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 customers with consistent quality 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. 20 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 warehouse lease arrangements generally align with contract length. The Company has both fixed-price contracts (closed book or hybrid contracts) and cost-plus contracts (open book contracts). Most of our customer contracts contain both fixed and variable components. The fixed component is typically designed to cover warehouse, technology and equipment costs, while the variable component is determined based on expected volumes and associated labor costs. Under fixed-price 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 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 September 30, 2023 Compared with the Three Months Ended September 30, 2022 Three Months Ended September 30, (In millions) 2023 2022 $ Change % Change Revenue $ 2,471 $ 2,287 $ 184 8 % Direct operating expense 2,012 1,885 127 7 % Selling, general and administrative expense 258 227 31 14 % Depreciation and amortization expense 101 89 12 13 % Transaction and integration costs 3 14 (11) (79) % Restructuring costs and other 7 — 7 n/m Operating income 90 72 18 25 % Other income, net 7 17 (10) (59) % Interest expense, net (14) (6) (8) n/m Income before income taxes 83 83 — — % Income tax expense (15) (19) 4 (21) % Net income $ 68 $ 64 $ 4 6 % n/m - not meaningful Revenue for the three months ended September 30, 2023, increased by 8%, or $184 million, to $2.5 billion compared with $2.3 billion for the same period in 2022. The increase in 2023 compared to the prior period primarily reflects growth in our Continental Europe and United Kingdom and Ireland operations. Foreign currency movement increased revenue by $126 million for the three months ended September 30, 2023 compared with the prior period. Direct operating expense is comprised of both fixed and variable expenses and consist of operating costs related to our warehouses, including personnel costs, rent expenses, utility costs, equipment maintenance and repair costs, transportation costs, costs of materials and supplies and information technology expenses. Direct operating expense for the three months ended September 30, 2023, increased by 7%, or $127 million, to $2.0 billion compared with $1.9 billion for the same period in 2022. Direct operating expense increased primarily due to higher personnel and temporary labor expenses and higher facilities and equipment expense. As a percentage of revenue, direct operating expense for the three months ended September 30, 2023, was 81.4% compared with 82.4% 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 September 30, 2023, 21 increased by 14%, or $31 million, to $258 million compared with $227 million for the same period in 2022. SG&A increased due to higher personnel costs, primarily for certain administrative functions, and higher bad debt expense. Depreciation and amortization expense for the three months ended September 30, 2023 increased by $12 million to $101 million compared with $89 million for the same period in 2022. Amortization expense was $18 million and $21 million for the three months ended September 30, 2023 and 2022, respectively. The increase in depreciation and amortization expense was primarily related to increased depreciation expense due to the impact of prior capital investments associated with new contracts. Transaction and integration costs for the three months ended September 30, 2023 were $3 million and primarily related to the acquisition of PFSweb, Inc. Transaction and integration costs for the three months ended September 30, 2022 were $14 million and primarily related to the Clipper Acquisition. Restructuring costs and other are primarily related to severance, including projects to optimize finance, human resources and information technology functions, and are not associated with customer attrition. Restructuring costs and other for the three months ended September 30, 2023 was $7 million and primarily related to the exit of non-core businesses in Asia. Other income, net decreased due to foreign currency movements and lower pension income. Other income, net was as follows: Three Months Ended September 30, (In millions) 2023 2022 $ Change % Change Net periodic pension income $ 2 $ 7 $ (5) (71) % Foreign currency: Realized foreign currency contracts gain (loss) (3) 10 (13) n/m Unrealized foreign currency contracts gain (loss) 8 (1) 9 n/m Foreign currency remeasurement gain — 1 (1) (100) % Total foreign currency gain 5 10 (5) (50) % Other income, net $ 7 $ 17 $ (10) (59) % n/m - not meaningful Interest expense, net increased primarily due to higher variable interest rates on our debt compared with the prior period. Interest expense, net was as follows: Three Months Ended September 30, (In millions) 2023 2022 $ Change % Change Debt and capital leases $ 25 $ 16 $ 9 56 % Cross-currency swaps (9) (9) — — % Interest income (2) (1) (1) 100 % Interest expense, net $ 14 $ 6 $ 8 n/m n/m - not meaningful Income before income taxes for both the three months ended September 30, 2023 and 2022 was $83 million. Income tax expense for the three months ended September 30, 2023 was $15 million compared with $19 million for the same period in 2022. Our effective tax rate was 17.9% for the three months ended September 30, 2023, compared with 22.5% for the same period in 2022. The change in our effective tax rate was primarily driven by a tax benefit related to return-to-provision true-up adjustments. 