Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

143K characters. Original on sec.gov · Markdown

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cummins Inc. and its consolidated subsidiaries are hereinafter sometimes referred to as “Cummins,” “we,” “our” or “us.”

CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION

Certain parts of this quarterly report contain forward-looking statements intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. Forward-looking statements include those that are based on current expectations, estimates and projections about the industries in which we operate and management’s beliefs and assumptions. Forward-looking statements are generally accompanied by words such as "anticipates," "expects," "forecasts," "intends," "plans," "believes," "seeks," "estimates," "could," "should," "may" or words of similar meaning. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which we refer to as "future factors," which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Some future factors that could cause our results to differ materially from the results discussed in such forward-looking statements are discussed below and shareholders, potential investors and other readers are urged to consider these future factors carefully in evaluating forward-looking statements. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. Future factors that could affect the outcome of forward-looking statements include the following:

GOVERNMENT REGULATION

  • any adverse results of our internal review into our emissions certification process and compliance with emission standards;

  • increased scrutiny from regulatory agencies, as well as unpredictability in the adoption, implementation and enforcement of emission standards around the world;

  • changes in international, national and regional trade laws, regulations and policies;

  • any adverse effects of the U.S. government's COVID-19 vaccine mandates;

  • changes in taxation;

  • global legal and ethical compliance costs and risks;

  • increasingly stringent environmental laws and regulations;

  • future bans or limitations on the use of diesel-powered products;

BU****SINESS CONDITIONS / DISRUPTIONS

  • any adverse effects of the conflict between Russia and Ukraine and the global response (including government bans or restrictions on doing business in Russia);

  • failure to successfully integrate the acquisition of Meritor, Inc.;

  • failure to realize all of the anticipated benefits from our acquisition of Meritor, Inc.;

  • raw material, transportation and labor price fluctuations and supply shortages;

  • aligning our capacity and production with our demand;

  • the actions of, and income from, joint ventures and other investees that we do not directly control;

  • large truck manufacturers' and original equipment manufacturers' customers discontinuing outsourcing their engine supply needs or experiencing financial distress, bankruptcy or change in control;

PRODUCTS AND TECHNOLOGY

  • product recalls;

  • variability in material and commodity costs;

  • the development of new technologies that reduce demand for our current products and services;

  • lower than expected acceptance of new or existing products or services;

  • product liability claims;

  • our sales mix of products;

GENERAL

  • failure to complete, adverse results from or failure to realize the expected benefits of the separation of our filtration business;

  • our plan to reposition our portfolio of product offerings through exploration of strategic acquisitions and divestitures and related uncertainties of entering such transactions;

  • challenging markets for talent and ability to attract, develop and retain key personnel;

  • climate change and global warming;

  • exposure to potential security breaches or other disruptions to our information technology environment and data security;

  • political, economic and other risks from operations in numerous countries including political, economic and social uncertainty and the evolving globalization of our business;

  • competitor activity;

  • increasing competition, including increased global competition among our customers in emerging markets;

  • labor relations or work stoppages;

  • foreign currency exchange rate changes;

  • the performance of our pension plan assets and volatility of discount rates;

  • the price and availability of energy;

  • continued availability of financing, financial instruments and financial resources in the amounts, at the times and on the terms required to support our future business; and

  • other risk factors described in Part II, Item 1A in this quarterly report and our 2021 Form 10-K, Part I, Item 1A, both under the caption "Risk Factors."

Shareholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are made only as of the date of this quarterly report and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

ORGANIZATION OF INFORMATION

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) was prepared to provide the reader with a view and perspective of our business through the eyes of management and should be read in conjunction with our Management's Discussion and Analysis of Financial Condition and Results of Operations section of our 2021 Form 10-K. Our MD&A is presented in the following sections:

  • EXECUTIVE SUMMARY AND FINANCIAL HIGHLIGHTS

  • RESULTS OF OPERATIONS

  • OPERATING SEGMENT RESULTS

  • OUTLOOK

  • LIQUIDITY AND CAPITAL RESOURCES

  • APPLICATION OF CRITICAL ACCOUNTING ESTIMATES

EXECUTIVE SUMMARY AND FINANCIAL HIGHLIGHTS

Overview

We are a global power leader that designs, manufactures, distributes and services diesel, natural gas, electric and hybrid powertrains and powertrain-related components including filtration, aftertreatment, turbochargers, fuel systems, controls systems, air handling systems, automated transmissions, electric power generation systems, batteries, electrified power systems, hydrogen production and fuel cell products. We sell our products to original equipment manufacturers (OEMs), distributors, dealers and other customers worldwide. We have long-standing relationships with many of the leading manufacturers in the markets we serve, including PACCAR Inc, Navistar International Corporation, Daimler Trucks North America and Stellantis N.V. We serve our customers through a service network of approximately 500 wholly-owned, joint venture and independent distributor locations and more than 10,000 Cummins certified dealer locations in approximately 190 countries and territories.

Our reportable operating segments consist of Engine, Distribution, Components, Power Systems and New Power. This reporting structure is organized according to the products and markets each segment serves. The Engine segment produces engines (15 liters and smaller) and associated parts for sale to customers in on-highway and various off-highway markets. Our engines are used in trucks of all sizes, buses and recreational vehicles, as well as in various industrial applications, including construction, agriculture, power generation systems and other off-highway applications. The Distribution segment includes wholly-owned and partially-owned distributorships engaged in wholesaling engines, generator sets and service parts, as well as performing service and repair activities on our products and maintaining relationships with various OEMs throughout the world. The Components segment sells filtration products, aftertreatment systems, turbochargers, electronics, fuel systems and automated transmissions. The Power Systems segment is an integrated power provider, which designs, manufactures and sells engines (16 liters and larger) for industrial applications (including mining, oil and gas, marine and rail), standby and prime power generator sets, alternators and other power components. The New Power segment designs, manufactures, sells and supports hydrogen production solutions as well as electrified power systems with innovative components and subsystems, including battery and fuel cell technologies. The New Power segment is currently in the development phase with a primary focus on research and development activities for our power systems, components and subsystems. We continue to serve all our markets as they adopt electrification and alternative power technologies, meeting the needs of our OEM partners and end customers.

Our financial performance depends, in large part, on varying conditions in the markets we serve, particularly the on-highway, construction and general industrial markets. Demand in these markets tends to fluctuate in response to overall economic conditions. Our sales may also be impacted by OEM inventory levels, production schedules, stoppages and supply chain challenges. Economic downturns in markets we serve generally result in reduced sales of our products and can result in price reductions in certain products and/or markets. As a worldwide business, our operations are also affected by geopolitical risks (such as the conflict between Russia and Ukraine), currency, political, economic, public health crises, epidemics or pandemics and regulatory matters, including adoption and enforcement of environmental and emission standards, in the countries we serve. As part of our growth strategy, we invest in businesses in certain countries that carry high levels of these risks such as China, Brazil, India, Mexico, Russia and countries in the Middle East and Africa. At the same time, our geographic diversity and broad product and service offerings have helped limit the impact from a drop in demand in any one industry or customer or the economy of any single country on our consolidated results.

Russian Operations

On March 17, 2022, the Board of Directors (the Board) decided to indefinitely suspend our operations in Russia due to the ongoing conflict in Ukraine. At the time of suspension, our Russian operations included a wholly-owned distributor in Russia, an unconsolidated joint venture (the Unconsolidated JV) with KAMAZ Publicly Traded Company (KAMAZ), a Russian truck manufacturer with whom we share the Unconsolidated JV, and direct sales into Russia from our other business segments. As a result of the suspension of operations, we evaluated the recoverability of assets in Russia and assessed other potential liabilities. We experienced and expect to continue to experience, an inability to collect customer receivables and may be the subject of litigation as a consequence of our suspension of commercial operations in Russia. We recorded a charge of $158 million in the first quarter related to these actions. In the second quarter, we recovered certain inventory and other expense amounts reserved in the first quarter and incurred some small additional charges resulting in a net recovery of $47 million. As of June 30, 2022, we had approximately $17 million of inventory and $26 million of receivables in Russia, all of which are fully reserved. In addition, we have cash balances of $84 million, some of which will be used to fund ongoing employee, tax and contract settlement obligations. The following summarizes the costs (recoveries) associated with the suspension of our Russian operations in our Condensed Consolidated Statements of Net Income:

Three months endedSix months ended
In millionsJune 30, 2022June 30, 2022
Inventory write-downs$(40)$19
Accounts receivable reserves—43
Impairment and other joint venture costs—31
Other(7)18
Total$(47)$111

We will continue to evaluate the situation as conditions evolve and may take additional actions as deemed necessary in future periods.

