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

OVERVIEW

Northrop Grumman Corporation (herein referred to as “Northrop Grumman,” the “company,” “we,” “us,” or “our”) is a leading global aerospace and defense company. We deliver a broad range of products, services and solutions to United States (U.S.) and international customers, and principally to the U.S Department of Defense (DoD) and intelligence community. Our broad portfolio is aligned to support national security priorities and our solutions equip our customers with capabilities they need to connect, protect and advance humanity.

The company is a leading provider of space systems, advanced aircraft, missile defense, advanced weapons and long-range fires capabilities, mission systems, networking and communications, strategic deterrence systems, and breakthrough technologies, such as artificial intelligence, advanced computing and cyber. We are focused on competing and winning programs that enable continued growth, performing on our commitments and affordably delivering capability our customers need. With the investments we've made in advanced technologies, combined with our talented workforce and digital transformation capabilities, Northrop Grumman is well positioned to meet our customers' needs today and in the future.

The following discussion should be read along with the financial statements included in this Form 10-Q, as well as our 2021 Annual Report on Form 10-K, which provides additional information on our business and the environment in which we operate and our operating results.

Disposition of IT and Mission Support Services Business

Effective January 30, 2021 (the “Divestiture date”), we completed the sale of our IT and mission support services business (the “IT services divestiture”) for $3.4 billion in cash and recorded a pre-tax gain of $2.0 billion. The IT and mission support services business was comprised of the majority of the former IS&S division of Defense Systems (excluding the Vinnell Arabia business); select cyber, intelligence and missions support programs, which were part of the former CIMS division of Mission Systems; and the former Space Technical Services business unit of Space Systems. Operating results include sales and operating income for the IT and mission support services business prior to the Divestiture date.

COVID-19

In March 2020, the World Health Organization characterized COVID-19 as a global pandemic, and the President declared a national emergency concerning the COVID-19 outbreak. In the more than two years since then, the pandemic (including the first and subsequent variants of COVID-19) has dramatically impacted the global health and economic environment, including millions of confirmed cases and deaths, business slowdowns or shutdowns, labor shortfalls, supply chain challenges, regulatory challenges, and market volatility. We discussed in some detail in our Annual Report on Form 10-K for the fiscal years ended December 31, 2020 and 2021, as well as interim Form 10-Qs, the pandemic, its impacts and risks, and actions taken up to the time of each filing. In this Form 10-Q, we provide a further update.

At a macro level, the number of hospitalizations and deaths, in the U.S. in particular, have eased recently, as more people are fully vaccinated, and communities have continued to open up. It, of course, remains unclear whether that trajectory will continue, but there is some reason for optimism. The company continues to work to monitor and address the pandemic and related developments, including the impact on our company, our employees, our customers, our suppliers and our communities. Our goals have been, and continue to be, to lessen the potential adverse impacts, both health and economic, and to continue to position the company for long-term success. Like the communities in which we operate, our actions have varied, and will continue to vary, depending on the spread of COVID-19 and applicable government requirements, and the needs of our stakeholders.

During the first quarter of 2022, COVID-19 case rates and the health and economic impacts of the pandemic fluctuated in different communities in the U.S. and globally, particularly with the spread of new variants. We continued to see a prolonged impact on the economy, our industry, and our company, with ongoing labor shortages, supply chain challenges, and inflation, among other impacts.

The company’s first quarter 2022 revenue and operating income were modestly reduced by the impact of the COVID-19 pandemic on the company earlier in the quarter, including through elevated levels of employee leave and supply chain challenges. While we cannot predict the future course of the pandemic, or its impact on us, we are not currently assuming significant additional impacts to our 2022 financial results. For further information on the pandemic and the potential impact to the company of COVID-19, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Liquidity and Capital Resources” below and “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2021 Annual Report on Form 10-K.

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Global Security and Economic Environment

The U.S. and its allies continue to face a global security environment of heightened tensions and instability, threats from state and non-state actors, including major global powers, as well as terrorist organizations, emerging nuclear tensions, diverse regional security concerns and political instability. The conflict in Ukraine has increased those tensions and instability, and highlighted threats. The market for defense products, services and solutions globally is driven by these complex and evolving security challenges, considered in the broader context of political and socioeconomic circumstances and priorities.

Our operations and financial performance, as well as demand for our products and services, are impacted by global events, including violence and unrest. The same is true for our suppliers and other business partners. We have begun to experience an increased demand for certain of our goods and services related to the conflict in the Ukraine, in particular, but we have not seen a significant increase to date. Although we are not currently experiencing significant disruption to our operations or our supply chain, or unanticipated costs as a result of the conflict, any or all of these may occur in the future. While we do not have sizeable business dealings in Russia or Ukraine, we do sell and procure some products and services in the region, including procuring engines and cores for the Antares rocket used in our Commercial Resupply Services contract. We are actively monitoring the situation and are exploring potential measures to mitigate the risk of future disruption and costs to our programs.

