XPO, Inc. 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview XPO Logistics provides cutting-edge supply chain solutions to the most successful companies in the world. We have two reporting segments: Transportation and Logistics. Our Transportation segment facilitates the movement of raw materials, parts and finished goods. We accomplish this by using our proprietary technology, third-party independent carriers and our transportation assets and service centers. Our transportation services include less-than-truckload (“LTL”), truck brokerage and other transportation services. In our Logistics segment, which we sometimes refer to as supply chain, we provide a wide range of services differentiated by our proprietary technology and our ability to customize solutions for individual customers. Our services include high-value-add warehousing and distribution, e-commerce and omnichannel fulfillment, cold chain logistics, packaging and labeling, factory support, aftermarket support, inventory management, order personalization and supply chain optimization, such as production flow management. In addition, we are a major provider of reverse logistics, which is also called returns management. Reverse logistics is a fast-growing area of logistics that includes the inspection, repackaging, refurbishment, resale or disposal of returned merchandise, as well as refunding and warranty management. In December 2020, we announced that our Board of Directors unanimously approved a plan to pursue a spin-off of 100% of our Logistics segment as a separate publicly traded company. We intend to structure the spin-off as a distribution that is generally tax-free for U.S. federal income tax purposes to XPO shareholders (except with respect to any cash received in lieu of fractional shares) and would result in XPO shareholders owning stock in both companies. If completed, the spin-off will result in separate public companies with clearly delineated service offerings. XPO will be a global provider of primarily LTL transportation and truck brokerage services, and the spun-off company will be the second largest contract logistics provider in the world. Both companies’ stocks are expected to trade on the New York Stock Exchange, and we plan to consider a dual listing on the London Stock Exchange for the spun-off company in due course. The transaction is currently expected to be completed in the second half of 2021, subject to various conditions. There can be no assurance that the spin-off will occur or, if it does occur, of its terms or timing. Separately, in March 2020, we announced that we had entered into an agreement to acquire the majority of Kuehne + Nagel’s contract logistics operations in the United Kingdom. The operations, which include roughly 5,700 employees and provide a range of logistics services, including inbound and outbound distribution, reverse logistics management and inventory management, will be included in our Logistics segment. The acquisition was completed in January 2021. This discussion focuses on our 2020 results, compared with 2019 results. The discussion of our 2019 results, compared with 2018 results, can be found in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our 2019 Annual Report on Form 10-K. Impacts of COVID-19 As a global provider of supply chain solutions, our business can be impacted to varying degrees by factors beyond our control. The rapid escalation of COVID-19 into a pandemic in 2020 has affected, and will continue to affect, economic activity broadly and customer sectors served by our industry. In response to the COVID-19 pandemic, the governments of many countries, states, cities and other geographic regions have taken and are continuing to take preventative or reactive actions, such as imposing restrictions on travel and business operations and establishing guidelines for social distancing and occupational safety. Due to the critical role we play in moving goods and equipment in the markets we serve, XPO is considered an “essential business,” providing supply chain solutions to crucial industries and delivering critical consumer goods. As a result, our sites have generally remained open and operating, and we have continued to serve our customers while employing significant measures to protect our employees and keep them safe. 38 Table of Contents The COVID-19 pandemic and associated impacts on economic activity had an adverse effect on our results of operations and financial condition for the year ended December 31, 2020, as discussed below. We experienced declines in demand for our services that began in the first quarter of 2020, had a substantial impact in the second quarter of 2020, and abated throughout the second half of 2020. These declines in demand meaningfully affected our results in both North America and Europe. Due to the largely unprecedented and evolving nature of the COVID-19 pandemic, it remains very difficult to predict the extent of the impact on our industry generally and our business in particular. Furthermore, the extent and pace of a recovery remains uncertain and may differ significantly among the countries in which we operate. We expect our results of operations will continue to be impacted by this pandemic in 2021. We have incurred net incremental costs related to COVID-19 to ensure that we meet the needs of our customers and employees; these include costs for personal protective equipment (“PPE”), temporary site closures, site cleanings and enhanced employee benefits. We also implemented supplemental “appreciation pay” programs for thousands of frontline employees who continued to work during the pandemic. We expect to continue to incur additional costs as we implement operational changes in response to the pandemic. However, the majority of our cost base is variable, and we have taken and, if appropriate, will continue to take aggressive actions to adjust our expenses to reflect changes in demand for our services. These actions include reduced use of contractors, reduced employee hours, furloughs, layoffs and required use of paid time off, consistent with applicable regulations. While we could not fully offset the decrease in demand for our services arising from the economic