RXO, 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 actual 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 discussion should be read in conjunction with the company’s unaudited Condensed Combined Financial Statements and related notes thereto included elsewhere in this Quarterly Report, and with the Audited Combined Financial Statements and related notes thereto included in the Form 10 declared effective on October 17, 2022 (the “Form 10”). Forward-looking statements set forth in this Quarterly Report speak only as of the date hereof, and we do not undertake any obligation to update forward-looking statements to reflect subsequent events or circumstances, changes in expectations or the occurrence of unanticipated events, except to the extent required by law. Business Overview RXO, Inc. (“RXO”, the “Company” or “we”) is a high-performing brokered transportation platform defined by cutting-edge technology and a nimble, asset-light business model, with the largest component being our core truck brokerage business. We are the fourth largest broker of full truckload freight transportation in the United States, and have approximately 4% share of the entire $88 billion brokered truckload industry. Our truck brokerage business has a variable cost structure with robust free cash flow conversion and a long track record of generating a high return on invested capital. Shippers create demand for our service, and we place their freight with qualified independent carriers using our technology. We price our service on either a contract or a spot basis. Notable factors driving growth and margin expansion in our business include our ability to access massive truckload capacity for shippers through our carrier relationships, our proprietary, cutting-edge technology, our strong management expertise and favorable industry tailwinds. As of September 30, 2022, we had approximately 108,000 carriers in our North American truck brokerage network, and access to more than 1.5 million trucks. We provide our customers with highly efficient access to capacity through our digital brokerage technology. This proprietary platform is a major differentiator for our truck brokerage business, and together with our pricing technology, we believe it can unlock incremental profitable growth well beyond our current levels. Our other brokered transportation services for managed transportation, last mile and freight forwarding also utilize our digital brokerage technology — these services are described below. Our managed transportation service provides asset-light solutions for shippers who outsource their freight transportation to gain reliability, visibility and cost savings. The service uses proprietary technology to enhance our revenue synergy, with cross-selling to truck brokerage, last mile and freight forwarding. Our last mile offering is an asset-light service that facilitates consumer deliveries performed by highly qualified third-party contractors. We are the largest provider of outsourced last mile for heavy goods in the United States, positioned within 125 miles of the vast majority of the U.S. population and serving a customer base of omnichannel and e-commerce retailers and direct-to-consumer manufacturers. 14 Table of Contents Our freight forwarding service is a scalable, asset-light offering managed with advanced technology that facilitates ocean, road and air transportation and assists with customs brokerage. We are a global freight forwarder with a network of company-owned and partner-owned locations and coverage of key trade lanes that reach approximately 160 countries and territories. The Spin-Off On November 1, 2022, XPO Logistics, Inc. (together with its subsidiaries, “XPO”) completed the spin-off of RXO in a transaction intended to be tax-free for U.S. federal income tax purposes, which was accomplished by the distribution of 100% of the outstanding common stock of RXO to XPO stockholders as of the close of business on October 20, 2022, the record date for the distribution. XPO stockholders received one share of RXO common stock for every share of XPO common stock held at the close of business on the record date. RXO is now a standalone publicly traded company, and, on November 1, 2022, regular-way trading of the common stock commenced on the New York Stock Exchange (the “NYSE”) under the ticker symbol “RXO.” The spin-off was completed pursuant to the Separation and Distribution Agreement and various other agreements that govern aspects of our relationship with XPO, including, but not limited to a Tax Matters Agreement (“TMA”), an Employee Matters Agreement (“EMA”), a Transition Services Agreement (“TSA”) and an Intellectual Property License Agreement (“IPLA”). See Note 8 — Subsequent Events for additional details. Impacts of COVID-19 and Other Notable External Conditions As a leading provider of freight transportation services, our business can be impacted to varying degrees by factors beyond our control. The COVID-19 pandemic that emerged in 2020 affected, and may continue to affect, economic activity