Supply Chain Disruptions

We continue to experience supply chain disruptions and related financial impacts reflected as increased cost of sales. Our industry continues to be unfavorably impacted by supply chain constraints leading to shortages across multiple components categories and limiting our collective ability to meet end-user demand. Our customers are also experiencing supply chain issues. Should the supply chain issues continue for an extended period of time or worsen, the impact on our production and supply chain could have a material adverse effect on our results of operations, financial condition and cash flows. The Board continues to monitor and evaluate all of these factors and the related impacts on our business and operations, and we are diligently working to minimize the supply chain impacts to our business and to our customers.

2022 Second Quarter and Year-to-Date Results

A summary of our results is as follows:

Three months endedSix months ended
In millions, except per share amountsJune 30, 2022July 4, 2021June 30, 2022July 4, 2021
Net sales$6,586$6,111$12,971$12,203
Net income attributable to Cummins Inc.7026001,1201,203
Earnings per common share attributable to Cummins Inc.
Basic$4.97$4.14$7.90$8.24
Diluted4.944.107.868.16

Our industry's sales continue to be unfavorably impacted by supply chain constraints leading to shortages across multiple components categories and limiting our collective ability to meet end-user demand. Our customers are also experiencing other supply chain issues limiting full production capabilities.

Worldwide revenues increased 8 percent in the three months ended June 30, 2022, compared to the same period in 2021, due to favorable pricing and higher demand in most operating segments and most geographic regions except for China. Net sales in the U.S. and Canada improved 15 percent, primarily due to favorable pricing and increased demand in North American on-highway markets, which positively impacted all components businesses, and most distribution product lines. International demand (excludes the U.S. and Canada) declined 2 percent, with lower sales in China (due to a sharp slowdown in truck and construction markets, exacerbated by COVID lockdowns) and Russia, partially offset by higher sales in all other geographic regions. The decrease in international sales was principally due to lower demand in China as the result of COVID-related lockdowns significantly reducing demand in most businesses. Unfavorable foreign currency fluctuations impacted international sales by 3 percent (primarily the Euro, British pound and Indian rupee).

Worldwide revenues increased 6 percent in the six months ended June 30, 2022, compared to the same period in 2021, due to favorable pricing and higher demand in most operating segments and most geographic regions except for China. Net sales in the U.S. and Canada improved 14 percent, primarily due to favorable pricing and increased demand in North American on-highway markets, which positively impacted all components businesses and all distribution product lines. International demand (excludes the U.S. and Canada) declined by 3 percent, with lower sales in China (due to a sharp slowdown in truck and construction markets, exacerbated by COVID lockdowns), partially offset by higher sales in all other geographic regions. The decrease in international sales was principally due to lower demand in China as the result of COVID-related lockdowns significantly reducing demand in most businesses. Unfavorable foreign currency fluctuations impacted international sales by 2 percent (primarily the Euro, British pound and Indian rupee).

The following tables contain sales and EBITDA (defined as earnings or losses before interest expense, income taxes, depreciation and amortization and noncontrolling interests) by operating segment for the three and six months ended June 30, 2022 and July 4, 2021. See NOTE 15, "OPERATING SEGMENTS," to the Condensed Consolidated Financial Statements for additional information and a reconciliation of our segment information to the corresponding amounts in our Condensed Consolidated Statements of Net Income.

Three months ended
Operating SegmentsJune 30, 2022July 4, 2021Percent change
PercentPercent2022 vs. 2021
In millionsSalesof TotalEBITDASalesof TotalEBITDASalesEBITDA
Engine$2,77542%$422$2,49141%$40211%5%
Distribution2,25334%2971,92031%20117%48%
Components1,95030%3521,99433%301(2)%17%
Power Systems1,20318%1281,14319%1395%(8)%
New Power421%(80)24—%(60)75%(33)%
Intersegment eliminations(1,637)(25)%(64)(1,461)(24)%(9)12%NM
Total$6,586100%$1,055(1)$6,111100%$9748%8%
"NM" - not meaningful information
(1) EBITDA includes $47 million of recoveries associated with the suspension of our Russian operations and $29 million of costs associated with the planned separation of our Filtration business.

Net income attributable to Cummins Inc. was $702 million, or $4.94 per diluted share, on sales of $6.6 billion for the three months ended June 30, 2022, versus the comparable prior year period net income attributable to Cummins Inc. of $600 million, or $4.10 per diluted share, on sales of $6.1 billion. The increases in net income attributable to Cummins Inc. and earnings per diluted share were driven by higher net sales, increased gross margin, recoveries associated with the suspension of our Russian operations and favorable discrete tax items, partially offset by unfavorable changes in corporate owned life insurance, increased consulting expenses driven by acquisitions and the work towards separation of the filtration business and lower equity, royalty and interest income from investees (primarily in China). See NOTE 3, "RUSSIAN OPERATIONS," to our Condensed Consolidated Financial Statements for additional information. The increase in gross margin was primarily due to favorable pricing and higher volumes, partially offset by higher material costs.

Six months ended
Operating SegmentsJune 30, 2022July 4, 2021Percent change
PercentPercent2022 vs. 2021
In millionsSalesof TotalEBITDASalesof TotalEBITDASalesEBITDA
Engine$5,52843%$814$4,95041%$75612%8%
Distribution4,37034%4073,75531%36116%13%
Components3,93830%6724,14634%722(5)%(7)%
Power Systems2,36318%2182,16518%2659%(18)%
New Power731%(147)59—%(111)24%(32)%
Intersegment eliminations(3,301)(26)%(154)(2,872)(24)%(39)15%NM
Total$12,971100%$1,810(1)$12,203100%$1,9546%(7)%
"NM" - not meaningful information
(1) EBITDA includes $111 million of costs associated with the suspension of our Russian operations and $46 million of costs associated with the planned separation of our Filtration business.

Net income attributable to Cummins Inc. was $1,120 million, or $7.86 per diluted share, on sales of $13.0 billion for the six months ended June 30, 2022, versus the comparable prior year period net income attributable to Cummins Inc. of $1,203 million, or $8.16 per diluted share, on sales of $12.2 billion. The decreases in net income attributable to Cummins Inc. and earnings per diluted share were driven by costs associated with the suspension of our Russian operations, increased consulting expenses driven by acquisitions and the work towards separation of the filtration business, lower equity, royalty and interest income from investees (primarily in China) and unfavorable changes in corporate owned life insurance, partially offset by higher net sales and increased gross margin. See NOTE 3, "RUSSIAN OPERATIONS," to our Condensed Consolidated Financial Statements for additional information. The increase in gross margin and gross margin as a percentage of sales was primarily due to favorable pricing and increased volumes, partially offset by higher material costs, increased freight costs due to supply chain constraints and unfavorable foreign currency impacts (principally the Euro). Diluted earnings per common share for the six months ended June 30, 2022, benefited $0.06 from fewer weighted-average shares outstanding due to the stock repurchase program.

We generated $763 million of cash from operations for the six months ended June 30, 2022, compared to $955 million for the comparable period in 2021. See the section titled "Cash Flows" in the "LIQUIDITY AND CAPITAL RESOURCES" section for a discussion of items impacting cash flows.

Our debt to capital ratio (total capital defined as debt plus equity) at June 30, 2022, was 31.4 percent, compared to 30.7 percent at December 31, 2021. The increase was primarily due to lower debt balances since December 31, 2021. At June 30, 2022, we had $3.0 billion in cash and marketable securities on hand and access to our $3.5 billion credit facilities, if necessary, to meet acquisition, working capital, investment and funding needs.

In the first six months of 2022, we purchased $347 million, or 1.7 million shares, of our common stock.

On August 3, 2022, we completed the acquisition of Meritor, Inc. (Meritor) with a purchase price of $3.0 billion (including convertible debt). See NOTE 14, "ACQUISITIONS," to our Condensed Consolidated Financial Statements for additional information.

On July 13, 2022, we entered into a loan agreement under which we may obtain delayed-draw loans in an amount up to $2.0 billion in the aggregate prior to October 13, 2022. We drew down the entire $2.0 billion balance on August 2, 2022, to fund the acquisition of Meritor.

In July 2022, the Board authorized an increase to our quarterly dividend of approximately 8 percent from $1.45 per share to $1.57 per share.

