GXO Logistics, Inc. (GXO) FY 2021 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This Form 10-K contains certain forward-looking statements that are intended to be covered by the safe harbors created by The Private Securities Litigation Reform Act of 1995. Please see “Cautionary Statement Regarding Forward-Looking Statements” and “Risk Factors” for a discussion of the uncertainties, risks and assumptions associated with these statements.

This section of this Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 are not included in this Form 10-K and can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Form 10, as amended, declared effective on July 21, 2021.

Business Overview

GXO Logistics, Inc., together with its subsidiaries (“GXO,” the “Company” or “we”), is the largest pure-play contract logistics provider in the world and a foremost innovator in an industry propelled by strong secular tailwinds. Our customers rely on us to move their goods with high efficiency through their supply chains — from the moment inbound goods arrive at our logistics sites, through fulfillment and distribution and the management of returned products. Our customer base includes many blue-chip leaders in sectors that demonstrate high growth and/or durable demand, with significant growth potential through customer outsourcing of logistics services.

We strive to provide all of our customers with consistently high levels of service and cutting-edge automation managed by our proprietary technology. We also collaborate with our largest customers on planning and forecasting and provide assistance with network optimization, working with these customers to design or redesign their supply chains to meet specific goals, such as sustainability metrics. Our multidisciplinary, consultative approach has led to many of our key customer relationships extending for years and expanding in scope.

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. As part of our growth strategy, we intend to develop additional business in consumer and other verticals where we already have deep expertise, prominent customer relationships and a strong track record of successful performance. We also intend to expand into new verticals by leveraging our capacity and technological strengths and by marketing the benefits of our proprietary platform for warehouse operations. We use technology to manage advanced automation, labor productivity, safety and the complex flow of goods within sophisticated logistics environments.

Our business model is asset-light and historically resilient in cycles, with high returns, strong free cash flow and visibility into revenue and earnings. The vast majority of our contracts with customers are multi-year agreements, and our facility lease arrangements generally align with contract length. Most of our customer contracts contain both fixed and variable components. The fixed component is typically designed to cover facility, technology and equipment costs and may cover management costs, while the variable component is determined based on expected volumes and associated labor costs.

The Separation

On August 2, 2021, we completed the separation from XPO Logistics, Inc. (“XPO”) (the “Separation”). The Separation was accomplished by the distribution of 100 percent of the outstanding common stock of GXO to XPO stockholders as of the close of business on July 23, 2021, the record date for the distribution. XPO stockholders received one share of GXO common stock for every share of XPO common stock held at the close of business on the record date. GXO is now a standalone publicly traded company. On August 2, 2021, regular-way trading of

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GXO’s common stock commenced on the New York Stock Exchange under the ticker symbol “GXO.” GXO was incorporated as a Delaware corporation in February 2021.

The Separation was completed under a Separation and Distribution Agreement and various other agreements that govern aspects of our relationship with XPO, including, but not limited to a Transition Services Agreement, a Tax Matters Agreement, an Employee Matters Agreement (“EMA”) and an Intellectual Property License Agreement. See Note — 3 The Separation to our consolidated financial statements for additional information.

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 and 2021 affected and may continue to affect economic activity broadly and customer sectors served by our industry.

Our operating results and cash flows fluctuated as a result of changes due to the COVID-19 pandemic and the seasonality of our business during the year ended December 31, 2020, and to a lesser extent for the year ended December 31, 2021, as discussed below. Future operating results and cash flows may fluctuate due to these and other factors beyond our control, which may include the cost and availability of labor, the timely procurement of equipment, the impact of product component shortages for our customers, foreign exchange rate fluctuations, changes in government regulations and economic changes in our operating regions. While we generally can pass cost increases through to our customers, inflation may affect our operating results and cash flows. The timing of these pass-through costs can vary.

The totality of the actions we have taken, and continue to take during the pandemic 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 while our strong liquidity and disciplined capital management enable us to continue to invest in key growth initiatives.

However, due to the evolving nature of the COVID-19 pandemic and the efficacy and distribution of vaccines, the extent of the impact of the pandemic on our industry and our business, in particular, remains difficult to predict. Furthermore, the extent and pace of recovery remain uncertain and may differ significantly between the countries in which we operate. Our results of operations may continue to be impacted by the pandemic throughout 2022.

Basis of Presentation

Prior to the Separation, GXO historical financial statements were prepared on a standalone combined basis and were derived from the consolidated financial statements and accounting records of XPO. On August 2, 2021, the Company became a standalone publicly traded company, and its financial statements are now presented on a consolidated basis. The financial statements for all periods presented, including the historical results of the Company before August 2, 2021, are now referred to as “Consolidated Financial Statements” and have been prepared under the rules and regulations for reporting on Form 10-K and following accounting principles generally accepted in the U.S. (“GAAP”), which requires us to make estimates and assumptions that impact the amounts reported and disclosed in our consolidated financial statements and the accompanying notes.

