GXO Logistics, Inc. Q4 FY2021 Earnings Call

Welcome to GXO’s Fourth Quarter and Fiscal Year 2021 Earnings Conference Call and Webcast. My name is Paul, and I’ll be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session. Please note that this conference is being recorded. Before the call begins, let me read a brief statement on behalf of the company regarding forward-looking statements, the use of non-GAAP financial measures, and company guidance. During this call, the company will be making certain forward-looking statements within the meaning of applicable securities laws, which by their nature involve a number of risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. A discussion of factors that could cause actual results to differ materially is contained in the company’s SEC filings. The forward-looking statements in the company’s earnings release or made on this call are made only as of today, and the company has no obligation to update any of these forward-looking statements, except to the extent required by law. The company may also refer to certain non-GAAP financial measures as defined under the applicable SEC rules during this call. Reconciliations of such non-GAAP financial measures to the most comparable GAAP measures are contained in the company’s earnings release and the related financial tables are on its website. Unless otherwise stated, all results reported on this call are reported in United States dollars. The company will also remind you that this guidance incorporates business trends to date and what it believes to be appropriate assumptions. The company’s results are inherently unpredictable and may be materially affected by many factors, including fluctuations in global exchange rates, changes in global economic conditions, consumer demand, labor market dynamics, global supply chain constraints, inflationary pressures, and various factors detailed in its filings with the SEC. This guidance also reflects the company’s estimates to date regarding the impact of the COVID-19 pandemic on its operations. It is not possible for the company to actually predict demand for its services, and therefore, its actual results could differ materially from the guidance. You can find a copy of the company’s earnings release, which contains additional important information regarding forward-looking statements and non-GAAP financial measures in the Investors section of the company website. I will now turn the call over to GXO’s Chief Executive Officer, Malcolm Wilson. Mr. Wilson, you may begin.

Thank you, Paul. Good morning, and welcome to GXO’s fourth quarter and full year 2021 earnings call. With me here today are Baris Oran, our Chief Financial Officer, and Mark Manduca, our Chief Investment Officer. In the fourth quarter, our operations again delivered the highest quarterly revenue and adjusted EBITDA in our history. We delivered double-digit organic revenue growth in every quarter of 2021. We finished the year with an accelerating trajectory growing at 19%. Moreover, we see great momentum as we have progressed into 2022. As a result, we are raising our 2022 guidance. We delivered a successful peak for our customers during the fourth quarter, and we played our role in delivering holiday cheer for millions of consumers. We managed the labor market exceptionally well, including recruiting over 20,000 new team members, and we navigated an elongated peak period that ran from mid-November to late December. We helped our customers manage the ongoing e-commerce channel shift with online spending of double digits. It’s worth highlighting that through the Thanksgiving weekend, our overall e-commerce activity levels were up 100% from the start of the quarter, and some of our sites handled over 0.5 million outbound e-commerce units per day. GXO continues to capitalize on the strong secular tailwinds of e-commerce, automation, and outsourcing. In 2021, we won contracts with an aggregate lifetime value of approximately $5 billion. This gives us a strong foundation to achieve our 2022 organic revenue growth target of 8% to 12%, and this growth is on an already record 2021 year. Recent and notable customer wins and expansions include Abercrombie and Fitch, ASOS, BT, Carphone, Currys, Kingfisher Raytheon, Saks, and Zalando. It’s worth noting that two of our recent large UK technology wins, BT and Currys, are first-time outsourcing partnerships. These wins are a direct benefit of the new technology verticals that we gained through our 2021 acquisition in the UK. Our sales pipeline at the end of the fourth quarter reached a new record level at $2.5 billion, and half of these opportunities are within the e-commerce sector. Approximately 60% of our revenue comes from customer relationships that span multiple countries, and over the course of the year, we were able to expand our operations with 80% of our top 20 customers. At GXO, we believe that being a leader in logistics means making sure we take care of our partners, people, and the planet. GXO is bringing significant environmental benefits to customers through our pioneering work on ESG solutions that increase order precision, optimize stock levels, reduce packaging, and streamline the consumer returns process. For example, our reverse logistics revenues were up 28% year-over-year in the fourth quarter, and this is indicative of our vital role in the circular economy as we help to reduce the carbon footprint from the global supply chain. We’re looking forward to updating you on our progress toward achieving our industry-leading ESG targets that underpin our AA MSCI ESG rating when we publish our inaugural sustainability report in the second quarter. I’m extremely proud of our team’s stellar performance in 2021. Our combination of world-class people, global scale, and industry-leading technology is delivering increasing value for our customers and shareholders. Given our strong results and continued confidence in our growth, we will be providing long-term expectations at our Capital Markets Day later this year. I will now hand the call over to Baris, who will take you through GXO’s fourth quarter and full year financial performance. Baris, over to you.

