GXO Logistics, Inc. (NYSE:GXO) Q3 2023 Earnings Call Transcript

GXO Logistics, Inc. (NYSE:GXO) Q3 2023 Earnings Call Transcript November 8, 2023

Operator: Welcome to the GXO Third Quarter 2023 Earnings Conference Call and Webcast. My name is Darryl, and I’ll be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] 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 the Company’s 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 in the forward-looking statements.

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 also may refer to certain non-GAAP financial measures as defined under 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 the United States dollars.

The Company will also remind you that its guidance incorporates business trends to date and what it believes today to be appropriate assumptions. The Company’s results are inherently unpredictable and may be materially affected by many factors including fluctuations in foreign exchange rates, changes in global economic conditions and consumer demand and spending, labor market and global supply chain constraints, inflationary pressures and the various factors detailed in its filings with the SEC. It is not possible for the Company to actually predict demand for its services, and therefore, actual results could differ materially from 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’s website.

I will now turn the call over to GXO’s Chief Executive Officer, Malcolm Wilson. Mr. Wilson, you may begin.

Malcolm Wilson: Thank you, Darryl, and good morning, everyone. With me in Greenwich today are Baris Oran, our Chief Financial Officer; and Adrian Stoch, our newly appointed Chief Automation Officer, first for GXO. We’re excited to have him update you on our automation strategy and how it will lead to further growth and higher returns for GXO. Turning directly to the third quarter. We’re pleased to report that we delivered record revenue of $2.5 billion, growing 8% year-over-year, of which 3% was organic growth. We’ve talked to you many times about the resilience of our business model, and we’re demonstrating just how beneficial that is proving to be this quarter. While the macro environment is uncertain, we’re performing strongly in those areas where we do have control, new business wins, profits and free cash flow.

Baris will give you more detail on our updated full year guidance in just a moment. Our adjusted EBITDA grew to $200 million, and our adjusted diluted earnings per share was $0.69, both coming in above expectations. On top of that, a few weeks ago, we closed the acquisition of PFSweb and the incremental benefit during the last part of the year allows us to raise both our adjusted EBITDA and adjusted diluted earnings per share guidance for the third this year. The results this quarter demonstrate two key strengths of our business. First, it illustrates that our model is working exactly as it’s designed to. We’re effectively managing all aspects of our long-term contractual business to deliver consistent margins and drive adjusted EBITDA growth.

Second, it shows an acceleration of the structural trends that are driving our growth. Customers are coming to us more than ever, and our value proposition for them is only growing stronger as they look to us to drive improved productivity, optimize their working capital and improve their services to the ever more demanding end consumers. This is clear from our new sales wins and our pipeline. We closed over $180 million of new sales wins in the third quarter, nearly half of which came from companies outsourcing their operations for the first time. These fantastic customers included Carlsberg, Daikin, Farfetch, SodaStream and Versace. And in October, we’ve began an exciting new partnership with The Quality Group, a great win for us in Germany.

These customers joined the exceptional blue-chip brands that continue to rely on GXO for their logistics needs. Also, in the last couple of weeks, we’ve entered into a significant new long-term contract for a fully automated warehouse project with a leading global sporting brand. We’re thrilled to partner with this brand to enable their long-term growth ambitions across both e-commerce and retail. We’re positioning the brand to optimize their inventory and costs by leveraging GXO’s industry-leading expertise and technologies. Adrian will provide more detail on exactly how we do this for our customers in just a moment. It’s exactly why we’ve created this new role of Chief Automation Officer. We’re not only proud of our results this quarter, but also excited by what’s ahead.

We’ve secured more than $0.5 billion of new business for 2024, tracking ahead of where we were this point last year. Our average contract length remains strong at around five years. GXO is winning market share from our competitors. Our total new contract wins in the quarter are up 15% year-over-year even after our record setting second quarter. Our pipeline remains solid at around $2 billion. It’s distributed evenly across our operating geographies and it’s well diversified across both consumer and industrial verticals. We’re excited by the opportunity to continue to grow our market share. I mentioned earlier that one of the key milestones this quarter is the acquisition of PFSweb, a premier e-commerce fulfillment provider based here in the U.S. PFS serves over 100 of the world’s most iconic brands, including L’Oreal, Pandora, Procter & Gamble, Yves Saint Laurent, and the U.S. Mint.