The global geopolitical and economic environments also continue to be impacted by uncertainty and stress. Geopolitical relationships have changed and are continuing to change. Global economic growth is expected to remain in the low single digits in 2022, reflecting, among other things, the continued impact of and uncertainty surrounding geopolitical tensions globally, financial market volatility, inflation and the COVID-19 pandemic. We expect still further impacts related to the conflict in Ukraine and economic sanctions imposed on Russia. The global economy may also be affected by the residual legal, regulatory and economic impacts of Britain’s exit from the European Union, the full impacts of which are complex and gradually becoming evident. Rising inflation has led to higher costs of various commodities and supplier products. It has also increased interest rates, raising the cost of borrowing for the federal government, which could impact other spending priorities. Additionally, and more broadly, economic tensions and changes in international trade policies, including higher tariffs on imported goods and materials and renegotiation of free trade agreements, could impact the global market for defense products, services and solutions.

U.S. Political and Economic Environment

On May 28, 2021, the Administration released its budget request for fiscal year (FY) 2022. The budget proposed $753 billion for national defense programs and $770 billion in non-defense discretionary funding. The Administration’s budget request included funding for an infrastructure and economic recovery plan as well as an education and economic support plan. On November 15, 2021, the President signed into law the $1.2 trillion Infrastructure and Investment and Jobs Act. Enactment of the infrastructure plan and any future spending plans, as well as the costs of the pandemic may have broader implications for the defense industry, our customers’ budgets and priorities, and the overall economic environment, including the national debt. It is difficult to predict the specific course of future defense budgets. However, we believe the ongoing conflict in Ukraine has highlighted some of the national security threats to our nation and our allies, and the need for strong deterrence and a robust defense capability, as well as impacting our political and economic environment. More generally, the threat to U.S. national security remains very substantial and we believe that our capabilities, particularly in space, missiles, missile defense, hypersonics, counter-hypersonics, survivable aircraft and mission systems should help our customers defend against current and future threats and, as a result, continue to allow for long-term profitable business growth.

On March 15, 2022, the President signed into law the consolidated appropriations act for FY 2022, which provides full-year funding through September 30, including $782 billion for national defense. This represents nearly $30 billion more than the Administration initially requested for FY 2022, and approximately 6%, or $42 billion higher than it was in FY 2021. The Pentagon’s portion of the overall national defense budget is $743 billion. Congress also approved $14 billion in emergency aid to support security, economic, and humanitarian assistance for Ukraine and Central European partners.

The Bipartisan Budget Act of 2019 suspended the debt ceiling through July 31, 2021. In October 2021, the statutory debt limit was increased by $480 billion and, in December 2021, was further increased by $2.5 trillion, which is currently expected to allow the Treasury Department to finance the government into 2023.

The political environment, federal budget and debt ceiling are expected to continue to be the subject of considerable debate, especially in light of the ongoing conflict in Ukraine and its potential long-term impacts, which could have material impacts on defense spending broadly and the company’s programs in particular.

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For further information on the risks we face from the current political and economic environment, see “Risk Factors” in our 2021 Annual Report on Form 10-K.

CONSOLIDATED OPERATING RESULTS

For purposes of the operating results discussion below, we assess our performance using certain financial measures that are not calculated in accordance with GAAP. Organic sales is defined as total sales excluding sales attributable to the company's IT services divestiture. This measure may be useful to investors and other users of our financial statements as a supplemental measure in evaluating the company’s underlying sales growth as well as in providing an understanding of our ongoing business and future sales trends by presenting the company’s sales before the impact of divestiture activity.

Transaction-adjusted net earnings and transaction-adjusted earnings per share (transaction-adjusted EPS) exclude impacts related to the IT services divestiture, including the gain on sale of the business, associated federal and state income tax expenses, transaction costs, and the make-whole premium for early debt redemption. They also exclude the impact of mark-to-market pension and OPB (“MTM”) benefit/(expense) and related tax impacts, which are generally only recognized during the fourth quarter. These non-GAAP measures may be useful to investors and other users of our financial statements as supplemental measures in evaluating the company’s underlying financial performance by presenting the company’s operating results before the non-operational impact of divestiture activity and pension and OPB actuarial gains and losses. These measures are also consistent with how management views the underlying performance of the business as the impact of the IT services divestiture and MTM accounting are not considered in management’s assessment of the company’s operating performance or in its determination of incentive compensation awards.

We reconcile these non-GAAP financial measures to their most directly comparable GAAP financial measures below. These non-GAAP measures may not be defined and calculated by other companies in the same manner and should not be considered in isolation or as an alternative to operating results presented in accordance with GAAP.