disruption of the pandemic in 2020, the actions we have taken, combined with the variable components of our cost structure, have mitigated the impact on our profitability relative to the impact on our revenue and volumes. A further discussion of the potential impact of the COVID-19 pandemic on our business is set forth above in Part I, Item 1A. Risk Factors. Consolidated Summary Financial Table Years Ended December 31, Percent of Revenue Change (Dollars in millions) 2020 (1) 2019 (2) 2020 2019 2020 vs. 2019 Revenue $ 16,252 $ 16,648 100.0 % 100.0 % (2.4) % Cost of transportation and services 7,852 8,303 48.3 % 49.9 % (5.4) % Direct operating expense 5,837 5,679 35.9 % 34.1 % 2.8 % Sales, general and administrative expense 2,172 1,845 13.4 % 11.1 % 17.7 % Operating income 391 821 2.4 % 4.9 % (52.4) % Other income (79) (54) (0.5) % (0.3) % (46.3) % Foreign currency (gain) loss (3) 9 — % 0.1 % (133.3) % Debt extinguishment loss — 5 — % — % (100.0) % Interest expense 325 292 2.0 % 1.8 % 11.3 % Income before income tax provision 148 569 0.9 % 3.4 % (74.0) % Income tax provision 31 129 0.2 % 0.8 % (76.0) % Net income $ 117 $ 440 0.7 % 2.6 % (73.4) % (1) Consolidated operating income for 2020 includes $100 million of transaction and integration costs, of which $21 million relates to our Transportation segment and $28 million relates to our Logistics segment, and $56 million of restructuring expense. (2) Consolidated operating income for 2019 includes $5 million of transaction and integration costs and $49 million of restructuring expense. The transaction and integration costs for 2020 are primarily related to our previously announced exploration of strategic alternatives that was terminated in March 2020 and costs related to our planned acquisition of the Kuehne + Nagel business. For further information on our restructuring actions, see Note 6—Restructuring Charges to the 39 Table of Contents Consolidated Financial Statements. We also incurred net incremental and direct costs as a result of the COVID-19 pandemic in 2020. Our consolidated revenue for 2020 decreased by 2.4% to $16.3 billion, from $16.6 billion in 2019. The decrease primarily reflects the impact of COVID-19. Foreign currency movement increased revenue by approximately 0.6 percentage points in 2020. Cost of transportation and services includes the cost of providing or procuring freight transportation for XPO customers and salaries paid to employee drivers in our LTL and truckload businesses. Cost of transportation and services in 2020 was $7.9 billion, or 48.3% of revenue, compared with $8.3 billion, or 49.9% of revenue in 2019. The year-over-year decrease as a percentage of revenue was primarily driven by a higher mix of logistics revenue, lower fuel costs and lower third-party transportation costs in our transportation segment, partially offset by incremental PPE and other COVID-19-related costs. Direct operating expenses are comprised of both fixed and variable expenses and consist of operating costs related to our logistics facilities, last mile warehousing facilities, LTL service centers and European LTL network. Direct operating expenses 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, depreciation expense, and gains and losses on sales of property and equipment. Direct operating expense in 2020 was $5.8 billion, or 35.9% of revenue, compared with $5.7 billion, or 34.1% of revenue, in 2019. The year-over-year increase as a percentage of revenue was primarily driven by the decline in revenue due to COVID-19, a higher mix of logistics revenue, higher facility and payroll costs, and incremental PPE and other COVID-19-related costs. Additionally, 2020 and 2019 included $92 million and $110 million, respectively, from gains on sales of property and equipment. Sales, general and administrative expense (“SG&A”) primarily consists of salaries and commissions for the sales function, salary and benefit costs for executive and certain administration functions, depreciation and amortization expense, professional fees, facility costs, bad debt expense and legal costs. SG&A was $2.2 billion in 2020, or 13.4% of revenue, compared with $1.8 billion, or 11.1% of revenue, in 2019. The year-over-year increase in SG&A as a percentage of revenue primarily resulted from the decline in revenue due to COVID-19, higher compensation costs, increased self-insurance expense and incremental PPE and other COVID-19-related costs. Compensation costs were higher for both the fourth quarter and the year ended December 31, 2020 in comparison to the prior-year periods due to the strength of our operating performance in a challenging macro-environment. Additionally, SG&A for 2020 included approximately $74 million of expenses related to our exploration of strategic alternatives, including professional service fees and employee retention costs. Other income primarily consists of pension income. Other income for 2020 was $79 million, compared with $54 million in 2019. The year-over-year increase reflects $27 million of higher net periodic pension income in 2020. Foreign currency (gain) loss was a $3 million gain in 2020, compared with a $9 million loss in 2019. Foreign currency (gain) loss in 2020 primarily reflected unrealized gains on foreign currency option and forward contracts and a realized gain on a terminated net investment hedge, partially offset by foreign currency transaction and measurement losses. Foreign currency loss in 2019 primarily reflected unrealized losses on foreign currency option and forward contracts. For additional information on our foreign currency option and forward contracts, see Note 11—Derivative Instruments to our Consolidated Financial Statements. Debt extinguishment loss was $5 million in 2019 and related to the write-off of debt issuance costs for an unsecured credit facility (“Unsecured Credit Facility”) that was repaid in 2019. There were no debt extinguishment losses in 2020. Interest expense for 2020 increased 11.3% to $325 million, from $292 million in 2019. The increase in interest expense was primarily due to higher average total indebtedness, including the senior notes due 2025 (the “Senior Notes due 2025”) that were issued in the second quarter of 2020, partially offset by lower interest rates in 2020. 