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 on Form 10-Q 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, 2022, as filed with the SEC on February 16, 2023 (the “2022 Form 10-K”), and the unaudited condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on 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 the industry. We provide our customers with high-value-add warehousing and distribution, order fulfillment, e-commerce, reverse logistics and other supply chain services differentiated by our ability to deliver technology-enabled, customized solutions at scale. Our customers rely on us to move their goods with high efficiency through their supply chains — from the moment inbound goods arrive at our warehouses, 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 and warehousing services. We strive to provide all of our customers with consistently high levels of service and cutting-edge automation. We also collaborate with our largest customers on planning and forecasting and assist with network optimization, working with these customers to design or redesign their supply chains to meet specific goals, such as environmental, social and governance. 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 e-commerce and related sectors, including omnichannel retail and other direct-to-consumer channels. We expect to attract new customers and expand the services we provide to existing customers through new projects, thus earning more of their external and internal logistics spending. We use technology to manage advanced automation, labor productivity, sustainability, safety and the complex flow of goods within sophisticated warehouse environments. 17 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 long-term in nature, and our facility lease arrangements generally align with contract length. The Company has both fixed-price contracts and cost-plus contracts. Most of our customer contracts contain both fixed and variable components. The fixed component is typically designed to cover facility, technology and equipment costs, while the variable component is determined based on expected volumes and associated labor costs. Under fixed-price contracts (closed book or hybrid contracts), the Company agrees to perform the specified work for a pre-determined price. To the extent the Company’s actual costs vary from the estimates upon which the price was negotiated, the Company will generate more or less profit. Cost-plus contracts, or open book contracts, provide for the payment of allowable costs incurred during the performance of the contract plus a specified margin. 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”). Due to the Clipper Acquisition, comparisons in our results of operations between 2023 and 2022 are less meaningful. Results of Operations Three Months Ended March 31, (In millions) 2023 2022 $ Change % Change Revenue $ 2,323 $ 2,083 $ 240 12 % Direct operating expense 1,906 1,748 158 9 % Selling, general and administrative expense 258 190 68 36 % Depreciation and amortization expense 83 76 7 9 % Transaction and integration costs 13 19 (6) (32) % Restructuring costs and other 21 13 8 62 % Operating income 42 37 5 14 % Other income, net — 16 (16) (100) % Interest expense, net (13) (4) (9) n/m Income before income taxes 29 49 (20) (41) % Income tax expense (3) (11) 8 (73) % Net income $ 26 $ 38 $ (12) (32) % n/m - not meaningful Revenue for the three months ended March 31, 2023 increased by 12%, or $240 million, to $2.3 billion compared with $2.1 billion for the same period of 2022. The increase in 2023 compared to the prior period primarily reflects an increase of $224 million due to the Clipper Acquisition and growth in our business primarily driven by new contract implementations. Foreign currency movement decreased revenue by $100 million in 2023. Direct operating expenses comprise both fixed and variable expenses and consist of operating costs related to our logistics facilities, including personnel costs, 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, 2023 increased by 9%, or $158 million, to $1.9 billion compared with $1.7 billion for the same period in 2022. Direct operating expense increased primarily due to the Clipper Acquisition and growth in our business. As a percentage of revenue, direct operating expense for the three months ended March 31, 2023, was 82.0% compared with 83.9% for the same period in 2022. 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 March 31, 2023 increased by 36%, or $68 million, to $258 million compared with $190 million for the same period in 2022. SG&A increased due to the Clipper Acquisition and higher personnel costs, primarily for certain administrative functions, reflecting the growth in our business. 18 Depreciation and amortization expense for the three months ended March 31, 2023 increased by $7 million to $83 million compared with $76 million for the same period in 2022. Amortization expense was $17 million and $14 million for the three months ended March 31, 2023 and 2022, respectively. Depreciation and amortization expense increased primarily due to the Clipper Acquisition. Transaction and integration costs for the three months ended March 31, 2023 were $13 million compared with $19 million for the same period in 2022. Transaction and integration costs in the first quarter of 2023 and 2022 primarily relate to the Clipper Acquisition. Restructuring costs are primarily related to severance, including projects to optimize finance, human resource and information technology functions, and are not associated with customer attrition. Restructuring costs and other for the three months ended March 31, 2023 were $21 million compared with $13 million for the same period in 2022. In the fourth quarter of 2022, the Company initiated a restructuring plan designed to centralize certain processes and standardize operating structures. For the three months ended March 31, 2023, restructuring costs and other included severance charges of $15 million and impairment charges of $6 million as a result of closing certain corporate and administrative offices. For the three months