Selected financial highlights are presented in the table below:

															Three Months Ended March 31												%
$ in millions, except per share amounts																					2022						2021						Change
Sales																					$	8,797					$	9,157					(4)		%
Operating costs and expenses																					7,900						8,315						(5)		%
Operating costs and expenses as a % of sales																					89.8		%				90.8		%
Gain on sale of business																					—						1,980						NM
Operating income																					897						2,822						NM
Operating margin rate																					10.2		%				30.8		%
Federal and foreign income tax expense																					189						821						(77)		%
Effective income tax rate																					16.5		%				27.2		%
Net earnings																					955						2,195						(56)		%
Diluted earnings per share																					$	6.10					$	13.43					(55)		%

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Sales

The table below reconciles sales to organic sales:

			Three Months Ended March 31
			2022												2021
$ in millions			Sales			IT services sales			Organic sales						Sales			IT services sales			Organic sales						Organic sales % change
Aeronautics Systems			$	2,703		$	—		$	2,703					$	2,990		$	—		$	2,990					(10)		%
Defense Systems			1,283			—			1,283						1,562			(106)			1,456						(12)		%
Mission Systems			2,497			—			2,497						2,589			(42)			2,547						(2)		%
Space Systems			2,855			—			2,855						2,521			(16)			2,505						14		%
Intersegment eliminations			(541)			—			(541)						(505)			2			(503)
Total			$	8,797		$	—		$	8,797					$	9,157		$	(162)		$	8,995					(2)		%

First quarter 2022 sales decreased $360 million due, in part, to a $162 million reduction in sales related to the IT services divestiture. First quarter 2022 organic sales decreased $198 million, or 2 percent, primarily due to lower sales at Aeronautics Systems and Defense Systems, partially offset by higher sales at Space Systems. First quarter 2022 organic sales reflect the continuation from 2021 of a tightened labor market as well as some temporal COVID-19-related headwinds early in the quarter related to supply chain and labor disruption.

See “Segment Operating Results” below for further information by segment and “Product and Service Analysis” for product and service detail. See Note 9 to the financial statements for information regarding the company’s sales by customer type, contract type and geographic region for each of our segments.

Operating Income and Margin Rate

First quarter 2022 operating income decreased $1.9 billion, or 68 percent, primarily due to a $2.0 billion pre-tax gain on sale and $192 million of unallocated corporate expenses recognized in the prior year associated with the IT services divestiture. Operating income also decreased due to a $65 million reduction in the FAS/CAS operating adjustment and $58 million of lower segment operating income. First quarter 2022 operating margin rate declined to 10.2 percent reflecting the items above.

First quarter 2022 general and administrative (G&A) costs as a percentage of sales increased to 11.1 percent from 9.8 percent in the prior year period primarily due to an increase in investments for future business opportunities as well as the timing of indirect cost recognition during the year.

See “Segment Operating Results” below for further information by segment. For information regarding product and service operating costs and expenses, see “Product and Service Analysis” below.

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Federal and Foreign Income Taxes

The first quarter 2022 effective tax rate (ETR) decreased to 16.5 percent from 27.2 percent primarily due to additional federal income taxes in the prior year resulting from the IT services divestiture. See Note 3 to the financial statements for additional information.

Net Earnings

The table below reconciles net earnings to transaction-adjusted net earnings:

									Three Months Ended March 31												%
$ in millions																		2022						2021						Change
Net earnings																		$	955					$	2,195					(56)		%
Gain on sale of business																		—						(1,980)						NM
State tax impact1																		—						160						NM
Transaction costs																		—						32						NM
Make-whole premium																		—						54						NM
Federal tax impact of items above2																		—						614						NM
Transaction adjustment, net of tax																		$	—					$	(1,120)					NM
Transaction-adjusted net earnings																		$	955					$	1,075					(11)		%

**(1)**The state tax impact includes $62 million of incremental tax expense related to $1.2 billion of nondeductible goodwill in the divested business.

**(2)**The federal tax impact was calculated by applying the 21 percent federal statutory rate to the adjustment items and also includes $250 million of incremental tax expense related to $1.2 billion of nondeductible goodwill in the divested business.

First quarter 2022 net earnings decreased $1.2 billion, or 56 percent, primarily due to a $1.1 billion after-tax decline associated with the IT services divestiture. Transaction-adjusted net earnings decreased $120 million, or 11 percent, primarily due to the lower operating income described above.

Diluted Earnings Per Share

The table below reconciles diluted earnings per share to transaction-adjusted EPS:

									Three Months Ended March 31												%
																		2022						2021						Change
Diluted EPS																		$	6.10					$	13.43					(55)		%
Gain on sale of business per share																		—						(12.11)						NM
State tax impact per share1																		—						0.98						NM
Transaction costs per share																		—						0.19						NM
Make-whole premium per share																		—						0.33						NM
Federal tax impact of line items above per share2																		—						3.75						NM
Transaction adjustment per share, net of tax																		$	—					$	(6.86)					NM
Transaction-adjusted EPS																		$	6.10					$	6.57					(7)		%

**(1)**The state tax impact includes $62 million of incremental tax expense related to $1.2 billion of nondeductible goodwill in the divested business.