40 Table of Contents Our consolidated income before income taxes in 2020 was $148 million, compared with $569 million in 2019. The decrease primarily was driven by lower operating income in our Transportation and Logistics segments, as discussed below, and higher interest expense, partially offset by higher other income. With respect to our U.S. operations, income before income taxes decreased by $330 million in 2020, compared with the prior year, primarily due to the impact of COVID-19 and higher interest expense. With respect to our non-U.S. operations, income before income taxes decreased by $91 million in 2020 compared with the prior year, primarily due to the impact of COVID-19. Our effective income tax rates were 21.1% and 22.6% in 2020 and 2019, respectively. The decrease in our effective income tax rate for the year ended December 31, 2020 compared to the year ended December 31, 2019 was primarily driven by income tax benefits associated with stock-based compensation. The U.S. Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) enacted in March 2020 provides numerous tax provisions and other stimulus measures, including temporary changes regarding the prior and future utilization of net operating losses, temporary changes to the prior and future limitations on interest deductions, and technical corrections from prior tax legislation for tax depreciation of certain qualified improvement property. We have applied the provisions of the CARES Act relating to income taxes and realized a $4 million reduction in cash taxes as well as an immaterial income tax benefit on our Consolidated Statements of Income in 2020. Additionally, we benefited from the ability to defer the payment of certain payroll taxes that would otherwise have been required in 2020. We have not applied for any government loans under the CARES Act or similar laws. Restructuring Charges We engage in restructuring actions as part of our ongoing efforts to best use our resources and infrastructure, including actions in response to COVID-19. Restructuring charges were recorded on our Consolidated Statements of Income as follows: Years Ended December 31, (In millions) 2020 2019 Cost of transportation and services $ 1 $ 2 Direct operating expense 7 1 Sales, general and administrative expense 48 46 Total $ 56 $ 49 For more information, see Note 6—Restructuring Charges to our Consolidated Financial Statements. Upon successful completion of the restructuring initiatives recorded in 2020, we expect to achieve annualized pre-tax savings of approximately $100 million by the end of 2021. In addition, we may incur incremental restructuring costs in 2021 in connection with the planned spin-off of our Logistics segment or for other reasons; however, we are currently unable to reasonably estimate these costs. Transportation Segment Years Ended December 31, Percent of Revenue Change (Dollars in millions) 2020 2019 2020 2019 2020 vs. 2019 Revenue $ 10,199 $ 10,687 100.0 % 100.0 % (4.6) % Operating income 507 752 5.0 % 7.0 % (32.6) % Total depreciation and amortization 453 447 1.3 % Revenue in our Transportation segment decreased 4.6% to $10.2 billion in 2020, compared with $10.7 billion in 2019. The decline in revenue primarily reflected the impact of COVID-19 and lower fuel revenue. Foreign currency movement increased revenue by approximately 0.4 percentage points in 2020. Operating income in our Transportation segment was $507 million, or 5.0% of revenue, in 2020, compared with $752 million, or 7.0% of revenue, in 2019. The decrease in operating income was primarily driven by lower 41 Table of Contents revenue, higher facility costs, expenses related to our exploration of strategic alternatives and incremental PPE and other COVID-19-related costs. These higher costs were partially offset by lower third-party transportation, fuel and personnel costs. Depreciation and amortization expense in 2019 included $6 million related to the impairment of customer relationship intangible assets associated with exiting the direct postal injection business. Logistics Segment Years Ended December 31, Percent of Revenue Change (Dollars in millions) 2020 2019 2020 2019 2020 vs. 2019 Revenue $ 6,182 $ 6,093 100.0 % 100.0 % 1.5 % Operating income 140 241 2.3 % 3.9 % (41.9) % Total depreciation and amortization 301 277 8.7 % Revenue in our Logistics segment increased 1.5% to $6.2 billion in 2020, compared with $6.1 billion in 2019. The increase in revenue compared to 2019 reflects growth in our European business, partially offset by the impact of COVID-19, our elimination of certain low-margin business and the downsizing of business by one of our largest customers in North America in 2019. Foreign currency movement increased revenue by approximately 0.8 percentage points in 2020. Operating income in our Logistics segment was $140 million, or 2.3% of revenue in 2020, compared with $241 million, or 3.9% of revenue, in 2019. The decrease in operating income was primarily driven by the impact of COVID-19 on revenues, costs and margins, increased depreciation and amortization expense, expenses related to our exploration of strategic alternatives and higher personnel costs, partially offset by higher revenue. Depreciation and amortization expense increased year-over-year due to the impact of prior capital investments, new contract startups and accelerated depreciation due to contract modifications. Liquidity and Capital Resources Our principal existing sources of cash are (i) cash generated from operations; (ii) borrowings available under our Second Amended and Restated Revolving Loan Credit Agreement, as amended (the “ABL Facility”) and a Senior Secured Term Loan Credit Agreement; and (iii) proceeds from the issuance of other debt. As of December 31, 2020, we have $883 million available to draw under our ABL Facility, based on a borrowing base of $1.1 billion, outstanding borrowings of $200 million and outstanding letters of credit of $17 million, as well as $150 million available to draw under the Senior Secured Term Loan Credit Agreement. Our cash and cash equivalents balance was $2.1 billion as of December 31, 2020, compared to $377 million as of December 