RXO, Inc. (RXO) FY 2023 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. This Annual Report 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 Annual Report generally discusses 2023 and 2022 items and year-to-year comparisons between 2023 and 2022. Discussions of 2021 items and year-to-year comparisons between 2022 and 2021 are not included in this Annual Report and can be found in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2022.

Overview

RXO, Inc. is a brokered transportation platform defined by cutting-edge technology and an asset-light business model. The largest component is our core truck brokerage business. Our operations also include three asset-light, brokered transportation services, all of which complement our truck brokerage business: managed transportation, last mile and freight forwarding.

Our truck brokerage business has a history of generating robust free cash flow conversion and a high return on invested capital. Shippers create demand for our service, and we place their freight with qualified independent carriers using our technology. We price our service on either a contract or a spot basis.

Notable factors driving volume growth in our business include our ability to access massive truckload capacity for shippers through our carrier relationships; our proprietary, cutting-edge technology; our strong management expertise; and favorable long-term industry tailwinds. As of December 31, 2023, we had approximately 115,000 carriers in our North American truck brokerage network, and access to more than 1.4 million trucks.

We provide our customers with highly efficient access to capacity through our digital brokerage technology. This proprietary platform is a major differentiator for our truck brokerage business, and together with our pricing technology, we believe it can unlock incremental profitable growth well beyond our current levels. Our complementary services for managed transportation, last mile and freight forwarding also utilize our digital brokerage technology.

Our managed transportation service provides asset-light solutions for shippers who outsource their freight transportation to gain reliability, visibility and cost savings. The service uses proprietary technology to enhance our revenue synergy, with cross-selling to truck brokerage, last mile and freight forwarding. Our managed transportation offering includes bespoke load planning and procurement, complex solutions tailored to specific challenges, performance monitoring, engineering and data analytics, among other services. Our control tower solution leverages the expertise of a dedicated team focused on continuous improvement, and digital, door-to-door visibility into order status and freight in transit. In addition, we offer technology-enabled managed expedite services that automate transportation procurement for time-critical freight moved by road and air charter carriers.

Our last mile offering is an asset-light service that facilitates consumer deliveries performed by highly qualified third-party contractors. We are the largest provider of outsourced last mile transportation for heavy goods in the United States, positioned within 125 miles of the vast majority of the U.S. population and serving a customer base of omnichannel and e-commerce retailers and direct-to-consumer manufacturers.

Our freight forwarding service is a scalable, asset-light offering managed with advanced technology that facilitates ocean, road and air transportation and assists with customs brokerage. We are a U.S.-based freight forwarder with a global network of company-owned and partner-owned locations and coverage of key trade lanes that reach approximately 150 countries and territories.

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The Separation

On November 1, 2022, we completed the separation from XPO, which we refer to as the Separation. The Separation was accomplished by the distribution of 100 percent of the outstanding common stock of RXO to XPO stockholders as of the close of business on October 20, 2022, the record date for the distribution. XPO stockholders received one share of RXO common stock for every share of XPO common stock held at the close of business on the record date. On November 1, 2022, RXO became a standalone publicly-traded company.

Notable External Conditions

As a leading provider of freight transportation services, our business can be impacted to varying degrees by factors beyond our control. The COVID-19 pandemic may continue to impact overall economic activity, customer sectors served by our industry, supply chains and labor markets. We cannot predict how long these dynamics will last, or whether any future resurgences will adversely affect our results of operations.

Impact of Inflation

Economic inflation can have a negative impact on our operating costs, and any economic recession could depress activity levels and adversely affect our results of operations. A prolonged period of inflation could cause interest rates, fuel, wages and other costs to continue to increase, which would adversely affect our results of operations unless our pricing to our customers correspondingly increases. Generally, inflationary increases in labor and operating costs related to our operations have historically been offset through price increases. However, the pricing environment generally becomes more competitive during economic downturns, which may, as it has in the past, affect our ability to obtain price increases from customers both during and following such periods.