It has a great track record of profitable growth from its premium service offerings. We believe the combination of GXO and PFS strengthens our book of business by bringing exposure to key growth verticals, including health and beauty, jewelry, and luxury goods. PFS continues to deliver robust growth and is winning great new contracts with brands like Glossier. We’ll build on this momentum and will leverage PFS vertical expertise to complement our existing business and grow into the massive addressable market on a global basis even faster. We celebrated causing the transaction with the PFS team in Dallas the week before last, and the level of excitement was palpable. On a personal note, I’m delighted to be working with this team. Like GXO, it’s clear that the high caliber of the people is why PFS has been able to build such an incredible business.

And lastly, on that note of people, we’re proud to have won numerous awards for employee satisfaction and inclusion this quarter. I’m very pleased that our constant efforts to create the best possible workplace for our people and to make GXO, the employer of choice in our industry are being recognized. In summary, we’re confident that we’re positioned to capitalize on the immense growth potential within our industry and the continuing tailwinds of automation, outsourcing and e-commerce. Now, I’ll hand it over to Baris to walk you through the numbers and our updated guidance. Baris, over to you.

Baris Oran: Thanks, Malcolm, and good morning, everyone. This quarter, we delivered a strong set of results, including great new sales wins, resilient adjusted EBITDA and finally, outstanding free cash flow conversion. As Malcolm mentioned, we delivered a record $2.5 billion of revenue in the quarter. This represents 8% year-over-year growth, about 3% of which was organic. Our top line performance clearly reflects the impact of near-term macro headwinds on customer volumes and as we highlighted in prior quarters, all other areas of the income statements reflect credible stability of our business and our continued strong management execution. Our operating income was up 25% year-over-year in the third quarter. We delivered adjusted EBITDA of $200 million.

We are delivering consistent adjusted EBITDA margins as a result of our resilient business model. Despite the headwind of 90 basis points from pension and FX hedges. And they have improved 20 basis points sequentially since the second quarter, while these headwinds have increased. This margin strength is driven by our continued focus on cost discipline, specifically productivities we are driving in our site level operations and in our central efficiencies initiatives. We also delivered net income attributable to shareholders of $66 million and adjusted diluted earnings per share of $0.69. Our return on invested capital was once again robust at well above 30%, our accelerating new business wins year-over-year highlight the ample opportunity for our business to continue to reinvest and generate these levels of returns in the future.

I would like to particularly highlight our free cash flow, which was a record $191 million for the third quarter, helped by strong cash collections and methodical deployment of capital. We are on track to deliver our free cash flow conversion target of approximately 30% of adjusted EBITDA for the full year. We reduced our net leverage to 1.6x as of September 30. We have no debt repayments due in 2024. Our balance sheet remains rock solid and investment grade after our acquisition of PFSweb and we expect to end the year with net leverage of around 1.7x. On PFS, I’d like to take a moment to welcome our new colleagues. The strength of talent of this team is just phenomenal. We are thrilled to have completed this deal. Plans to accelerate our growth together are already underway and as Malcolm mentioned, we believe this is positioning GXO for continued and accelerated growth.

Our acquisition of PFS exemplifies our approach to M&A. We are highly selective in our total targets, and we established a track record of pursuing companies that bring opportunities to expand our presence in key markets and further enhance our offerings for new and existing customers. In PFS, we bought a double-digit growth trajectory at a very attractive valuation. Going forward, we will continue to deploy our excess cash in the best interest of our shareholders, which includes either share buybacks or accretive M&A. Turning to full year, you’ll see that we are revising our full year 2023 organic revenue guidance from 6% to 8% to 2% to 4%. For this holiday season, we are seeing lower customer volume growth than anticipated, particularly in consumer-focused sectors, in many cases and in contrast with last year, the global brands we are serving are prioritizing pricing over volume.