**(2)**The federal tax impact was calculated by applying the 21 percent federal statutory rate to the adjustment items and also includes $250 million of incremental tax expense related to $1.2 billion of nondeductible goodwill in the divested business.

First quarter 2022 diluted earnings per share decreased 55 percent, principally due to a $6.86 after-tax decline associated with the IT services divestiture. Transaction-adjusted earnings per share decreased $0.47, or 7 percent, reflecting an 11 percent decrease in transaction-adjusted net earnings and a 4 percent reduction in weighted-average diluted shares outstanding.

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SEGMENT OPERATING RESULTS

Basis of Presentation

The company is aligned in four operating sectors, which also comprise our reportable segments: Aeronautics Systems, Defense Systems, Mission Systems and Space Systems. We present our sectors in the following business areas, which are reported in a manner reflecting core capabilities:

Aeronautics Systems						Defense Systems						Mission Systems						Space Systems
Autonomous Systems						Battle Management & Missile Systems						Airborne Multifunction Sensors						Launch & Strategic Missiles
Manned Aircraft						Mission Readiness						Maritime/Land Systems & Sensors						Space
												Navigation, Targeting & Survivability
												Networked Information Solutions

This section discusses segment sales, operating income and operating margin rates. In evaluating segment operating performance, we look primarily at changes in sales and operating income. Where applicable, significant fluctuations in operating performance attributable to individual contracts or programs, or changes in a specific cost element across multiple contracts, are described in our analysis. Based on this approach and the nature of our operations, the discussion of results of operations below first focuses on our four segments before distinguishing between products and services. Changes in sales are generally described in terms of volume, while changes in margin rates are generally described in terms of performance and/or contract mix. For purposes of this discussion, volume generally refers to increases or decreases in sales or cost from production/service activity levels and performance generally refers to non-volume related changes in profitability. Contract mix generally refers to changes in the ratio of contract type and/or lifecycle (e.g., cost-type, fixed-price, development, production, and/or sustainment).

Segment Operating Income and Margin Rate

Segment operating income, as reconciled in the table below, and segment operating margin rate (segment operating income divided by sales) are non-GAAP measures that reflect the combined operating income of our four segments less the operating income associated with intersegment sales. Segment operating income includes pension expense allocated to our sectors under FAR and CAS and excludes FAS pension service expense and unallocated corporate items (certain corporate-level expenses, which are not considered allowable or allocable under applicable FAR and CAS requirements, and costs not considered part of management’s evaluation of segment operating performance). These non-GAAP measures may be useful to investors and other users of our financial statements as supplemental measures in evaluating the financial performance and operational trends of our sectors. These measures may not be defined and calculated by other companies in the same manner and should not be considered in isolation or as alternatives to operating results presented in accordance with GAAP.

															Three Months Ended March 31												%
$ in millions																					2022						2021						Change
Operating income																					$	897					$	2,822					NM
Reconciliation to segment operating income:
CAS pension expense																					$	(46)					$	(123)					(63)		%
FAS pension service expense																					92						104						(12)		%
FAS/CAS operating adjustment																					46						(19)						(342)		%
Gain on sale of business																					—						(1,980)						NM
IT services divestiture – unallowable state taxes and transaction costs																					—						192						NM
Intangible asset amortization and PP&E step-up depreciation																					60						65						(8)		%
Other unallocated corporate expense																					34						15						127		%
Unallocated corporate expense (income)																					94						(1,708)						NM
Segment operating income																					$	1,037					$	1,095					(5)		%
Segment operating margin rate																					11.8		%				12.0		%

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First quarter 2022 segment operating income decreased $58 million, or 5 percent. First quarter 2021 segment operating income included $20 million from the IT services business, as well as a benefit of approximately $100 million due to the impact of lower overhead rates on the company’s fixed price contracts. Segment operating margin rate decreased to 11.8 percent from 12.0 percent and reflects a lower operating margin rate at Space Systems, partially offset by higher operating margin rates at Aeronautics Systems and Defense Systems.

FAS/CAS Operating Adjustment

First quarter 2022 FAS/CAS operating adjustment decreased primarily due to lower CAS pension expense resulting from favorable plan asset returns in 2021 and changes in certain CAS actuarial assumptions as of December 31, 2021.

Unallocated Corporate Expense (Income)

The change in unallocated corporate expense (income) is primarily due to the $2.0 billion pre-tax gain on sale and $192 million of unallowable state taxes and transaction costs recognized in the prior year associated with the IT services divestiture.

