CUMMINS INC (CMI) FY 2022 MD&A

ITEM 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations

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 Consolidated Financial Statements and the accompanying notes to those financial statements. Our MD&A is presented in the following sections:

•EXECUTIVE SUMMARY AND FINANCIAL HIGHLIGHTS

•RESULTS OF OPERATIONS

•OPERATING SEGMENT RESULTS

•2023 OUTLOOK

•LIQUIDITY AND CAPITAL RESOURCES

•APPLICATION OF CRITICAL ACCOUNTING ESTIMATES

•RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

The following is the discussion and analysis of changes in the financial condition and results of operations for fiscal year 2022 compared to fiscal year 2021. The discussion and analysis of fiscal year 2020 and changes in the financial condition and results of operations for fiscal year 2021 compared to fiscal year 2020 that are not included in this Form 10-K may be found in Part II, ITEM 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the Securities and Exchange Commission (SEC) on February 8, 2022.

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, axles, drivelines, brakes, suspension systems, electric power generation systems, batteries, electrified power systems, electric powertrains, 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, Traton Group (formerly Navistar International Corporation), Daimler Trucks North America and Stellantis N.V. We serve our customers through a service network of approximately 460 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, Components, Distribution, 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 Components segment sells filtration products, aftertreatment systems, turbochargers, electronics, fuel systems, automated transmissions, axles, drivelines, brakes and suspension systems. 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 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, fuel cell and electric powertrain technologies. The New Power segment is currently in the early stages of commercializing these technologies with efforts primarily focused on the development of our electrolyzers for hydrogen production and electrified power systems and related 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.

33

Table of Contents

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 fluctuations, political and economic uncertainty, 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 higher levels of these risks such as China, Brazil, India, Mexico 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, region, the economy of any single country or customer on our consolidated results.

Meritor Acquisition

On August 3, 2022, we completed the acquisition of Meritor, Inc. (Meritor) with a purchase price of $2.9 billion (including debt repaid concurrent with the acquisition). Our consolidated results and segment results include Meritor's activity since the date of acquisition. Meritor was split into the newly formed axles and brakes business and electric powertrain. The results for the axles and brakes business are included in our Components segment while the electric powertrain portion is included in our New Power segment. See NOTE 2, "ACQUISITIONS," to the Consolidated Financial Statements for additional information.

Supply Chain Disruptions

We continue to experience supply chain disruptions, increased price levels and related financial impacts reflected as increased cost of sales and inventory holdings. Our industry continues to be unfavorably impacted by supply chain constraints leading to shortages and price increases across multiple component 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 of Directors (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.

Russian Operations

On March 17, 2022, the Board indefinitely suspended our operations in Russia due to the ongoing conflict in Ukraine, which resulted in reduced sales in Russia and charges of $111 million in 2022. See NOTE 23, "RUSSIAN OPERATIONS," to our Consolidated Financial Statements for additional information.

2022 Results

A summary of our results is as follows:

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 improved 17 percent in 2022 compared to 2021, due to Meritor sales of $1.9 billion since the date of acquisition, favorable pricing and higher demand in all operating segments and most geographic regions except for China and Russia. Net sales in the U.S. and Canada improved by 24 percent primarily due to favorable pricing and increased demand in North American heavy-duty and medium-duty on-highway markets, which positively impacted all Components businesses and all Distribution product lines, as well as incremental sales of axles and brakes in North America since the acquisition of Meritor. International demand (excludes the U.S. and Canada) improved by 8 percent compared to 2021, with lower sales in China (due to a sharp slowdown in construction and truck markets, exacerbated by COVID lockdowns) and Russia (resulting from the indefinite suspension of our Russian operations)

34

Table of Contents

more than offset by higher sales in most other geographic regions. The increase in international sales was principally due to incremental sales of axles and brakes in Latin America and Western Europe since the acquisition of Meritor, favorable pricing and higher demand for power generation and generator technologies equipment and all distribution product lines. Unfavorable foreign currency fluctuations impacted international sales by 5 percent (mainly the Euro, Chinese renminbi, British pound and Indian rupee).

The following table contains sales and EBITDA (defined as earnings or losses before interest expense, income taxes, depreciation and amortization and noncontrolling interests) by operating segment for the years ended December 31, 2022 and 2021. See NOTE 24, "OPERATING SEGMENTS," to the Consolidated Financial Statements for additional information and a reconciliation of our segment information to the corresponding amounts in our Consolidated Statements of Net Income.

Net income attributable to Cummins Inc. for 2022 was $2.2 billion, or $15.12 per diluted share, on sales of $28.1 billion, compared to 2021 net income attributable to Cummins Inc. of $2.1 billion, or $14.61 per diluted share, on sales of $24.0 billion.

The increases in net income attributable to Cummins Inc. and earnings per diluted share were driven by higher net sales and increased gross margin, partially offset by higher selling, general and administrative expenses (including Meritor acquisition and integration costs and costs associated with the planned separation of our filtration business), increased research, development and engineering expenses, lower equity, royalty and interest income from investees (primarily in China), costs associated with the suspension of our Russian operations, losses in corporate owned life insurance, increased interest expense related to new borrowings and higher intangible asset amortization resulting from our acquisitions. The increase in gross margin and gross margin as a percentage of sales was mainly due to favorable pricing and increased volumes, partially offset by higher material costs and increased compensation expenses. Diluted earnings per common share for 2022 benefited $0.15 per share from fewer weighted-average shares outstanding, primarily due to the stock repurchase program.

We generated $2.0 billion of operating cash flows in 2022, compared to $2.3 billion 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 December 31, 2022, was 44.1 percent, compared to 31.5 percent at December 31, 2021. The increase was primarily due to higher debt balances since December 31, 2021, resulting from funding the acquisition of Meritor. At December 31, 2022, we had $2.6 billion in cash and marketable securities on hand and access to our $4.0 billion credit facilities, net of commercial paper outstanding, to meet acquisition, working capital, investment and funding needs.

