfer or convert Mexican pesos into U.S. dollars or other currencies for the purpose of making timely payments of our U.S. dollar-denominated debt and contractual commitments. Devaluation or depreciation of the Mexican peso against the U.S. dollar may also adversely affect U.S. dollar prices for our securities. Currency fluctuations are likely to continue to have an effect on our financial condition in future periods.

Inflation and interest rates may adversely affect our financial condition.

     Mexico’s annual rate of inflation was 4.4%, 5.7%, 4.0%, 5.2% and 3.3% for 2001, 2002, 2003, 2004 and 2005, respectively. Mexico has experienced much higher rates of inflation in certain prior year periods before 2001. High inflation rates can adversely affect our business and results of operations in the following ways:

	•		inflation can adversely affect consumer purchasing power, thereby adversely affecting demand for the products we transport;
	•		to the extent inflation exceeds our price increases, our prices and revenues will be adversely affected in “real” terms; and
	•		if the rate of Mexican inflation exceeds the rate of the depreciation of the Mexican peso against the dollar, our dollar-denominated sales will decrease in relative terms when stated in constant Mexican pesos.

     Interest rates on 28-day Certificados de la Tesorería de la Federación (Mexican treasury bills), or Cetes , averaged 11.3%, 7.1%, 6.2%, 6.8% and 9.2% for 2001, 2002, 2003, 2004 and 2005, respectively. High interest rates in Mexico may significantly increase our financing costs and thereby impair our financial condition, results of operations and cash flows.

     We performed an analysis under the guidance of FAS 52, “Foreign Currency Translation,” to determine whether the U.S. dollar or the Mexican peso should be used by us as our functional currency. Based on the results of this analysis, we concluded that the U.S. dollar is the appropriate functional currency for U.S. GAAP and SEC reporting purposes. We update the results of this analysis on an ongoing basis. If we were required to change our functional currency to Mexican pesos, our results of operations for U.S. GAAP and SEC reporting purposes may be substantially different. There can be no assurance that Mexico will not be classified as highly inflationary in the future, or that we will not be required to change our functional currency to Mexican pesos.

Political developments may adversely affect our business, financial condition and results of operations.

     Presidential and federal congressional elections in Mexico will be held in July 2006. The electoral process could lead to further friction among political parties and the executive branch officers, which could potentially cause political and economic instability. Additionally, once the President and representatives are elected, there could be significant changes in laws, public policies and government programs, which could have an adverse effect on our business, financial condition and results of operation.

     National politicians are currently focused on the 2006 elections and crucial reforms regarding fiscal and labor policies, gas, electricity, social security and oil have not been and may not be approved. The effects on the social and political situation in Mexico could adversely affect the Mexican economy, which in turn could have a material adverse effect on our business, financial condition and results of operations.

Item 1B. Unresolved Staff Comments.

     None.

     The portion of the Mexico City — Nuevo Laredo core route between Mexico City and Querétaro (approximately 143 miles) has double track, which accommodates greater traffic volume and maximum allowable speeds of approximately 50 mph. Our rail lines support a weight of 130 tons per railcar.

     We run freight trains at average speeds of approximately 25 to 50 mph along our core routes between Mexico City and the U.S. border. Approximately 85.0% of our main line track handles speeds of up to 37 mph.

     Installations along our rail lines include supply centers, locomotive inspection centers, car inspection areas, repair shops, warehouses, freight yards and intermodal terminals.

Bridges, Tunnels and Culverts

     Our core routes and feeder lines include 1,226 bridges having a total length of 15.7 miles of which 1,111 are permanent and 115 are temporary; 301 are steel structures, 810 are concrete structures and 115 have inverted floor systems made of timber or mixed components.

     There are 98 tunnels on our rail lines, having a total length of 16.7 miles, which are on our main lines and allow for the passage of double-stack trains. In addition, there are 7,273 culverts along the railway.

Equipment

     We own an estimated 23.0% of the railcars running over our rail lines and the remaining 77.0% are privately-owned, belonging to Mexican and foreign, mainly U.S., companies or railroads. Our fleet consists of 398 locomotives, of which 392 are diesel. Electro Motive Diesel built 168 and GE built 224 of these diesel locomotives. We are party to long-term lease for 75 AC-traction locomotives. Through our long-term leasing program, we are improving locomotive efficiency and utilization by adding to our fleet state-of-the-art locomotives that provide 40% to 47.0% more horsepower per unit, compared to our 3,000 horsepower road engines, and 38.5% more horsepower compared to our previous total horsepower base, allowing us to haul longer trains with fewer locomotives. We have continued a decrease in fuel consumption due primarily to the fuel efficiency of these new locomotives and the fact that fewer locomotives are needed to haul the same freight.

