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 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”), and the unaudited condensed consolidated financial statements and related notes thereto included elsewhere in this Form 10-Q. 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. 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. We use technology to manage advanced automation, labor productivity, safety and the complex flow of goods within sophisticated logistics environments. 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. 22 The Separation On August 2, 2021, we 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 in accordance with generally accepted accounting principles in the United States of America (“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 carryover 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 is recorded within Selling, general and administrative expense; Depreciation and amortization expense; and Transaction and integration costs in the Condensed Consolidated Statements of Operations. The Company’s Condensed Consolidated Financial Statements include the accounts of GXO and its majority-owned subsidiaries and variable interest entities of which the Company is the primary beneficiary. The Company has eliminated intercompany accounts and transactions. We have a single reportable segment. Clipper Acquisition On May 24, 2022, the Company completed the acquisition of Clipper Logistics plc (“Clipper”), an omnichannel retail logistics specialist based in Leeds, England (the “Clipper Acquisition”). The Company acquired Clipper for $1,103 million, consisting of $900 million in cash and the issuance of 3,749,266 shares of GXO common stock having a value of $203 million. The Clipper Acquisition was subject to review by the Competition and Markets Authority in the United Kingdom (the “CMA”). On October 4, 2022, the CMA approved 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 Delayed Draw Term Loan; (iii) the Company entered into a Five-Year Term Loan; and (iv) the Company terminated its Bridge Term Loan. For additional information regarding the financing agreements entered into in connection with the Clipper Acquisition, see Note 7. Debt and Financing Arrangements. The Company included Clipper’s results of operations from the date of acquisition. For the three and nine months ended September 30, 2022, the Company recorded $239 million and $319 million of revenue, respectively, and $— million and $1 million of income before income taxes, respectively. 23 Results of Operations Three Months Ended September 30, (In millions) 2022 2021 $ Change % Change Revenue $ 2,287 $ 1,974 $ 313 16 % Direct operating expense 1,885 1,651 234 14 % Selling, general and administrative expense 227 171 56 33 % Depreciation and amortization expense 89 85 4 5 % Transaction and integration costs 14 29 (15) (52) % Restructuring costs and other — 2 (2) (100) % Operating income 72 36 36 100 % Other income, net 17 11 6 55 % Interest expense, net (6) (5) (1) 20 % Income before income taxes 83 42 41 98 % Income tax (expense) benefit (19) 31 (50) n/m Net income $ 64 $ 73 $ (9) (12) % n/m - not meaningful Three Months Ended September 30, 2022 compared with the Three Months Ended September 30, 2021 Revenue for the three months ended September 30, 2022 increased by 16%, or $313 million, to $2.3 billion, compared with $2.0 billion for the same period in 2021. Our North America, Asia and Pacific operations and European operations reported growth of 18% and 15%, respectively. The Clipper Acquisition contributed 16% to our European revenue and 10% to total revenue. Foreign currency movements decreased revenue by approximately 11% for the three months ended September 30, 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 September 30, 2022 was $1.9 billion, or 82% of revenue, compared with $1.7 billion, or 84% of revenue, for the same period in 2021. For the three months ended September 30, 2022, direct operating expenses primarily increased due to higher personnel and temporary labor costs of $131 million, higher facilities and transportation costs of $76 million and higher costs of materials and supplies of $16 million, these increases are mainly driven by the Clipper Acquisition. Selling, general and administrative expense (“SG&A”) primarily consists of salary and benefits for executive and administrative functions, professional fees and legal costs. SG&A for the three months ended September 30, 2022 increased by $56 million, to $227 million, compared with $171 million for the same period in 2021. SG&A for the three months ended September 30, 2022 increased compared with the same prior year period due to higher personnel costs, primarily for certain administrative functions and the Clipper Acquisition. Depreciation and amortization