In 2022, we repurchased $374 million or 1.9 million shares of common stock. See NOTE 17, "CUMMINS INC. SHAREHOLDERS' EQUITY" to the Consolidated Financial Statements for additional information.

On November 30, 2022, we completed the acquisition of Siemens' Commercial Vehicles Propulsion business (Siemens CVP) for approximately $187 million. See NOTE 2, "ACQUISITIONS," to our Consolidated Financial Statements for additional information.

On September 30, 2022, certain of our subsidiaries entered into a $1.0 billion credit agreement, consisting of a $400 million revolving credit facility and a $600 million term loan facility, in anticipation of the separation of our filtration business. See NOTE 13, "DEBT," to our Consolidated Financial Statements for additional information.

On August 17, 2022, we entered into an amended and restated 364-day credit agreement and an incremental 364-day credit agreement, which allow us to borrow up to $1.5 billion and $500 million, respectively, of unsecured funds at any time prior to August 16, 2023.

35

Table of Contents

On August 3, 2022, we completed the acquisition of Meritor with a purchase price of $2.9 billion (including debt that was retired on the closing date). See NOTE 2, "ACQUISITIONS," to our 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 20, 2022, we filed a confidential registration statement announcing our intent to separate the filtration business into a stand-alone company.

On April 8, 2022, we completed the acquisition of Jacobs Vehicle Systems business (Jacobs) from Altra Industrial Motion Corp. with a purchase price of $345 million. See NOTE 2, "ACQUISITIONS," to our Consolidated Financial Statements for additional information.

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.

On February 7, 2022, we purchased Westport Fuel System Inc.'s stake in Cummins Westport, Inc. (Westport JV) with a purchase price of $42 million. See NOTE 2, "ACQUISITIONS," to our Consolidated Financial Statements for additional information.

In 2022, the investment loss on our U.S. pension trusts was 5.7 percent while our U.K. pension trusts' loss was 41.3 percent. Our global pension plans, including our unfunded and non-qualified plans, were 120 percent funded at December 31, 2022. Our U.S. defined benefit plans (qualified and non-qualified), which represented approximately 69 percent of the worldwide pension obligation, were 121 percent funded, and our U.K. defined benefit plans were 119 percent funded at December 31, 2022. We expect to contribute approximately $106 million in cash to our global pension plans in 2023. In addition, we expect our 2023 net periodic pension income to approximate $2 million. See application of critical accounting estimates within MD&A and NOTE 11, "PENSIONS AND OTHER POSTRETIREMENT BENEFITS," to the Consolidated Financial Statements, for additional information concerning our pension and other postretirement benefit plans.

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

36

Table of Contents

RESULTS OF OPERATIONS

2022 vs. 2021

Net Sales

Net sales increased $4.1 billion, primarily driven by the following:

•Components segment sales increased 27 percent largely due to axles and brakes sales since the completion of the Meritor acquisition.

•Distribution segment sales increased 15 percent mainly due to higher demand across all product lines in North America.

•Engine segment sales increased 10 percent principally due to favorable pricing and stronger medium-duty and heavy-duty on-highway demand (including higher aftermarket sales) in North America.

•Power Systems segment sales increased 14 percent primarily due to favorable pricing and higher demand in power generation markets in Latin America, North America and India and stronger demand in industrial markets with higher aftermarket sales and increased oil and gas demand in North America and China.

•New Power segment sales increased 71 percent principally due to higher electrified components sales, traction sales since the completion of the Meritor and Siemens CVP acquisitions and improved sales of fuel cells and electrolyzers.

These increases were partially offset by unfavorable foreign currency fluctuations of 2 percent of total sales, primarily in the Euro, Chinese renminbi, British pound and Indian rupee.

37

Table of Contents

Sales to international markets (excluding the U.S. and Canada), based on location of customers, were 41 percent of total net sales in 2022, compared with 44 percent of total net sales 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 $1.0 billion and increased 0.2 points as a percentage of sales. The increase in gross margin and gross margin as a percentage of sales was mainly due to favorable pricing and increased volumes, partially offset by higher material costs and increased compensation expenses. The provision for base warranties issued as a percentage of sales, was 1.8 percent in 2022 and 2.1 percent in 2021.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $313 million, primarily due to higher consulting expenses driven by acquisitions, integration and the work towards the separation of the filtration business, higher compensation costs and increased travel expenses, partially offset by lower variable compensation expenses. Overall, selling, general and administrative expenses, as a percentage of sales, decreased to 9.6 percent in 2022 from 9.9 percent in 2021. The decrease in selling, general and administrative expenses as a percentage of sales was due mainly to net sales increasing at a faster rate than the increase in selling, general and administrative expenses.

Research, Development and Engineering Expenses

Research, development and engineering expenses increased $188 million, principally due to higher compensation costs, increased spending on prototypes, testing and supplies and higher consulting expenses, partially offset by lower variable compensation expenses. Overall, research, development and engineering expenses, as a percentage of sales, increased to 4.6 percent in 2022 from 4.5 percent in 2021.

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 $157 million, mainly due to lower earnings at Beijing Foton Cummins Engine Co., Ltd. and Dongfeng Cummins Engine Co., Ltd., the $28 million impairment of our investment in our Russian joint venture with KAMAZ and the February 7, 2022, purchase of Westport Fuel System Inc.'s stake in Westport JV. See NOTE 2, "ACQUISITIONS," and NOTE 23, "RUSSIAN OPERATIONS," to our Consolidated Financial Statements for additional information.

38

Table of Contents

Other Operating Expense, Net

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

Interest Expense

Interest expense increased $88 million, primarily due to the overall increase in floating interest rates, new term loan borrowings and higher short-term borrowings, including commercial paper.