Prior to the Separation, GXO historical assets and liabilities presented were wholly owned by XPO and were reflected on a historical cost basis. In connection with the Separation, GXO assets and liabilities were transferred to the Company on a carry-over basis.

Prior to the Separation, GXO historical results of operations included allocations of XPO costs and expenses, including XPO’s corporate function which incurred a variety of expenses including, but not limited to, information technology, human resources, accounting, sales and sales operations, procurement, executive services, legal, corporate finance and communications. An allocation of these expenses is included to burden all business units comprising XPO’s historical results of operations, including GXO. The charges reflected have been either specifically identified or allocated using drivers including proportional adjusted earnings before interest, taxes,

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depreciation and amortization, which include adjustments for transaction and integration costs, as well as restructuring costs and other adjustments, or headcount. These allocated costs are recorded within Selling, general and administrative expense (“SG&A”), Depreciation and amortization expense and Transaction and integration costs in the Consolidated Statements of Operations. All charges and allocations for facilities, functions and services performed by XPO organizations have been deemed settled in cash by GXO to XPO in the year in which the charges and allocations were recorded in the Consolidated Statements of Operations.

For the periods ended before the Separation, GXO was a member of the XPO consolidated group, and its U.S. taxable income was included in XPO’s consolidated U.S. federal income tax return as well as in the tax returns filed by XPO with certain state and local taxing jurisdictions. For the periods ended after the Separation, GXO will file a consolidated U.S. federal income tax return as well as state and local income tax returns. GXO’s foreign income tax returns are filed on a full-year basis.

GXO has one reportable segment.

Results of Operations

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Revenue for 2021 increased by 28.2%, or $1.7 billion, to $7.9 billion compared with $6.2 billion for 2020. The increase in 2021 compared to the prior year primarily reflects a 29% growth in our e-commerce, omnichannel retail and consumer technology vertical and the acquisition of the majority of Kuehne + Nagel’s contract logistics operations in the U.K. in January 2021 (the “K + N acquisition”). The Kuehne + Nagel business contributed approximately 15.8 percentage points to revenue growth in our European operations and 9.8 percentage points to our total revenue growth for 2021 compared to 2020. Our European and North American operations reported growth of 38.9% and 11.1%, respectively. Foreign currency movement increased revenue by approximately 3.5 percentage points in 2021.

Direct operating expenses comprise both fixed and variable expenses and consist of operating costs related to our logistics facilities, including personnel costs, facility and equipment expenses, such as rent, utilities, equipment maintenance and repair, transportation costs, costs of materials and supplies and information technology expenses. Direct operating expense for 2021 increased by 28.4%, or $1.5 billion, to $6.6 billion compared with $5.2 billion for 2020. As a percentage of Revenue, Direct operating expense were 83.6% and 83.4% in 2021 and 2020, respectively. Direct operating expense increased primarily due to higher personnel and temporary labor expense of $913 million, as well as higher third-party transportation costs and facilities expense of $369 million.

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SG&A, including the allocated costs of XPO prior to the Separation, primarily consists of salary and benefit costs for executive and certain administration functions, professional fees, facility costs other than those related to our logistics facilities, bad debt expense and legal costs. SG&A for 2021 increased by 16.9%, or $103 million, to $714 million, compared with $611 million in 2020. SG&A increased due to higher personnel expenses primarily associated with the K + N acquisition.

Depreciation and amortization expense for 2021 increased by 3.7%, or $12 million, to $335 million compared with $323 million for 2020. The increase was primarily due to the impact of capital expenditures associated with new contracts. Depreciation and amortization expense included allocated corporate charges from XPO of $15 million and $21 million in 2021 and 2020, respectively. Depreciation and amortization expense included amortization of intangible assets of $61 million in 2021 and 2020.

Transaction and integration costs were $99 million, compared with $47 million for 2020. Transaction and integration costs in 2021 primarily relate to the Separation and the K + N acquisition. Transaction and integration costs in 2020 relate to costs allocated by XPO, including its exploration of strategic alternatives in 2020.

We engage in restructuring actions as part of our ongoing efforts to best use our resources and infrastructure. These costs are primarily related to severance. Restructuring costs for 2021 were $4 million compared with $29 million for 2020. Restructuring charges in 2021 included an adjustment to a previously recognized liability.

Other income, net consists primarily of pension income. In connection with the Separation, GXO became the plan sponsor for a defined benefit pension plan in the U.K. Other income, net increased to $23 million in 2021 from $2 million in 2020. See Note — 14 Employee Benefit Plans to our consolidated financial statements for additional information.