On April 8, 2022, we completed the acquisition of Jacobs Vehicle Systems business (Jacobs) from Altra Industrial Motion Corp with a purchase price of $346 million.

On April 20, 2022, we filed a confidential registration statement announcing our intent to separate the filtration business into a stand-alone company.

As a well-known seasoned issuer, we filed an automatic shelf registration of an undetermined amount of debt and equity with the Securities and Exchange Commission (SEC) on February 8, 2022.

In the first six months of 2022, the investment loss on our U.S. pension trust was 5.0 percent while our U.K. pension trust loss was 17.8 percent. We anticipate making additional defined benefit pension contributions during the remainder of 2022 of $10 million for our U.S. and U.K. qualified and non-qualified pension plans. We expect our 2022 annual net periodic pension cost to approximate $31 million.

As of the date of this filing, our credit ratings and outlooks from the credit rating agencies remain unchanged.

RESULTS OF OPERATIONS

Three months endedFavorable/Six months endedFavorable/
June 30, 2022July 4, 2021(Unfavorable)June 30, 2022July 4, 2021(Unfavorable)
In millions, except per share amountsAmountPercentAmountPercent
NET SALES$6,586$6,111$4758%$12,971$12,203$7686%
Cost of sales4,8604,633(227)(5)%9,7139,239(474)(5)%
GROSS MARGIN1,7261,47824817%3,2582,96429410%
OPERATING EXPENSES AND INCOME
Selling, general and administrative expenses622600(22)(4)%1,2371,174(63)(5)%
Research, development and engineering expenses299276(23)(8)%597536(61)(11)%
Equity, royalty and interest income from investees95137(42)(31)%191303(112)(37)%
Other operating expense, net34125%11412(102)NM
OPERATING INCOME89773516222%1,5011,545(44)(3)%
Interest expense3429(5)(17)%5157611%
Other (expense) income, net(8)73(81)NM(17)74(91)NM
INCOME BEFORE INCOME TAXES8557797610%1,4331,562(129)(8)%
Income tax expense1481671911%3033393611%
CONSOLIDATED NET INCOME7076129516%1,1301,223(93)(8)%
Less: Net income attributable to noncontrolling interests512758%10201050%
NET INCOME ATTRIBUTABLE TO CUMMINS INC.$702$600$10217%$1,120$1,203$(83)(7)%
Diluted Earnings Per Common Share Attributable to Cummins Inc.$4.94$4.10$0.8420%$7.86$8.16$(0.30)(4)%
"NM" - not meaningful information
Three months endedFavorable/ (Unfavorable)Six months endedFavorable/ (Unfavorable)
June 30, 2022July 4, 2021June 30, 2022July 4, 2021
Percent of salesPercentage PointsPercentage Points
Gross margin26.2%24.2%2.025.1%24.3%0.8
Selling, general and administrative expenses9.4%9.8%0.49.5%9.6%0.1
Research, development and engineering expenses4.5%4.5%—4.6%4.4%(0.2)

Net Sales

Net sales for the three months ended June 30, 2022, increased by $475 million versus the comparable period in 2021. The primary drivers were as follows:

  • Distribution segment sales increased 17 percent principally due to higher demand across most product lines in North America.

  • Engine segment sales increased 11 percent due to favorable pricing and increased on-highway demand (including higher aftermarket sales) in North America.

  • Power Systems segment sales increased 5 percent primarily due to higher demand in oil and gas markets (including higher aftermarket sales) in North America and India and generator technologies markets in Europe and India.

These increases were partially offset by the following drivers:

  • Components segment sales decreased 2 percent largely due to lower demand in all businesses in China, partially offset by higher demand in North America.

  • Unfavorable foreign currency fluctuations of 1 percent of total sales, primarily in the Euro, British pound and Indian rupee.

Net sales for the six months ended June 30, 2022, increased $768 million versus the comparable period in 2021. The primary drivers were as follows:

  • Distribution segment sales increased 16 percent principally due to higher demand across most product lines in North America.

  • Engine segment sales increased 12 percent due to favorable pricing and stronger on-highway demand (including higher aftermarket sales) in North America.

  • Power Systems segment sales increased 9 percent primarily due to higher demand in power generation markets in China and India and global mining markets and oil and gas markets (including higher aftermarket sales) in North America, China and India.

These increases were partially offset by the following drivers:

  • Components segment sales decreased 5 percent largely due to lower demand in all businesses in China, partially offset by higher demand in North America.

  • Unfavorable foreign currency fluctuations of 1 percent of total sales, primarily in the Euro, British pound and Indian rupee.

Sales to international markets (excluding the U.S. and Canada), based on location of customers, for the three and six months ended June 30, 2022, were 39 percent and 40 percent of total net sales compared with 43 percent and 44 percent of total net sales for the comparable periods in 2021. A more detailed discussion of sales by segment is presented in the “OPERATING SEGMENT RESULTS” section.

Cost of Sales

The types of expenses included in cost of sales are the following: parts and material consumption, including direct and indirect materials; salaries, wages and benefits; depreciation on production equipment and facilities and amortization of technology intangibles; estimated costs of warranty programs and campaigns; production utilities; production-related purchasing; warehousing, including receiving and inspection; freight costs; engineering support costs; repairs and maintenance; production and warehousing facility property insurance; rent for production facilities; charges for the write-downs of inventories in Russia and other production overhead.

Gross Margin

Gross margin increased $248 million for the three months ended June 30, 2022 and increased 2.0 points as a percentage of net sales versus the comparable period in 2021. The increase in gross margin and gross margin as a percentage of sales was primarily due to favorable pricing and higher volumes, partially offset by higher material costs.

Gross margin increased $294 million for the six months ended June 30, 2022 and increased 0.8 points as a percentage of sales versus the comparable period in 2021. The increase in gross margin and gross margin as a percentage of sales was primarily due to favorable pricing and increased volumes, partially offset by higher material costs, increased freight costs due to supply chain constraints and unfavorable foreign currency impacts (principally the Euro).

The provision for base warranties issued as a percent of sales for the three and six months ended June 30, 2022, was 2.2 percent and 2.1 percent, respectively, compared to 2.4 percent and 2.5 percent for the comparable periods in 2021.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $22 million for the three months ended June 30, 2022, versus the comparable period in 2021, primarily due to higher consulting expenses driven by acquisitions and the work towards separation of the filtration business, partially offset by lower variable compensation expenses. Overall, selling, general and administrative expenses as a percentage of net sales decreased to 9.4 percent in the three months ended June 30, 2022, from 9.8 percent in the comparable period in 2021. The decrease in selling, general and administrative expenses as a percentage of net sales was mainly due to selling, general and administrative expenses increasing at a slower rate than the growth in net sales.

Selling, general and administrative expenses increased $63 million for the six months ended June 30, 2022, versus the comparable period in 2021, primarily due to higher consulting expenses driven by acquisitions and the work towards the separation of the filtration business, partially offset by lower variable compensation expenses. Overall, selling, general and administrative expenses, as a percentage of sales, decreased to 9.5 percent in the six months ended June 30, 2022, from 9.6 percent in the comparable period in 2021. The decrease in selling, general and administrative expenses as a percentage of net sales was mainly due to selling, general and administrative expenses increasing at a slower rate than the increase in net sales.

Research, Development and Engineering Expenses

Research, development and engineering expenses increased $23 million for the three months ended June 30, 2022, versus the comparable period in 2021, primarily due to increased consulting expenses and higher spending on supplies. Overall, research, development and engineering expenses as a percentage of net sales remained flat at 4.5 percent in the three months ended June 30, 2022, and the comparable period in 2021.

Research, development and engineering expenses increased $61 million for the six months ended June 30, 2022, versus the comparable period in 2021, primarily due to increased consulting expenses and higher spending on prototypes and supplies. Overall, research, development and engineering expenses as a percentage of sales increased to 4.6 percent in the six months ended June 30, 2022, from 4.4 percent in the comparable period in 2021. The increase in research, development and engineering expenses as a percentage of net sales was mainly due to research, development and engineering expenses increasing at a faster rate than the increase in net sales.

Research activities continue to focus on development of new products to meet future emission standards around the world, improvements in fuel economy performance of diesel and natural gas powered engines and related components as well as development activities around battery electric, fuel cell electric and hydrogen engine solutions.