Net EAC Adjustments - We record changes in estimated contract earnings at completion (net EAC adjustments) using the cumulative catch-up method of accounting. Net EAC adjustments can have a significant effect on reported sales and operating income and the aggregate amounts are presented in the table below:

									Three Months Ended March 31
$ in millions															2022						2021
Favorable EAC adjustments															$	357					$	348
Unfavorable EAC adjustments															(184)						(158)
Net EAC adjustments															$	173					$	190

Net EAC adjustments by segment are presented in the table below:

									Three Months Ended March 31
$ in millions															2022						2021
Aeronautics Systems															$	103					$	37
Defense Systems															25						30
Mission Systems															57						88
Space Systems															(8)						37
Eliminations															(4)						(2)
Net EAC adjustments															$	173					$	190

For purposes of the discussion in the remainder of this Segment Operating Results section, references to operating income and operating margin rate reflect segment operating income and segment operating margin rate, respectively.

AERONAUTICS SYSTEMS															Three Months Ended March 31												%
$ in millions																					2022						2021						Change
Sales																					$	2,703					$	2,990					(10)		%
Operating income																					307						308						—		%
Operating margin rate																					11.4		%				10.3		%

Sales

First quarter 2022 sales decreased $287 million, or 10 percent, due to lower volume in both Manned Aircraft and Autonomous Systems, including restricted programs and the E-2, Triton and F/A-18 production programs.

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Operating Income

First quarter 2022 operating income was comparable to the prior year period. Operating margin rate increased to 11.4 percent from 10.3 percent primarily due to a $67 million favorable EAC adjustment on the engineering, manufacturing and development phase of the B-21 program largely related to performance incentives, partially offset by the previously described overhead rate benefit to fixed price contracts in the prior year.

DEFENSE SYSTEMS															Three Months Ended March 31												%
$ in millions																					2022						2021						Change
Sales																					$	1,283					$	1,562					(18)		%
Operating income																					155						177						(12)		%
Operating margin rate																					12.1		%				11.3		%

Sales

First quarter 2022 sales decreased $279 million due, in part, to a $106 million reduction in sales related to the IT services divestiture. First quarter 2022 organic sales decreased $173 million, or 12 percent, principally due to lower scope on an international training program as well as lower volume on the Advanced Anti-Radiation Guided Missile (AARGM) and Precision Guided Kit (PGK) programs due to timing of ramp-up on follow-on production lots. These reductions were partially offset by higher volume on an international weapons program.

Operating Income

First quarter 2022 operating income decreased $22 million, or 12 percent, due, in part, to a $14 million reduction in operating income related to the IT services divestiture. Lower organic sales volume was partially offset by a higher operating margin rate, which increased to 12.1 percent from 11.3 percent primarily due to improved performance at Battle Management and Missile Systems.

MISSION SYSTEMS															Three Months Ended March 31												%
$ in millions																					2022						2021						Change
Sales																					$	2,497					$	2,589					(4)		%
Operating income																					385						397						(3)		%
Operating margin rate																					15.4		%				15.3		%

Sales

First quarter 2022 sales decreased $92 million due, in part, to a $42 million reduction in sales related to the IT services divestiture. First quarter 2022 organic sales decreased $50 million, or 2 percent, primarily due to lower volume on Navigation, Targeting and Survivability programs, as well as lower volume on airborne radar and electronic warfare programs. These decreases were partially offset by an increase in restricted sales, higher volume on the Ground/Air Task-Oriented Radar program, as well as higher intercompany volume largely related to ramp-up on the Ground Based Strategic Deterrent (GBSD) program.

Operating Income

First quarter 2022 operating income decreased $12 million, or 3 percent, principally due to lower sales. Operating margin rate was comparable to the prior year period and reflects improved performance on Maritime/Land Systems and Sensors and Navigation, Targeting and Survivability programs, partially offset by the previously described overhead rate benefit to fixed price contracts in the prior year.

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SPACE SYSTEMS															Three Months Ended March 31												%
$ in millions																					2022						2021						Change
Sales																					$	2,855					$	2,521					13		%
Operating income																					261						276						(5)		%
Operating margin rate																					9.1		%				10.9		%

Sales

First quarter 2022 sales increased $334 million, or 13 percent, and includes a $16 million reduction in sales related to the IT services divestiture. First quarter 2022 organic sales increased $350 million, or 14 percent, due to higher sales in both the Launch & Strategic Missiles and Space business areas. Launch & Strategic Missiles sales increased primarily due to ramp-up on development programs, including a $130 million increase on the Next Generation Interceptor program and a $117 million increase on GBSD. Space sales were driven by higher volume on CRS and restricted programs, partially offset by lower volume on the James Webb Space Telescope after its successful launch in December 2021.

Operating Income

First quarter 2022 operating income decreased $15 million, or 5 percent, due to a lower operating margin rate, partially offset by higher sales volume. Operating margin rate decreased to 9.1 percent from 10.9 percent primarily due to lower net EAC adjustments on commercial space programs as well as the previously described overhead rate benefit to fixed price contracts in the prior year.