31, 2019. The increase in cash and cash equivalents is largely due to the issuance of our Senior Notes due 2025 in 2020 and cash flows generated from operating activities in 2020. Managing our balance sheet prudently and maintaining appropriate liquidity are high priorities during the disruption caused by COVID-19. In order to best position us to navigate this uncertain period, we have taken a number of actions to further strengthen our liquidity. We borrowed a net $200 million in revolving loans under our existing ABL Facility in 2020. In addition, in April 2020, we entered into the Senior Secured Term Loan Credit Agreement which allows us to borrow up to $150 million in aggregate principal amount of committed secured term loans and request the issuance of up to $200 million in aggregate face amount of secured letters of credit under an evergreen letter of credit facility. Also in the second quarter of 2020, we completed private placements of $1.15 billion aggregate principal amount of Senior Notes due 2025. The Senior Secured Term Loan Credit Agreement and Senior Notes due 2025 are discussed further below. In June 2020, we amended certain provisions of the ABL Facility to provide additional debt financing flexibility. 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 42 Table of Contents the next 12 months. In conjunction with the planned spin-off of our Logistics segment, we expect to further evaluate our liquidity needs, capital structure and sources of capital for the Transportation and Logistics businesses on a stand-alone basis. Trade Receivables Securitization and Factoring Programs We sell certain of our trade accounts receivable on a non-recourse basis to third-party financial institutions under factoring agreements. We account for these transactions as sales of receivables and present cash proceeds as cash provided by operating activities in the Consolidated Statements of Cash Flows. We also sell trade accounts receivable under a securitization program described below. We use trade receivables securitization and factoring programs to help manage our cash flows and offset the impact of extended payment terms for some of our customers. XPO Logistics Europe SA (“XPO Logistics Europe”), one of our majority-owned subsidiaries, participates in a trade receivables securitization program co-arranged by three European banks (the “Purchasers”). Under the program, a wholly-owned bankruptcy-remote special purpose entity of XPO Logistics Europe sells trade receivables that originate with wholly-owned subsidiaries of XPO Logistics Europe in the United Kingdom and France to unaffiliated entities managed by the Purchasers. The special purpose entity is a variable interest entity and is consolidated by XPO based on our control of the entity’s activities. We account for transfers under our securitization and factoring arrangements as sales because we sell full title and ownership in the underlying receivables and control of the receivables is considered transferred. For these transfers, the receivables are removed from our Consolidated Balance Sheets at the date of transfer. In the securitization and factoring arrangements, any of our continuing involvement is limited to servicing the receivables. The fair value of any servicing assets and liabilities is immaterial. Our trade receivables securitization program permits us to borrow, on an unsecured basis, cash collected in a servicing capacity on previously sold receivables, which we report within short-term debt on our Consolidated Balance Sheets. Under a securitization program that was terminated in July 2019, we accounted for transfers as either sales or secured borrowings based on an evaluation of whether control has transferred. For the transfers that did not meet the criteria for surrender of control, the transaction was accounted for as a secured borrowing. These secured borrowings were repaid when the program was terminated. For transfers that were accounted for as sales, the consideration received included a simultaneous cash payment and a deferred purchase price receivable. The deferred purchase price receivable was not a trade receivable and was recorded based on its fair value and reported within Other current assets on our Consolidated Balance Sheets. The cash payment which we received on the date of the transfer was reflected within Net cash provided by operating activities on our Consolidated Statement of Cash Flows. As we received cash payments on the deferred purchase price receivable, it was reflected as an investing activity. The new program does not include a deferred purchase price mechanism. The maximum amount of net cash proceeds available at any one time under the new program, inclusive of any unsecured borrowings, is €400 million (approximately $489 million as of December 31, 2020). As of December 31, 2020, €75 million (approximately $92 million) was available to us, subject to having sufficient receivables available to sell to the Purchasers. Under the current program, we service the receivables we sell on behalf of the Purchasers, which gives us visibility into the timing of customer payments. The benefit to our cash flow includes the difference between the cash consideration in the table below and the amount we collected as a servicer on behalf of the Purchasers. In 2020 and 2019, we collected cash as servicer of $2.9 billion and $2.2 billion, respectively. 