Equity, Royalty and Interest Income from Investees

Equity, royalty and interest income from investees decreased $42 million for the three months ended June 30, 2022, versus the comparable period in 2021, primarily due to decreased earnings at Beijing Foton Cummins Engine Co., Ltd. and Dongfeng Cummins Engine Co., Ltd. and the February 7, 2022, purchase of Westport Fuel System Inc.'s stake in Cummins Westport Joint Venture. See NOTE 14, "ACQUISITIONS," to our Condensed Consolidated Financial Statements for additional information.

Equity, royalty and interest income from investees decreased $112 million for the six months ended June 30, 2022, versus the comparable period in 2021, mainly due to decreased earnings at Beijing Foton Cummins Engine Co., Ltd. and Dongfeng Cummins Engine Co., Ltd., the $28 million impairment of our Russian joint venture with KAMAZ and the February 7, 2022, purchase of Westport Fuel System Inc.'s stake in Cummins Westport Joint Venture. See NOTE 3, "RUSSIAN OPERATIONS," and NOTE 14, "ACQUISITIONS," to our Condensed Consolidated Financial Statements for additional information.

Other Operating Expense, Net

Other operating (expense) income, net was as follows:

Three months endedSix months ended
In millionsJune 30, 2022July 4, 2021June 30, 2022July 4, 2021
Amortization of intangible assets$(9)$(5)$(14)$(11)
Loss on write-off of assets(3)—(8)(4)
Asset impairments and other charges——(36)—
Gain (loss) on sale of assets, net—(2)1(1)
Royalty income, net3355
Russian suspension recoveries (costs)7(1)—(61)(1)—
Other, net(1)—(1)(1)
Total other operating expense, net$(3)$(4)$(114)$(12)
(1) See NOTE 3, "RUSSIAN OPERATIONS," to our Condensed Consolidated Financial Statements for additional information.

Interest Expense

Interest expense increased $5 million and decreased $6 million for the three and six months ended June 30, 2022, versus the comparable periods in 2021. The three month increase is primarily due to the overall increase in floating interest rates in the second quarter of 2022. The six month decrease is principally due to the performance on the fixed to floating swaps placed in 2021 for our 2030 and 2050 debt maturities.

Other (Expense) Income, Net

Other (expense) income, net was as follows:

Three months endedSix months ended
In millionsJune 30, 2022July 4, 2021June 30, 2022July 4, 2021
(Loss) gain on corporate owned life insurance$(48)$20$(85)$(12)
(Loss) gain on marketable securities, net(5)3(9)3
Foreign currency (loss) gain, net(1)3(13)(2)
Gain on sale of land—18—18
Interest income751511
Non-service pension and OPEB credit32256549
Other, net7(1)107
Total other (expense) income, net$(8)$73$(17)$74

Income Tax Expense

Our effective tax rate for 2022 is expected to approximate 21.5 percent, excluding any discrete items that may arise.

Our effective tax rates for the three and six months ended June 30, 2022, were 17.3 percent and 21.1 percent, respectively. Our effective tax rates for the three and six months ended July 4, 2021, were 21.4 percent and 21.7 percent, respectively.

The three months ended June 30, 2022, contained favorable discrete tax items of $36 million, primarily due to $36 million of favorable changes in tax reserves, $10 million of favorable changes associated with uncertainty in our Russian operations and $8 million of net favorable other discrete tax items, partially offset by $18 million of unfavorable tax costs associated with internal restructuring ahead of the planned separation of our filtration business.

The six months ended June 30, 2022, contained favorable net discrete tax items of $5 million, primarily due to $27 million of favorable changes in tax reserves and $4 million of net favorable other discrete tax items, partially offset by $18 million of unfavorable tax costs associated with internal restructuring ahead of the planned separation of our filtration business and $8 million of unfavorable changes associated with uncertainty in our Russian operations.

The three months ended July 4, 2021, contained unfavorable discrete items of $7 million, primarily due to a $10 million unfavorable statutory change in tax rates (mostly in the UK), partially offset by $3 million of other favorable discrete items.

The six months ended July 4, 2021, contained unfavorable discrete items of $3 million, primarily due to a $10 million unfavorable statutory change in tax rates (mostly in the UK), partially offset by $7 million of other favorable discrete items.

Noncontrolling Interests

Noncontrolling interests eliminate the income or loss attributable to non-Cummins ownership interests in our consolidated entities. Noncontrolling interests in income of consolidated subsidiaries for the three and six months ended June 30, 2022, decreased $7 million and $10 million, respectively, versus the comparable periods in 2021. The decrease for the three and six months ended June 30, 2022, was primarily due to lower earnings at Cummins India Limited and Hydrogenics Corporation.

Net Income Attributable to Cummins Inc. and Diluted Earnings Per Common Share Attributable to Cummins Inc.

Net income and diluted earnings per common share attributable to Cummins Inc. for the three months ended June 30, 2022, increased $102 million and $0.84 per diluted share versus the comparable period in 2021, primarily due to higher net sales, increased gross margin, recoveries associated with the suspension of our Russian operations and favorable discrete tax items, partially offset by unfavorable changes in corporate owned life insurance, increased consulting expenses driven by acquisitions and the work towards separation of the filtration business and lower equity, royalty and interest income from investees (primarily in China). See NOTE 3, "RUSSIAN OPERATIONS," to our Condensed Consolidated Financial Statements for additional information.

Net income and diluted earnings per common share attributable to Cummins Inc. for the six months ended June 30, 2022, decreased $83 million and $0.30 per diluted share versus the comparable period in 2021, primarily due to costs associated with the suspension of our Russian operations, increased consulting expenses driven by acquisitions and the work towards separation of the filtration business, lower equity, royalty and interest income from investees (primarily in China) and unfavorable changes in corporate owned life insurance, partially offset by higher net sales and increased gross margin. See NOTE 3, "RUSSIAN OPERATIONS," to our Condensed Consolidated Financial Statements for additional information. Diluted earnings per common share for the six months ended June 30, 2022, benefited $0.06 from fewer weighted-average shares outstanding due to the stock repurchase program.

Comprehensive Income - Foreign Currency Translation Adjustment

The foreign currency translation adjustment was a net loss of $245 million and $241 million, respectively, for the three and six months ended June 30, 2022, compared to a net gain of $22 million and net loss of $34 million, respectively, for the three and six months ended July 4, 2021, driven by the following:

Three months ended
June 30, 2022July 4, 2021
In millionsTranslation adjustmentPrimary currency driver vs. U.S. dollarTranslation adjustmentPrimary currency driver vs. U.S. dollar
Wholly-owned subsidiaries$(175)Chinese renminbi, Indian rupee$20Brazilian real, Chinese renminbi, partially offset by Indian rupee, British pound
Equity method investments(55)Chinese renminbi9Chinese renminbi, partially offset by Indian rupee
Consolidated subsidiaries with a noncontrolling interest(15)Indian rupee(7)Indian rupee
Total$(245)$22
Six months ended
June 30, 2022July 4, 2021
In millionsTranslation adjustmentPrimary currency driver vs. U.S. dollarTranslation adjustmentPrimary currency driver vs. U.S. dollar
Wholly-owned subsidiaries$(159)Chinese renminbi, Indian rupee$(28)British pound, Indian rupee, partially offset by Chinese renminbi
Equity method investments(59)Chinese renminbi1Chinese renminbi, partially offset by Indian rupee
Consolidated subsidiaries with a noncontrolling interest(23)Indian rupee(7)Indian rupee
Total$(241)$(34)

OPERATING SEGMENT RESULTS

Our reportable operating segments consist of the Engine, Distribution, Components, Power Systems and New Power segments. This reporting structure is organized according to the products and markets each segment serves. We use segment EBITDA as a primary basis for the Chief Operating Decision Maker to evaluate the performance of each of our reportable operating segments. We believe EBITDA is a useful measure of our operating performance as it assists investors and debt holders in comparing our performance on a consistent basis without regard to financing methods, capital structure, income taxes or depreciation and amortization methods, which can vary significantly depending upon many factors. Segment amounts exclude certain expenses not specifically identifiable to segments. See NOTE 15, "OPERATING SEGMENTS," to the Condensed Consolidated Financial Statements for additional information and a reconciliation of our segment information to the corresponding amounts in our Condensed Consolidated Statements of Net Income.

We continue to experience supply chain disruptions and related financial impacts reflected as increased cost of sales. Our industry continues to be unfavorably impacted by supply chain constraints leading to shortages across multiple components categories and limiting our collective ability to meet end-user demand. Our customers are also experiencing supply chain issues.

Following is a discussion of results for each of our operating segments.