Other Income, Net

Other income, net was as follows:

Income Tax Expense

Our effective tax rate for 2022 was 22.6 percent compared to 21.3 percent for 2021.

The year ended December 31, 2022, contained discrete tax items that netted to zero, primarily due to $31 million of favorable changes in accrued withholding taxes, $29 million of favorable changes in tax reserves, $15 million of favorable valuation allowance adjustments and $9 million of favorable other net discrete items, offset by $69 million of unfavorable tax costs associated with internal restructuring ahead of the planned separation of our filtration business and $15 million of unfavorable return to provision adjustments related to the 2021 filed tax returns.

The year ended December 31, 2021, contained $9 million of unfavorable net discrete tax items, primarily due to $12 million of unfavorable provision to return adjustments related to the 2020 filed tax returns, partially offset by $3 million of favorable other discrete tax items.

The change in effective tax rate for the year ended December 31, 2022, versus year ended December 31, 2021, was primarily due to the jurisdictional mix of pre-tax income.

Our effective tax rate for 2023 is expected to approximate 22.0 percent, excluding any discrete tax items that may arise.

39

Table of Contents

On August 16, 2022, the U.S. federal government enacted the Inflation Reduction Act of 2022 into law effective beginning in 2023. The bill includes numerous tax provisions, including a 15 percent corporate minimum tax as well as a one percent excise tax on share repurchases. We do not currently expect the legislation will have a material effect on our results of operations or liquidity.

Net Income Attributable to 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 decreased $1 million principally due to lower earnings at Hydrogenics Corporation, partially offset by higher earnings at Eaton Cummins Joint Venture.

2021 vs. 2020

For prior year results of operations comparisons to 2020 see the Results of Operations section of our 2021 Form 10-K.

Comprehensive Income - Foreign Currency Translation Adjustment

The foreign currency translation adjustment was a net loss of $384 million and $9 million for the years ended December 31, 2022 and 2021, respectively. The details were as follows:

2021 vs. 2020

For prior year foreign currency translation adjustment comparisons to 2020 see the Results of Operations section of our 2021 Form 10-K.

40

Table of Contents

OPERATING SEGMENT RESULTS

Our reportable operating segments consist of the Engine, Components, Distribution, 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 the 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 24, "OPERATING SEGMENTS," to the Consolidated Financial Statements for additional information and a reconciliation of our segment information to the corresponding amounts in our Consolidated Statements of Net Income.

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

For all prior year segment results comparisons to 2020 see the Results of Operations section of our 2021 Form 10-K.

Engine Segment Results

Financial data for the Engine segment was as follows:

41

Table of Contents

Sales for our Engine segment by market were as follows:

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

2022 vs. 2021

Sales

Engine segment sales increased $991 million across most markets. The following were the primary drivers by market:

•Medium-duty truck and bus sales increased $683 million mainly due to favorable pricing and higher demand (including higher aftermarket sales), especially in North America.

•Heavy-duty truck engine sales increased $519 million principally due to favorable pricing and stronger demand (including higher aftermarket sales), especially in North America with shipments up 18 percent.

The increases were partially offset by decreased light-duty automotive demand of $174 million primarily due to our indefinite suspension of our operations in Russia and lower sales to Stellantis.

Segment EBITDA

Engine segment EBITDA increased $130 million, primarily due to favorable pricing and improved mix, partially offset by higher material costs, lower equity, royalty and interest income from investees (principally decreased earnings at Beijing Foton Cummins Engine Co., Ltd. and Dongfeng Cummins Engine Co., Ltd., the $28 million impairment of our investment in our Russian joint venture with KAMAZ and the February 7, 2022, purchase of Westport Fuel System Inc.'s stake in the Westport JV) and increased research, development and engineering expenses. See NOTE 2, "ACQUISITIONS," and NOTE 23, "RUSSIAN OPERATIONS," to our Consolidated Financial Statements for additional information.

42

Table of Contents

Components Segment Results

Financial data for the Components segment was as follows:

Sales for our Components segment by business were as follows:

2022 vs. 2021

Sales

Components segment sales increased $2.1 billion across most businesses. The following were the primary drivers by business:

•Axles and brakes sales added $1.9 billion in sales since the completion of the Meritor acquisition.

•Filtration sales increased $119 million mainly due to stronger aftermarket demand in North America.

•Automated transmissions sales increased $115 million largely due to higher demand in North America.

These increases were partially offset by the following:

•Electronics and fuel systems sales decreased $107 million principally due to weaker demand in China, partially offset by higher demand in North America.

43

Table of Contents

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

Segment EBITDA

Components segment EBITDA increased $166 million, mainly due to favorable pricing, improved mix and increased volumes (including axles and brakes since the completion of the Meritor acquisition), partially offset by higher material costs and Meritor acquisition and integration costs.

Distribution Segment Results

Financial data for the Distribution segment was as follows:

Sales for our Distribution segment by region were as follows:

44

Table of Contents

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

2022 vs. 2021

Sales

Distribution segment sales increased $1.2 billion across all product lines primarily due to $1.0 billion of increased North American sales representing 90 percent of the total change in Distribution segment sales, largely due to higher demand for parts and engines. The increase was partially offset by unfavorable foreign currency fluctuations, mainly in the Euro, Australian dollar, Indian rupee, Japanese yen and Canadian dollar.

Segment EBITDA

Distribution segment EBITDA increased $157 million, primarily due to higher volumes, partially offset by unfavorable foreign currency fluctuations (principally in emerging market currencies, South African rand, Australian dollar and Japanese yen), costs associated with the suspension of our Russian operations, increased freight costs due to supply chain constraints, higher compensation expenses and an inventory write-off. See NOTE 23, "RUSSIAN OPERATIONS," to our Consolidated Financial Statements for additional information.