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PRODUCT AND SERVICE ANALYSIS

The following table presents product and service sales and operating costs and expenses by segment:

									Three Months Ended March 31
$ in millions												2022						2021
Segment Information:																		Sales			Operating Costs and Expenses			Sales			Operating Costs and Expenses
Aeronautics Systems
Product																		$	2,045		$	1,804		$	2,524		$	2,274
Service																		593			533			422			369
Intersegment eliminations																		65			59			44			39
Total Aeronautics Systems																		2,703			2,396			2,990			2,682
Defense Systems
Product																		610			527			680			595
Service																		474			425			697			624
Intersegment eliminations																		199			176			185			166
Total Defense Systems																		1,283			1,128			1,562			1,385
Mission Systems
Product																		1,762			1,509			1,760			1,493
Service																		489			396			592			497
Intersegment eliminations																		246			207			237			202
Total Mission Systems																		2,497			2,112			2,589			2,192
Space Systems
Product																		2,424			2,195			2,058			1,829
Service																		400			371			424			381
Intersegment eliminations																		31			28			39			35
Total Space Systems																		2,855			2,594			2,521			2,245
Segment Totals
Total Product																		$	6,841		$	6,035		$	7,022		$	6,191
Total Service																		1,956			1,725			2,135			1,871
Total Segment**(1)**																		$	8,797		$	7,760		$	9,157		$	8,062

(1)A reconciliation of segment operating income to total operating income is included in “Segment Operating Results.”

Product Sales and Costs

First quarter 2022 product sales decreased $181 million, or 3 percent, primarily due to decreases in product sales at Aeronautics Systems and Defense Systems, partially offset by increases in product sales at Space Systems. The decrease at Aeronautics Systems was principally due to lower volume on restricted programs, as well as the E-2 and F/A-18 production programs. The decrease at Defense Systems was driven by lower volume on the AARGM and PGK programs. The increase at Space Systems is principally related to ramp-up on development programs including NGI and GBSD.

First quarter 2022 product costs decreased $156 million, or 3 percent, consistent with the lower product sales.

Service Sales and Costs

First quarter 2022 service sales decreased $179 million, or 8 percent, primarily due to the IT services divestiture and lower volume on an international training program at Defense Systems. Sales from the divested IT services business, which were largely included in service sales, were $162 million in the prior year period. The decreases were partially offset by higher service volume on restricted programs at Aeronautics Systems.

First quarter 2022 service costs decreased $146 million, or 8 percent, consistent with the lower service sales.

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NORTHROP GRUMMAN CORPORATION

BACKLOG

Backlog represents the future sales we expect to recognize on firm orders received by the company and is equivalent to the company’s remaining performance obligations at the end of each period. It comprises both funded backlog (firm orders for which funding is authorized and appropriated) and unfunded backlog. Unexercised contract options and indefinite delivery indefinite quantity (IDIQ) contracts are not included in backlog until the time an option or IDIQ task order is exercised or awarded. Backlog is converted into sales as costs are incurred or deliveries are made.

Backlog consisted of the following as of March 31, 2022 and December 31, 2021:

						March 31, 2022																		December 31, 2021
$ in millions						Funded						Unfunded						Total Backlog						Total Backlog						% Change in 2022
Aeronautics Systems						$	8,906					$	8,735					$	17,641					$	18,277					(3)		%
Defense Systems						5,404						737						6,141						6,349						(3)		%
Mission Systems						9,960						4,055						14,015						14,306						(2)		%
Space Systems						6,828						31,168						37,996						37,114						2		%
Total backlog						$	31,098					$	44,695					$	75,793					$	76,046					—		%

New Awards

First quarter 2022 net awards totaled $8.5 billion and backlog totaled $75.8 billion. Significant first quarter new awards include $2.5 billion for restricted programs (primarily at Aeronautics Systems and Mission Systems), $1.3 billion for Commercial Resupply Service Missions, $0.7 billion for the Space Development Agency Tranche 1 Transport Layer and $0.6 billion for F-35 at Aeronautics Systems.

LIQUIDITY AND CAPITAL RESOURCES

We are focused on the efficient conversion of operating income into cash and to provide for the company’s material cash requirements, including working capital needs, satisfaction of contractual commitments, funding of our pension and OPB plans, investment in our business through capital expenditures, and shareholder return through dividend payments and share repurchases.

At March 31, 2022, we had $2.2 billion in cash and cash equivalents. We expect cash and cash equivalents and cash generated from operating activities, supplemented by borrowings under credit facilities, commercial paper and/or in the capital markets through our shelf registration with the SEC, if needed, to be sufficient to provide liquidity to the company in the short-term and long-term. The company has a five-year senior unsecured credit facility in an aggregate principal amount of $2.0 billion, and in April 2022, we renewed our one-year $500 million uncommitted credit facility. At March 31, 2022, there was no balance outstanding under these credit facilities.

Effective January 30, 2021, we completed the IT services divestiture for $3.4 billion cash. Proceeds were primarily used in the first quarter of 2021 for a $2.0 billion accelerated share repurchase and to fund redemption of $1.5 billion of the company’s 2.55 percent unsecured notes due October 2022.