Engine Segment Results

Financial data for the Engine segment was as follows:

Three months endedFavorable/Six months endedFavorable/
June 30,July 4,(Unfavorable)June 30,July 4,(Unfavorable)
In millions20222021AmountPercent20222021AmountPercent
External sales$2,092$1,920$1729%$4,141$3,815$3269%
Intersegment sales68357111220%1,3871,13525222%
Total sales2,7752,49128411%5,5284,95057812%
Research, development and engineering expenses11699(17)(17)%225191(34)(18)%
Equity, royalty and interest income from investees59104(45)(43)%103(1)217(114)(53)%
Interest income11——%54125%
Russian suspension costs(2)1—(1)NM33(3)—(33)NM
Segment EBITDA422402205%814756588%
Percentage PointsPercentage Points
Segment EBITDA as a percentage of total sales15.2%16.1%(0.9)14.7%15.3%(0.6)
"NM" - not meaningful information
(1) Includes a $28 million impairment of our joint venture with KAMAZ and $3 million of royalty charges as part of our costs associated with the suspension of our Russian operations. In addition, on February 7, 2022, we purchased Westport Fuel System Inc.'s stake in Cummins Westport Joint Venture. See NOTE 3, "RUSSIAN OPERATIONS," and NOTE 14, "ACQUISITIONS," to our Condensed Consolidated Financial Statements for additional information.
(2) See NOTE 3, "RUSSIAN OPERATIONS," to our Condensed Consolidated Financial Statements for additional information.
(3) Includes $31 million of Russian suspension costs reflected in the Equity, royalty and interest income from investees line above.

Sales for our Engine segment by market were as follows:

Three months endedFavorable/Six months endedFavorable/
June 30,July 4,(Unfavorable)June 30,July 4,(Unfavorable)
In millions20222021AmountPercent20222021AmountPercent
Heavy-duty truck$1,001$839$16219%$1,909$1,666$24315%
Medium-duty truck and bus87568818727%1,7231,36236127%
Light-duty automotive456484(28)(6)%954965(11)(1)%
Total on-highway2,3322,01132116%4,5863,99359315%
Off-highway443480(37)(8)%942957(15)(2)%
Total sales$2,775$2,491$28411%$5,528$4,950$57812%
Percentage PointsPercentage Points
On-highway sales as percentage of total sales84%81%383%81%2

Unit shipments by engine classification (including unit shipments to Power Systems and off-highway engine units included in their respective classification) were as follows:

Three months endedFavorable/Six months endedFavorable/
June 30,July 4,(Unfavorable)June 30,July 4,(Unfavorable)
20222021AmountPercent20222021AmountPercent
Heavy-duty30,90029,4001,5005%59,50060,100(600)(1)%
Medium-duty68,80067,5001,3002%141,400140,6008001%
Light-duty60,40068,100(7,700)(11)%126,900136,600(9,700)(7)%
Total unit shipments160,100165,000(4,900)(3)%327,800337,300(9,500)(3)%

Sales

Engine segment sales for the three months ended June 30, 2022, increased $284 million versus the comparable period in 2021. The following were the primary drivers by market:

  • Medium-duty truck and bus sales increased $187 million mainly due to favorable pricing and higher demand (including higher aftermarket sales), especially in North America.

  • Heavy-duty truck sales increased $162 million principally due to favorable pricing and stronger demand (including higher aftermarket sales) in North America and Latin America.

These increases were partially offset by decreased off-highway sales of $37 million primarily due to lower demand in construction markets in China, partially offset by increased demand in Western Europe.

Engine segment sales for the six months ended June 30, 2022, increased $578 million versus the comparable period in 2021. The following were the primary drivers by market:

  • Medium-duty truck and bus sales increased $361 million mainly due to favorable pricing and higher demand (including higher aftermarket sales), especially in North America.

  • Heavy-duty truck sales increased $243 million principally due to favorable pricing and stronger demand (including higher aftermarket sales), especially in North America with higher shipments of 5 percent.

Segment EBITDA

Engine segment EBITDA for the three months ended June 30, 2022, increased $20 million versus the comparable period in 2021, primarily due to favorable pricing, partially offset by higher material costs, lower equity, royalty and interest income from investees (principally Beijing Foton Cummins Engine Co., Ltd. and Dongfeng Cummins Engine Co., Ltd.) and increased freight costs due to supply chain constraints.

Engine segment EBITDA for the six months ended June 30, 2022, increased $58 million versus the comparable period in 2021, mainly due to favorable pricing, partially offset by higher material costs, lower equity, royalty and interest income from investees (principally Beijing Foton Cummins Engine Co., Ltd. and Dongfeng Cummins Engine Co., Ltd.) and costs associated with the suspension of our Russian operations including a $28 million impairment of our joint venture with KAMAZ. See Note 3, "RUSSIAN OPERATIONS," to our Condensed Consolidated Financial Statements for additional information.

Distribution Segment Results

Financial data for the Distribution segment was as follows:

Three months endedFavorable/Six months endedFavorable/
June 30,July 4,(Unfavorable)June 30,July 4,(Unfavorable)
In millions20222021AmountPercent20222021AmountPercent
External sales$2,247$1,913$33417%$4,358$3,740$61817%
Intersegment sales67(1)(14)%1215(3)(20)%
Total sales2,2531,92033317%4,3703,75561516%
Research, development and engineering expenses1312(1)(8)%2625(1)(4)%
Equity, royalty and interest income from investees2115640%3732516%
Interest income32150%53267%
Russian suspension (recoveries) costs(1)(45)—45NM55—(55)NM
Segment EBITDA2972019648%4073614613%
Percentage PointsPercentage Points
Segment EBITDA as a percentage of total sales13.2%10.5%2.79.3%9.6%(0.3)
"NM" - not meaningful information
(1) See NOTE 3, "RUSSIAN OPERATIONS," to our Condensed Consolidated Financial Statements for additional information.

Sales for our Distribution segment by region were as follows:

Three months endedFavorable/Six months endedFavorable/
June 30,July 4,(Unfavorable)June 30,July 4,(Unfavorable)
In millions20222021AmountPercent20222021AmountPercent
North America$1,494$1,230$26421%$2,861$2,401$46019%
Asia Pacific242227157%4884414711%
Europe1791611811%32832441%
China99772229%1821641811%
Russia7566914%2111238872%
Latin America5648817%9788910%
Africa and Middle East5569(14)(20)%101123(22)(18)%
India53421126%102911112%
Total sales$2,253$1,920$33317%$4,370$3,755$61516%

Sales for our Distribution segment by product line were as follows:

Three months endedFavorable/Six months endedFavorable/
June 30,July 4,(Unfavorable)June 30,July 4,(Unfavorable)
In millions20222021AmountPercent20222021AmountPercent
Parts$990$765$22529%$1,914$1,522$39226%
Power generation441454(13)(3)%842872(30)(3)%
Engines4293517822%87068518527%
Service3933504312%7446766810%
Total sales$2,253$1,920$33317%$4,370$3,755$61516%

Sales

Distribution segment sales for the three months ended June 30, 2022, increased $333 million versus the comparable period in 2021. The following were the primary drivers by region:

  • North American sales increased $264 million, representing 79 percent of the total change in Distribution segment sales, mainly due to higher demand for parts and vocational engines.

These increases were partially offset by unfavorable foreign currency fluctuations, primarily in the Euro, Australian dollar, Canadian dollar and Indian rupee.

Distribution segment sales for the six months ended June 30, 2022, increased $615 million versus the comparable period in 2021. The following were the primary drivers by region:

  • North American sales increased $460 million, representing 75 percent of the total change in Distribution segment sales, largely due to higher demand for parts and vocational engines.

  • Russian sales increased $88 million as a result of increased demand for engines and parts following our announcement to indefinitely suspend our operations in Russia.

These increases were partially offset by unfavorable foreign currency fluctuations, mainly in the Euro, Australian dollar and Japanese yen.

Segment EBITDA

Distribution segment EBITDA for the three months ended June 30, 2022, increased $96 million versus the comparable period in 2021, primarily due to higher volumes and recoveries associated with the suspension of our Russian operations, partially offset by unfavorable foreign currency fluctuations (principally in emerging market currencies and South African rand). See NOTE 3, "RUSSIAN OPERATIONS," to our Condensed Consolidated Financial Statements for additional information.

Distribution segment EBITDA for the six months ended June 30, 2022, increased $46 million versus the comparable period in 2021, mainly due to higher volumes and favorable pricing, partially offset by costs associated with the suspension of our Russian operations, unfavorable foreign currency fluctuations (principally in the emerging market currencies and Australian dollar), increased freight costs due to supply chain constraints and the absence of an $18 million gain on sale of land recorded in the second quarter of 2021. See NOTE 3, "RUSSIAN OPERATIONS," to our Condensed Consolidated Financial Statements for additional information.