Power Systems Segment Results

Financial data for the Power Systems segment was as follows:

45

Table of Contents

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

2022 vs. 2021

Sales

Power Systems segment sales increased $618 million across all product lines. The following were the primary drivers:

•Power generation sales increased $275 million mainly due to improved pricing and higher demand in Latin America, North America and India.

•Industrial sales increased $238 million principally due to stronger aftermarket demand and improved oil and gas sales in North America and China.

•Generator technologies sales increased $105 million due to higher demand in Europe and India.

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

Segment EBITDA

Power Systems segment EBITDA increased $100 million, primarily due to favorable pricing, partially offset by higher material costs, increased freight costs due to supply chain constraints and costs associated with the suspension of our Russian operations.

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, fuel cell and electric powertrain technologies. The New Power segment is currently in the early stages of commercializing these technologies with efforts primarily focused on the development of our electrolyzers for hydrogen production and electrified power systems and related components and subsystems.

Financial data for the New Power segment was as follows:

New Power segment sales increased 71 percent principally due to higher electrified components sales, traction sales since the completion of the Meritor and Siemens CVP acquisitions and improved sales of fuel cells and electrolyzers.

46

Table of Contents

2023 OUTLOOK

Supply Chain Disruptions

We continue to experience supply chain disruptions, increased price levels and related financial impacts reflected as increased cost of sales and inventory holdings. Our industry continues to be unfavorably impacted by supply chain constraints leading to shortages and price increases across multiple component categories and limiting our collective ability to meet end-user demand. Our customers are also experiencing supply chain issues. 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 in 2023.

Positive Trends

•We expect demand for pick-up, medium-duty and heavy-duty trucks in North America to remain strong.

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

•We expect demand within our Power Systems business to remain strong, including the power generation, mining, oil and gas and marine markets.

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

•We expect demand for trucks in China to improve from the low demand levels in 2022 as COVID-19 restrictions are eased. Significant outbreaks of infection among the population, could, however, hamper the level of demand improvement through the year.

Challenges

•Continued increases in material and labor 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.

•We expect demand in construction markets in China to decline in 2023 due to emission changes and a build-up of inventory.

•The completion of the Meritor, Inc. acquisition in 2022 impacted our liquidity and resulted in incremental interest expense for debt utilized in funding the transaction and increased amortization of intangible assets which will negatively impact net income.

•We expect the planned separation of our filtration business, into a stand-alone company, will continue to result in incremental expenses.

•Increasing interest rates could increase borrowing costs and negatively impact net income.

47

Table of Contents

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:

Cash Flows

Cash and cash equivalents were impacted as follows:

2022 vs. 2021

Net cash provided by operating activities decreased $294 million, primarily due to higher working capital requirements of $646 million, partially offset by lower equity earnings, net of dividends of $147 million and Russian suspension costs of $111 million. The higher working capital requirements resulted in a cash outflow of $1.0 billion compared to a cash outflow of $359 million in the comparable period in 2021, mainly due to decreased accrued expenses (as a result of lower variable compensation accruals in 2022) and higher accounts receivable due to increased sales, partially offset by a lower spend in inventories and favorable changes in accounts payable.

Net cash used in investing activities increased $3.3 billion, principally due to $3.2 billion of acquisitions, net of cash acquired for Meritor, Jacobs Vehicle Systems, Siemens CVP and Westport JV. See NOTE 2, "ACQUISITIONS," to our Consolidated Financial Statements for additional information.

Net cash provided by financing activities increased $3.9 billion, primarily due to higher net borrowings of commercial paper of $2.3 billion, increased proceeds from borrowings of $2.0 billion (principally our $2.0 billion term loan) and lower repurchases of common stock of $1.0 billion, partially offset by higher payments on borrowings and finance lease obligations of $1.5 billion ($0.9 billion of which relates to debt assumed in the Meritor acquisition that was retired during the third quarter of 2022 and $450 million of term loan payments in the fourth quarter of 2022).

The effect of exchange rate changes on cash and cash equivalents increased $15 million, primarily due to favorable fluctuations in the British pound, partially offset by unfavorable fluctuations in the Chinese renminbi.

48

Table of Contents

2021 vs. 2020

For prior year liquidity comparisons see the Liquidity and Capital Resources section of our 2021 Form 10-K.

Sources of Liquidity

We generate significant ongoing operating cash flow. Cash provided by operations is our principal source of liquidity with $2.0 billion provided in 2022. At December 31, 2022, our sources of liquidity included:

Cash, Cash Equivalents and Marketable Securities

A significant portion of our cash flows are 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, Canada (including underlying subsidiaries) and Netherlands domiciled subsidiaries. At present, we do not foresee a need to repatriate any earnings for which we assert 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

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 interest rate is based on Secured Overnight Financing Rate (SOFR) for the one-month interest period plus the relevant spread. The loan will mature on August 1, 2025. 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 17, 2022, we entered into an amended and restated 364-day credit agreement, which allows us to borrow up to $1.5 billion of unsecured funds at any time prior to August 16, 2023. This credit agreement amended and restated the prior $1.5 billion 364-day credit facility that matured on August 17, 2022. On August 17, 2022, we also entered into an incremental 364-day credit agreement, which allows us to borrow up to $500 million of unsecured funds at any time prior to August 16, 2023.

In connection with the new credit agreements, on August 17, 2022, we entered into an amendment to our $2.0 billion five-year facility to replace LIBOR with SOFR as an interest rate benchmark and to make other conforming changes to interest rate determinations.

We have access to committed credit facilities totaling $4.0 billion, including the $1.5 billion 364-day facility that expires August 16, 2023, $500 million incremental 364-day facility that expires August 16, 2023, and $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

49

Table of Contents

replacing these facilities at or before expiration. The credit agreements include various financial covenants, including, among others, maintaining a net debt to capital ratio of no more than 0.65 to 1.0. At December 31, 2022, our net leverage ratio was 0.31 to 1.0. There were no outstanding borrowings under these facilities at December 31, 2022.