broadly and customer sectors served by our industry. Labor shortages, particularly a shortage of truck drivers, and equipment shortages continue to present challenges to many transportation-related industries. Additionally, disruptions in supply chains for industrial materials and supplies, such as semiconductor chips, have impacted some of the end-market activities that create demand for our services. We cannot predict how long these dynamics will last, or whether future challenges, if any, will adversely affect our results of operations. To date, the totality of the actions we have taken during the pandemic, and continue to take, have mitigated the impact on our profitability relative to the impact on our revenue and volumes, while our strong liquidity and disciplined capital management enable us to continue to invest in growth initiatives. Additionally, economic inflation can have a negative impact on our operating costs. A prolonged period of inflation could cause interest rates, fuel, wages and other costs to continue to increase, which would adversely affect our results of operations unless our pricing to our customers correspondingly increases. During 2021 and the three and nine months ended September 30, 2022, the transportation industry’s truck driver shortage, together with rising fuel prices, resulted in higher transportation procurement costs to meet growing demand, which costs were largely offset by mechanisms in our customer contracts, including fuel surcharge clauses and general rate increases. An economic recession could depress activity levels and adversely affect our results of operations. Regarding the war between Russia and Ukraine, we have no direct exposure to those geographies. We cannot predict how global supply chain activities or the economy at large may be impacted by a prolonged war in Ukraine or sanctions imposed in response to the war, or whether future conflicts, if any, may adversely affect our results of operations. Basis of Presentation Refer to Note 2 — Basis of Presentation for details regarding the basis of presentation used for the Company’s Condensed Combined Financial Statements. Cost of transportation and services (exclusive of depreciation and amortization) primarily includes the cost of providing or procuring freight transportation for RXO customers. Direct operating expenses (exclusive of depreciation and amortization) are comprised of both fixed and variable expenses and consist mainly of personnel costs, facility and equipment expenses, such as rent, utilities, equipment maintenance and repair, costs of materials and supplies, information technology expenses, and gains and losses on sales of property and equipment. 15 Table of Contents SG&A, including the allocated costs of XPO, primarily consists of salaries and commissions for the sales function, salary and benefit costs for executive and certain administration functions, third-party professional fees, facility costs, bad debt expense and legal costs. RXO has a single reportable segment. Results of Operations Three Months Ended September 30, Percent of Revenue Nine Months Ended September 30, Percent of Revenue (In millions) 2022 2021 2022 2021 2022 2021 2022 2021 Revenue $ 1,138 $ 1,198 100.0 % 100.0 % $ 3,676 $ 3,362 100.0 % 100.0 % Cost of transportation and services (exclusive of depreciation and amortization) 857 958 75.3 % 80.0 % 2,782 2,630 75.7 % 78.2 % Direct operating expense (exclusive of depreciation and amortization) 56 48 4.9 % 4.0 % 167 143 4.5 % 4.3 % Sales, general and administrative expense 158 130 13.9 % 10.9 % 485 387 13.2 % 11.5 % Depreciation and amortization expense 23 22 2.0 % 1.8 % 65 62 1.8 % 1.8 % Transaction and integration costs 23 1 2.0 % 0.1 % 44 2 1.2 % 0.1 % Restructuring costs 6 1 0.5 % 0.1 % 9 1 0.2 % — % Operating income $ 15 $ 38 1.3 % 3.2 % $ 124 $ 137 3.4 % 4.1 % Other expense 1 — 0.1 % — % — 1 — % — % Interest income $ (1) $ — (0.1) % — % $ (1) $ — — % — % Income before income taxes $ 15 $ 38 1.3 % 3.2 % $ 125 $ 136 3.4 % 4.1 % Income tax provision 2 5 0.2 % 0.4 % 29 28 0.8 % 0.8 % Net income $ 13 $ 33 1.1 % 2.8 % $ 96 $ 108 2.6 % 3.3 % Three and Nine Months Ended September 30, 2022 Compared with Three and Nine Months Ended September 30, 2021 Our revenue decreased 5.0% to $1.1 billion in the third quarter of 2022, compared with $1.2 billion for the same quarter in 2021. Revenue for the first nine months of 2022 increased 9.3% to $3.7 billion compared with $3.4 billion for the same period in 2021. The year-over-year decrease in revenue in the third quarter of 2022 was primarily driven by (i) lower revenue generated from services in our managed transportation operation, (ii) lower ocean volume in our freight forwarding business and (iii) lower revenue generated from our truck brokerage business, primarily driven by lower truckload pricing in the spot market, partially offset by a year-over-year increase in volume. The increase in revenue in the first nine months of 2022 primarily reflects an increase in truck brokerage loads, facilitated by our digital platform, as