Components Segment Results

Financial data for the Components segment was as follows:

Three months endedFavorable/Six months endedFavorable/
June 30,July 4,(Unfavorable)June 30,July 4,(Unfavorable)
In millions20222021AmountPercent20222021AmountPercent
External sales$1,477$1,556$(79)(5)%$2,994$3,280$(286)(9)%
Intersegment sales473438358%944866789%
Total sales1,9501,994(44)(2)%3,9384,146(208)(5)%
Research, development and engineering expenses737968%14915453%
Equity, royalty and interest income from investees912(3)(25)%3731619%
Interest income211100%32150%
Russian suspension (recoveries) costs(1)(2)—2NM4—(4)NM
Segment EBITDA3523015117%672722(50)(7)%
Percentage PointsPercentage Points
Segment EBITDA as a percentage of total sales18.1%15.1%3.017.1%17.4%(0.3)
"NM" - not meaningful information
(1) See NOTE 3, "RUSSIAN OPERATIONS," to our Condensed Consolidated Financial Statements for additional information.

Sales for our Components segment by business were as follows:

Three months endedFavorable/Six months endedFavorable/
June 30,July 4,(Unfavorable)June 30,July 4,(Unfavorable)
In millions20222021AmountPercent20222021AmountPercent
Emission solutions$863$882$(19)(2)%$1,773$1,917$(144)(8)%
Filtration391374175%773746274%
Turbo technologies355(1)35141%701(1)718(17)(2)%
Electronics and fuel systems198241(43)(18)%414504(90)(18)%
Automated transmissions143146(3)(2)%277261166%
Total sales$1,950$1,994$(44)(2)%$3,938$4,146$(208)(5)%
(1) The three and six months ended June 30, 2022, included revenues of $37 million related to the newly acquired Jacobs Vehicle Systems business. See NOTE 14, "ACQUISITIONS," to our Condensed Consolidated Financial Statements for additional information.

Sales

Components segment sales for the three months ended June 30, 2022, decreased $44 million versus the comparable period in 2021. The following were the primary drivers by business:

  • Electronics and fuel systems sales decreased by $43 million principally due to weaker demand in China.

  • Unfavorable foreign currency fluctuations primarily in the Euro, British pound and Indian rupee.

  • Emission solutions sales decreased $19 million primarily due to lower demand in China, partially offset by stronger demand in North America and India.

These decreases were partially offset by increased sales of $17 million in the filtration business mainly due to stronger demand in North America and Latin America, partially offset by lower demand in China.

Components segment sales for the six months ended June 30, 2022, decreased $208 million versus the comparable period in 2021. The following were the primary drivers by business:

  • Emission solutions sales decreased $144 million primarily due to lower demand in China, partially offset by stronger demand in North America.

  • Electronics and fuel systems sales decreased $90 million mainly due to weaker demand in China, partially offset by higher demand in North America.

  • Unfavorable foreign currency fluctuations, primarily in the Euro and Indian rupee.

These decreases were partially offset by increased sales of $27 million in the filtration business mainly due to stronger demand in North America and Latin America, partially offset by lower demand in China.

Segment EBITDA

Components segment EBITDA for the three months ended June 30, 2022, increased $51 million versus the comparable period in 2021, mainly due to favorable pricing and lower product coverage costs, partially offset by increased material costs.

Components segment EBITDA for the six months ended June 30, 2022, decreased $50 million versus the comparable period in 2021, primarily due to lower volumes and increased material costs, partially offset by favorable pricing.

Power Systems Segment Results

Financial data for the Power Systems segment was as follows:

Three months endedFavorable/Six months endedFavorable/
June 30,July 4,(Unfavorable)June 30,July 4,(Unfavorable)
In millions20222021AmountPercent20222021AmountPercent
External sales$734$699$355%$1,417$1,311$1068%
Intersegment sales469444256%9468549211%
Total sales1,2031,143605%2,3632,1651989%
Research, development and engineering expenses586023%122117(5)(4)%
Equity, royalty and interest income from investees109111%2121——%
Interest income11——%22——%
Russian suspension (recoveries) costs(1)(1)—1NM19—(19)NM
Segment EBITDA128139(11)(8)%218265(47)(18)%
Percentage PointsPercentage Points
Segment EBITDA as a percentage of total sales10.6%12.2%(1.6)9.2%12.2%(3.0)
"NM" - not meaningful information
(1) See NOTE 3, "RUSSIAN OPERATIONS," to our Condensed Consolidated Financial Statements for additional information.

Sales for our Power Systems segment by product line were as follows:

Three months endedFavorable/Six months endedFavorable/
June 30,July 4,(Unfavorable)June 30,July 4,(Unfavorable)
In millions20222021AmountPercent20222021AmountPercent
Power generation$657$655$2—%$1,321$1,266$554%
Industrial428399297%8217239814%
Generator technologies118892933%2211764526%
Total sales$1,203$1,143$605%$2,363$2,165$1989%

Sales

Power Systems segment sales for the three months ended June 30, 2022, increased $60 million versus the comparable period in 2021. The following were the primary drivers by product line:

  • Industrial sales increased $29 million due to stronger demand (including higher aftermarket sales) in oil and gas markets in North America and India.

  • Generator technologies sales increased $29 million due to higher demand in Europe and India.

These increases were partially offset by unfavorable foreign currency fluctuations, primarily in the Euro, British pound and Indian rupee.

Power Systems segment sales for the six months ended June 30, 2022, increased $198 million versus the comparable period in 2021. The following were the primary drivers by product line:

  • Industrial sales increased $98 million due to stronger demand (including higher aftermarket sales) in oil and gas markets in North America and China and global mining markets.

  • Power generation sales increased $55 million due to higher demand in China and India, partially offset by weaker demand in North America.

  • Generator technologies sales increased $45 million due to higher demand in Europe and India.

These increases were partially offset by unfavorable foreign currency fluctuations, primarily in the Euro, British pound and Indian rupee.

Segment EBITDA

Power Systems segment EBITDA for the three months ended June 30, 2022, decreased $11 million versus the comparable period in 2021, mainly due to higher material costs, increased freight costs due to supply chain constraints and higher product coverage costs, partially offset by favorable pricing.

Power Systems segment EBITDA for the six months ended June 30, 2022, decreased $47 million versus the comparable period in 2021, primarily due to higher material costs, increased freight costs due to supply chain constraints and costs associated with the suspension of our Russian operations, partially offset by favorable pricing. See NOTE 3, "RUSSIAN OPERATIONS," to our Condensed Consolidated Financial Statements for additional information.

New Power Segment Results

The New Power segment designs, manufactures, sells and supports hydrogen production solutions as well as electrified power systems with innovative components and subsystems, including battery and fuel cell technologies. The New Power segment is currently in the development phase with a primary focus on research and development activities for our power systems, components and subsystems. Financial data for the New Power segment was as follows:

Three months endedFavorable/Six months endedFavorable/
June 30,July 4,(Unfavorable)June 30,July 4,(Unfavorable)
In millions20222021AmountPercent20222021AmountPercent
External sales$36$23$1357%$61$57$47%
Intersegment sales615NM12210NM
Total sales42241875%73591424%
Research, development and engineering expenses3926(13)(50)%7549(26)(53)%
Equity, royalty and interest (loss) income from investees(4)(3)(1)(33)%(7)2(9)NM
Segment EBITDA(80)(60)(20)(33)%(147)(111)(36)(32)%
"NM" - not meaningful information

OUTLOOK

Supply Chain Disruptions

We continue to experience supply chain disruptions and related financial impacts reflected as increased cost of sales. Our industry continues to be unfavorably impacted by supply chain constraints leading to shortages across multiple components categories and limiting our collective ability to meet end-user demand. Our customers are also experiencing supply chain issues. Should the supply chain issues continue for an extended period of time or worsen, the impact on our production and supply chain could have a material adverse effect on our results of operations, financial condition and cash flows. The Board continues to monitor and evaluate all of these factors and the related impacts on our business and operations, and we are diligently working to minimize the supply chain impacts to our business and to our customers.

Business Outlook

Our outlook reflects the following positive trends and challenges to our business that could impact our revenue and earnings potential for the remainder of 2022.

Positive Trends

  • We expect demand for pick-up trucks in North America to remain strong.