Thank you, Malcolm, and good morning, everyone. 2021 has been a year of records: record revenue, record EBITDA, and record EPS. In the fourth quarter, we generated revenue of $2.3 billion, net income of $56 million, and adjusted EBITDA of $167 million. Our organic revenue growth was an impressive 19% in the quarter, the highest for any quarter last year against our toughest quarterly comparison. For the full year, we generated revenue of $7.9 billion, net income of $153 million, and pro forma adjusted EBITDA of $633 million. Our return on invested capital has surpassed 30%, a level we expect to exceed looking forward. This full year revenue represents a year-over-year increase of 28% and is up 15% on an organic basis, with M&A contributing 10% and FX contributing 3%. Don’t underestimate what we are achieving in terms of absolute growth. In dollar terms, that 28% increase is equivalent to the prior year sales of our largest European pure-play competitors. In 2021, revenue from our top 20 customers grew organically by approximately 22%, demonstrating the success of our land-and-expand strategy. The largest brands in the world want to directly reach consumers via e-commerce; GXO is their partner of choice. Moving to earnings: our 39% growth in full year adjusted pro forma EBITDA reflects our strong revenue growth and our high-quality contracts that enable us to pass through labor costs in an inflationary environment. Our business is naturally a high inflation hedge. Our full year adjusted pro forma EBITDA growth was $0.73. Our cash flow from operations for the full year 2021 was $455 million. We spent $250 million in CapEx, specifically we dedicated half of our total CapEx to automation, technology, and software. As we continue to lead the industry in tech implementation, digitization, and robotics, we generated free cash flow of $216 million for the full year, which converted about 30% of our adjusted EBITDA. Our fourth quarter free cash flow was $137 million, which reflects our rigorous cash collection processes. Turning to the balance sheet: we are committed to maintaining our investment-grade credit rating. We finished 2021 with net debt of $628 million. Our leverage ratio is one time, which is in line with our previously discussed net long-term leverage range of 1 to 1.5 times. And for additional flexibility, we also have an available $800 million revolving credit facility. Our balance sheet strength is very important to our customers and gives us great optionality for future growth initiatives. I’ll now turn the call over to Mark.