43 Table of Contents Information related to the trade receivables sold was as follows: Years Ended December 31, (In millions) 2020 2019 2018 Securitization programs (1) Receivables sold in period $ 2,868 $ 2,231 $ 231 Cash consideration 2,868 2,095 179 Deferred purchase price — 135 52 Factoring programs Receivables sold in period 687 858 663 Cash consideration 686 854 660 (1) Receivable transfers under the securitization programs are accounted for as either sales or secured borrowings. In the prior program, a portion of the transfers were accounted for as secured borrowings while under the new program, all transfers are accounted for as sales. This change had the effect of increasing the amount of trade receivables we reported as sold in 2019. In addition to the cash considerations referenced above, we received $186 million in the year ended December 31, 2019, for the realization of cash on the deferred purchase price receivable for our prior securitization program. Secured Debt In April 2020, we entered into a Senior Secured Term Loan Credit Agreement, comprised of a $150 million committed secured term loan facility and a $200 million uncommitted secured evergreen letter of credit facility. We did not draw on the term loan facility through its term, which ended in January 2021. Letters of credit under the letter of credit facility shall expire within one year of issuance and may contain automatic one-year renewals until the letter of credit facility terminates. As of December 31, 2020, we have issued $200 million in aggregate face amount of letters of credit, and have not drawn on the term loan commitments. The credit agreement governing the term loan and letter of credit facilities contains representations and warranties and affirmative and negative covenants customary for financings of this type as well as customary events of default. Term Loan Facilities In March 2019, we entered into an amendment to our senior secured term loan credit agreement (the “Term Loan Credit Agreement”) and borrowed an additional $500 million of incremental loans under a new tranche of term loans. For more information on the amendment, refer to Note 12—Debt to our Consolidated Financial Statements. Proceeds from the new tranche of loans were used for general corporate purposes, including funding purchases of our common stock as described in Note 14—Stockholders’ Equity. Senior Notes In the second quarter of 2020, we completed private placements of $1.15 billion aggregate principal amount of Senior Notes due 2025. Net proceeds from the notes were invested in cash and cash equivalents. In February 2019, we completed a private placement of $1.0 billion aggregate principal amount of senior notes (“Senior Notes due 2024”). We used the proceeds from the Senior Notes due 2024 to repay our outstanding obligation under the Unsecured Credit Facility described below and to finance a portion of our share repurchases described in Note 14—Stockholders’ Equity to our Consolidated Financial Statements. In January 2021, we redeemed our outstanding Senior Notes due 2022 that were originally issued in 2015. See Note 19—Subsequent Events. 44 Table of Contents Unsecured Credit Facility In December 2018, we entered into a $500 million Unsecured Credit Facility and borrowed $250 million. We borrowed an additional $250 million in January 2019. We used the proceeds of both borrowings to finance a portion of our share repurchases described in Note 14—Stockholders’ Equity to our Consolidated Financial Statements. In connection with the issuance of the Senior Notes due 2024 described above, we repaid our outstanding obligations under the Unsecured Credit Facility and terminated it in February 2019. We recorded a debt extinguishment loss of $5 million in 2019 in connection with this repayment. Preferred Stock and Warrant Exchanges In December 2020, some holders of our convertible preferred stock exchanged their holdings for a combination of our common stock, based on the stated conversion price, and a lump-sum payment that represents an approximation of the net present value of the future dividends payable on the preferred stock. Additionally, some holders of our warrants exchanged (or committed to exchange subject to the satisfaction of certain customary closing conditions) their holdings, including Jacobs Private Equity, LLC, an entity controlled by the Company’s chairman and chief executive officer, for a number of shares of our common stock equal to the number of shares of common stock that such holder would be entitled to receive upon an exercise of the warrants less the number of shares of common stock that have an approximate value equal to the exercise price of the warrants. With respect to the preferred stock, 69,445 shares were exchanged, and we issued 9.9 million shares of common stock and paid $22 million of cash. The $22 million has been reflected as a preferred stock conversion charge in the accompanying consolidated financial statements. With respect to the warrants, 0.3 million warrants were exchanged, and we issued 0.3 million shares of common stock. Additional commitments were made with respect to 9.6 million warrants, which are expected to be converted into 9.1 million shares of common stock in the first quarter of 2021. These exchanges are intended to simplify our equity capital structure, including in contemplation of our previously announced plan to pursue a spin-off of our Logistics segment. Share Repurchases In December 2018, our Board of Directors authorized the repurchase of up to $1 billion of our common stock, which was completed in the first quarter of 2019. The share repurchases were funded by our Unsecured Credit Facility and available cash. In February 2019, our Board of Directors authorized additional repurchases of up to $1.5 billion of our common stock. The 2019 authorization permits us to purchase shares in both the open market and in private transactions, with the timing and number of shares dependent on a variety of factors, including price, general business conditions, market conditions, alternative investment opportunities and funding considerations. We are not obligated to repurchase any specific number of shares and may suspend or discontinue the program at any time. The share purchases under this program have been funded by our available cash and proceeds from our 2019 debt offerings. Information regarding our shares repurchased, based on settlement date, were as follows: Years Ended December 31, (In millions, except per share data) 2020 2019 2018 Shares purchased and retired 2 25 10 Aggregate value $ 114 $ 1,347 $ 536 Average price per share $ 66.58 $ 53.41 $ 53.46 Remaining authorization $ 503 $ 617 $ 464 Loan Covenants and Compliance As of December 31, 2020, we were in compliance with the covenants and other provisions of our debt agreements. Any failure to comply with any material provision or covenant of these agreements could have a material adverse effect on our liquidity and operations. 