We can issue up to $4.0 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 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 paper programs should not exceed $4.0 billion. At December 31, 2022, we had $2.6 billion of commercial paper outstanding, which effectively reduced our available capacity under our revolving credit facilities to $1.4 billion. See NOTE 13, "DEBT," to our Consolidated Financial Statements for additional information.

In 2021 we entered into a series of interest rate swaps to effectively convert our $500 million senior notes, due in 2025, from a fixed rate of 0.75 percent to a floating rate equal to the three-month LIBOR plus a spread. We also entered into a series of interest rate swaps to effectively convert $765 million of our $850 million senior notes, due in 2030, from a fixed rate of 1.50 percent to a floating rate equal to the three-month LIBOR plus a spread. The swaps were designated, and are accounted for, as fair value hedges.

In 2019 we entered into $350 million of interest rate lock agreements, and in 2020 we entered into an additional $150 million of lock agreements to reduce the variability of the cash flows of the interest payments on a total of $500 million of fixed rate debt forecast to be issued in 2023 to replace our senior notes at maturity. In December 2022, we settled certain rate lock agreements with notional amounts totaling $150 million for $49 million in cash. This amount will remain in other comprehensive income to be recognized over the term of the anticipated new debt as discussed above.

As a well-known seasoned issuer, we filed an automatic shelf registration for an undetermined amount of debt and equity securities 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 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 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 revolving credit and term loan agreements incorporate the use of SOFR as a replacement for LIBOR. Our 5-year credit facility maturing August 18, 2026, as amended to date, also incorporates SOFR. Additionally, with respect to our approximately $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.

On September 30, 2022, certain of our subsidiaries entered into a $1.0 billion credit agreement (Credit Agreement), consisting of a $400 million revolving credit facility and a $600 million term loan facility (Facilities), in anticipation of the separation of our filtration business. Borrowings under the Credit Agreement will not become available under the Credit Agreement unless and until, among other things, there is a sale to the public of shares in our subsidiary that holds the filtration business (Parent Borrower). The Credit Agreement will automatically terminate if no such public sale of shares of Parent Borrower occurs on or prior to March 30, 2023. Borrowings under the Credit Agreement would be available to Parent Borrower and one or more of its subsidiaries (Borrower). If borrowings become available under the Credit Agreement, the Facilities would mature on September 30, 2027.

Borrowings under the Credit Agreement would bear interest at varying rates, depending on the type of loan and, in some cases, the rates of designated benchmarks and the applicable Borrower’s election. Generally, U.S. dollar-denominated loans would bear interest at adjusted term SOFR (which includes a 0.10 percent credit spread adjustment to term SOFR) for the applicable interest period plus a rate ranging from 1.125 percent to 1.75 percent depending on Parent Borrower's net leverage ratio.

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 $532 million. We do not reimburse vendors for any costs they incur for participation in the program and their participation is

50

Table of Contents

completely voluntary. As a result, all amounts owed to the financial intermediaries are presented as accounts payable in our Consolidated Balance Sheets. Amounts due to the financial intermediaries reflected in accounts payable at December 31, 2022, were $331 million.

Uses of Cash

Acquisitions

Acquisitions for the year ended December 31, 2022, were as follows.

See NOTE 2, "ACQUISITIONS," to our Consolidated Financial Statements for additional information.

Dividends

Total dividends paid to common shareholders in 2022, 2021 and 2020 were $855 million, $809 million and $782 million, respectively. Declaration and payment of dividends in the future depends upon our income and liquidity position, among other factors, and is subject to declaration by the Board, who meets quarterly to consider our dividend payment. We expect to fund dividend payments with cash from operations.

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. Cash dividends per share paid to common shareholders and the Board authorized increases for the last three years were as follows:

51

Table of Contents

Stock Repurchases

In December 2021, the Board authorized the acquisition of up to $2.0 billion of additional common stock upon completion of the $2.0 billion repurchase plan authorized in 2019. For the year ended December 31, 2022, we made the following purchases under our stock repurchase program:

We intend to repurchase outstanding shares from time to time during 2023 to enhance shareholder value.

Capital Expenditures

Capital expenditures were $916 million, $734 million and $528 million in 2022, 2021 and 2020, respectively. We continue to invest in new product lines and targeted capacity expansions. We plan to spend an estimated $1.2 billion to $1.3 billion in 2023 on capital expenditures with over 60 percent of these expenditures expected to be invested in North America.

Current Maturities of Short and Long-Term Debt

We had $2.6 billion of commercial paper outstanding at December 31, 2022, that matures in less than one year. The maturity schedule of our existing long-term debt requires significant cash outflows in 2023 when our 3.65 percent senior notes and 2025 when our term loan and 0.75 percent senior notes are due. Required annual long-term debt principal payments range from $44 million (2024) to $2.1 billion (2025) over the next five years. See NOTE 13, "DEBT," to the Consolidated Financial Statements for additional information.

Pensions

Our global pension plans, including our unfunded and non-qualified plans, were 120 percent funded at December 31, 2022. Our U.S. defined benefit plans (qualified and non-qualified), which represented approximately 69 percent of the worldwide pension obligation, were 121 percent funded, and our U.K. defined benefit plans were 119 percent funded at December 31, 2022. 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 2022, the investment loss on our U.S. pension trusts was 5.7 percent while our U.K. pension trusts' loss was 41.3 percent.

We sponsor funded and unfunded domestic and foreign defined benefit pension plans. Contributions to the U.S. and U.K. plans were as follows:

We anticipate making total contributions of approximately $106 million to our global defined benefit pension plans in 2023. Expected contributions to our defined benefit pension plans in 2023 will meet or exceed the current funding requirements.