Basis of Presentation

Prior to the Separation, the Company’s financial statements were prepared on a standalone combined basis and were derived from the consolidated financial statements and accounting records of XPO (the “historical financial statements”). On November 1, 2022, the Company became a standalone publicly traded company, and its financial statements post-Separation are prepared on a consolidated basis. The combined financial statements for all periods presented prior to the Separation are now also referred to as “consolidated financial statements,” and have been prepared under the U.S. generally accepted accounting principles (“GAAP”).

Cost of transportation and services (exclusive of depreciation and amortization) primarily includes the cost of providing or procuring freight transportation for RXO customers.

Direct operating expenses (exclusive of depreciation and amortization) includes both fixed and variable expenses and consists mainly of personnel costs; facility and equipment expenses, such as rent, utilities, equipment maintenance and repair; costs of materials and supplies; information technology expenses; and gains and losses on sales of property and equipment.

Sales, general and administrative expense (“SG&A”), including the allocated costs of XPO prior to the Separation, primarily consists of salaries and commissions for the sales function; salary and benefit costs for executive and certain administration functions; third-party professional fees; facility costs; bad debt expense; and legal costs.

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

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Prior to the Separation, the 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 RXO. The charges reflected have either been specifically identified or allocated using drivers including proportionally adjusted earnings before interest, taxes, depreciation and amortization, which includes adjustments for transaction and integration costs, as well as restructuring costs and other adjustments, or headcount. The Company believes the assumptions regarding allocations of XPO corporate expenses are reasonable. Nevertheless, the consolidated financial statements may not reflect the results of operations, cash flows and financial position had the Company been a standalone entity during the periods presented. The majority of these allocated costs are recorded within Sales, general and administrative expense; Depreciation and amortization expense; Transaction and integration costs; and Restructuring 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 RXO to XPO in the year in which the cost was recorded in the Consolidated Statements of Operations.

For the periods ended before the Separation, XPO investment represents XPO’s historical investment in RXO and includes the net effects of transactions with and allocations from XPO as well as RXO’s accumulated earnings. Certain transactions between RXO and XPO, including XPO’s non-RXO subsidiaries, have been included in these consolidated financial statements, and are considered to be effectively settled at the time the transaction is recorded. The total net effect of the cash settlement of these transactions is reflected in the Consolidated Statements of Cash Flows as a financing activity and in the Consolidated Statements of Changes in Equity as XPO investment. The components of the net transfers to and from XPO include certain costs allocated from XPO's corporate functions, income tax expense, certain cash receipts and payments made on behalf of RXO and general financing activities.

For the periods ended before the Separation, the Company 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, the Company will file a consolidated U.S. federal income tax return as well as certain state and local income tax returns. The Company's foreign tax returns are filed on a full-year basis.

The Company’s consolidated financial statements include the accounts of RXO, Inc. and its majority-owned subsidiaries. The Company has eliminated intercompany accounts and transactions.

RXO has one reportable segment.

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Results of Operations

Year Ended December 31, 2023 Compared with Year Ended December 31, 2022

Revenue for 2023 decreased by 18.1% to $3.9 billion, from $4.8 billion in 2022. The year-over-year decrease was driven primarily by a $571 million decrease in revenue generated from our truck brokerage business, as a result of a 28% reduction in revenue per load, which was impacted by a combination of transportation market rates, fuel prices, length of haul and freight mix. The decline was partially offset by a 12% increase in load volume. Additionally, revenue generated from our freight forwarding business decreased by $171 million, driven primarily by a decrease in ocean rates and volume.

Cost of transportation and services (exclusive of depreciation and amortization) in 2023 was $3.0 billion, or 75.6% of revenue, compared with $3.6 billion, or 75.6% of revenue in 2022. In 2023, we experienced (i) lower transportation costs as a percentage of revenue in last mile and (ii) an improvement in mix in our freight forwarding business. This was offset by a 3.0 percentage point increase in truck brokerage cost of transportation and services as a percentage of revenue, as lower freight rates were not fully offset by corresponding reductions in cost of purchased transportation during the year.