     Our long-term locomotive lease is for a term of 20 years. The average age of the locomotives in our fleet is approximately 19 years, which we believe is one of the youngest locomotive fleets operated by a Class I railroad. The average remaining useful life of the locomotives in our fleet is about 9 years.

     Of the 398 locomotives in our fleet, approximately 263 are assigned to the hauling of freight, 58 are used for yard work, 27 are used for industry switching and maintenance of way trains, 32 are running under a horsepower-per-hour interchange agreement, 6 are electric (and out of service), 8 are leased to some industries and 4 of our yard and road engines are currently in storage.

     The following table describes our locomotive fleet and maintenance contractors as of December 31, 2005.

     Railcars owned and leased by us as of December 31, 2005 consisted of the following:

     To supplement our fleet of owned railcars, we have implemented an operating lease program that allows us to effectively manage our railcar capacity to meet the varying demands of our traffic volumes. Our leased railcars consist of covered hoppers used to transport grain, new and rebuilt gondolas, box cars, open top hoppers, flat cars and tri-level and bi-level carriers. We also lease automobiles, large and small trucks and other equipment for a variety of functions.

Item 3. Legal Proceedings

Disputes with the Mexican Government

Settlement Relating to Value Added Tax Lawsuit, Commercial Lawsuit on Put Right

     On September 12, 2005, we, Grupo TFM, and KCS, along with Grupo TMM, entered into a settlement agreement with the Mexican government resolving and terminating the controversies and disputes between the companies and the Mexican government concerning the payment of a refund of the value added taxes (“VAT”) paid when the concession title and

certain other assets were transferred to the Company and Grupo TFM’s obligation to purchase of the remaining shares of us owned by the Mexican government (the “Put Litigation”). As a result of this settlement, KCS and its subsidiaries now own 100% of Grupo TFM and us, and the Mexican government’s remaining 20% ownership interest in us has been eliminated; the potential obligation of KCS, Grupo TFM and Grupo TMM to acquire the Mexican government’s remaining 20% interest in us has been eliminated; and the legal obligation of the Mexican government to issue the VAT refund to us has been satisfied. Part of the value of the VAT refund was used to purchase our shares owned by the Mexican government and to cover taxes related to the settlement. There was no cash payment made by any party under the settlement agreement. In addition, the parties have entered into mutual releases of all existing and potential claims relating to the VAT refund and the Put litigation, and have dismissed all of the existing litigation between the parties.

     Our published financial statements include legal disclosures with respect to the VAT refund claim, the Put Litigation and the 1997 Tax Audit. As a result of the September 12, 2005 settlement agreement, all pending litigation related to the VAT refund claim and the Put Litigation was dismissed. The 1997 Tax Audit was rendered null, void and of no legal effect when the Mexican government failed to assess any taxes or penalties as a result of the audit within the time allowed by Mexican law.

     As a result of the final resolution of our VAT claim, KCS made a contingency payment of up to $110.0 million to Grupo TMM in accordance with the terms of the December 15, 2004 Amended and Restated Acquisition Agreement in a combination of stock, notes and cash. The note in the amount of $40 million has been deposited into an escrow and remains subject to certain contingencies that may not expire until April 1, 2010.

     The following discussions provide additional background information related to the VAT claim, the Put Litigation and the 1997 Tax Audit.

Value Added Tax Lawsuit

     The VAT lawsuit, or the VAT claim, arose out of the Mexican Federal Treasury’s delivery of a VAT credit certificate to a Mexican governmental agency rather than to us in 1997. The face value of the VAT credit at issue is 2,111 million Mexican pesos, or approximately $196.0 million in US dollars, based on current exchange rates. The amount of the VAT refund would, in accordance with Mexican law, reflect the face value of the VAT credit adjusted for inflation and interest from 1997.