well as strong pricing across our service offerings. Of the $0.3 billion increase in revenue in the first nine months of 2022, compared with the same period in 2021, 76% was driven by volume increases and 27% was driven by pricing increases, partially offset by a 3% reduction from changes in mix. Cost of transportation and services (exclusive of depreciation and amortization) for the third quarter of 2022 was $857 million, or 75.3% of revenue, compared with $958 million or 80.0% of revenue, for the same quarter in 2021. Cost of transportation and services (exclusive of depreciation and amortization) for the first nine months of 2022 was $2.8 billion, or 75.7% of revenue, compared with $2.6 billion or 78.2% of revenue, for the same period in 2021. Third party transportation costs as a percentage of revenue decreased year-over-year by 4.7 and 2.3 percentage points for the third quarter and first nine months of 2022, respectively. The year-over-year decreases in both 2022 periods were due primarily to our ability to purchase services at lower cost as the transportation market softened, while the majority of our revenue reflected fixed terms on customer contracts established in stronger rate environments prior to 2022. 16 Table of Contents Direct operating expense (exclusive of depreciation and amortization) for the third quarter of 2022 was $56 million, or 4.9% of revenue, compared with $48 million, or 4.0% of revenue, for the same quarter in 2021. Direct operating expense (exclusive of depreciation and amortization) for the first nine months of 2022 was $167 million, or 4.5% of revenue, compared with $143 million, or 4.3% of revenue, for the same period in 2021. The year-over-year increase as a percentage of revenue in the third quarter of 2022 was primarily a result of higher compensation-related costs and facilities costs, which increased as a percentage of revenue by approximately 0.4 and 0.2 percentage points, respectively. The year-over-year increase as a percentage of revenue in the first nine months of 2022 was primarily the result of higher compensation-related costs, which increased as a percentage of revenue by approximately 0.2 percentage points. Sales, general and administrative expense for the third quarter of 2022 was $158 million or 13.9% of revenue, compared with $130 million, or 10.9% of revenue, for the same quarter in 2021. SG&A for the first nine months of 2022 was $485 million, or 13.2% of revenue, compared with $387 million, or 11.5% of revenue, for the same period in 2021. The year-over-year increases in SG&A as a percentage of revenue primarily resulted from higher compensation-related costs of 2.5 and 1.2 percentage points, respectively, for the third quarter and first nine months of 2022. Depreciation and amortization expense for the third quarter of 2022 was $23 million, compared with $22 million for the same quarter in 2021. Depreciation and amortization expense for the first nine months of 2022 was $65 million, compared with $62 million for the same period in 2021. Depreciation and amortization expense included amortization of acquisition-related intangible assets of $5 million and $6 million for the third quarter of 2022 and 2021, respectively. Depreciation and amortization expense included amortization of acquisition-related intangible assets of $16 million and $18 million for the first nine months of 2022 and 2021, respectively. Transaction and integration costs for the third quarter and first nine months of 2022 were $23 million and $44 million, respectively, and are primarily comprised of spin-off related costs. Restructuring costs for the third quarter and first nine months of 2022 were $6 million and $9 million, respectively, and are primarily comprised of spin-off related costs. Our effective income tax rates were 18.5% and 14.2% for the third quarter of 2022 and 2021, respectively, and 23.6% and 20.7% for the first nine months of 2022 and 2021, respectively. The effective tax rates for the third quarter and nine-month periods of 2022 and 2021 were based on forecasted full-year effective tax rates, adjusted for discrete items that occurred within the periods presented. Our effective tax rates for the third quarter of 2022 and 2021 differ from the U.S. corporate income tax rate of 21% primarily due to a tax benefit of $1 million and $5 million, respectively, from changes in reserves for uncertain tax positions partially offset by state income taxes within the U.S. Our effective tax rate for the first nine months of 2022 differs from the U.S. corporate income tax rate of 21% due to state income taxes within the U.S. partially offset by a tax benefit of $1 million from changes in reserves for uncertain tax positions. Our effective tax rate for the first nine months of 2021 differs from the U.S. corporate income tax rate of 21% due to tax benefits of $5 million from changes in reserves for uncertain tax positions and $2 million from revaluing state deferred tax assets partially offset by state income taxes within the U.S. Liquidity and Capital Resources