expense for the three months ended September 30, 2022 was $89 million, compared with $85 million for the same period in 2021. Depreciation and amortization expense included amortization of intangible assets of $21 million and $16 million for the three months ended September 30, 2022 and 2021, respectively. The increase was primarily due to higher depreciation and amortization from the Clipper Acquisition, partially offset by lower depreciation as a result of contract modifications in the prior year. Transaction and integration costs for the three months ended September 30, 2022 were $14 million, primarily related to the Clipper Acquisition and rebranding as a result of the Separation. Transaction and integration costs for the three months ended September 30, 2021 were $29 million, primarily related to the Separation. Restructuring costs and other for the three months ended September 30, 2022 and 2021 was not material. 24 Other income, net consists primarily of foreign exchange gains and losses, including foreign currency contracts, and pension income. Other income, net for the three months ended September 30, 2022 was $17 million compared with $11 million for the same period in 2021. For the three months ended September 30, 2022, the gain on foreign currency contracts was $9 million and pension income was $7 million. For the three months ended September 30, 2021, pension income was $10 million. Interest expense, net for the three months ended September 30, 2022 was $6 million compared with $5 million for the same period in 2021. For the three months ended September 30, 2022, interest expense primarily related to outstanding debt and capital lease obligations, partially offset by interest income on the cross-currency swap agreements. For the three months ended September 30, 2021, interest expense primarily related to debt issued in connection with the Separation, and related-party debt with XPO before the Separation, partially offset by interest income on the cross-currency swap agreements. Income before income taxes for the three months ended September 30, 2022 increased by $41 million, to $83 million, compared with $42 million for the same period in 2021. The increase was primarily due to growth in our business, lower transaction and integration costs, and other income from a pension plan and foreign currency contracts. Income tax for the three months ended September 30, 2022 was $19 million expense compared with $31 million benefit for the same period in 2021. Our effective tax rate was 22.5% for the three months ended September 30, 2022 compared with (72.5)% for the same period in 2021. The change in our effective tax rate was primarily driven by a discrete tax benefit from the initial recognition of a deferred tax asset in connection with the Separation. Nine Months Ended September 30, (In millions) 2022 2021 $ Change % Change Revenue $ 6,526 $ 5,678 $ 848 15 % Direct operating expense 5,408 4,725 683 14 % Selling, general and administrative expense 637 519 118 23 % Depreciation and amortization expense 242 259 (17) (7) % Transaction and integration costs 57 82 (25) (30) % Restructuring costs and other 14 5 9 n/m Operating income 168 88 80 91 % Other income, net 56 11 45 n/m Interest expense, net (19) (16) (3) 19 % Income before income taxes 205 83 122 n/m Income tax (expense) benefit (51) 21 (72) n/m Net income $ 154 $ 104 $ 50 48 % n/m - not meaningful Nine Months Ended September 30, 2022 compared with the Nine Months Ended September 30, 2021 Revenue for the nine months ended September 30, 2022 increased by 15%, or $848 million, to $6.5 billion, compared with $5.7 billion for the same period in 2021. For the nine months ended September 30, 2022, our North America, Asia and Pacific operations and European operations reported growth of 18% and 13%, respectively. The Clipper Acquisition contributed 7% to European revenue and 5% to total revenue. Foreign currency movements decreased revenue by approximately 8% for the nine months ended September 30, 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 nine months ended September 30, 2022 was $5.4 billion, or 83% of revenue, compared with $4.7 billion, or 83% of revenue for the same period in 2021. For the nine months ended September 30, 2022, direct operating expenses primarily increased due to higher personnel and temporary labor 25 expenses of $457 million, higher facilities and transportation costs of $171 million, and higher costs of materials and supplies of $43 million. SG&A primarily consists of salary and benefits for executive and administrative functions, professional fees and legal costs. SG&A for the nine months ended September 30, 2022 increased by $118 million, to $637 million, compared with $519 million for the same period in 2021. SG&A for the nine months increased compared with the