Interest expense primarily consists of interest related to indebtedness for money borrowed, capital lease obligations, and net investment hedges. Interest expense for 2021 decreased by 12.5%, or $3 million, to $21 million, compared to $24 million for the same period in 2020. In connection with the Separation, we settled our related-party debt with XPO and issued $800 million in notes and entered into cross-currency swap agreements.

Income tax for 2021 was an $8 million benefit compared to a $16 million expense for 2020. Our effective tax rate was negative 5.6% in 2021 and not meaningful in 2020. In 2021, the effective tax rate was primarily impacted by the benefit from intangible assets transferred under the Separation. In 2020, the income tax expense was driven by the net impact of changes to valuation allowances in our foreign operations, and contribution- and margin-based income taxes that we incurred even though our pretax income was negative.

Liquidity and Capital Resources

Overview

Prior to the Separation on August 2, 2021, the Company participated in XPO’s centralized treasury model, which included cash pooling and other intercompany financing arrangements. As part of XPO, we generated positive cash flows from operations. We have generated and expect to continue generating positive cash flows from operations after the Separation.

Our ability to fund our operations and anticipated capital needs are reliant upon the generation of cash from operations, supplemented as necessary by periodic utilization of our revolving credit facility. Our principal uses of cash in the future will be primarily to fund our operations, working capital needs, capital expenditures, repayment of borrowings and strategic business development transactions. The timing and magnitude of our start-ups can vary and may positively or negatively impact our cash flows.

We continually evaluate our liquidity requirements and capital structure in light of our operating needs, growth initiatives and capital resources. We believe that our existing liquidity and sources of capital are sufficient to support our operations over the next 12 months.

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Capital Expenditures

Our 2022 capital expenditures include capital associated with fulfillment costs and investments in technology and automation to improve the speed and accuracy of order fulfillment and the resiliency of their supply chains. The level and the timing of the Company’s capital expenditures within these categories can vary as a result of a variety of factors outside of our control, such as the timing of new contracts, availability of labor and materials, and foreign currency fluctuations. We believe that we have significant discretion over the amount and timing of our capital expenditures as we are not subject to any agreement that would require significant capital expenditures on a designated schedule or upon the occurrence of designated events.

Debt and Financing Arrangements

Revolving Credit Facility

In June 2021, we entered into a five-year unsecured multi-currency revolving credit facility (the “Revolving Credit Facility”). The Revolving Credit Facility provides commitments of up to $800 million, of which $60 million will be available for the issuance of letters of credit. There were no amounts outstanding under the Revolving Credit Facility as of December 31, 2021.

Unsecured Notes

In July 2021, the Company completed an offering of $800 million aggregate principal amount of notes, consisting of $400 million of notes due 2026 (the “2026 Notes”) and $400 million of notes due 2031 (the “2031 Notes,” and together with the 2026 Notes, the “Notes”). The 2026 Notes bear interest at a rate of 1.65% per annum payable semiannually in arrears on January 15 and July 15 of each year, beginning January 15, 2022, and mature on July 15, 2026. The 2031 Notes bear interest at a rate of 2.65% per annum payable semiannually in arrears on January 15 and July 15 of each year, beginning January 15, 2022, and mature on July 15, 2031.

At December 31, 2021, we complied with all applicable covenants under our debt and financing arrangements.

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 also sell certain European trade accounts receivable under a securitization program that contains financial covenants customary for this type of arrangement, including maintaining a defined average days sales outstanding ratio. We use trade receivables securitization and factoring programs to help manage our cash flows.

In July 2021, in connection with the Separation, XPO’s existing trade receivable securitization program was amended; the previous €400 million ($455 million) program is now comprised of two separate €200 million ($227 million) programs, one of which remains with the Company and expires in July 2024. As of July 2021, the Company’s special purpose entity no longer purchases trade receivables from XPO. As of December 31, 2020, current assets include trade receivables purchased from XPO in connection with our trade receivables securitization program of $105 million.

In January 2022, the Company halted sales of European trade accounts receivable related to our securitization program with the intention to terminate the program in 2022. The company may replace the securitization program with additional factoring activity or cash on hand.

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Information related to the trade receivables sold was as follows:

See Note — 11 Debt and Financing Arrangements to the consolidated financial statements for additional information.

Financial Condition

The following table summarizes our asset and liability balances as of December 31, 2021 and 2020:

The increase in our assets and liabilities from December 31, 2020 to December 31, 2021 primarily reflects the impact of the K + N acquisition. Total long-term assets also reflect an increase in contract assets and operating lease assets associated with our new contracts. Total long-term liabilities also reflect the settlement of related-party notes, issuance of the Notes in 2021, and operating lease liabilities associated with our new contracts.