22 Nine Months Ended September 30, 2023 Compared with the Nine Months Ended September 30, 2022 Nine months ended September 30, (In millions) 2023 2022 $ Change % Change Revenue $ 7,188 $ 6,526 $ 662 10 % Direct operating expense 5,875 5,408 467 9 % Selling, general and administrative expense 761 637 124 19 % Depreciation and amortization expense 268 242 26 11 % Transaction and integration costs 22 57 (35) (61) % Restructuring costs and other 31 14 17 n/m Operating income 231 168 63 38 % Other income, net 8 56 (48) (86) % Interest expense, net (41) (19) (22) n/m Income before income taxes 198 205 (7) (3) % Income tax expense (38) (51) 13 (25) % Net income $ 160 $ 154 $ 6 4 % n/m - not meaningful Revenue for the nine months ended September 30, 2023 increased by 10%, or $662 million, to $7.2 billion compared with $6.5 billion for the same period in 2022. The increase primarily reflects an increase of $378 million from the Clipper Acquisition for the periods that were not comparable and growth in our Continental Europe operations. Foreign currency movement increased revenue by $43 million for the nine months ended September 30, 2023 compared with the prior period. Direct operating expense is comprised of both fixed and variable expenses and consist of operating costs related to our warehouses, including personnel costs, rent expenses, utility costs, equipment maintenance and repair costs, transportation costs, costs of materials and supplies and information technology expenses. Direct operating expense for the nine months ended September 30, 2023 increased by 9%, or $467 million, to $5.9 billion compared with $5.4 billion for the same period in 2022. Direct operating expense increased primarily due to the Clipper Acquisition, as well as higher personnel and temporary labor expenses and higher facilities and equipment expense. As a percentage of revenue, direct operating expense for the nine months ended September 30, 2023, was 81.7% compared with 82.9% 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 nine months ended September 30, 2023, increased by 19%, or $124 million, to $761 million compared with $637 million for the same period in 2022. SG&A increased primarily due to the Clipper Acquisition and higher personnel costs, primarily for certain administrative functions, and higher bad debt expense. Depreciation and amortization expense for the nine months ended September 30, 2023 increased by $26 million to $268 million compared with $242 million for the same period in 2022. Amortization expense was $54 million and $48 million for the nine months ended September 30, 2023 and 2022, respectively. Depreciation and amortization expense increased primarily due to the Clipper Acquisition. Transaction and integration costs for the nine months ended September 30, 2023 were $22 million compared with $57 million for the same period in 2022. Transaction and integration costs for the nine months ended September 30, 2023 and 2022, primarily related to the Clipper Acquisition. Restructuring costs and other are primarily related to severance, including projects to optimize finance, human resources and information technology functions, and are not associated with customer attrition. Restructuring costs and other for the nine months ended September 30, 2023 was $31 million and included severance charges of 23 $24 million and impairment charges of $7 million due to closing certain corporate and administrative offices and the exit of non-core businesses in Asia. For the nine months ended September 30, 2022, Restructuring costs and other was $14 million and included severance charges of $6 million and $8 million related to the deconsolidation of a joint venture. Other income, net decreased due to foreign currency movements and lower pension income. Other income, net was as follows: Nine Months Ended September 30, (In millions) 2023 2022 $ Change % Change Net periodic pension income $ 6 $ 25 $ (19) (76) % Foreign currency: Realized foreign currency contracts gain (loss) (9) 19 (28) n/m Unrealized foreign currency contracts gain 12 14 (2) (14) % Foreign currency remeasurement loss (1) (2) 1 (50) % Total foreign currency gain 2 31 (29) (94) % Other income, net $ 8 $ 56 $ (48) (86) % n/m - not meaningful Interest expense, net increased primarily due to debt incurred for the Clipper Acquisition and higher variable interest rates on our debt compared with the prior period, partially offset by higher gains on cross-currency swaps in the current period. Interest expense, net was as follows: Nine Months Ended September 30, (In millions) 2023 2022 $ Change % Change Debt and capital leases $ 72 $ 37 $ 35 95 % Cross-currency swaps (25) (16) (9) 56 % Interest income (6) (2) (4) n/m Interest expense, net $ 41 $ 19 $ 22 n/m n/m - not meaningful Income before income taxes for the nine months ended September 30, 2023, decreased to $198 million compared with $205 million for the same period in 2022. The decrease was due to lower Other income, net and higher interest expense, partially offset by higher operating income. Income tax expense for the nine months ended September 30, 2023 was $38 million compared with $51 million for the same period in 2022. Our effective tax rate was 19.1% for the nine months ended September 30, 2023, compared with 24.7% for the same period in 2022. The change in our effective tax rate was primarily driven by a tax benefit related to a valuation allowance release. 