52

Table of Contents

Future Uses of Cash

A summary of our contractual obligations and other commercial commitments at December 31, 2022, are as follows:

The contractual obligations reported above exclude our unrecognized tax benefits of $283 million as of December 31, 2022, which includes $104 million of current tax liabilities and $179 million of long-term deferred tax liabilities. We are not able to reasonably estimate the period in which cash outflows relating to uncertain tax contingencies could occur. See NOTE 5, "INCOME TAXES," to the Consolidated Financial Statements for additional information.

Redeemable Noncontrolling Interests

A 19 percent minority shareholder in one of our businesses, Hydrogenics Corporation (Hydrogenics), has, among other rights and subject to related obligations and restrictive covenants, rights that are exercisable between September 2022 and September 2026 to require us to (1) purchase such shareholder's shares (put option) at an amount up to the fair market value (calculated pursuant to a process outlined in the shareholders' agreement) and (2) sell to such shareholder Hydrogenics' electrolyzer business at an amount up to the fair market value of the electrolyzer business (calculated pursuant to a process outlined in the shareholders’ agreement). We recorded the estimated fair value of the put option as redeemable noncontrolling interests in our Consolidated Financial Statements with an offset to additional paid-in capital. At December 31, 2022, the redeemable noncontrolling interest balance was $258 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:

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 access to capital markets, our existing cash and marketable securities, operating cash flow and revolving credit facilities provide us with the financial flexibility needed to fund acquisitions, dividend payments, common stock repurchases, targeted capital expenditures, projected pension obligations, working capital and debt service obligations through 2023 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.

53

Table of Contents

APPLICATION OF CRITICAL ACCOUNTING ESTIMATES

A summary of our significant accounting policies is included in NOTE 1, "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES," of our Consolidated Financial Statements which discusses accounting policies that we selected from acceptable alternatives.

Our Consolidated Financial Statements are prepared in accordance with generally accepted accounting principles in the U.S. which often requires 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 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. We believe our critical accounting estimates include estimating liabilities for warranty programs, fair value of intangible assets, assessing goodwill impairments, accounting for income taxes and pension benefits.

Warranty Programs

We estimate and record a liability for base warranty programs at the time our products are sold. Our estimates are based on historical experience and reflect management's best estimates of expected costs at the time products are sold and subsequent adjustment to those expected costs when actual costs differ. As a result of the uncertainty surrounding the nature and frequency of product recall programs, the liability for such programs is recorded when we commit to a recall action or when a recall becomes probable and estimable, which generally occurs when management internally approves or commits to the action. Our warranty liability is generally affected by component failure rates, repair costs and the point of failure within the product life cycle. Future events and circumstances related to these factors could materially change our estimates and require adjustments to our liability. New product launches require a greater use of judgment in developing estimates until historical experience becomes available. Product specific experience is typically available four or five quarters after product launch, with a clear experience trend evident eight quarters after launch. We generally record warranty expense for new products upon shipment using a preceding product's warranty history and a multiplicative factor based upon preceding similar product experience and new product assessment until sufficient new product data is available for warranty estimation. We then use a blend of actual new product experience and preceding product historical experience for several subsequent quarters and new product specific experience thereafter. NOTE 14, "PRODUCT WARRANTY LIABILITY," to our Consolidated Financial Statements contains a summary of the activity in our warranty liability account for 2022, 2021 and 2020 including adjustments to pre-existing warranties.

Fair Value of Intangible Assets

We make strategic acquisitions that may have a material impact on our consolidated results of operations or financial position. We allocate the purchase price of acquired businesses to the assets acquired and liabilities assumed in the transaction at their estimated fair values. The determination of the fair value of intangible assets, which represent a significant portion of the purchase price in many of our acquisitions can be complex and requires the use of significant judgment with regard to (i) the fair value and (ii) the period and the method by which the intangible asset will be amortized. We use information available to us to make fair value determinations and engage independent valuation specialists, when necessary, to assist in the fair value determination of significant acquired intangibles. We estimate the fair value of acquisition-related intangible assets principally based on projections of cash flows that will arise from identifiable intangible assets of acquired businesses, which includes estimates of discount rates, revenue growth rates, earnings or losses before interest expense, income taxes, depreciation and amortization and noncontrolling interests (EBITDA), royalty rates, customer attrition rates, customer renewal rates and technology obsolesce rates. The projected cash flows are discounted to determine the present value of the assets at the dates of acquisition. Although we believe the projections, assumptions and estimates made were reasonable and appropriate, these estimates require significant judgment by management, are inherently uncertain and subject to refinement. During the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Any adjustments subsequent to the measurement period are recorded to our consolidated statements of income. See NOTE 2, "ACQUISITIONS," to our Consolidated Financial Statements for additional information about our recent business combinations.

54

Table of Contents

Goodwill Impairment

We are required to make certain subjective and complex judgments in assessing whether a goodwill impairment event has occurred, including assumptions and estimates used to determine the fair value of our reporting units. We test for goodwill impairment at the reporting unit level and our reporting units are the operating segments or the components of operating segments that constitute businesses for which discrete financial information is available and is regularly reviewed by management.

We have the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value as a basis for determining whether it is necessary to perform an annual quantitative goodwill impairment test. We elected this option on certain reporting units. The following events and circumstances are considered when evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount:

•Macroeconomic conditions, such as a deterioration in general economic conditions, fluctuations in foreign exchange rates and/or other developments in equity and credit markets;

•Industry and market considerations, such as a deterioration in the environment in which an entity operates, material loss in market share and significant declines in product pricing;

•Cost factors, such as an increase in raw materials, labor or other costs;

•Overall financial performance, such as negative or declining cash flows or a decline in actual or forecasted revenue;

•Other relevant entity-specific events, such as material changes in management or key personnel and

•Events affecting a reporting unit, such as a change in the composition or carrying amount of its net assets including acquisitions and dispositions.