Historically, our principal existing sources of cash are cash generated from operations and funding from XPO. Treasury activities at XPO are generally centralized, while certain balances are managed locally. To the extent cash and cash equivalents are legally owned by RXO, they are reflected in the Condensed Combined Financial Statements. Following our spin-off from XPO, our capital structure and sources of liquidity changed from our historical capital structure because we no longer participate in XPO’s centralized cash management program. Additionally, we incurred $455 million of new debt in October 2022. We continually evaluate our liquidity requirements 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. In conjunction with the spin-off, we expect to further evaluate our liquidity needs, capital structure and sources of capital on a standalone basis. See Note 8 —Subsequent Events for additional details. 17 Table of Contents Financial Condition The following table summarizes our asset and liability balances as of September 30, 2022 and December 31, 2021: As of September 30, As of December 31, (In millions) 2022 2021 Total current assets $ 1,225 $ 1,083 Total long-term assets 1,012 985 Total current liabilities 888 816 Total long-term liabilities 205 182 Total assets increased by $169 million from December 31, 2021 to September 30, 2022 primarily due to an increase in cash in 2022 generated by cash flows from operations. Total liabilities increased by $95 million from December 31, 2021 to September 30, 2022, primarily due to an $27 million increase in accounts payable and a $36 million increase in accrued expenses in 2022. The increases in accounts payable and accrued expenses were primarily due to an increase in managed transportation volume. Cash Flow Activity Our cash flows from operating, investing and financing activities, as reflected on our Condensed Combined Statements of Cash Flows, are summarized as follows: Nine Months Ended September 30, (In millions) 2022 2021 Net cash provided by operating activities $ 234 $ 119 Net cash used in investing activities (38) (29) Net cash used in financing activities (38) (130) During the first nine months of 2022, we generated cash from operating activities of $234 million, which was used to fund (i) $39 million of net transfers to XPO and (ii) the purchase of $39 million of property and equipment. During the first nine months of 2021, we generated cash from operating activities of $119 million, which was used to fund (i) $131 million of net transfers to XPO and (ii) the purchase of $30 million of property and equipment. Net cash provided by operating activities for the first nine months of 2022 increased by $115 million, compared with the first nine months of 2021. The increase reflects favorable changes in working capital in the first nine months of 2022, primarily related to accounts receivable using $10 million of cash, compared to using $101 million during the same period in 2021 as the revenue growth rate decelerated in 2022. Investing activities used $38 million of cash in the first nine months of 2022 compared to $29 million in the same period of 2021, primarily to purchase property and equipment. The increase in property and equipment purchases between periods is primarily driven by increased spending on computer software and equipment. Financing activities used $38 million of cash for the first nine months of 2022 compared with using $130 million of cash for the same period in 2021. The primary use of cash from financing activities in both periods was for net transfers to XPO. Contractual Obligations As of September 30, 2022, the Company’s future contractual obligations have not materially changed as compared with December 31, 2021. In connection with the spin-off, subsequent to September 30, 2022 we incurred approximately $455 million of new indebtedness with associated annual interest expense of approximately $35 million. See Note 8—Subsequent Events for additional details. We anticipate full year net capital expenditures to be between $40 million and $50 million in 2022, funded by cash from operations and available liquidity. 18 Table of Contents Critical Accounting Policies Our significant accounting policies, which include management’s most subjective and complex estimates and judgments, are included in Note 2—Basis of Presentation to the Combined Financial Statements for the year ended December 31, 2021 included in the Form 10. A discussion of accounting estimates, considered critical because of the potential for a significant impact on the financial statements due to the inherent uncertainty in such estimates, are disclosed in the Critical Accounting Policies section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Form 10. There have been no significant changes in the Company’s critical accounting estimates since December 31, 2021. New Accounting Standards Information related to new accounting standards is included in Note 2 —Basis of Presentation to our Condensed Combined Financial Statements in this Quarterly Report on Form 10-Q.