Direct operating expense (exclusive of depreciation and amortization) of $235 million in 2023 increased $9 million, or 4.0%, from $226 million in 2022. As a percentage of revenue, direct operating expense (exclusive of depreciation and amortization) increased to 6.0% in 2023 compared to 4.7% in 2022 due to deleverage on lower revenue.

SG&A of $591 million in 2023 decreased $49 million, or 7.7%, from $640 million in 2022. As a percentage of revenue, SG&A increased to 15.0% in 2023 compared to 13.3% in 2022 due to higher compensation-related costs of 1.5 percentage points reflecting deleverage on lower revenue and incremental corporate costs of operating RXO as a standalone public company. This was partially offset by cost savings from restructuring actions executed in 2023, which primarily comprised employee severance. We anticipate the restructuring actions will result in cumulative annualized net cost savings of approximately $32 million.

Depreciation and amortization expense in 2023 was $67 million, compared with $86 million in 2022. The year-over-year reduction was driven by (i) a decrease in intangible asset amortization expense as a result of a customer relationship intangible asset being fully amortized in December 2022 and (ii) a decrease in depreciation for our allocated share of XPO’s corporate overhead.

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Transaction and integration costs in 2023 and 2022 were $12 million and $84 million, respectively, and primarily comprised spin-off related costs.

Restructuring costs in 2023 and 2022 were $16 million and $13 million, respectively, and primarily comprised severance costs.

Interest expense primarily consists of interest related to indebtedness for money borrowed and finance lease obligations. The increase in interest expense in 2023 as compared to 2022 is primarily due to a full year of interest incurred in 2023 on borrowings made in connection with the Separation in the fourth quarter of 2022.

Our effective income tax rates were (13.0)% and 22.6% in 2023 and 2022, respectively. The change in our effective income tax rate for the year ended December 31, 2023 compared to the year ended December 31, 2022 was driven primarily by a tax benefit of $2 million realized in 2023 from changes in reserves for uncertain tax positions.

For the year ended December 31, 2023, our effective tax rate differs from the U.S. corporate income tax rate of 21% due to a tax benefit of $2 million from changes in reserves for uncertain tax positions. For the year ended December 31, 2022, our effective tax rate differs from the U.S. corporate income tax rate of 21% due to state income taxes within the United States, partially offset by a tax benefit of $3 million from provision to return and other deferred tax adjustments.

Liquidity and Capital Resources

Overview

Our ability to fund our operations and anticipated capital needs are reliant upon the generation of cash from operations, supplemented as necessary by 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, share repurchases and strategic business development transactions. The timing and magnitude of our growth and working capital needs 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.

Capital Expenditures

Our 2023 capital expenditures include capital associated with strategic investments in technology, equipment and real estate. 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 and availability of labor and equipment. 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

On October 18, 2022, we entered into a five-year unsecured, multi-currency revolving credit facility (the “Revolver”) with initial aggregate commitments of $500 million, of which $50 million is available for the issuance of letters of credit. Loans under the Revolver bear interest at a fluctuating rate plus an applicable margin calculated based on the Company's credit ratings. There was $5 million outstanding under the Revolver as of December 31, 2023.

On November 2, 2023, the Company exercised a feature to increase the total commitments under its Revolver from $500 million to $600 million.

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Term Loan Facilities

On October 18, 2022, we entered into a five-year $100 million unsecured term loan facility (the “Term Loan”). On November 2, 2023, the Company repaid all of the outstanding obligations in respect of the $100 million principal amount, interest and fees under the Term Loan and terminated the Term Loan.

Notes

On October 25, 2022, we completed an offering of $355 million in aggregate principal amount of unsecured notes (the “Notes” or the “7.50% Notes due 2027”). The Notes bear interest at a rate of 7.50% per annum payable semiannually in cash in arrears on May 15 and November 15 of each year, beginning May 15, 2023, and mature on November 15, 2027, unless earlier repurchased or redeemed. RXO is permitted to redeem some or all of the Notes prior to their maturity at redemption prices described in the indenture governing the Notes. The Notes were issued at a price of 98.962% of par.