Thank you, Baris. We’ve talked before about the three megatrends of automation, e-commerce, and outsourcing. And it’s very clear from our fourth quarter results that these continue to propel us forward. Never before has the case for automation been so compelling. Automation provides reliability and massive operational benefits for our customers and an improved working environment for our team members. GXO leads the marketplace in automated solutions. And in 2021, we deployed more than 2,000 new pieces of technology across our sites, up nearly 100% year-over-year. Our use of goods-to-person systems was up over 100% year-over-year, and our use of cobots grew over 200%. Now to give a real-world example, in one of our recent expansions in the grocery vertical, traditionally viewed by many as a lower-tech, more manual environment, we’re deploying cobots that will drive a game-changing 70% uplift in cases picked per hour. This is just one of many examples of how we’re using tech to drive efficiency and higher return on invested capital. The industry as a whole has yet to embrace technology to the same degree as GXO. We really do have a first-mover advantage, but we’re not stopping there. We’re currently testing 200 new technologies from around 100 new suppliers. We also have 1,000 tech experts that specialize in bringing together best-in-class technologies. The deployment of technology underpinned our record quarter. Going forward, it’s helping us drive more value-added solutions across an increasing number of verticals. This, in turn, we believe, will fuel many years of future growth here at GXO. Now moving to e-com. We benefited in 2021 from persistent strong secular growth versus tough year-over-year comparisons. Our e-commerce revenue increased approximately 45% year-over-year in the quarter, markedly accelerating from the third quarter. We’re also now seeing return volumes continue to rise into 2022. Our e-commerce expertise is clearly well recognized, as evidenced by our wins that Malcolm mentioned, including Abercrombie and Fitch, where we’re deploying a cutting-edge goods-to-person robot solution and Saks, which is a valid and growing customer for our GXO Direct flexible fulfillment solution. Thirdly, on outsourcing, the runway here remains significant with a massive potential addressable market of $430 billion, of which $300 million is yet to be outsourced. In 2021, roughly 36% of our wins came from new outsourced contracts, which was a year-over-year increase of over 25%. As Malcolm mentioned, we are confident about our 8% to 12% organic revenue growth rate for 2022. This range is the amalgamation of growth from existing customers and net new customer wins. On the net new customer wins, what really gives us confidence is the fact that we’ve secured contracts with approximately $830 million of brand-new gross revenue uplift for 2022. This is essentially the equivalent of a gross revenue growth rate of approximately 10%, even before we consider the opportunity from further wins from our e-commerce-heavy $2.5 billion pipeline or any growth from existing customers. On top of those growth win announcements, our revenue retention rate since the spin has risen to the mid to high-90s. It’s worth highlighting that the industry around us is clearly consolidating, as technology and scale drive natural selection. In the last couple of years, warehousing has been recognized as a critical piece of the value chain and the consumer experience. We are seeing more and more M&A in our space. GXO is a rare breed of company, which combines high revenue growth, high returns, and high visibility. We delivered compelling double-digit revenue and adjusted EBITDA growth in 2021, and this will importantly be the basis for our North Star that we’re going to share at our Capital Markets Day later this year.

Thank you, Mark. Our strong 2021 performance and record pipeline gives us increased confidence for fiscal 2022. In light of all these results and our visibility into the year, we have upgraded our full-year 2022 guidance. We expect another year of strong revenue growth in this high return on invested capital business. We are exceptionally busy in the first quarter as we implement new wins. We are now forecasting 8% to 12% organic revenue growth alongside an adjusted EBITDA of $707 million to $742 million and adjusted EBITDAR of $1.5 billion to $1.6 billion. There are two positives that I would like to highlight regarding our value creation. First, in 2021, the growth within the business skewed towards high return on invested capital open book contracts, helping us achieve our higher return on invested capital over 30% in 2021. One benefit of having more open book contracts is that we see lower asset intensity across the business. This results in a margin dynamic where adjusted pro forma EBITDA margins increased by 60 basis points in 2021 versus 2020, while adjusted pro forma EBITA margins increased by 120 basis points. In 2022, we expect a similar dynamic between EBITDA and EBITA. Second, we had a strong working capital performance in Q4 of 2021. This drove our robust free cash flow results with us converting more than 30% of our adjusted pro forma EBITDA. This underscores the strength of our business model, which delivers high returns, cash flow, and growth simultaneously. Given these dynamics, I’m pleased to announce that we’re targeting a return on invested capital in excess of 30% on an ongoing basis for the business. All in all, the record fourth quarter that we have delivered is a precursor for more records to come. We’ll now open the call up to Q&A.

Thank you. We’ll now be conducting a question-and-answer session. Our first question is from Chris Wetherbee with Citi. Please proceed with your question.