     On January 19, 2004, we received a Special Certificate from the Mexican Federal Treasury (the “Special Certificate”) in the amount of 2,111 million Mexican pesos. The Special Certificate delivered to us on January 19, 2004 had the same face amount as the original VAT refund claimed by us in 1997. We also filed a complaint against the Mexican government, seeking to have the amount of the Special Certificate adjusted to reflect interest and inflation in accordance with Mexican law. The Mexican Fiscal Court initially denied our claim. In a decision dated November 24, 2004, the Mexican Federal Appellate Court upheld our claim that we are entitled to inflation and interest from 1997 on the VAT refund. The Federal Appellate Court remanded the case to the Mexican Fiscal Court with instructions to enter a new order consistent with this decision. On January 26, 2005, the Mexican Fiscal Court issued from the bench an oral order implementing the Appellate Court decision. On February 18, 2005, we were served with the confirming written order from the Mexican Fiscal Court.

     On June 21, 2005, the Mexican Government filed an additional appeal seeking the Mexican Federal Appellate Court’s review of the written order issued by the Mexican Fiscal Court on February 18, 2005 in order to determine whether the Mexican Fiscal Court had properly carried out the November 24, 2004 decision of the Mexican Federal Appellate court. In a decision dated August 24, 2005, the Mexican Federal Appellate Court found that the Mexican Government’s appeal was not well founded.

     Under the terms of the January 31, 1997 share purchase agreement (as amended by the parties of June 9, 1997) through which Grupo TFM agreed to purchase the shares of us from the Mexican government (the “Share Purchase Agreement”), the Mexican government had the right to compel the purchase of its 20% interest in us (the “Put”) by Grupo TFM following its compliance with the terms and conditions of the Share Purchase Agreement. Upon exercise of

the Put in accordance with the terms of the Share Purchase Agreement, Grupo TFM would be obligated to purchase our capital stock at the initial share price paid by Grupo TFM, adjusted for interest and inflation. In October 2003, Grupo TFM filed suit in the Federal District Court of Mexico City seeking, among other things, a declaratory judgment interpreting whether Grupo TFM was obligated to honor its obligation under the Share Purchase Agreement, as the Mexican government had not made any effort to sell our shares subject to the Put prior to October 31, 2003. In its suit, Grupo TFM named Grupo TMM and KCS as additional interested parties. The Mexican court admitted Grupo TFM’s complaint. Grupo TFM also filed a suit seeking constitutional protection against the Mexican government exercising the Put, and that court issued an injunction that blocked the Mexican government from exercising the Put. The Mexican government provided Grupo TFM with notice of its intention to sell its interest in us on October 30, 2003. Grupo TFM responded to the Mexican government’s notice reaffirming its right and interest in purchasing the Mexican government’s remaining interest in KCSM, but also advising the Mexican government that it would not take any action until its lawsuit seeking a declaratory judgment was resolved. As a result of the settlement entered into with the Mexican government on September 12, 2005, all controversies relating to the Put have been resolved, all lawsuits related to the Put have been dismissed, and all obligations with respect to the Put have been satisfied.

Commercial Lawsuit on Put Right

     On December 3, 2004, the Mexican government filed a commercial lawsuit against us, Grupo TFM, Grupo TMM and KCS in a Mexican federal civil court. In the lawsuit, the Mexican government requested a finding from the court as to whether the defendants had complied with all of their legal obligations arising out of the process of privatization of FNM , including those related to the Put. As a result of the settlement entered into with the Mexican government on September 12, 2005, all controversies relating to the Put right have been resolved and the commercial lawsuit has been dismissed with prejudice.

1997 Tax Audit

     We were served on January 20, 2004 with an official letter (“Tax Audit Summary”) notifying us of the Mexican government’s preliminary findings and conclusions arising from its tax audit of our 1997 tax returns (the “1997 Tax Audit”). In the Tax Audit Summary, the Mexican government notified us of its preliminary conclusion that the documentation provided by us in support of the VAT refund claim and depreciation of our concession title, and the assets reported on our 1997 tax return did not comply with the formalities required by the applicable tax legislation. In addition, the Mexican government attached the Special Certificate received from the Mexican Federal Treasury in connection with our VAT refund claim pending resolution of the 1997 Tax Audit. We contested the conclusions of the Mexican tax authorities within the time allowed by the Tax Audit Summary. On March 16, 2005, we were notified by the Mexican Fiscal Administration Service ( Servicio de Administracion Tributaria (“SAT”)) that it had finished its audit of our 1997 tax returns. The SAT failed to assess taxes or penalties within the time allowed by law, rendering the tax audit null, void and without any legal effect.