45 Table of Contents LIBOR Uncertainty related to the London Interbank Offered Rate (“LIBOR”) phase-out at the end of 2021 may adversely impact the value of, and our obligations under, our ABL and term loan facilities. See the applicable discussion under Item 1A. Risk Factors. Sources and Uses of Cash Our cash flows from operating, investing and financing activities, as reflected on our Consolidated Statements of Cash Flows, are summarized as follows: Years Ended December 31, (In millions) 2020 2019 Net cash provided by operating activities $ 885 $ 791 Net cash used in investing activities (357) (161) Net cash provided by (used in) financing activities 1,136 (759) Effect of exchange rates on cash, cash equivalents and restricted cash 14 2 Net increase (decrease) in cash, cash equivalents and restricted cash $ 1,678 $ (127) During 2020, we: (i) generated cash from operating activities of $885 million; (ii) generated proceeds from sales of property and equipment (primarily real estate) of $195 million and (iii) received net proceeds of $1.4 billion from our issuances of debt and short-term borrowings. We used cash during this period primarily to: (i) purchase property and equipment of $526 million; (ii) repurchase common stock of $114 million; and (iii) make payments on debt and finance leases of $102 million. During 2019, we: (i) generated cash from operating activities of $791 million; (ii) generated proceeds from sales of property and equipment of $252 million; (iii) collected $186 million on the deferred purchase price receivable as described above; and (iv) received proceeds of $1.8 billion on our debt. We used cash during this period primarily to: (i) purchase property and equipment of $601 million; (ii) repurchase common stock of $1.3 billion; (iii) make payments on debt and finance leases of $867 million and (iv) purchase noncontrolling interests of $258 million. Cash flows from operating activities for 2020 increased by $94 million compared with 2019. The increase reflects the impact of operating assets and liabilities generating $499 million more in cash in 2020, partially offset by lower net income. Within operating assets and liabilities, accrued expenses and other liabilities was a source of cash for 2020 as compared to a use of cash in 2019. This fluctuation primarily reflects the deferral of certain tax payments and an increase in compensation and purchased transportation accruals in 2020. Partially offsetting the impact of accrued expenses and other liabilities was the higher use of cash due to increased accounts receivable as a result of higher revenues in the fourth quarter of 2020 compared to 2019. Investing activities used $357 million of cash in 2020 compared with $161 million used in 2019. During 2020, we used $526 million of cash to purchase property and equipment and received $195 million from sales of property and equipment. During 2019, we used $601 million of cash to purchase property and equipment, received $252 million of cash from sales of property and equipment and received proceeds of $186 million related to the realization of cash on deferred purchase price receivable. Financing activities generated $1.1 billion of cash in 2020 and used $759 million of cash in 2019. The primary sources of cash from financing activities in 2020 were $1.1 billion of net proceeds from the issuance of Senior Notes due 2025; $200 million of proceeds from borrowings on our ABL Facility, net of payments, and $47 million from net borrowings related to our securitization program. The primary uses of cash from financing activities in 2020 were $114 million used to purchase XPO common stock and $102 million used to repay debt and finance leases. By comparison, the primary uses of cash from financing activities in 2019 were $1.3 billion to repurchase XPO common stock, $867 million used to repay debt and finance leases, and $258 million used to purchase a shareholder’s noncontrolling interest in XPO Logistics Europe SA. The primary source of cash from financing activities in 2019 was $1.7 billion of net proceeds from the issuance of long-term debt, as described above. 46 Table of Contents Defined Benefit Pension Plans We sponsor both funded and unfunded defined benefit plans for some employees in the U.S. and internationally. The largest of these plans include the funded U.S. plan and the unfunded U.S. plan and the funded U.K. plan. Historically, we have realized income, rather than expense, from these plans. We generated aggregate income from our U.S. and U.K. plans of $83 million in 2020, $54 million in 2019 and $74 million in 2018. The plans have been generating income due to their funded status and because they do not allow for new plan participants or additional benefit accruals. Defined benefit pension plan amounts are calculated using various actuarial assumptions and methodologies. Assumptions include discount rates, inflation rates, expected long-term rate of return on plan assets, mortality rates, and other factors. The assumptions used in recording the projected benefit obligations and fair value of plan assets represent our best estimates based on available information regarding historical experience and factors that may cause future expectations to differ. Differences in actual experience or changes in assumptions could materially impact our obligation and future expense or income. Discount Rate In determining the appropriate discount rate, we are assisted by actuaries who utilize a yield-curve model based on a universe of high-grade corporate bonds (rated AA or better by Moody’s, S&P or Fitch rating services). The model determines a single equivalent discount rate by applying the yield curve to expected future benefit payments. The discount rates used in determining the net periodic benefit costs and benefit obligations are as follows: U.S. Qualified Plans U.S. Non-Qualified Plans U.K. Plan 2020 2019 2020 2019 2020 2019 Discount rate - net periodic benefit costs 2.96 % 4.08 % 2.40% - 2.78% 3.65% - 3.95% 1.84 % 2.56 % Discount rate - benefit obligations 2.48 % 3.35 % 1.62% - 2.30% 2.72% - 3.20% 1.37 % 2.04 % An increase or decrease of 25 basis points in the discount rate would decrease or increase our 2020 pre-tax pension income by $3 million for the