COVID-19 and the CARES Act

The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) established a program with provisions to allow U.S. companies to defer the employer’s portion of social security taxes between March 27, 2020 and December 31, 2020 and pay such taxes in two installments in 2021 and 2022. Our first installment of deferred social security taxes of $200 million was paid in the fourth quarter of 2021 and the second installment of $200 million is due in the fourth quarter of 2022. Under Section 3610, the CARES Act also authorized the government to reimburse qualifying contractors for certain costs of providing paid leave to employees as a result of COVID-19. The company continues to seek, and anticipates continuing to seek, recovery for certain COVID-19-related costs under Section 3610 of the CARES Act and through our contract provisions, though it is unclear how much we will be able to recover. In addition, the U.S. Department of Defense (DoD) has, to date, taken steps to increase the rate for certain progress payments from 80 percent to 90 percent for costs incurred and work performed on relevant contracts; it is unclear what steps the DoD will continue to take.

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Internal Revenue Code (IRC) Section 174

Beginning in 2022, the Tax Cuts and Jobs Act of 2017 (“TCJA”) eliminates the option to deduct research and development expenditures currently and requires taxpayers to amortize them over five years pursuant to IRC Section 174. Congress is considering, but has not passed, legislation that would defer the amortization requirement to later years. Although first quarter 2022 cash from operations was not impacted, if legislation is not passed and made effective retroactively to January 1, 2022, we estimate the provisions currently in effect will reduce cash from operations for the year ended December 31, 2022 by approximately $1 billion. The actual impact on 2022 cash from operations will depend on if and when Congress passes additional legislation, whether such legislation is made effective retroactively, the amount of research and development expenditures incurred and paid by the company during 2022, and whether the IRS issues guidance on the provision which differs from our current interpretation.

Cash Flow Measures

In addition to our cash position, we consider various cash flow measures in capital deployment decision-making, including cash provided by operating activities and adjusted free cash flow, a non-GAAP measure described in more detail below.

Operating Cash Flow

The table below summarizes key components of cash flow used in operating activities:

															Three Months Ended March 31												%
$ in millions																					2022						2021						Change
Net earnings																					$	955					$	2,195					(56)		%
Gain on sale of business																					—						(1,980)						NM
Non-cash items(1)																					(178)						41						(534)		%
Pension and OPB contributions																					(36)						(38)						(5)		%
Changes in trade working capital																					(1,254)						(310)						305		%
Other, net																					25						26						(4)		%
Net cash used in operating activities																					$	(488)					$	(66)					639		%

(1)Includes depreciation and amortization, non-cash lease expense, stock based compensation expense, deferred income taxes and net periodic pension and OPB income.

First quarter 2022 cash used in operating activities increased $422 million, as compared with the same period in 2021, principally due to increases in trade working capital. The net use of cash during the first quarter is consistent with the company’s historical timing of operating cash flows, which are generally more heavily weighted towards the second half of the year.

Adjusted Free Cash Flow

Adjusted free cash flow, as reconciled in the table below, is a non-GAAP measure defined as net cash provided by or used in operating activities, less capital expenditures, plus proceeds from the sale of equipment to a customer (not otherwise included in net cash provided by or used in operating activities) and the after-tax impact of discretionary pension contributions. Adjusted free cash flow includes proceeds from the sale of equipment to a customer as such proceeds were generated in a customer sales transaction. It also includes the after-tax impact of discretionary pension contributions for consistency and comparability of financial performance. This measure may not be defined and calculated by other companies in the same manner. We use adjusted free cash flow as a key factor in our planning for, and consideration of, acquisitions, the payment of dividends and stock repurchases. This non-GAAP measure may be useful to investors and other users of our financial statements as a supplemental measure of our cash performance, but should not be considered in isolation, as a measure of residual cash flow available for discretionary purposes, or as an alternative to operating cash flows presented in accordance with GAAP.

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The table below reconciles net cash used in operating activities to adjusted free cash flow:

															Three Months Ended March 31												%
$ in millions																					2022						2021						Change
Net cash used in operating activities																					$	(488)					$	(66)					639		%
Capital expenditures																					(244)						(205)						19		%
Adjusted free cash flow																					$	(732)					$	(271)					170		%

First quarter 2022 adjusted free cash flow decreased $461 million, as compared with the same period in 2021, due to higher net cash used in operating activities and an increase in capital expenditures.

Investing Cash Flow

First quarter 2022 net cash used in investing activities was $249 million compared to net cash provided by investing activities of $3.2 billion in the prior year period, principally due to $3.4 billion in cash received from the sale of our IT services business during the first quarter of 2021.

Financing Cash Flow

First quarter 2022 net cash used in financing activities decreased $3.9 billion, as compared with the same period in 2021, principally due to a $2.2 billion decrease in debt repayments and a $1.7 billion reduction in share repurchases.