ended March 31, 2022, restructuring costs and other included severance charges of $5 million and $8 million related to the deconsolidation of a joint venture. Other income decreased due to foreign currency movements and pension income. Other income, net was as follows: Three Months Ended March 31, (In millions) 2023 2022 $ Change % Change Net periodic pension income $ 2 $ 9 $ (7) (78) % Foreign currency: Realized foreign currency contracts gain (loss) (2) 2 (4) n/m Unrealized foreign currency contracts gain 1 6 (5) (83) % Foreign currency remeasurement loss (1) (1) — — % Total foreign currency gain (loss) $ (2) $ 7 $ (9) n/m Other income, net $ — $ 16 $ (16) (100) % n/m - not meaningful Interest expense increased primarily due to debt incurred for the Clipper Acquisition. Interest expense, net was as follows: Three Months Ended March 31, (In millions) 2023 2022 $ Change % Change Debt and capital leases $ 24 $ 9 $ 15 n/m Cross-currency swaps (8) (4) (4) 100 % Other (3) (1) (2) n/m Interest expense, net $ 13 $ 4 $ 9 n/m n/m - not meaningful Income before income taxes for the three months ended March 31, 2023 decreased to $29 million compared with $49 million for the same period in 2022. The decrease was primarily due to higher interest expense, lower pension income and a foreign currency loss, partially offset by higher operating income in 2023. Income tax expense for the three months ended March 31, 2023 was $3 million compared with $11 million for the same period in 2022. Our effective tax rate was 11.0% for the three months ended March 31, 2023, compared with 22.1% for the same period in 2022. The change in our effective tax rate was primarily driven by discrete tax benefits from the release of valuation allowances as it is more likely than not that the deferred income tax assets will be realized. 19 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. At March 31, 2023, we held cash and cash equivalents of $426 million, and we had $799 million of borrowing capacity available, net of letters of credit under our Revolving Credit Facility. On April 7, 2023, we repaid $35 million of our Two-Year Term Loan due 2024. 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. 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 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. Information related to the trade receivables sold was as follows: Three Months Ended March 31, (In millions) 2023 2022 Receivables sold in period $ 263 $ 229 Cash consideration 261 228 Net cash provided in operating cash flows (1) — 6 (1) The three months ended March 31, 2022 includes $124 million of cash provided by factoring programs, reduced by $118 million used in the securitization program that was terminated in the first quarter of 2022. Covenants and Compliance The covenants in the unsecured notes, term loans and revolving credit facilities, which are customary for financings of this type, limit the Company’s ability to incur indebtedness and grant liens, among other restrictions. In addition, the facilities require the Company to maintain a consolidated leverage ratio below a specified maximum. As of March 31, 2023, the Company was in compliance with the covenants contained in its debt and financing arrangements. 20 Financial Condition The following table summarizes our asset and liability balances: (In millions) March 31, 2023 December 31, 2022 $ Change % Change Total current assets $ 2,311 $ 2,428 (117) (5) % Total long-term assets 6,779 6,791 (12) — % Total current liabilities 2,421 2,532 (111) (4) % Total long-term liabilities 3,950 4,009 (59) (1) % The decrease in total assets and total liabilities from December 31, 2022 to March 31, 2023 primarily reflects the seasonality of our business. 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) 2023 2022 $ Change % Change Net cash provided by operating activities $ 39 $ 46 $ (7) (15) % Net cash used in investing activities (82) (44) (38) 86 % Net cash used in financing activities (29) (18) (11) 61 % Effect of exchange rates on cash and cash equivalents 3 (5) 8 n/m Net decrease in cash and cash equivalents $ (69) $ (21) $ (48) n/m n/m - not meaningful Operating Activities Cash flows provided by operating activities for the three months ended March 31, 2023, decreased by $7 million compared with the same period in 2022, primarily due to lower net income, net of non-cash expenses. Investing Activities Investing activities used $82 million of cash for the three months ended March 31, 2023, compared with $44 million used for the same period of 2022. During the three months ended March 31, 2023, we used $91 million of cash to purchase property and equipment and received $9 million of cash from sales of property and equipment. During the three months ended March 31, 2022, we used $65 million of cash to purchase property and equipment, received $14 million from the release of an escrow related to the Kuehne + Nagel acquisition and received $3 million of cash from sales of property and equipment. Financing Activities Financing activities used $29 million of cash for the three months ended March 31, 2023, including $21 million used to repay debt, $8 million to repay finance lease obligations and $4 million in payments for employee taxes on net settlement of equity awards. Financing activities used $18 million of cash for the three months ended March 31, 2022, including $11 million in payments for employee taxes on net settlement of equity awards and $9 million to repay finance lease obligations. 21 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, 2023, the Company’s contractual obligations had not materially changed compared with December 31, 2022. Critical Accounting Policies and Estimates There have been no material changes to the critical accounting policies and estimates as previously disclosed in “Critical Accounting Policies” in Part II, Item 7 of our Form 10-K for the year ended December 31, 2022. Accounting Pronouncements Information related to new accounting standards is included in Note 1 — Basis of Presentation and Significant Accounting Policies in Part I, Item 1 of this Quarterly Report on Form 10-Q. 22