GXO Logistics, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Cautionary Statement Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q and other written reports and oral statements we make from time to time contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements other than statements of historical fact are, or may be deemed to be, forward-looking statements. In some cases, forward-looking statements can be identified by the use of forward-looking terms such as “anticipate,” “estimate,” “believe,” “continue,” “could,” “intend,” “may,” “plan,” “potential,” “predict,” “should,” “will,” “expect,” “objective,” “projection,” “forecast,” “goal,” “guidance,” “outlook,” “effort,” “target,” “trajectory” or the negative of these terms or other comparable terms. However, the absence of these words does not mean that the statements are not forward-looking. These forward-looking statements are based on certain assumptions and analyses made by the Company in light of its experience and its perception of historical trends, current conditions and expected future developments, as well as other factors it believes are appropriate in the circumstances. These forward-looking statements are subject to known and unknown risks, uncertainties and assumptions that may cause actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Factors that might cause or contribute to a material difference include those discussed below and the risks discussed in the Company’s other filings with the Securities and Exchange Commission (the “SEC”). All forward-looking statements set forth in this Quarterly Report are qualified by these cautionary statements, and there can be no assurance that the results or developments anticipated by the Company will be realized or, even if substantially realized, that they will have the expected consequence to or effects on the Company or its business or operations. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021, as filed with the SEC on February 17, 2022 (the “2021 Form 10-K”). Business Overview GXO Logistics, Inc., together with its subsidiaries (“GXO,” the “Company” or “we”), is the largest pure-play contract logistics provider in the world and a foremost innovator in an industry propelled by strong secular tailwinds. Our customers rely on us to move their goods with high efficiency through their supply chains — from the moment inbound goods arrive at our logistics sites, through fulfillment and distribution and the management of returned products. Our customer base includes many blue-chip leaders in sectors that demonstrate high growth and/or durable demand, with significant growth potential through customer outsourcing of logistics services. We strive to provide all of our customers with consistently high levels of service and cutting-edge automation managed by our proprietary technology. We also collaborate with our largest customers on planning and forecasting and provide assistance with network optimization, working with these customers to design or redesign their supply chains to meet specific goals, such as sustainability metrics. Our multidisciplinary, consultative approach has led to many of our key customer relationships extending for years and expanding in scope. The most dramatic growth in secular demand in recent years has been in ecommerce and related sectors, including omnichannel retail and other direct-to-consumer channels. As part of our growth strategy, we intend to develop additional business in consumer and other verticals where we already have deep expertise, prominent customer relationships and a strong track record of successful performance. We also intend to expand into new verticals by leveraging our capacity and technological strengths and by marketing the benefits of our proprietary platform for warehouse operations. We use technology to manage advanced automation, labor productivity, safety and the complex flow of goods within sophisticated logistics environments. 18 Our business model is asset-light and historically resilient in cycles, with high returns, strong free cash flow and visibility into revenue and earnings. The vast majority of our contracts with customers are multi-year agreements, and our facility lease arrangements generally align with contract length. Most of our customer contracts contain both fixed and variable components. The fixed component is typically designed to cover facility, technology and equipment costs and may cover management costs, while the variable component is determined based on expected volumes and associated labor costs. The Separation On August 2, 2021, the Company completed the separation from XPO Logistics, Inc. (“XPO”) (the “Separation”). Prior to the Separation, the Company’s financial statements were prepared on a standalone combined basis and were derived from the consolidated financial statements and accounting records of XPO. On August 2, 2021, the Company became a standalone publicly-traded company, and its financial statements post-Separation are prepared on a consolidated basis. The combined consolidated financial statements for all periods presented prior to the Separation are now also referred to as “condensed consolidated financial statements” and have been prepared under GAAP. Prior to the Separation, the Company’s historical assets and liabilities presented were wholly owned by XPO and were reflected