Hey, thanks for having me. Good morning, guys. Maybe I could start on the revenue guidance. So Mark, as you noted, I think there's a pretty robust backlog that you guys have that accounts for some pretty significant growth already for 2022 booked through February. So you have a fairly robust line of sight, I would imagine that the backlog isn’t necessarily going to stop here in the first quarter and probably will continue to grow. So can you talk about sort of the confidence interval around that 8% to 12% revenue growth target? Why can’t you be at the upper end of that or maybe potentially better particularly considering it sounds like the attrition customers is really trending lower?

Yes, good shout, Chris. It’s Mark here. So a couple of things. Let me talk about the 8% to 12% organic revenue growth rate, as you mentioned, and why we kept it from a percentage perspective. The first point is really that the base is higher. So implicitly, we’re actually upgrading in absolute terms, the revenue guidance range by nature of the fact that we’ve obviously got a percentage number on a higher base in 2021. The second point is we’ve got great visibility in this business; we’re sitting here in February with e-commerce comps in the second half of the year getting markedly tougher. Now for a business like ours, we’ve done better as the comps have got harder over the course of Q3 and Q4, but I don’t think at this stage, sitting here in February getting ahead of our skis so early on in the year is necessary. On the third point, talk about this confidence regarding the 8% to 12%. Let me give you a breakdown of it, so we fully understand it. The range here is the amalgamation of growth from two forces. One, as you say, existing customers — which is the 3% to 4%. And two, the new customer wins: the net new customer wins of 5% to 8%. So, within each of these buckets, the 3% to 4% and the 5% to 8%, there are knowns and unknowns. On the 3% to 4%, we’ve been tracking mildly ahead of that in Q3 and slightly ahead of that as well in Q4, largely as a function of inflation. So the unknown is what’s your view on inflation going through the course of 2022. But volume and inflation have both been tracking well so far against that 3% to 4%, and like I said, tracking slightly ahead of that range. When it comes to the 5% to 8% from new customer wins, there are two things to keep in mind. One is the gross revenue uplift that we’ve had, which is the $830 million. That, as you know, translates to a gross revenue growth rate of some 10%. But the bits that is the unknown is obviously this retention rate. And as you know, we’ve been improving that — the revenue retention rate has improved since the spin to the mid to high 90s. That’s the bit that’s unknown within that calculation. I think you made a really, really good point in your question as well, which is there is potential to have further wins above and beyond the gross revenue growth rate that’s already banked of 10% through the course of this year. I would view it as in the window between January and April, where we’ll still be able to get some revenue that hits this year. And if not, it falls into 2023 and 2024, which talks to the durability and visibility of this business. But you can see, if you add all those numbers up, you get very comfortably within the 8% to 12% range. That underpins our confidence in that range, and that’s why we’ve reiterated the guidance today.

That’s super helpful. I appreciate the color there. And then maybe Baris, a little – maybe a little bit help on the margin outlook for 2022. So same revenue growth, but obviously, off of a higher base. Revenues are going up relative to what our expectation was a couple of months ago. Adjusted EBITDA is also going up, but arguably at a little bit of a slower pace there. I know you mentioned some dynamics between EBITA margins and EBITDA margins. Can you talk a little bit about what you’re seeing, whether it be from an open-book perspective around the cost profile of the new business wins? And if there’s any change in there that we should be thinking about in terms of that ultimate adjusted EBITDA margin for 2022?

Sure. Regardless of whether you’re looking at EBITDA or EBITA margin, you should expect margin improvement year-over-year in 2022. We will have the annualization of our acquisition as well as costs associated with being a stand-alone enterprise. Beyond these factors, we will see underlying margin expansion driven by our improved mix relating to higher-margin automated contracts. As far as the seasonality of the margins are concerned, we are very busy. We have a lot of startup right now. You will see the startup activity, particularly from us in the first half of the year, and the impact on that revenue and EBITDA will be spread out throughout the year. So you should see this expansion throughout the year with all these drivers getting into our accounts.

And just so I’m clear, that should be in the neighborhood of maybe 30 to 50 basis points of type of sort of full-year EBITDA margin improvements or any sort of parameters you can put around that?