U.S. plans and $2 million for the U.K. plan, respectively. We use a full yield curve approach to estimate the interest cost component of net periodic benefit cost by applying specific spot rates along the yield curve used to determine the benefit obligation to each of the underlying projected cash flows based on time until payment. Rate of Return on Plan Assets We estimate the expected return on plan assets using current market data as well as historical returns. The expected return on plan assets is based on estimates of long-term returns and considers the plans’ anticipated asset allocation over the course of the next year. The plan assets are managed using a long-term liability-driven investment strategy that seeks to mitigate the funded status volatility by increasing participation in fixed-income investments generally as funded status increases. This strategy was developed by analyzing a variety of diversified asset-class combinations in conjunction with the projected liabilities of the plans. For the year ended December 31, 2020, our expected return on plan assets was $102 million for the U.S. plans and $57 million for the U.K. plan, compared to the actual return on plan assets of $274 million for the U.S. plans and $120 million for the U.K. plan. The actual annualized return on plan assets for the U.S. plans for 2020 was approximately 15%, which was above the expected return on asset assumption for the year due to positive performance in a strong long duration fixed income market environment, which represented over 82% of the portfolio, and positive performance from the domestic and international equity markets. The actual annualized return on plan assets for the U.K. plan for 2020 was approximately 11%, which was above the expected return on asset assumption for the year as a result of strong performances across equity and credit asset classes. An increase or decrease of 25 basis points in the expected return on plan assets would increase or decrease our 2020 pre-tax pension income by $5 million for the U.S. plans and $3 million for the U.K. plan. 47 Table of Contents Actuarial Gains and Losses Changes in the discount rate and/or differences between the expected and actual rate of return on plan assets results in unrecognized actuarial gains or losses. For our defined benefit pension plans, accumulated unrecognized actuarial losses were $50 million for the U.S. plans and $158 million for the U.K. plan as of December 31, 2020. The portion of the unrecognized actuarial gain/loss that exceeds 10% of the greater of the projected benefit obligation or the fair value of plan assets at the beginning of the year is amortized and recognized as income/expense over the estimated average remaining life expectancy of plan participants. We expect to recognize $1 million of amortization of actuarial gain in our net periodic benefit income for the U.K. plan for 2021. Effect on Results The effects of the defined benefit pension plans on our results consist primarily of the net effect of the interest cost on plan obligations for the U.S. plans and the U.K. plan, and the expected return on plan assets. We estimate that the defined benefit pension plans will contribute annual pre-tax income in 2021 of $61 million for the U.S. plans and $41 million for the U.K. plan. Funding In determining the amount and timing of pension contributions for the U.S. plans, we consider our cash position, the funded status as measured by the Pension Protection Act of 2006 and generally accepted accounting principles, and the tax deductibility of contributions, among other factors. We contributed $5 million to the U.S. plans in 2020 and 2019, respectively, and we estimate that we will contribute $5 million to the U.S. plans in 2021. For the U.K. plan, the amount and timing of pension contributions are determined in accordance with U.K. pension codes and trustee negotiations. We contributed $3 million and $2 million to the U.K. plan in 2020 and 2019, respectively. We estimate that we will contribute $1 million to the U.K. plan in 2021. For additional information, see Note 13—Employee Benefit Plans to our Consolidated Financial Statements. Contractual Obligations Our contractual obligations as of December 31, 2020 were: Payments Due by Period (In millions) Total 2021 2022-2023 2024-2025 Thereafter Contractual obligations Finance leases $ 479 $ 97 $ 169 $ 107 $ 106 Operating leases (1) 2,718 579 957 547 635 Purchase commitments 109 73 31 5 — Debt (excluding finance leases) 6,444 1,254 536 4,354 300 Interest on debt (2) 1,167 246 476 272 173 Total contractual cash obligations $ 10,917 $ 2,249 $ 2,169 $ 5,285 $ 1,214 (1) As of December 31, 2020, we had additional operating leases that have not yet commenced with future undiscounted lease payments of $202 million. These operating leases will commence in 2021 through 2022 with initial lease terms of 2 years to 15 years. (2) Estimated interest payments have been calculated based on the principal amount of debt and the applicable interest rates as of December 31, 2020. As of December 31, 2020, our Consolidated Balance Sheet reflects a long-term liability of $371 million for deferred taxes. Additionally, our Consolidated Balance Sheet reflects gross unrecognized tax benefits of $27 million, which are primarily included in long-term liabilities. As the timing of future cash outflows for these liabilities is uncertain, they are excluded from the above table. Actual amounts of contractual cash obligations may differ from estimated amounts due to changes in foreign currency exchange rates. We anticipate net capital expenditures to be between 48 Table of Contents $475 million and $525 million in 2021 (without giving effect to the planned spin-off of our Logistics segment), funded by cash on hand and available liquidity. Critical Accounting Policies We prepare our consolidated financial statements in accordance with U.S. generally accepted accounting principles. A summary of our significant accounting policies is contained in Note 2—Basis of Presentation and Significant Accounting Policies to our Consolidated Financial Statements. The methods, assumptions, and estimates that we use in applying our accounting policies may require