on a historical cost basis. In connection with the Separation, the Company’s assets and liabilities were transferred to the Company on a carry-over basis. Prior to the Separation, the historical results of operations included allocations of XPO costs and expenses, including XPO’s corporate function, which incurred a variety of expenses including, but not limited to, information technology, human resources, accounting, sales and sales operations, procurement, executive services, legal, corporate finance and communications. An allocation of these expenses is included to burden all business units comprising XPO’s historical results of operations, including GXO. The charges reflected have been either specifically identified or allocated using drivers including proportional adjusted earnings before interest, taxes, depreciation and amortization, which include adjustments for transaction and integration costs, as well as restructuring costs and other adjustments, or headcount. The majority of these allocated costs are recorded within Selling, general and administrative expense; Depreciation and amortization expense; and Transaction and integration costs in the Consolidated Statements of Operations. The Company’s consolidated financial statements include the accounts of GXO Logistics, Inc. and its majority-owned subsidiaries and variable interest entities where the Company is the primary beneficiary. The Company has eliminated intercompany accounts and transactions. The Company has a single reportable segment. Clipper Acquisition On February 28, 2022, the Company and the board of directors of Clipper Logistics plc, a retail logistics company based in Leeds, England (“Clipper”), reached an agreement on the terms of a cash and share offer by the Company for the acquisition of the entire issued ordinary share capital of Clipper for approximately £1.0 billion (approximately $1.3 billion) (the “Clipper Acquisition”). In connection with the Clipper Acquisition, (i) the Company and Clipper entered into a Cooperation Agreement, (ii) the Company entered into a Bridge Term Loan Credit Agreement and (iii) the Company entered into a Term Loan Credit Agreement. In April 2022, the Clipper Acquisition was approved by Clippers’ shareholders. 19 Results of Operations Three Months Ended March 31, (In millions) 2022 2021 $ Change % Change Revenue $ 2,083 $ 1,822 $ 261 14 % Direct operating expense 1,748 1,520 228 15 % Selling, general and administrative expense 190 171 19 11 % Depreciation and amortization expense 76 79 (3) (4) % Transaction and integration costs 19 18 1 6 % Restructuring costs and other 13 4 9 n/m Operating income 37 30 7 23 % Other income, net 16 1 15 n/m Interest expense, net (4) (5) 1 (20) % Income before income taxes 49 26 23 88 % Income tax expense (11) (9) (2) 22 % Net income $ 38 $ 17 $ 21 124 % n/m - not meaningful Revenue for the three months ended March 31, 2022, increased by 14%, or $261 million, to $2.1 billion compared with $1.8 billion for the same period in 2021. For the three months ended March 31, 2022, our North America, Asia and Pacific operations reported growth of 15% and our European operations reported growth of 14%. Foreign currency movement decreased revenue by approximately 5% for the three months ended March 31, 2022. Direct operating expenses comprise both fixed and variable expenses and consist of operating costs related to our logistics facilities, including personnel costs and facility and equipment expenses, such as rent, utilities, equipment maintenance and repair, transportation costs, costs of materials and supplies and information technology expenses. Direct operating expense for the three months ended March 31, 2022 increased by 15%, or $228 million, to $1.7 billion compared with $1.5 billion for the same period in 2021. As a percentage of revenue, direct operating expense for the three months ended March 31, 2022, was 84% compared with 83% for the same period in 2021. Direct operating expense increased primarily due to higher personnel and temporary labor expense of $180 million, as well as higher third-party facilities and transportation costs of $42 million. Selling, general and administrative expense (“SG&A”) primarily consists of salary and benefits for executive and administration functions, professional fees and legal costs. SG&A for the three months ended March 31, 2022, increased by 11%, or $19 million, to $190 million compared with $171 million for the same period in 2021. SG&A increased due to higher personnel costs, primarily for certain administration functions, reflecting the growth in our business. Depreciation and amortization expense for the three months ended March 31, 2022, decreased by $3 million to $76 million compared with $79 million for the same period in 2021. Depreciation and amortization expense included the amortization of intangible assets of $14 million for both the three months ended March 31, 2022, and 2021. For the three months ended March 31, 2021, depreciation expense included $6 million allocated from XPO before the Separation. Transaction and integration costs for the three months ended March 31, 2022, were $19 million compared with $18 million for the same period in 2021. Transaction and integration costs in 2022 relate to the Clipper Acquisition and transaction and integration costs in 2021 primarily relate to the Separation. Restructuring costs and other for the three months ended March 31, 2022, were $13 million compared with $4 million for the same period in 2021. For the three months ended March 31, 2022, restructuring costs and other included $5 million primarily related to severance costs and $8 million related to the deconsolidation of a joint venture. 