The examples noted above are not all-inclusive, and we consider other relevant events and circumstances that affect the fair value of a reporting unit in determining whether to perform the quantitative goodwill impairment test.

Our goodwill recoverability assessment is based on our annual strategic planning process. This process includes an extensive review of expectations for the long-term growth of our businesses and forecasted future cash flows. In order to determine the valuation of our reporting units, we use either the market approach or the income approach using a discounted cash flow model. Our income approach method uses a discounted cash flow model in which cash flows anticipated over several periods, plus a terminal value at the end of that time horizon, are discounted to their present value using an appropriate rate of return. Our estimates are based upon our historical experience, our current knowledge from our commercial relationships and available external information about future trends.

The discounted cash flow model requires us to make projections of revenue, gross margin, operating expenses, working capital investment and fixed asset additions for the reporting units over a multi-year period. Additionally, management must estimate a weighted-average cost of capital, which reflects a market rate, for each reporting unit for use as a discount rate. The discounted cash flows are compared to the carrying value of the reporting unit and, if less than the carrying value, the difference is recorded as a goodwill impairment loss. In addition, we also perform a sensitivity analysis to determine how much our forecasts can fluctuate before the fair value of a reporting unit would be lower than its carrying amount. Future changes in the judgments, assumptions and estimates that are used in our goodwill impairment testing, including discount rates or future operating results and related cash flow projections, could result in significantly different estimates of the fair values in the future. An increase in discount rates, a reduction in projected cash flows or a combination of the two could lead to a reduction in the estimated fair values, which may result in impairment charges that could materially affect our financial statements in any given year. We perform the required procedures as of the end of our fiscal third quarter.

After considering the results of the recent fair value valuations related to the Meritor acquisition, the capital markets environment, economic conditions, results of operations and other factors, we concluded that the fair value of all of our reporting units exceeded their carrying value as of September 30, 2022. However, given the recent acquisition of Meritor, when fair value equaled carrying value as of the acquisition date (August 3, 2022), there is a heightened risk of a future impairment to the extent its fair value changes in future periods.

55

Table of Contents

Accounting for Income Taxes

We determine our income tax expense using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax effects of temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Future tax benefits of net operating loss and credit carryforwards are also recognized as deferred tax assets. We evaluate the recoverability of our deferred tax assets each quarter by assessing the likelihood of future profitability and available tax planning strategies that could be implemented to realize our net deferred tax assets. At December 31, 2022, we recorded a net deferred tax liability of $24 million. The net deferred tax assets included $799 million for the value of net operating loss and credit carryforwards. A valuation allowance of $704 million was recorded to reduce the tax assets to the net value management believed was more likely than not to be realized. In the event our operating performance deteriorates, future assessments could conclude that a larger valuation allowance will be needed to further reduce the deferred tax assets.

In addition, we operate within multiple taxing jurisdictions and are subject to tax audits in these jurisdictions. These audits can involve complex issues, which may require an extended period of time to resolve. We accrue for the estimated additional tax and interest that may result from tax authorities disputing uncertain tax positions. We believe we made adequate provisions for income taxes for all years that are subject to audit based upon the latest information available. A more complete description of our income taxes and the future benefits of our net operating loss and credit carryforwards is disclosed in NOTE 5, "INCOME TAXES," to our Consolidated Financial Statements.

Pension Benefits

We sponsor a number of pension plans globally, with the majority of assets in the U.S. and the U.K. In the U.S. and the U.K., we have major defined benefit plans that are separately funded. We account for our pension programs in accordance with employers' accounting for defined benefit pension plans, which requires that amounts recognized in financial statements be determined using an actuarial basis. As a result, our pension benefit programs are based on a number of statistical and judgmental assumptions that attempt to anticipate future events and are used in calculating the expense and liability related to our plans each year at December 31. These assumptions include discount rates used to value liabilities, assumed rates of return on plan assets, future compensation increases, inflation, employee turnover rates, actuarial assumptions relating to retirement age, mortality rates and participant withdrawals. The actuarial assumptions we use may differ significantly from actual results due to changing economic conditions, participant life span and withdrawal rates. These differences may result in a material impact to the amount of net periodic pension cost to be recorded in our Consolidated Financial Statements in the future.

The expected long-term return on plan assets is used in calculating the net periodic pension cost. We considered several factors in developing our expected rate of return on plan assets. The long-term rate of return considers historical returns and expected returns on current and projected asset allocations. Projected returns are based primarily on broad, publicly traded passive fixed income and equity indices and forward-looking estimates of the value added by active investment management. At December 31, 2022, based upon our target asset allocations, it is anticipated that our U.S. investment policy will generate an average annual return over the 30-year projection period equal to or in excess of 6.50 percent, including the additional positive returns expected from active investment management.

The one-year return for our U.S. plans was a 5.7 percent loss for 2022. Our U.S. plan assets averaged annualized returns of 6.58 percent over the prior ten years and resulted in approximately $166 million of actuarial losses in accumulated other comprehensive loss (AOCL) in the same period. Based on the historical returns and forward-looking return expectations for capital markets, as plan assets continue to be de-risked, consistent with our investment policy, we believe our investment return assumption of 7.00 percent in 2023 for U.S. pension assets is reasonable and attainable.