same prior year period due to higher personnel costs, primarily for certain administrative functions. Depreciation and amortization expense for the nine months ended September 30, 2022 was $242 million, compared with $259 million for the same period in 2021. Depreciation and amortization expense included amortization of intangible assets of $48 million and $44 million for the nine months ended September 30, 2022 and 2021, respectively. The decrease was primarily a result of $15 million allocated corporate charges from XPO before the Separation in the prior year and lower depreciation as a result of contract modifications in the prior year, partially offset by higher depreciation and amortization from the Clipper Acquisition. Transaction and integration costs for the nine months ended September 30, 2022 were $57 million, primarily related to the Clipper Acquisition and rebranding as a result of the Separation. Transaction and integration costs for the nine months ended September 30, 2021 were $82 million, primarily related to the Separation. Restructuring costs and other for the nine months ended September 30, 2022 were $14 million. For the nine months ended September 30, 2022, restructuring costs and other included $8 million related to the deconsolidation of a joint venture and $6 million related to severance costs. Restructuring costs and other for the nine months ended September 30, 2021 were $5 million and related to severance costs. Other income, net consists primarily of foreign exchange gains and losses, including foreign currency contracts, and pension income. Other income, net for the nine months ended September 30, 2022 was $56 million compared with $11 million for the same period in 2021. For the nine months ended September 30, 2022, the gain on foreign currency contracts was $33 million and pension income was $25 million. For the nine months ended September 30, 2021, pension income was $10 million. Interest expense, net for the nine months ended September 30, 2022 was $19 million compared with $16 million for the same period in 2021. For the nine months ended September 30, 2022, interest expense primarily related to outstanding debt and capital lease obligations, partially offset by interest income on the cross-currency swap agreements. For the nine months ended September 30, 2021, interest expense primarily related to debt issued in connection with the Separation, related-party debt with XPO before the Separation, and capital lease obligations, partially offset by interest income on the cross-currency swap agreements. Income before income taxes for the nine months ended September 30, 2022 increased by $122 million, to $205 million, compared with $83 million for the same period in 2021. The increase was primarily due to growth in our business, lower transaction and integration costs, and other income from a pension plan and foreign currency contracts, partially offset by restructuring costs due to the deconsolidation of a joint venture. Income tax for the nine months ended September 30, 2022 was $51 million expense compared with $21 million benefit for the same period in 2021. Our effective tax rate was 24.7% for the nine months ended September 30, 2022 compared with (24.8)% for the same period in 2021. The change in our effective tax rate was primarily driven by a discrete tax benefit from the initial recognition of a deferred tax asset in connection with the Separation and non-deductible transaction cost, offset by deferred true-ups in 2022. 26 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 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. Debt and Financing Arrangements Five-Year Term Loan On May 25, 2022, we entered into a five-year unsecured Term Loan (the “Five-Year Term Loan”) that provided a $500 million unsecured term loan facility to fund the Clipper Acquisition. On May 26, 2022, we borrowed $500 million that will mature on May 26, 2027. The loan bears interest at a fluctuating rate per annum equal to, at our option, the alternate base rate or the adjusted Secured Overnight Financing Rate (SOFR), plus an applicable margin based on the Company’s credit ratings. Delayed Draw Term Loan On March 22, 2022, we entered into an unsecured delayed draw Term Loan (the “Delayed Draw Term Loan”) that provided a £375 million unsecured term loan facility to fund the Clipper Acquisition. The loan was available to us in U.S. dollars or British pounds sterling. On May 26, 2022, we borrowed in U.S. dollars a $165 million 2-year term loan tranche (the “Two-Year Term Loan”) and a $235 million 3-year term loan tranche (the “Three-Year Term Loan”) that will mature on May 26, 2024, and May 26, 2025, respectively. Loans bear interest at a fluctuating rate per annum equal to, at our option, the alternate base rate or the adjusted SOFR, plus an applicable margin based on the Company’s credit ratings. Bridge Term Loan On February 28, 2022, we entered into an unsecured Bridge Term Loan (the “Bridge Term Loan”) that provided a £745 million unsecured term loan facility to fund the Clipper Acquisition. The commitments under the Bridge Term Loan were terminated with the effectiveness of the Five-Year Term Loan and the Delayed Draw Term Loan. No amounts were drawn under the Bridge Term Loan. 