Other Litigation

Disputes with Ferromex

      Disputes Relating to Payments for the use of Trackage and Haulage Rights and Interline Services. We and Ferromex both initiated administrative proceedings seeking a determination by the Secretaria de Communicaciones y Transportes (“Ministry of Communications and Transportation” or “SCT”) of the rates that we should pay each other in connection with the use of trackage and haulage rights and interline and terminal services. The SCT, on March 13, 2002, issued a ruling setting the rates for trackage and haulage rights. On August 5, 2002, the SCT issued a ruling setting the rates for interline and terminal services. We and Ferromex appealed both rulings and, following trial and appellate court decisions, the Mexican Supreme Court on February 24, 2006, in a ruling from the bench, sustained our appeal of the SCT’s trackage and haulage rights ruling, vacating the ruling and ordering the SCT to issue a new ruling consistent with the Court’s opinion. We have not yet received the written opinion of the Mexican Supreme Court relating to the decision announced on February 24, 2006, nor has the Mexican Supreme Court decided the interline and terminal services appeal. We believe that even if the rates set in 2002 become effective, there will be no material adverse effect on our results of operation.

      Disputes Relating to the Exercise of Trackage Rights. We and Ferromex are also parties to various civil cases involving disputes over the application and proper interpretation of the mandatory trackage rights, none of which we believe to be material individually or in the aggregate.

      Disputes Relating to the Scope of the Mandatory Trackage Rights. In August 2002, the SCT issued rulings determining Ferromex’s trackage rights in Monterrey and KCSM’s trackage rights in Altamira. We and Ferromex both appealed the SCT’s rulings. At the administrative federal court level, we obtained favorable rulings in both cases. Ferromex appealed these rulings. In connection with the Altamira proceedings, on August 10, 2005, an appellate court granted Ferromex’s appeal and ordered the Administrative Federal Court determined to vacate its prior resolution and issue a new resolution declaring as null and void the SCT’s determination that our trackage rights should include access to the Port of Altamira. In connection with the Monterrey proceedings, the case was remanded to the Administrative Federal Court with instructions to consider additional arguments before issuing its ruling. We are still awaiting that ruling but do not expect that ruling would have a material adverse effect on our results of operation.

 Miscellaneous legal proceedings

      Arrendadora Internacional, S.A.’s claim. In January 2004, Arrendadora Internacional, S.A. (“Arrendadora Internacional”), a company in the process of liquidation, filed a commercial lawsuit against FNM. FNM requested that we, Ferromex, Ferrosur and the SCT appear in the trial. Arrendadora Internacional claims that a certain lease agreement between Arrendadora Internacional and FNM executed in 1996, for the lease of 113 locomotives, was terminated in 2001 and therefore required (i) the return of the leased locomotives, (ii) the payment of rent from January 2001 to the date the locomotives were returned, and (iii) the payment of any damages caused to the locomotives. In the process of the privatization, and as explicitly authorized by Arrendadora Internacional, FNM subleased 70 of those 113 locomotives to us, giving us all rights and obligations under the lease with Arrendadora Internacional with respect to such locomotives. FNM subleased the remaining locomotives to Ferromex and Ferrosur. We answered the lawsuit in April 2004. The lawsuit’s first stage (primera instancia) is currently suspended pending an appeal by FNM in April 2005 challenging the court’s jurisdiction over the matter.

     On November 8, 2005, we entered into a purchase agreement with Arrendadora Internacional, pursuant to which we purchased the locomotives that were the subject of the dispute, effectively terminating the commercial lawsuit. The agreement was approved by the SCT as required by Mexican law relating to companies in liquidation.

     SCT Sanction Proceedings

      On April 6, 2006 and April 7, 2006, the SCT initiated sanction proceedings against us, arguing that we failed in the years 2004 and 2005 to make the capital investments projected under the five year plan filed with the SCT. We must answer the SCT’s letter of April 6 before May 2, 2006, and the letter of April 7 by May 4, 2006. In each case we anticipate providing the SCT with arguments explaining the Company’s capital investment program and arguing that it is not appropriate for the SCT to sanction the Company. We believe that even if the threatened SCT sanctions become effective, there will be no material adverse effect on the Company.

      Other. We are a party to various other legal proceedings and administrative actions arising in the ordinary course of business. Although it is impossible to predict the outcome of any legal proceeding or administrative action, in management’s opinion, such proceedings and actions should not, either individually or in the aggregate, have a material adverse effect on our financial condition or results of operations.