This is resulting in a more uncertain peak. In addition, some seasonal Christmas pop-up projects will not recur this year because of lower customer volumes. This is a one-off impact in the fourth quarter, causing our organic growth to be softer. Our adjusted EBITDA and free cash flow remained robust due to the structure and predictability of our customer contracts, which helps to insulate our financial performance from volume swings. The incremental benefit from our acquisition of PFS gives us the confidence to upgrade our full year adjusted EBITDA guidance to $730 million to $755 million. We are also pleased to upgrade our guidance for adjusted diluted earnings per share to $2.55 to $2.65. And finally, following our free cash flow results this quarter, we are reiterating our full year free cash flow conversion target of approximately 30% as well as our return on invested capital target of about 30%.

Looking ahead, our long-term growth is underpinned by our continued new business wins. This reflects the value of the services that we are providing to our customers helping them to manage their businesses more efficiently in the current environment. We won $841 million of new business year-to-date. We’ve got $520 million of incremental revenue booked for 2024 and nearly $200 million of incremental revenue booked for 2025. In the third quarter, almost half of our new business wins were outsourcing. They’re making more headway into our $0.5 trillion total addressable market. At the same time, we continue to produce profits and cash flows throughout the cycle. Our margins are resilient and our free cash flow conversion is rock solid. We will continue to manage GXO with a rigorous focus on contract governance, cost discipline and capital allocation to serve the interest of both our customers as well as our shareholders.

And now I’ll pass the mic over to Adrian, who was named as our first Chief Automation Officer in July. He’ll brief you on one of our most important levers for growth and value creation, our automation strategy. Over to you, Adrian.

Adrian Stoch: Thanks, Baris. Good morning, everyone. I’ve been at GXO for over two years, and I’ve been working in supply chain and operations for more than three decades. I moved into my role as Chief Automation Officer last quarter. I’ve had the pleasure of meeting some of you during site visits while I was in my previous role as Head of our North American Consumer division. Today, I’d like to put some texture around our automation and AI differentiation as well as how we’re going to accelerate our existing strategy. By unifying our global technology agenda, we will shape the future of the industry, drive better outcomes for our customers and improve our employees’ experience. GXO is already the market leader in supply chain automation.

Today, about 30% of our revenue comes from automated operations versus the industry average of less than 10%. Additionally, we’ve accelerated our deployment of post go-live adaptive tech, and this has increased the proportion of our revenue from these sites from 5% a year ago to 11% today. The overall amount of tech actively deployed across our footprint has increased by almost 70% year-over-year. At every site where we deploy this technology, we provide outsized benefits to our customers. As a result, we grow faster, increase our market share and deliver margins of 200 basis points higher than the group average. We are at a critical inflection point in the automation of warehouse operations. Up until now, the focus has been on automating tasks that are repetitive, laborious and require heavy lifting.

Because significant advancements have been made, today, we have multiple finely tuned solutions that can address this problem. The vision of what’s ahead is what is truly exciting. The next phase of automation includes seamless integration of existing discrete solutions combined with AI to solve significantly more complex problems in merely replacing manual tasks. This will enable operations to be performed faster and more reliably and free up workers to focus on the value-added services that are critical to our customers’ dynamic and complex supply chain needs. Let’s bring this to life. In my previous role, we conducted a major site retrofit for a household name apparel retailer, where we implemented several additional technologies that transformed the warehouse into a completely integrated end-to-end flow.

This increased productivity, reduced cycle time, improved our safety performance, which is already well above industry average, and drove an overall reduction in cost per unit of 18%. It was a game changer for the customer and without question, deepened our partnership. While the consumer team led this specific example, there are myriad other successes just like this across our organization. Part of my mission is to unify our efforts and deploy technology that optimizes each of the core warehouse process paths. We will create global standards and best practices, which will accelerate deployment and ultimately lead to better margin performance. This is the embodiment of continuous improvement that has been the cornerstone of my operations experience and now I’ll bring this philosophy of CI to automation.

In tandem, we’re partnering with innovators across the globe to guide and validate their solutions in multiple sites within the consumer division we successfully deployed AI combined with a goods-to-person robotic solution to increase the number of barcodes traveled by around 5x per bot stop. This increased productivity tremendously resulting in significant value creation for the customer and a huge step-up in ROI. The opportunities that AI unlocks for warehouse automation are staggering, and we are partnering with hardware and software vendors alike to identify the most suitable platforms to meet our customers’ needs. In addition, we have been the first to adapt mature solutions from other sectors into the logistics industry. For example, we implemented a high-volume, high-precision storage and retrieval solution that was originally developed for the pharmaceutical industry and adapted it for a specific customer’s needs in consumer electronics.