If you take the midpoint of our guidance that we have guided for, you should have a higher EBITA margin expansion compared to an EBITDA margin expansion.

Okay. That’s helpful. Thanks for the time this morning, I appreciate it.

Thank you.

Thank you. Our next question is from Scott Schneeberger with Oppenheimer. Please proceed with your question.

Thanks very much. Good morning, all. I just want to delve in a little bit about the new contracts, one, and talk about automation. You have this 30% company average you speak to in Europe. I think it’s similar in North America. Just curious how the new contract wins, what type of mix is automated? I assume much higher, but if you could elaborate on that a little bit. And where could that 30% go in time just to get a perspective on how quickly that could move. Thank you.

Hi, Scott. It’s Malcolm. Overall, pretty much in everything that we are implementing nowadays, there’s a degree of automation. And also, you’ve got the dynamic where we’re going back into historically less automated business, and we’re adding new automation, so collaborative robots, goods-to-person robotics, robotic arms, these are very easy to add back and they deliver very speedy improvements in efficiency, improvements in productivity. Going back to Baris’ comment, that’s one of the reasons why we have our confidence levels on margins. So overall, that’s the environment that we’re seeing. We’ll see a steady increasing path for automation. But not to the side of the fact that our business still has a large incumbent workforce, 100,000 very valuable team members. They’re very valuable in our business. And so it really goes hand-in-hand. But overall, you’ll see a steady increasing level of automation across the business.

And Scott, was there a second part to your question about recent contracts we stood up and the benefits that we’re applying to customers?

So we’ve done a number of different things on the customer side, Scott. Just to give you an example, we obviously talked on the call about a grocery vertical, where we were improving things with the technology that Malcolm talked about, but there are multiple examples throughout 2021, and I’ll give you one as a standout and a solution that we recently stood out for a well-known e-commerce customer. We have reduced the variable cost by 40% per unit via our technology. We’ve reduced the inventory stock units by some 40% and perhaps most importantly, we’ve helped them to deliver a 45% uplift in their Net Promoter Scores. That’s one of multiple examples of how we help our customers and why they come to the scale, technologically proficient player in the space.

Excellent. Thanks. It sounds like a great value proposition for the customer. I wanted to touch on reverse logistics as well since we’re coming off peak season. The growth there was 28% year-over-year, very strong. Just wanted to talk about how that’s going to carry in the first quarter, what you’re seeing and the potential for that growth remaining elevated? Thanks.

Yes, Scott. Reverse logistics is growing at a very fast pace. You’re right, 28% in the fourth quarter, and that’s accelerating. We’re expecting similar high levels, even higher levels of growth through 2022. What’s happening is customers typically are expanding the services that we have with customers. Reverse logistics is a typical service where when we’re operating for the first time with a new customer, remember that our business wins in 2021, which shouldn’t be so different in 2022. You’ve got broadly around 36% coming from brand-new outsourcing projects. Typically, for a new fulfillment customer, for example, we start with the e-fulfillment, the outbound process, the stockholding. And then we gravitate; they generally ask us to take over returns or repair activity that they might be doing in-house at present, or alternative with another competitor. So returns are definitely increasing exponentially across the rest of the business. We’re really good at it. We’ve got great tech that we deploy in it. It’s super efficient. It’s touching the customer. So it’s really very vital for our customers. We’re very pleased that this part of our business is growing very well.

That’s great. Thanks. I’ll turn it over.

Thank you. Our next question comes from Amit Mehrotra with Deutsche Bank. Please proceed with your questions.

Thanks, operator. Hi, everyone. Congrats on the results. I guess I just wanted to come back to Chris’ question on the profitability really quickly. So, I know you guys manage the business on an ROIC basis, not margins necessarily. But at least from our perspective, it’s just helpful to understand how the EBITDA growth compares to revenue growth over a sustainable period of time. And I think that would be helpful to just get your philosophy around that because obviously, you’re putting together this five-year plan. I just want to understand, is it the right assumption under this business model to assume kind of EBITDA growth that’s consistent or maybe even a little bit better than revenue growth because that’s what the case is in 2022 with respect to the guidance. I just want to understand philosophically that’s the right way to think about it.