  • We expect North American medium-duty and heavy-duty truck demand will remain strong.

  • We believe market demand for trucks in India will continue to improve.

  • We anticipate demand in our aftermarket business will continue to be robust, driven primarily by increased truck utilization in North America and improved demand in our Power Systems business.

  • Our liquidity of $5.8 billion in cash, marketable securities and available credit facilities puts us in a strong position to deal with any uncertainties that may arise in the remainder of 2022.

Challenges

  • Supply constraints driven by strong demand in multiple end markets and regions may lead to increased costs, including higher freight and conversion costs.

  • Continued increases in material and commodity costs, as well as other inflationary pressures, could negatively impact earnings.

  • Our industry's sales continue to be unfavorably impacted by supply chain constraints leading to shortages across multiple components categories and limiting our collective ability to meet end-user demand. Our customers are also experiencing other supply chain issues limiting full production capabilities.

  • Resurgence of COVID-19 in China led to lockdowns in several cities that negatively impacted the economy and our end markets. Any continued lockdowns will also contribute to further disruptions in the global supply chain, negatively impacting both our revenues and profitability.

  • We expect market demand in truck and construction markets in China to decline from 2021 full year levels.

  • The indefinite suspension of our operations in Russia is expected to impact our revenue and profitability. The 2021 sales through our wholly-owned distributor in Russia and direct sales into Russia were 2.7 percent of net sales.

  • We expect to incur incremental expenses as a result of the completion of the Meritor, Inc. acquisition and its integration into our business.

  • The completion of the Meritor, Inc. acquisition will impact our liquidity and result in incremental interest expense for debt utilized in funding the transaction.

  • Planned separation of our filtration business into a stand-alone company is expected to result in incremental expenses.

LIQUIDITY AND CAPITAL RESOURCES

Key Working Capital and Balance Sheet Data

We fund our working capital with cash from operations and short-term borrowings, including commercial paper, when necessary. Various assets and liabilities, including short-term debt, can fluctuate significantly from month to month depending on short-term liquidity needs. As a result, working capital is a prime focus of management's attention. Working capital and balance sheet measures are provided in the following table:

Dollars in millionsJune 30, 2022December 31, 2021
Working capital (1)$5,091$5,225
Current ratio1.661.74
Accounts and notes receivable, net$4,156$3,990
Days' sales in receivables5759
Inventories$4,765$4,355
Inventory turnover4.24.6
Accounts payable (principally trade)$3,405$3,021
Days' payable outstanding5957
Total debt$4,425$4,159
Total debt as a percent of total capital31.4%30.7%
(1) Working capital includes cash and cash equivalents.

Cash Flows

Cash and cash equivalents were impacted as follows:

Six months ended
In millionsJune 30, 2022July 4, 2021Change
Net cash provided by operating activities$763$955$(192)
Net cash used in investing activities(576)(146)(430)
Net cash used in financing activities(391)(1,722)1,331
Effect of exchange rate changes on cash and cash equivalents74(7)81
Net decrease in cash and cash equivalents$(130)$(920)$790

Net cash provided by operating activities decreased $192 million for the six months ended June 30, 2022, versus the comparable period in 2021, primarily due to higher working capital requirements of $239 million. During the first six months of 2022, the higher working capital requirements resulted in a cash outflow of $670 million compared to a cash outflow of $431 million in the comparable period in 2021, mainly due to higher variable compensation payouts in accrued expenses, partially offset by favorable changes in inventories and accounts receivable.

Net cash used in investing activities increased $430 million for the six months ended June 30, 2022, versus the comparable period in 2021, primarily due to the acquisition of Jacobs Vehicle Systems and Cummins Westport Joint Venture, net of cash acquired, of $245 million, higher investments in and net advances to equity investees of $63 million, unfavorable changes in cash flows from derivatives not designated as hedges of $44 million and higher capital spending of $39 million.

Net cash used in financing activities decreased $1,331 million for the six months ended June 30, 2022, versus the comparable period in 2021, primarily due to lower repurchases of common stock of $743 million and higher net borrowings of commercial paper of $515 million.

The effect of exchange rate changes on cash and cash equivalents for the six months ended June 30, 2022, versus the comparable period in 2021, increased $81 million primarily due to favorable fluctuations in the British pound of $124 million, partially offset by unfavorable fluctuations in the Chinese renminbi of $38 million.

Sources of Liquidity

We generate significant ongoing cash flow. Cash provided by operations is our principal source of liquidity with $763 million generated in the six months ended June 30, 2022. Our sources of liquidity include:

June 30, 2022
In millionsTotalU.S.InternationalPrimary location of international balances
Cash and cash equivalents$2,462$732$1,730China, Singapore, Belgium, Australia, Mexico, India
Marketable securities (1)536100436India
Total$2,998$832$2,166
Available credit capacity
Revolving credit facilities (2)$2,795
International and other uncommitted domestic credit facilities$271
(1) The majority of marketable securities could be liquidated into cash within a few days.
(2) The five-year credit facility for $2.0 billion and the 364-day credit facility for $1.5 billion, maturing August 2026 and August 2022, respectively, are maintained primarily to provide backup liquidity for our commercial paper borrowings and general corporate purposes. At June 30, 2022, we had $705 million of commercial paper outstanding, which effectively reduced our available capacity under our revolving credit facilities to $2.8 billion.

Cash, Cash Equivalents and Marketable Securities

A significant portion of our cash flow is generated outside the U.S. We manage our worldwide cash requirements considering available funds among the many subsidiaries through which we conduct our business and the cost effectiveness with which those funds can be accessed. As a result, we do not anticipate any local liquidity restrictions to preclude us from funding our operating needs with local resources.

If we distribute our foreign cash balances to the U.S. or to other foreign subsidiaries, we could be required to accrue and pay withholding taxes, for example, if we repatriated cash from certain foreign subsidiaries whose earnings we asserted are completely or partially permanently reinvested. Foreign earnings for which we assert permanent reinvestment outside the U.S. consist primarily of earnings of our China, India and Netherlands domiciled subsidiaries. At present, we do not foresee a need to repatriate any earnings for which we asserted permanent reinvestment. However, to help fund cash needs of the U.S. or other international subsidiaries as they arise, we repatriate available cash from certain foreign subsidiaries whose earnings are not permanently reinvested when it is cost effective to do so.

Debt Facilities and Other Sources of Liquidity

As of June 30, 2022, we had access to committed credit facilities totaling $3.5 billion, including the $1.5 billion 364-day facility that expires August 17, 2022 and our $2.0 billion five-year facility that expires on August 18, 2026. These revolving credit facilities are maintained primarily to provide backup liquidity for our commercial paper borrowings and general corporate purposes. We intend to maintain credit facilities at the current or higher aggregate amounts by renewing or replacing these facilities at or before expiration. There were no outstanding borrowings under these facilities at June 30, 2022. We anticipate renewing our 364-day credit facility before expiration and adding another credit facility available for general corporate purposes in the near-term.

We can issue up to $3.5 billion of unsecured, short-term promissory notes (commercial paper) pursuant to the Board authorized commercial paper programs. These programs facilitate the private placement of unsecured short-term debt through third-party brokers. We intend to use the net proceeds from the commercial paper borrowings for acquisitions and general corporate purposes. The total combined borrowing capacity under the revolving credit facilities and commercial programs should not exceed $3.5 billion. See NOTE 10, "DEBT," to our Condensed Consolidated Financial Statements for additional information.

At June 30, 2022, we had $705 million of commercial paper outstanding, which effectively reduced our available capacity under our revolving credit facilities to $2.8 billion.

As a well-known seasoned issuer, we filed an automatic shelf registration of an undetermined amount of debt and equity with the SEC on February 8, 2022. Under this shelf registration we may offer, from time to time, debt securities, common stock, preferred and preference stock, depositary shares, warrants, stock purchase contracts and stock purchase units.