20 Other income, net consists primarily of pension income and foreign exchange gains and losses. Other income, net for the three months ended March 31, 2022, was $16 million compared with $1 million for the same period in 2021. For the three months ended March 31, 2022, pension income was $9 million and the gain on foreign currency options was $8 million. Interest expense, net for the three months ended March 31, 2022, was $4 million compared with $5 million for the same period in 2021. For the three months ended March 31, 2022, interest expense primarily relates to debt issued in 2021 and capital lease obligations, partially offset by interest income on the cross-currency swap agreements. For the three months ended March 31, 2021, interest expense primarily relates to related-party debt obligations with XPO before the Separation and capital lease obligations. Income before income taxes for the three months ended March 31, 2022, increased by $23 million to $49 million compared with $26 million for the same period in 2021. The increase was primarily due to higher revenue and increased other income as a result of pension income and foreign currency options, partially offset by the deconsolidation of a joint venture. Income tax expense for the three months ended March 31, 2022, was $11 million compared with a $9 million expense for the same period in 2021. Our effective tax rate was 22.1% for the three months ended March 31, 2022, compared with 33.4% for the same period in 2021. The effective tax rates for the first quarters of 2022 and 2021 were based on forecasted full-year effective tax rates, adjusted for discrete items that occurred within the periods presented. The effective tax rate for the first quarter of 2022 was driven by pre-tax losses in certain jurisdictions for which no benefit was recognized and offset by discrete items having a tax benefit of $3 million from stock-based compensation. The effective tax rate for the first quarter of 2021 was driven by pre-tax losses in certain jurisdictions for which no benefit was recognized and discrete items having a tax expense of $2 million for adjustment of prior period taxes offset by a tax benefit of $2 million from stock-based compensation. Liquidity and Capital Resources Our ability to fund our operations and anticipated capital needs is reliant upon the generation of cash from operations, supplemented as necessary by periodic utilization of our revolving credit facility. Our principal uses of cash in the future will be primarily to fund our operations, working capital needs, capital expenditures, repayment of borrowings and strategic business development transactions. The timing and magnitude of our start-ups can vary and may positively or negatively impact our cash flows. We continually evaluate our liquidity requirements and capital structure in light of our operating needs, growth initiatives and capital resources. We believe that our existing liquidity and sources of capital are sufficient to support our operations over the next 12 months. Term Loan Credit Agreement On March 22, 2022, we entered into a Term Loan Credit Agreement that provides a £375 million ($493 million as of March 31, 2022) unsecured term loan facility, which will fund the Clipper Acquisition. The Term Loan Credit Agreement consists of two delayed draw term loans of £187.5 million ($246 million as of March 31, 2022) each. The loans may be borrowed in multiple draws beginning on the acquisition date. The loans mature on the second and third anniversary following the funding date, respectively. Loans under the Term Loan Credit Agreement bear interest at a fluctuating rate per annum equal to (a) with respect to borrowings in U.S. dollars, at our option, the alternate base rate or the adjusted secured overnight financing rate and (b) with respect to borrowings in British Pounds Sterling, the daily simple Sterling Overnight Interbank Average rate (“SONIA”), in each case, plus an applicable margin based on the Company’s credit ratings. 21 Bridge Term Loan Credit Agreement On February 28, 2022, we entered into a Bridge Term Loan Credit Agreement that provided a £745 million ($979 million as of March 31, 2022) unsecured term loan facility for the Clipper Acquisition. The Bridge Term Loan Credit Agreement matures 364 days after an advance. Loans under the Bridge Term Loan Credit Agreement bear interest at the daily simple SONIA rate plus an applicable margin calculated based on the Company’s credit ratings. Interest will be paid in arrears, initially on the three-month anniversary of the acquisition closing date and thereafter on the date that is three months following the previous payment date. Concurrently with the effectiveness of the Term Loan Credit Agreement, we reduced commitments under the Bridge Term Loan Credit Agreement by the aggregate amount of commitments under the Term Loan Credit Agreement. Unsecured Notes In 2021, we completed an offering of $800 million aggregate principal amount of notes, consisting of $400 million of notes due 2026 (the “2026 