us to apply judgments regarding matters that are inherently uncertain and may change based on changing circumstances or changes in our analysis. Material changes in these assumptions, estimates and/or judgments have the potential to materially alter our results of operations. We have identified below our accounting policies that we believe could potentially produce materially different results if we were to change underlying assumptions, estimates and/or judgments. Although actual results may differ from estimated results, we believe the estimates are reasonable and appropriate. Evaluation of Goodwill We measure goodwill as the excess of consideration transferred over the fair value of net assets acquired in business combinations. We allocate goodwill to our reporting units for the purpose of impairment testing. We evaluate goodwill for impairment annually, or more frequently if an event or circumstance indicates an impairment loss may have been incurred. We measure goodwill impairment, if any, at the amount a reporting unit’s carrying amount exceeds its fair value, not to exceed the carrying amount of goodwill. Our reporting units are our operating segments or one level below our operating segments for which discrete financial information is prepared and regularly reviewed by segment management. Application of the goodwill impairment test requires judgment, including the identification of reporting units, the assignment of assets and liabilities to reporting units, the assignment of goodwill to reporting units, and a determination of the fair value of each reporting unit. For our 2020 and 2019 goodwill assessments, we performed a quantitative analysis for all five of our reporting units using a combination of income and market approaches, with the assistance of a third-party valuation appraiser. As of August 31, 2020 and 2019, we completed our annual impairment tests for goodwill with all of our reporting units having fair values in excess of their carrying values, resulting in no impairment of goodwill. The income approach of determining fair value is based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. The discount rates reflect management’s judgment and are based on a risk adjusted weighted-average cost of capital utilizing industry market data of businesses similar to the reporting units. Inherent in our preparation of cash flow projections are assumptions and estimates derived from a review of our operating results, business plans, expected growth rates, cost of capital and tax rates. Our forecasts also reflect expectations concerning future economic conditions, interest rates and other market data. The market approach of determining fair value is based on comparable market multiples for companies engaged in similar businesses, as well as recent transactions within our industry. We believe this approach, which utilizes multiple valuation techniques, yields the most appropriate evidence of fair value. Many of the factors used in assessing fair value are outside the control of management, and these assumptions and estimates may change in future periods. Changes in assumptions or estimates could materially affect the estimate of the fair value of a reporting unit, and therefore could affect the likelihood and amount of potential impairment. Self-Insurance Accruals We use a combination of self-insurance programs and purchased insurance to provide for the costs of medical, casualty, liability, vehicular, cargo and workers’ compensation claims. We periodically evaluate our level of insurance coverage and adjust our insurance levels based on risk tolerance and premium expense. Liabilities for the risks we retain, including estimates of claims incurred but not reported, are not discounted and are estimated, in part, by considering historical cost experience, demographic and severity factors, and judgments about current and expected levels of cost per claim and retention levels. Additionally, claims may emerge in future years for events that occurred in a prior year at a rate that differs from previous actuarial projections. We believe the actuarial 49 Table of Contents methods are appropriate for measuring these self-insurance accruals. However, based on the number of claims and the length of time from incurrence of the claims to ultimate settlement, the use of any estimation method is sensitive to the assumptions and factors described above. Accordingly, changes in these assumptions and factors can affect the estimated liability and those amounts may be different than the actual costs paid to settle the claims. Income Taxes Our annual effective tax rate is based on our income and statutory tax rates in the various jurisdictions in which we operate. Judgment and estimates are required in determining our tax expense and in evaluating our tax positions, including evaluating uncertainties. We review our tax positions quarterly and as new information becomes available. Our effective tax rate in any financial statement period may be materially impacted by changes in the mix and/or level of earnings by taxing jurisdiction. Deferred income tax assets represent amounts available to reduce income taxes payable in future years. Such assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating losses and tax credit carryforwards. We evaluate the recoverability of these future tax deductions and credits by assessing all available evidence, including the reversal of deferred tax liabilities, carrybacks available, and historical and projected pre-tax profits generated by our operations. Valuation allowances are established when, in management’s judgment, it is more likely than not that our deferred tax assets will not be realized. In assessing the need for a valuation allowance, management weighs the available positive and negative evidence, including limitations on the use of tax losses and other carryforwards due to changes in ownership, historic information, and projections of future sources of taxable income that include and exclude future reversals of taxable temporary differences. New Accounting Standards Information related to new accounting standards is included in Note 2—Basis of Presentation and Significant Accounting Policies.