The methodology used to determine the rate of return on pension plan assets in the U.K. was based on establishing an equity-risk premium over current long-term bond yields adjusted based on target asset allocations. At December 31, 2022, based upon our target asset allocations, it is anticipated that our U.K. investment policy will generate an average annual return over the 20-year projection period equal to or in excess of 4.01 percent. The one-year return for our U.K. plans was a 41.3 percent loss for 2022. The majority of the Cummins U.K. plan’s assets and certain Meritor U.K. plan’s assets are linked to the price of U.K. government gilts in order to hedge movements in the liabilities. U.K. government gilts fell approximately 40 percent during 2022 while our total U.K. pension assets fell by 41.3 percent as a result of the asset price declines over the same period. We generated average annualized returns of 2.76 percent over ten years, resulting in approximately $310 million of actuarial losses in AOCL. Our strategy with respect to our investments in pension plan assets is to be invested with a long-term outlook. Based on the historical returns and forward-looking

56

Table of Contents

return expectations as the plan assets continue to be de-risked, we believe that an investment return assumption of 5.00 percent in 2023 for U.K. pension assets is reasonable and attainable.

Our target allocation for 2023 and pension plan asset allocations, excluding Meritor, at December 31, 2022 and 2021 are as follows:

Meritor’s investment policies in the U.S. and U.K. have historically targeted a well-diversified asset allocation strategy to promote asset growth while maintaining an acceptable level of risk over the long-term with a goal of minimizing company contributions. We are actively reviewing the plan investments and will pursue adjustments to the allocation when appropriate and necessary to align the assets more closely with our management’s strategy and view of prudent and acceptable risk to the company, the plan and its funding goals. Target allocation for 2023 and pension plan asset allocation at December 31, 2022, for Meritor plans are as follows:

Due to the extreme market volatility in the U.K. during the fourth quarter of 2022, the Meritor U.K. plan rebalanced a significant portion of the plan into liability matching assets. The current investment policy and asset allocation targets for the U.K. plan are being actively reviewed to determine if any changes are appropriate.

The differences between the actual return on plan assets and expected long-term return on plan assets are recognized in the asset value used to calculate net periodic cost over five years. The table below sets forth our expected rate of return for 2023 and the expected return assumptions used to develop our pension cost for the period 2020-2022.

Pension accounting offers various acceptable alternatives to account for the differences that eventually arise between the estimates used in the actuarial valuations and the actual results. It is acceptable to delay or immediately recognize these differences. Under the delayed recognition alternative, changes in pension obligations (including those resulting from plan amendments) and changes in the value of assets set aside to meet those obligations are not recognized in net periodic pension cost as they occur but are recognized initially in AOCL and subsequently amortized as components of net periodic pension cost systematically and gradually over future periods. In addition to this approach, we may also adopt immediate recognition of actuarial gains or losses. Immediate recognition introduces volatility in financial results. We have chosen to delay recognition and amortize actuarial differences over future periods. If we adopted the immediate recognition approach, we would record a loss of $693 million ($525 million after-tax) from cumulative actuarial net losses for our U.S. and U.K. pension plans.

The difference between the expected return and the actual return on plan assets is deferred from recognition in our results of operations and under certain circumstances, such as when the difference exceeds 10 percent of the greater of the market value of plan assets or the projected benefit obligation, the difference is amortized over future years of service. This is also true of changes to actuarial assumptions. Under the delayed recognition alternative, the actuarial gains and losses are recognized and recorded in AOCL. As our losses related to the U.S. and U.K. pension plans exceed 10 percent of their respective plan assets, the excess is amortized over the average remaining service lives of participating employees. Net actuarial losses decreased our shareholders' equity by $129 million after-tax in 2022. The loss is primarily due to unfavorable asset returns, partially offset by higher discount rates in the U.S. and U.K.

57

Table of Contents

The table below sets forth the net periodic pension (income) cost for the years ended December 31 and our expected cost for 2023.

We expect 2023 net periodic pension income to increase compared to 2022, primarily due to the full year benefit of the Meritor pension plans added during the acquisition and a higher estimated return on assets in the U.S. and U.K. The decrease in net periodic pension cost in 2022 compared to 2021 was primarily due to higher discount rates in the U.S. and U.K. and favorable actuarial experience in the U.S., partially offset by a lower expected rate of return in the U.K. The decrease in net periodic pension cost in 2021 compared to 2020 was due to favorable actuarial experience and investment returns, partially offset by lower discount rates in the U.S. and U.K.

The weighted-average discount rates used to develop our net periodic pension cost are set forth in the table below.

The discount rate enables us to state expected future cash payments for benefits as a present value on the measurement date. The guidelines for setting this rate suggest the use of a high-quality corporate bond rate. We used bond information provided by Moody's Investor Services, Inc. and Standard & Poor's Rating Services. All bonds used to develop our hypothetical portfolio in the U.S. and U.K. were deemed high-quality, non-callable bonds (Aa or better) at December 31, 2022, by at least one of the bond rating agencies.

Our model called for projected payments until near extinction for the U.S. and the U.K. For both countries, our model matches the present value of the plan's projected benefit payments to the market value of the theoretical settlement bond portfolio. A single equivalent discount rate is determined to align the present value of the required cash flow with the value of the bond portfolio. The resulting discount rate is reflective of both the current interest rate environment and the plan's distinct liability characteristics.

The table below sets forth the estimated impact on our 2023 net periodic pension income relative to a change in the discount rate and a change in the expected rate of return on plan assets.

The above sensitivities reflect the impact of changing one assumption at a time. A higher discount rate decreases the plan obligations and decreases our net periodic pension cost. A lower discount rate increases the plan obligations and increases our net periodic pension cost. It should be noted that economic factors and conditions often affect multiple assumptions simultaneously and the effects of changes in key assumptions are not necessarily linear. NOTE 11, "PENSIONS AND OTHER POSTRETIREMENT BENEFITS," to our Consolidated Financial Statements provides a summary of our pension benefit plan activity, the funded status of our plans and the amounts recognized in our Consolidated Financial Statements.

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

See NOTE 1, "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES" to our Consolidated Financial Statements for additional information.