Notes”) and $400 million of notes due 2031 (the “2031 Notes”). The 2026 Notes bear interest at a rate of 1.65% per annum payable semiannually in cash in arrears on January 15 and July 15 of each year, beginning January 15, 2022, and maturing on July 15, 2026. The 2031 Notes bear interest at a rate of 2.65% per annum payable semiannually in cash in arrears on January 15 and July 15 of each year, beginning January 15, 2022, and maturing on July 15, 2031. Revolving Credit Facility In 2021, we entered into a five-year unsecured multi-currency Revolving Credit Facility (the “Revolving Credit Facility”). The Revolving Credit Facility provides commitments of up to $800 million, of which $60 million is available for the issuance of letters of credit. No amounts were outstanding under the Revolving Credit Facility as of March 31, 2022. Sales of Certain Receivables We sell certain of our trade accounts receivables on a non-recourse basis to third-party financial institutions under various factoring agreements. The Company also sold certain European trade accounts receivable under a securitization program. In the first quarter of 2022, we terminated our securitization program.We account for these transactions as sales of receivables and present cash proceeds as cash provided by operating activities in the Consolidated Statements of Cash Flows. We use the sale of certain receivables to help manage our working capital. Information related to the trade receivables sold was as follows: Three Months Ended March 31, (In millions) 2022 2021 Factoring agreements Receivables sold in period $ 229 $ 100 Cash consideration 228 100 Securitization program Receivables sold in period $ — $ 428 Cash consideration — 428 Covenants and Compliance As of March 31, 2022, we were in compliance with the covenants contained in our debt and financing arrangements. 22 Financial Condition The following table summarizes our asset and liability balances as of March 31, 2022 and December 31, 2021: (In millions) March 31, 2022 December 31, 2021 $ Change % Change Total current assets $ 2,030 $ 2,099 (69) (3) % Total long-term assets 5,096 5,172 (76) (1) % Total current liabilities 2,122 2,329 (207) (9) % Total long-term liabilities 2,629 2,552 77 3 % There were no significant changes in our total assets and total liabilities from December 31, 2021 to March 31, 2022. Cash Flow Activity Our cash flows from operating, investing and financing activities, as reflected on our Condensed Consolidated Statements of Cash Flows, are summarized as follows: Three Months Ended March 31, (In millions) 2022 2021 $ Change % Change Net cash provided by operating activities $ 46 $ 47 $ (1) (2) % Net cash used in investing activities (44) (38) (6) 16 % Net cash provided by (used in) financing activities (18) 80 (98) (123) % Effect of exchange rates on cash and cash equivalents (5) (3) (2) 67 % Net increase (decrease) in cash and cash equivalents $ (21) $ 86 $ (107) (124) % Operating Activities Cash flows from operating activities for the three months ended March 31, 2022, decreased by $1 million compared with the same period in 2021. The decrease is due to a $28 million decrease in working capital, offset by a $21 million increase in net income. Investing Activities Investing activities used $44 million of cash for the three months ended March 31, 2022, compared with $38 million used for the same period of 2021. During the three months ended March 31, 2022, we used $65 million of cash to purchase property and equipment and received $3 million of cash from sales of property and equipment. During the three months ended March 31, 2021, we used $67 million of cash to purchase property and equipment, received $20 million in connection with the purchase and sale of affiliate trade receivables and received $9 million from the Kuehne + Nagel acquisition. Financing Activities Financing activities used $18 million of cash for the three months ended March 31, 2022, including a $9 million use of cash to repay debt and finance leases. Financing activities generated $80 million of cash for the three months ended March 31, 2021. The primary sources of cash from financing activities in the three months ended March 31, 2021, were $138 million of net transfers from XPO, partially offset by a $25 million repayment of debt related to securitization transactions and $26 million used to repay debt and finance leases. 23 Off-Balance Sheet Arrangements We do not engage in any off-balance sheet financial arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. Contractual Obligations As of March 31, 2022, the Company’s future contractual obligations had not materially changed as compared with December 31, 2021. Critical Accounting Policies and Estimates Preparation of our condensed consolidated financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of certain assets, liabilities, revenues and expenses, as well as related disclosure of contingent assets and liabilities. There have been no material changes to the critical accounting policies and estimates as previously disclosed in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2021, and that are hereby incorporated by reference. Accounting Pronouncements Information related to new accounting standards is included in Note 1—Basis of Presentation and Significant Accounting Policies to the condensed consolidated financial statements.