Yes. In 2022, we are guiding for an EBITDA margin expansion. On top of that, we are providing an EBITA margin expansion above the EBITDA margin expansion. As you rightly said, we are writing contracts for return on invested capital, and we have surpassed a 30% return in invested capital this quarter, and that will be our minimum target moving forward.

Okay. I want to talk – I’m going to return. I’ll get into ROIC in a second. But Baris, the Kuehne + Nagel acquisition, I think they closed very early in 2021. It was obviously pretty dilutive to margins in 2021. What would the EBITDA margin have been ex the Kuehne + Nagel acquisition for the entire 2021? So we should get a little bit better compare and contrast versus 2020.

Sure. For Q4, there has been a margin degradation coming from the impact of Kuehne + Nagel acquisition of around 100 basis points. Again, for Q4, we saw exceptional growth in our open book contracts, and this brings us higher EBITA margins but lower EBITDA margins as they are less capital intensive. When you look at the acquisition itself overall, we have been integrating quite well. Despite the COVID environment, we have been able to realize over $30 million of synergies through this acquisition. You will see the full-year impact of that in 2022.

Right. And so just so I understand, so what you’re saying is that – yes, I’m sorry, go ahead.

Well, I was just going to add to Baris’ comment, this is Malcolm. If you imagine that deal, roughly half of that business is operating already at quite similar margins to the rest of our UK activity. In fact, it is growing quickly. Two of those recent big open book contracts, we’ve curated around a very significant size, tech retailer in the UK and more recently announced that this week, British Telecom, a 10-year deal. Those are coming out of the technology vertical that Kuehne + Nagel really wanted to add in our UK business. The flip side of that is 50% of it deals with the hospitality industry. And for sure, through 2021 and even into quarter four, that was a bit down really primarily coming out of the pandemic. Thankfully now, certainly in the UK market, we can see all the signs of Omicron really reducing, with the government recently announcing a removal of most of the remaining limitations. We’re really expecting that business to bounce back and thrive during the rest of 2022.

To Malcolm’s point, as we move out of the Kuehne + Nagel integration into 2022, this business is deserving of margin expansion. It’s not how we write contracts naturally, we’ve had that conversation before, obviously. But returns are how we think about this business. Margins are the natural output of that, and it’s going to be margin expansion obviously as we continue to write great contracts. This business will see margin expansion largely because of automation. Automated contracts versus non-automated contracts have roughly 300 basis points better margins, that, therefore, is the flywheel that we’re talking about here. Continue to write great contracts and great returns, and amazing free cash flow and amazing margins come out the other side.

Right. And this is – that’s very helpful. Just as a follow-up. The return on invested capital, I appreciate the calculation you presented in the presentation. I guess I think about things more on like an incremental return on incremental capital. What was interesting to me, and I want to get your thoughts on this, Baris, is that the invested capital base actually shrunk sequentially because of the cash you’re generating. And obviously, that’s super interesting to me because I want to understand the trajectory of the invested capital base because it seems like it’s shrinking while the earnings are growing, which allows you to grow the absolute like the incremental returns on capital are much higher than the absolute. If you could just talk about that.

We are basically looking for a three-year cash-on-cash payback that we’ll write contracts. So, I give $100 to my operator. I expect about $30 back every year. That’s what we are writing these contracts for on average about five-year contracts. Now, coming back to your question around cash generation, it has been an extraordinary quarter of cash generation, and we have performed very well in the cash collection process in Q4 and that has resulted in an accumulation of cash. Actually, you’re right, that will reduce our net debt base moving forward as we generate further cash throughout the year.

All right. Okay, thank you very much, everybody. I appreciate your time.

Thank you.

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