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 September 30, 2022. 27 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. We also sold certain European trade accounts receivables 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 Condensed 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 Nine Months Ended September 30, September 30, (In millions) 2022 2021 2022 2021 Factoring agreements Receivables sold in period $ 259 $ 132 $ 716 $ 331 Cash consideration 258 132 714 331 Securitization program Receivables sold in period $ — $ 418 $ — $ 1,320 Cash consideration — 418 — 1,320 Covenants and Compliance As of September 30, 2022, we were in compliance with the covenants contained in our debt and financing arrangements. Financial Condition The following table summarizes our asset and liability balances as of September 30, 2022 and December 31, 2021: (In millions) September 30, 2022 December 31, 2021 $ Change % Change Total current assets $ 2,242 $ 2,099 $ 143 7 % Total long-term assets 6,564 5,172 1,392 27 % Total current liabilities 2,275 2,329 (54) (2) % Total long-term liabilities 3,932 2,552 1,380 54 % The increase in our assets and liabilities from December 31, 2021 to September 30, 2022 primarily reflects the assets acquired and liabilities assumed, as well as various debt instruments entered into in connection with the Clipper Acquisition. Cash Flow Activity Our cash flows from operating, investing and financing activities, as reflected on our Condensed Consolidated Statements of Cash Flows, were summarized as follows: Nine Months Ended September 30, (In millions) 2022 2021 $ Change % Change Net cash provided by operating activities $ 316 $ 251 $ 65 26 % Net cash used in investing activities (1,056) (140) (916) n/m Net cash provided by (used in) financing activities 863 (165) 1,028 n/m Effect of exchange rates on cash and cash equivalents (22) 1 (23) n/m Net increase (decrease) in cash and cash equivalents $ 101 $ (53) $ 154 n/m n/m - not meaningful 28 Operating Activities Cash flows from operating activities for the nine months ended September 30, 2022 increased by $65 million compared with the same period in 2021. The increase was due to $50 million higher net income in 2022 and $39 million non-cash adjustments driven by a deferred tax benefit in 2021, partially offset by a $24 million decrease in working capital. Investing Activities Investing activities used $1,056 million of cash for the nine months ended September 30, 2022, compared with $140 million used for the same period of 2021. During the nine months ended September 30, 2022, we used $874 million, net of cash received, to fund the Clipper Acquisition, used $239 million to purchase property and equipment, received $26 million in proceeds from the settlement of cross-currency swap agreements, excluding accrued interest, and received $22 million from sales of property and equipment. During the nine months ended September 30, 2021, we used $180 million to purchase property and equipment, received $34 million net cash from the Kuehne + Nagel acquisition, and received $8 million from sales of property and equipment. Financing Activities Financing activities generated $863 million of cash for the nine months ended September 30, 2022, compared with $165 million used for the same period of 2021. The primary sources of cash from financing activities in the nine months ended September 30, 2022, were $898 million in proceeds from long-term debt, net, partially offset by $23 million repayment of debt and finance leases and $12 million in payments for employee taxes on net settlement of equity awards. The primary uses of cash from financing activities in the nine months ended September 30, 2021, were $774 million of net transfers to XPO, $128 million in the purchase of noncontrolling interest, $64 million in repayments of debt and finance leases, and $21 million in repayment of debt related to a trade securitization program, partially offset by $794 million in proceeds from long-term debt. Off-Balance Sheet Arrangements We do not engage in any off-balance sheet financing 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 The Company’s contractual cash requirements have not changed materially since the 2021 Form 10-K, except for the new term loan credit agreements described above. 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. 29