In July 2017, the U.K.'s Financial Conduct Authority, which regulates the London Interbank Offered Rate (LIBOR), announced it intends to phase out LIBOR by the end of 2021. The cessation date for submission and publication of rates for certain tenors of

LIBOR has since been extended until mid-2023. Various central bank committees and working groups continue to discuss replacement of benchmark rates, the process for amending existing LIBOR-based contracts and the potential economic impacts of different alternatives. The Alternative Reference Rates Committee has identified the Secured Overnight Financing Rate (SOFR) as its preferred alternative rate for U.S. dollar LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions. We have evaluated the potential impact of the replacement of the LIBOR benchmark interest rate including risk management, internal operational readiness and monitoring the Financial Accounting Standards Board standard-setting process to address financial reporting issues that might arise in connection with transition from LIBOR to a new benchmark rate. While we do not believe the change will materially impact us due to our operational and system readiness coupled with relevant contractual fallback language, we continue to evaluate all eventual transition risks. In anticipation of LIBOR's phase out, our most recent revolving credit agreements include a well-documented transition mechanism for selecting a benchmark replacement rate for LIBOR, subject to our agreement. Additionally, with respect to our $1.3 billion in LIBOR-based fixed to variable rate swaps maturing in 2025 and 2030, we reviewed and believe our adherence to the 2020 LIBOR fallback protocol will allow for a smooth transition to the designated replacement rate when that transition occurs.

Supply Chain Financing

We currently have supply chain financing programs with financial intermediaries, which provide certain vendors the option to be paid by financial intermediaries earlier than the due date on the applicable invoice. When a vendor utilizes the program and receives an early payment from a financial intermediary, they take a discount on the invoice. We then pay the financial intermediary the face amount of the invoice on the regularly scheduled due date. The maximum amount that we may have outstanding under the program is $457 million. We do not reimburse vendors for any costs they incur for participation in the program and their participation is completely voluntary. As a result, all amounts owed to the financial intermediaries are presented as Accounts payable in our Condensed Consolidated Balance Sheets. Amounts due to the financial intermediaries reflected in accounts payable at June 30, 2022, were $336 million.

Uses of Cash

Stock Repurchases

In December 2021, the Board authorized the acquisition of up to $2.0 billion of additional common stock upon completion of the 2019 repurchase plan. In December 2019, the Board authorized the acquisition of up to $2.0 billion of additional common stock upon completion of the 2018 repurchase plan. In the first six months of 2022, we made the following purchases under the 2019 stock repurchase program:

In millions, except per share amountsShares PurchasedAverage Cost Per ShareTotal Cost of RepurchasesRemaining Authorized Capacity (1)
March 311.6$199.27$311$2,281
June 300.1194.00362,245
Total1.7198.72$347
(1) The remaining $245 million authorized capacity under the 2019 plan was calculated based on the cost to purchase the shares, but excludes commission expenses in accordance with the authorized plan.

We intend to repurchase outstanding shares from time to time during 2022 to enhance shareholder value.

Dividends

We paid dividends of $411 million during the six months ended June 30, 2022. In July 2022, the Board authorized an increase to our quarterly dividend of approximately 8 percent from $1.45 per share to $1.57 per share.

Capital Expenditures

Capital expenditures, including spending on internal use software, for the six months ended June 30, 2022, were $275 million versus $234 million in the comparable period in 2021. We plan to spend an estimated $850 million to $900 million in 2022 on capital expenditures, excluding internal use software, with over 60 percent of these expenditures expected to be invested in North America. In addition, we plan to spend an estimated $60 million to $70 million on internal use software in 2022.

Current Maturities of Short and Long-Term Debt

We had $705 million of commercial paper outstanding at June 30, 2022, that matures in less than one year. The maturity schedule of our existing long-term debt does not require significant cash outflows until 2023 when our 3.65 percent senior notes and 2025 when our 0.75 percent senior notes are due. Required annual long-term debt principal payments range from $41 million to $545 million over the next five years (including the remainder of 2022). See NOTE 10, "DEBT," to the Condensed Consolidated Financial Statements for additional information.

Pensions

Our global pension plans, including our unfunded and non-qualified plans, were 121 percent funded at December 31, 2021. Our U.S. defined benefit plan, which represented approximately 52 percent of the worldwide pension obligation, was 138 percent funded, and our U.K. defined benefit plan was 127 percent funded at December 31, 2021. The funded status of our pension plans is dependent upon a variety of variables and assumptions including return on invested assets, market interest rates and levels of voluntary contributions to the plans. In the first six months of 2022, the investment loss on our U.S. pension trust was 5.0 percent while our U.K. pension trust loss was 17.8 percent. Approximately 64 percent of our pension plan assets are held in highly liquid investments such as fixed income and equity securities. The remaining 36 percent of our plan assets are held in less liquid, but market valued investments, including real estate, private equity, venture capital, opportunistic credit and insurance contracts. We anticipate making additional defined benefit pension contributions during the remainder of 2022 of $10 million for our U.S. and U.K. qualified and non-qualified pension plans. These contributions may be made from trusts or company funds either to increase pension assets or to make direct benefit payments to plan participants. We expect our 2022 annual net periodic pension cost to approximate $31 million.

Credit Ratings

Our rating and outlook from each of the credit rating agencies as of the date of filing are shown in the table below:

Long-TermShort-Term
Credit Rating Agency (1)Senior Debt RatingDebt RatingOutlook
Standard and Poor’s Rating ServicesA+A1Stable
Moody’s Investors Service, Inc.A2P1Stable
(1) Credit ratings are not recommendations to buy, are subject to change, and each rating should be evaluated independently of any other rating. In addition, we undertake no obligation to update disclosures concerning our credit ratings, whether as a result of new information, future events or otherwise.

Subsequent Events

On July 13, 2022, we entered into a loan agreement under which we may obtain delayed-draw loans in an amount up to $2.0 billion in the aggregate prior to October 13, 2022. We drew down the entire $2.0 billion balance on August 2, 2022, to help fund the acquisition of Meritor. The initial interest rate, based on the Secured Overnight Financing Rate for the one-month interest period plus the relevant spread, is 3.11 percent. The loan will mature on August 2, 2025. Borrowings under the agreement will not be secured by liens on any of our assets or assets of our subsidiaries. The agreement contains customary events of default and financial and other covenants, including maintaining a net debt to capital ratio of no more than 0.65 to 1.0.

On August 3, 2022, we completed the acquisition of Meritor with a purchase price of $3.0 billion (including convertible debt). We borrowed an additional $1.3 billion under our commercial paper program to complete the acquisition. The acquisition reduced our borrowing capacity under the revolving credit facilities to $1.43 billion at the time of filing. See NOTE 14, "ACQUISITIONS," to our Condensed Consolidated Financial Statements for additional information.

Management's Assessment of Liquidity

Our financial condition and liquidity remain strong. Our solid balance sheet and credit ratings enable us to have ready access to credit and the capital markets. We assess our liquidity in terms of our ability to generate adequate cash to fund our operating, investing and financing activities. We believe our existing cash and marketable securities, operating cash flow and revolving credit facilities provide us with the financial flexibility needed to fund acquisitions, common stock repurchases, dividend payments, targeted capital expenditures, projected pension obligations, working capital and debt service obligations through 2022 and beyond. We continue to generate significant cash from operations and maintain access to our revolving credit facilities and commercial paper programs as noted above.

APPLICATION OF CRITICAL ACCOUNTING ESTIMATES

A summary of our significant accounting policies is included in NOTE 1, “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,” of the Notes to the Consolidated Financial Statements of our 2021 Form 10-K, which discusses accounting policies that we have selected from acceptable alternatives.

Our Condensed Consolidated Financial Statements are prepared in accordance with generally accepted accounting principles that often require management to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts presented and disclosed in the financial statements. Management reviews these estimates and assumptions based on historical experience, changes in business conditions and other relevant factors they believe to be reasonable under the circumstances. In any given reporting period, our actual results may differ from the estimates and assumptions used in preparing our Condensed Consolidated Financial Statements.

Critical accounting estimates are defined as follows: the estimate requires management to make assumptions about matters that were highly uncertain at the time the estimate was made; different estimates reasonably could have been used; or if changes in the estimate are reasonably likely to occur from period to period and the change would have a material impact on our financial condition or results of operations. Our senior management has discussed the development and selection of our accounting policies, related accounting estimates and the disclosures set forth below with the Audit Committee of the Board. Our critical accounting estimates disclosed in the Form 10-K address estimating liabilities for warranty programs, assessing goodwill impairment, accounting for income taxes and pension benefits.

A discussion of our critical accounting estimates may be found in the “Management’s Discussion and Analysis” section of our 2021 Form 10-K under the caption “APPLICATION OF CRITICAL ACCOUNTING ESTIMATES.” Within the context of these critical accounting estimates, we are not currently aware of any reasonably likely events or circumstances that would result in different policies or estimates being reported in the first six months of 2022.

Previous: Item 1. Condensed Consolidated Financial Statements · Next: Item 3. Quantitative and Qualitative Disclosures About Market Risk