The financial benefit of everything I’ve just described is extremely compelling, but there’s a multiplier effect from the results we drive that also include cycle times, improved quality, reliability, agility and workforce safety. This intersection of taking operations is the secret source that makes us the partner that our customers turn to, and they are doing so on an increasingly global basis. My role in all of this is to identify, prove and accelerate the right technologies to customers’ needs. In turn, we will grow our 2% market share in this $0.5 trillion industry. I look forward to updating you all on our progress. And with that, I’ll hand you back to Malcolm.

Malcolm Wilson: Thanks, Adrian. We’re very pleased with our performance this quarter against a softer macro our teams have delivered substantial contract wins as well as strong and predictable adjusted EBITDA and free cash flow and we’ve closed another great acquisition. As a result, we’ve raised our profit guidance for the third time this year. Our mission remains to enable our customers to run their businesses more efficiently and cost effectively. We are succeeding and we’re also growing our market share. Our heightened focus on automation will help fuel our growth and bolster our resiliency and we’ll continue to optimize our operating model, drive high returns and allocate our capital in the best interest of our shareholders. With that, we’ll hand the mic back to Daryl and transition to Q&A.

See also 13 Best ESG Stocks To Buy Now and 15 Most Powerful Militaries in Asia.

Q&A Session

Operator: [Operator Instructions] Our first question has come from the line of Stephanie Moore with Jefferies. Please proceed with your question.

Stephanie Moore: I was hoping you could just help us understand what about the macro change since the last boat to drive kind of such a material cut in organic growth guidance for the year? Or have you been seeing some of these kind of moderating or temporary trends really since the first quarter? I’d love to get your thoughts there.

Malcolm Wilson: Stephanie, it’s Malcolm here. Let me give you first the big picture and then more detail. So when we look at the regions that GXO is working in, our Continental European business, so the big countries, France, Netherlands, Spain and Italy, actually doing all care, we’ve seen a slight recovery and going well. Our U.K. business, we think that’s probably at about the bottom and actually some early signs of green shoots. And here in North America, we think we’re quite close to the bottom. So that’s the kind of macro picture that we’re seeing. For this last quarter, it’s interesting. We’ve delivered organic growth across every single region, and that’s despite is clearly softening in the consumer macro environment.

We can see in some of the verticals that we’re work in, technology, aerospace, food services, actually, they’re in a good trajectory. They’re doing quite well, but that’s countered by definitely a slower, a softer consumer-related business. If we think about our Q4, what we expect to see looking ahead. We’re not expecting to see many of the seasonal pop-up type of short-term warehousing activities that we’ve seen in previous years. We think that’s a consequence of inventory levels generally normalizing and actually how many of our customers are approaching the holiday season. We’ve seen that several of our customers are choosing to focus on holding price vis-à-vis a kind of volume type of environment. And we’re also hearing that evidence that the consumer themselves, they’re putting off holiday shopping.

They’re looking later into the season or maybe bargains and so on. We should contrast that, though against very, very strong sales, quarter three very strong sales, $181 million, that’s up 15% year-over-year. And as we mentioned in the call, quarter four, it’s off to a great start with a new very long-term fully automated contract in its life of contracts worth around $1 billion. So, we’re very, very pleased about that. In all the areas where we do see softer trading, it’s also worth to remember that the contract model that we have, we’ve often talked about the resiliency of our contract, the pass-through of inflationary pressures. That’s protecting us and it’s allowing our profitability to remain very good. And you see that, in fact, in the guidance that we’ve just been talking about.

This uncertain macro, it’s kind of an environment where GXO thrive. It really helps us to better demonstrate to our existing customers, but importantly, new customers, remember of $180 million, roughly half of that was coming from new first-time outsourcing customers and they’re benefiting from working with GXO, they’re benefiting from how we help them improve productivity, improve their services. We’re transforming operations for them. And technologies play such a big part of that, and I’m so pleased now that we have Adrian in his new mission, and I hope you’ll hear from him later in the call. And then the last thing I would say, just a couple of interesting points, but nevertheless, it’s a summary of the environment. Wage inflation is really moderated.