24 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 facilities. 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. As of September 30, 2023, we held cash and cash equivalents of $473 million and we had $799 million of borrowing capacity available, net of letters of credit under our Revolving Credit Facility. We continually evaluate our liquidity requirements and capital structure in consideration 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. Factoring Programs We sell certain of our trade 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 September 30, Nine Months Ended September 30, (In millions) 2023 2022 2023 2022 Receivables sold in period $ 288 $ 259 $ 820 $ 716 Cash consideration 286 258 815 714 Net cash provided by operating cash flows (1) 27 18 27 16 (1) The nine months ended September 30, 2022, includes $134 million of cash provided by factoring program, reduced by $118 million of cash 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 our ability to incur indebtedness and grant liens, among other restrictions. In addition, the facilities require us to maintain a consolidated leverage ratio below a specified maximum. As of September 30, 2023, we were in compliance with the covenants contained in our debt and financing arrangements. 25 Financial Condition The following table summarizes our asset and liability balances: (In millions) September 30, 2023 December 31, 2022 $ Change % Change Current assets $ 2,466 $ 2,428 $ 38 2 % Long-term assets 6,625 6,791 (166) (2) % Total Assets $ 9,091 $ 9,219 $ (128) (1) % Current liabilities $ 2,434 $ 2,532 $ (98) (4) % Long-term liabilities 3,840 4,009 (169) (4) % Total Liabilities $ 6,274 $ 6,541 $ (267) (4) % The decrease in total assets from December 31, 2022 to September 30, 2023 reflects a decrease in long-term assets primarily due to depreciation and amortization of property and equipment, operating leases and intangible assets. The decrease in total liabilities from December 31, 2022 to September 30, 2023 primarily reflects the decrease in accounts payable due to the timing of payments and the early repayment of our $115 million two-year term loan. 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: Nine Months Ended September 30, (In millions) 2023 2022 $ Change % Change Net cash provided by operating activities $ 343 $ 316 $ 27 9 % Net cash used in investing activities (192) (1,056) 864 (82) % Net cash provided by (used in) financing activities (170) 863 (1,033) n/m Effect of exchange rates on cash, restricted cash and cash equivalents (2) (22) 20 (91) % Net (decrease) increase in cash, restricted cash and cash equivalents $ (21) $ 101 $ (122) (121) % Operating Activities Cash flows provided by operating activities for the nine months ended September 30, 2023 increased by $27 million compared with the same period in 2022 due to increase in cash generated from net income adjusted for non-cash charges. Investing Activities Investing activities used $192 million of cash for the nine months ended September 30, 2023, compared with $1.1 billion used for the same period of 2022. During the nine months ended September 30, 2023, we used $205 million of cash to purchase property and equipment and received $13 million of cash from sales of property and equipment. During the nine months ended September 30, 2022, we used $874 million, net of cash received, to fund the Clipper Acquisition, used $239 million of cash to purchase property and equipment, received $26 million in proceeds from cross-currency swap agreements, excluding accrued interest, and received $22 million of cash from sales of property and equipment. 26 Financing Activities Financing activities used $170 million of cash for the nine months ended September 30, 2023, including $139 million used to repay debt, $24 million to repay finance lease obligations and $7 million in payments for employee taxes on stock-based compensation awards. Financing activities generated $863 million of cash for the nine months ended September 30, 2022, including $898 million in proceeds from long-term debt, partially offset by $23 million to repay finance lease obligations and $12 million in payments for employee taxes on stock-based compensation awards. 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 September 30, 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. 27