Loan Covenants and Compliance

As of December 31, 2023, 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.

Financial Condition

The following table summarizes our asset and liability balances as of December 31, 2023 and 2022:

Total assets decreased by $206 million from December 31, 2022 to December 31, 2023, driven primarily by a $157 million decrease in accounts receivable as a result of a decrease in revenue due to decreased rates and a $93 million decrease in cash and cash equivalents as a result of the payoff of the Term Loan, partially offset by a $36 million increase in operating lease assets. Total liabilities decreased by $213 million from December 31, 2022 to December 31, 2023, driven primarily by a decrease in third party transportation costs due to decreased rates and a $95 million decrease in long-term debt as a result of the payoff of the Term Loan.

Cash Flow Activity

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

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Net cash provided by operating activities for 2023 decreased by $221 million compared with 2022. The decrease in cash provided by operating activities reflects the impact of an $88 million decrease in net income between periods and changes in working capital. The change in working capital was driven primarily by the balance sheet impact of decreased revenues and cost of third party transportation between periods.

Investing activities used $66 million of cash in 2023 compared with $56 million of cash used in 2022. The primary use of cash in both periods was to purchase property and equipment.

Financing activities used $117 million of cash in 2023 compared with using $183 million of cash in 2022. The primary uses of cash from financing activities in 2023 were (i) $104 million for debt and finance lease repayments, driven primarily by the payoff of the Term Loan and (ii) $14 million for payments of tax withholdings related to vesting of stock compensation awards. The primary use of cash from financing activities in 2022 was $621 million in net transfers to XPO in connection with the Separation. The primary source of cash from financing activities in 2022 was the issuance of long-term debt of $451 million, offset by payment of debt issuance costs of $9 million. Net proceeds from the issuance of the Notes and the incurrence of the Term Loan, together with cash on RXO's balance sheet, were used to fund a net cash distribution of $604 million from RXO to XPO, in the fourth quarter of 2022.

Contractual Obligations

We lease certain facilities and equipment under non-cancellable operating lease arrangements. As of December 31, 2023, our outstanding discounted obligations under operating and finance leases were $199 million and $6 million, respectively. See Note 6 — Leases to the consolidated financial statements for additional information.

As of December 31, 2023, we had $355 million of the Notes outstanding with interest payable semiannually in cash in arrears on May 15 and November 15 of each year, beginning May 15, 2023. The Notes mature on November 15, 2027, unless earlier repurchased or redeemed, if applicable. As of December 31, 2023, we had $5 million outstanding under the Revolver, with interest payable monthly or quarterly, depending on RXO’s upfront election. Borrowings under the Revolver are payable, at our option, at any time prior to or at maturity on October 18, 2027. See Note 8 — Debt 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.

Critical Accounting Policies and Estimates

We prepare our consolidated financial statements in accordance with GAAP. 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.

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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. We have six reporting units. Application of the goodwill impairment test requires judgment, including the identification of the reporting units, the assignment of assets and liabilities to the reporting units, the assignment of goodwill to the reporting units, and a determination of the fair value of the reporting units.

For our 2023 goodwill assessment, we performed a quantitative analysis for our reporting units using a combination of income and market approaches. As of November 30, 2023 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.

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 our 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 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.

Insurance

We participate in a combination of self-insurance programs and purchased insurance that are managed to provide for the costs of medical, casualty, liability, vehicular, cargo, workers’ compensation, cyber risk and property claims. Insurance coverage levels are adjusted annually 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 retention levels, historical cost experience, demographic and severity factors, and judgments about current and expected levels of cost per claim. Additionally, claims may emerge in future years for events that occurred in a prior year at a rate that differs from previous actuarial projections. Changes in these assumptions can impact actual costs paid to settle the claims and those amounts may be different than estimates.

New Accounting Standards

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

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