We’re seeing that wages pretty much have caught up to the broader inflation. That’s helping the consumer. And the last point is we’re seeing equally in the real estate environment, it’s really kind of moderated. We’re not in the difficulty as we would have been six months ago of having to look long and hard to find real estate. It’s a much easier market. So all of that, as we see the picture right now as we will be exiting Q4, a lot of these kind of one-off type of impacts that we’re seeing right now, we think we’ll recede, and we should go back to a growth environment in the first half of next year.

Stephanie Moore: I really appreciate all the incremental color. Just as a quick follow-up, and you kind of touched on this a little bit I’m trying to understand the raise in the EBITDA guidance for the year and kind of the puts and takes, despite the cut in organic growth. It sounds like FX was a little bit worse. So that’s likely, but that’s slightly being offset by the PFS acquisition. So maybe just talk about what were kind of the underlying drivers to still be able to raise the low end of that EBITDA guidance on this core business.

Malcolm Wilson: Stephanie, let me ask Baris to comment on that.

Baris Oran: Sure, Malcom. In Q4, our margin will continue to expand, excluding FX and pension headwinds, as you would recall these were roughly about $15 million per quarter. We expect to continue moderate margin expansion, excluding FX and pension in Q4 and this company is delivering on our promises as we highlighted many times in the past, even when the volume comes down, we continue to generate profits and cash flows due to our strong contract governance. Furthermore, we will have low single-digit contribution million from PFS in Q4. We have been getting a lot of headway into our integration and restructuring benefits and they will contribute even more into Q4, getting into a $40 million at the end of the year as we start into next year, that’s going to be helping our next year operating profitability.

The impact of those in Q4 will be roughly about $10 million incremental versus the prior year. So all in all, contracts are working well. Productivity benefits are delivering its promises and even in this volume environment, we will continue to deliver strong results.

Operator: Our next questions come from the line of Chris Wetherbee with Citigroup. Please proceed with your question.

Chris Wetherbee: Maybe picking up on that last question, particularly around the fourth quarter and the EBITDA guidance, I think normal seasonality the last couple of years has seen EBITDA accelerate from 3Q to 4Q. I know there’s a range here, and I think there’s a lot of factors kind of at play, but the range bookend the third quarter, both up and on the downside. So could you talk a little bit about how you think this might play out? And what sort of would be the factors potentially offsetting that normal seasonal uplift that you have? I think you’ve talked a little bit about some of the seasonal activity maybe not being quite as good, but a little bit of finer point are, that would be great.

Baris Oran: Chris, this is Baris. I mean, first is the organic revenue growth. As you’ve seen, we are now seeing organic revenue growth guidance of 2% to 4%. And we have — we delivered 3% in Q3, but heading into Q4, we do see headwinds coming from these reduced pop-up activities, slower ramp-up of new facilities and more importantly, reduced volume from existing facilities. All of this is balanced by with our business wins and inflation and pricing pass-through. That’s on the top line. On the margin side, we continue to deliver steady EBITDA margins. And as I highlighted, we’re going to be providing a slight uptick in our margin, excluding FX and pensions, and that’s expected to be a headwind of $15 million into Q4, and we see roughly $10 million benefit coming from the productivity projects we had, integration benefits and restructuring that we have done.

As you recall, we took a number of initiatives this year, including on procurement side, outsourcing of noncore activities. We eliminated roughly 10% of our nonoperational noncustomer serving staff, reduced the layers in our organization, increase the span of control, basically, meaning more people report to a person. That’s the definition of span of control. So all of these are delivering results in Q4 and helping us go through this lower volume environment. But at the core of this is our contract structure, just like we told you about a year ago, how our contracts would operate would perform in a down cycle you’ll see that in our operation.

Chris Wetherbee: I appreciate that incremental color. And then maybe stepping back a little bit and beginning to think about 2024, obviously, organic revenue growth is decelerating, but it does appear that the pipeline of new business opportunities remains relatively stable. So as we think out to 2024, are you seeing any deceleration in terms of incoming interest from the customers about signing up new business? So, we expect the pace of new contract awards to be roughly the same as we start to turn the corner into 2024, can that accelerate? Or is there going to be some economic pressure on that?