Credit Facilities, Commercial Paper and Financial Arrangements - See Note 6 to the financial statements for further information on our credit facilities, commercial paper and our use of standby letters of credit and guarantees.

Share Repurchases - See Note 2 to the financial statements for further information on our share repurchase programs.

Long-term Debt - See Note 4 to the financial statements for further information.

CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS

There have been no material changes to our critical accounting policies, estimates or judgments from those discussed in our 2021 Annual Report on Form 10-K.

ACCOUNTING STANDARDS UPDATES

See Note 1 to our financial statements for further information on accounting standards updates.

FORWARD-LOOKING STATEMENTS AND PROJECTIONS

This Form 10-Q and the information we are incorporating by reference contain statements that constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “will,” “expect,” “anticipate,” “intend,” “may,” “could,” “should,” “plan,” “project,” “forecast,” “believe,” “estimate,” “outlook,” “trends,” “goals” and similar expressions generally identify these forward-looking statements. Forward-looking statements include, among other things, statements relating to our future financial condition, results of operations and/or cash flows. Forward-looking statements are based upon assumptions, expectations, plans and projections that we believe to be reasonable when made, but which may change over time. These statements are not guarantees of future performance and inherently involve a wide range of risks and uncertainties that are difficult to predict. Specific risks that could cause actual results to differ materially from those expressed or implied in these forward-looking statements include, but are not limited to, those identified and discussed more fully in the section entitled “Risk Factors” in our 2021 Annual Report on Form 10-K and from time to time in our other filings with the Securities and Exchange Commission (SEC). These risks and uncertainties are amplified by the global COVID-19 pandemic and the related effects on the broader economic environment, which have caused and will continue to cause significant challenges, instability and uncertainty. They include:

Industry and Economic Risks

• our dependence on the U.S. government for a substantial portion of our business

• significant delays or reductions in appropriations for our programs, and U.S. government funding and program support more broadly, including related to hostilities and other global events

• the use of estimates when accounting for our contracts and the effect of contract cost growth and/or changes in estimated contract revenues and costs

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• increased competition within our markets and bid protests

Legal and Regulatory Risks

• investigations, claims, disputes, enforcement actions, litigation and/or other legal proceedings

• the improper conduct of employees, agents, subcontractors, suppliers, business partners or joint ventures in which we participate and the impact on our reputation and our ability to do business

• changes in procurement and other laws, SEC and other regulations, contract terms and practices applicable to our industry, findings by the U.S. government as to our compliance with such requirements, and changes in our customers’ business practices globally

• environmental matters, including unforeseen environmental costs and government and third party claims

• unanticipated changes in our tax provisions or exposure to additional tax liabilities

Business and Operational Risks

• impacts of the COVID-19 pandemic (or future health epidemics, pandemics or similar outbreaks), including potential new variants, case surges or prolonged recovery periods, their effects on the broader environment, and varying related government requirements, on: our business, our ability to maintain a qualified and productive workforce, work slowdowns or stoppages, labor shortages, supply chain and logistics challenges, costs we cannot recover and liabilities for which we are not compensated, performance challenges (including cost and schedule), government funding, changes in government acquisition priorities and processes, government payment rules and practices, insurance challenges, and potential impacts on access to capital, the markets and the fair value of our assets

• cyber and other security threats or disruptions faced by us, our customers or our suppliers and other partners, and changes in related regulations

• the ability to maintain a qualified workforce with the required security clearances and requisite skills

• the performance and viability of our subcontractors and suppliers and the availability and pricing of raw materials and components

• climate change, its impacts on our company, our operations and our stakeholders (employees, suppliers, customers, shareholders and regulators), and changes in laws, regulations and priorities related to greenhouse gas emissions and other climate change related concerns

• our exposure to additional risks as a result of our international business, including risks related to geopolitical and economic factors, suppliers, laws and regulations

• our ability to meet performance obligations under our contracts, including obligations that require innovative design capabilities, are technologically complex, require certain manufacturing expertise or are dependent on factors not wholly within our control

• natural disasters

• products and services we provide related to hazardous and high risk operations, including the production and use of such products, which subject us to various environmental, regulatory, financial, reputational and other risks

• our ability appropriately to exploit and/or protect intellectual property rights

• our ability to develop new products and technologies and maintain technologies, facilities, and equipment to win new competitions and meet the needs of our customers

General and Other Risk Factors

• the adequacy and availability of our insurance coverage, customer indemnifications or other liability protections

• the future investment performance of plan assets, changes in actuarial assumptions associated with our pension and other postretirement benefit plans and legislative or other regulatory actions impacting our pension and postretirement benefit obligations

• changes in business conditions that could impact business investments and/or recorded goodwill or the value of other long-lived assets

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We urge you to consider the limitations on, and risks associated with, forward-looking statements and not unduly rely on the accuracy of forward-looking statements. These forward-looking statements speak only as of the date this report is first filed or, in the case of any document incorporated by reference, the date of that document. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law.