Cash Flow Activity for the Years Ended December 31, 2021 and 2020

Our cash flows from operating, investing and financing activities are summarized as follows:

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Operating Activities

Cash flows provided by operating activities for 2021 increased by $122 million compared with 2020. The increase primarily reflects higher net income of $183 million in 2021, partially offset by cash provided by working capital of $31 million in 2020.

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Investing Activities

Investing activities used $207 million of cash in 2021 compared with $280 million used in 2020. During 2021, we used $250 million of cash for capital expenditures, received $32 million in connection with the K + N acquisition and received $11 million from sales of property and equipment. During 2020, we used $222 million of cash for capital expenditures, used $40 million, net, in connection with the purchase and sale of affiliate trade receivables and used $30 million in connection with a pre-acquisition deposit for the K + N acquisition. During 2020, we received $12 million from sales of property and equipment.

Financing Activities

Financing activities used $241 million of cash in 2021 and generated $67 million of cash in 2020. The primary uses of cash from financing activities in 2021 were $774 million of net transfers to XPO in connection with the Separation, $128 million to purchase the remaining noncontrolling interest in GXO Logistics Europe SAS that we did not own, $72 million cash used to repay debt and finance leases and $26 million to repay borrowings related to our securitization program. The source of cash from financing activities in 2021 was the issuance of long-term debt of $794 million. By comparison, the primary sources of cash from financing activities in 2020 were $168 million of net transfers from XPO and $24 million from net borrowings related to our securitization program. The primary uses of cash from financing activities in 2020 were $123 million used to repay debt and finance leases and $21 million to purchase noncontrolling interests in GXO Logistics Europe SAS.

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

We lease certain facilities and equipment under non-cancellable operating lease arrangements. As of December 31, 2021, the value of our obligations under operating and finance leases was $1.8 billion and $167 million, respectively. See Note — 8 Leases to the consolidated financial statements for additional information.

As of December 31, 2021, we have $800 million of unsecured notes outstanding with interest payable semiannually, in arrears on January 15 and July 15 of each year. See Note — 11 Debt and Financing Arrangements to the consolidated financial statements for additional information.

In addition, we have obligations for agreements to purchase goods or services entered into in the ordinary course of business that are enforceable and legally binding and gross unrecognized tax benefits.

Critical Accounting Policies

We prepare our consolidated financial statements in accordance with U.S. generally accepted accounting principles. We make assumptions, estimates and judgments that affect our reported amounts of assets, liabilities, revenues, expenses, gains and losses. Material changes in these assumptions, estimates and/or judgments have the potential to materially alter our results of operations. We have identified the following accounting policies to be the most critical as they are important to our financial condition and results of operations, and require significant judgment and estimates on the part of management in their application.

Evaluation of Goodwill

Goodwill is tested at the reporting unit, which is an operating segment or one level below. At December 31, 2021, we had two reporting units. As of August 31, 2021, we completed qualitative impairment tests for goodwill to determine if our reporting units had fair values in excess of their carrying values. For each reporting unit, we

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weighed the relative impact of factors that are specific to the reporting unit as well as industry and macroeconomic factors. The reporting unit specific factors that were considered included actual and expected financial performance and changes to the reporting units’ carrying amounts since the most recent impairment tests. Based on the qualitative assessments, considering the aggregation of the relevant factors, we concluded that it is not more likely than not that the fair value of each reporting unit is less than its respective carrying amount and therefore performing quantitative impairment tests was unnecessary.

A quantitative goodwill impairment test, when performed, includes estimating the fair value of a reporting unit using an income approach and/or a market-based approach. The income approach of determining fair value is based on the present value of estimated future cash flows, which requires us to make various judgmental assumptions, including assumptions about the timing and amount of future cash flows, growth rates and discount rates. 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 any potential impairment.

Employee Benefit Plans

We sponsor an international defined benefit pension plan. Assumptions used in the accounting for these employee benefit plans include the discount rate and expected return on plan assets. Assumptions are determined based on company data and appropriate market indicators and are evaluated each year at December 31. A change in any of these assumptions would have an effect on net periodic pension costs reported in the consolidated financial statements.

The discount rate is determined based on the yield on a portfolio of high-quality bonds, constructed to provide cash flows necessary to meet our pension plans’ expected future benefit payments, as determined for the accumulated benefit obligation. A 25 basis point decrease in the discount rate would result in an estimated increase in the accumulated benefit obligation of approximately $58 million. The expected return on plan assets assumption is derived using the current and expected asset allocation of the pension plan assets and considering historical as well as expected returns on various classes of plan assets. An increase or decrease of 25 basis points in the expected long-term rate of return would have decreased or increased 2021 pension expense by approximately $4 million. See Note — 14 Employee Benefit Plans to the consolidated financial statements for additional information.

New Accounting Standards

Information related to new accounting standards is included in Note — 2 Basis of Presentation and Significant Accounting Policies to the consolidated financial statements.

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