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 generally eased in 2022, 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 second 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. Although direct COVID-19-related impacts on our business generally declined this quarter, including in the areas of employee absenteeism and leave-taking, the company’s second quarter 2022 revenue and operating income were reduced by the broader macroeconomic environment, including a tight labor market and extended material lead times, which we expect to continue. While we cannot predict the future course of the pandemic, we are not currently assuming significant additional direct COVID-19-related impacts on 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”

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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.

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, as well as disrupted supply chains and added costs. 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 continue 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. We also continue to experience modest disruption to some of our programs and supply chain, including with unanticipated cost growth, as a result of the conflict, particularly with respect to our Commercial Resupply Services contract. We do not have sizable business dealings in Russia or Ukraine, and do not anticipate significant adverse impacts. We are actively monitoring the situation and exploring both opportunities and risks, including 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, and global inflationary pressures. 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. Rising inflation has led to higher costs of various commodities and supplier products. Increased interest rates, raising the cost of borrowing for the federal government, could impact other spending priorities. Economic tensions and changes in international trade policies, including higher tariffs on imported goods and materials and renegotiation of free trade agreements, could also impact the global market for defense products, services and solutions.

U.S. Political and Economic Environment

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 percent, or $42 billion higher than it was in FY 2021. The Pentagon’s portion of the overall national defense budget is $743 billion. In March 2022, Congress also approved $14 billion in emergency aid to support security, economic, and humanitarian assistance for Ukraine and Central European partners. An additional $40 billion in emergency supplemental appropriations was approved by Congress in May 2022. Current and future spending in connection with the conflict in Ukraine and other priorities, global inflation, the national debt and the costs of the pandemic, among other things, will continue to impact our customers’ budgets and priorities, and our industry. We expect the government, our customers and our industry will also continue to face challenges from the macroeconomic environment, including a tight labor market and supply chain disruptions.

The Administration’s current budget for FY 2023 proposes $813 billion for national defense programs, and the Pentagon’s portion of the overall defense budget is $773 billion. On July 18, 2022, the Senate Armed Services Committee released its annual defense bill, which authorizes $847 billion in defense spending, an increase over the Administration’s budget request. 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.

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.

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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 the inflationary environment, which could have material impacts on defense spending broadly and the company’s programs in particular.

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 June 30												%						Six Months Ended June 30												%
$ in millions, except per share amounts			2022						2021						Change						2022						2021						Change
Sales			$	8,801					$	9,151					(4)		%				$	17,598					$	18,308					(4)		%
Operating costs and expenses			7,847						8,107						(3)		%				15,747						16,422						(4)		%
Operating costs and expenses as a % of sales			89.2		%				88.6		%										89.5		%				89.7		%
Gain on sale of business			—						—						—		%				—						1,980						NM
Operating income			954						1,044						(9)		%				1,851						3,866						(52)		%
Operating margin rate			10.8		%				11.4		%										10.5		%				21.1		%
Federal and foreign income tax expense			204						265						(23)		%				393						1,086						(64)		%
Effective income tax rate			17.7		%				20.4		%										17.1		%				25.2		%
Net earnings			946						1,037						(9)		%				1,901						3,232						(41)		%
Diluted earnings per share			$	6.06					$	6.42					(6)		%				$	12.16					$	19.89					(39)		%

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Sales

The table below reconciles sales to organic sales for the six months ended June 30, 2022. Sales for the three months ended June 30, 2022 and 2021 were not impacted by the sale of the company's IT services business:

			Six Months Ended June 30
			2022												2021
$ in millions			Sales			IT services sales			Organic sales						Sales			IT services sales			Organic sales						Organic sales % change
Aeronautics Systems			$	5,237		$	—		$	5,237					$	5,903		$	—		$	5,903					(11)		%
Defense Systems			2,577			—			2,577						2,989			(106)			2,883						(11)		%
Mission Systems			5,013			—			5,013						5,177			(42)			5,135						(2)		%
Space Systems			5,834			—			5,834						5,269			(16)			5,253						11		%
Intersegment eliminations			(1,063)			—			(1,063)						(1,030)			2			(1,028)
Total			$	17,598		$	—		$	17,598					$	18,308		$	(162)		$	18,146					(3)		%

Current Quarter

Second quarter 2022 sales decreased $350 million due to lower sales at Aeronautics Systems, Defense Systems and Mission Systems, partially offset by 8 percent growth at Space Systems. Second quarter 2022 sales reflect continued headwinds from the macroeconomic environment, including a tight labor market and extended material lead times, which are affecting the timing of sales.

Year to Date

Year to date 2022 sales decreased $710 million due, in part, to a $162 million reduction in sales related to the IT services divestiture. Year to date 2022 organic sales decreased $548 million, or 3 percent, primarily due to lower sales at Aeronautics Systems and Defense Systems, partially offset by 11 percent growth at Space Systems.

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

Current Quarter

Second quarter 2022 operating income decreased $90 million, or 9 percent, primarily due to a $69 million reduction in the FAS/CAS operating adjustment and lower sales. Second quarter 2022 operating margin rate declined to 10.8 percent due to the lower FAS/CAS operating adjustment, partially offset by lower unallocated corporate expense.

Second quarter 2022 general and administrative (G&A) costs as a percentage of sales increased to 11.4 percent from 10.9 percent in the prior year period primarily due to an increase in investments for future business opportunities.

Year to date

Year to date 2022 operating income decreased $2.0 billion, or 52 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 $134 million reduction in the FAS/CAS operating adjustment and lower sales. Year to date 2022 operating margin rate declined to 10.5 percent, largely due to the prior year gain on sale of the IT services business.

Year to date 2022 G&A costs as a percentage of sales increased to 11.3 percent from 10.4 percent in the prior year period primarily due to an increase in investments for future business opportunities.

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.

Federal and Foreign Income Taxes

Current Quarter

The second quarter 2022 ETR decreased to 17.7 percent from 20.4 percent in the prior year period. The second quarter 2021 ETR was impacted by a change made in tax revenue recognition on certain long term contracts, which increased taxable income in years prior to the 2017 Tax Cuts and Jobs Act at a rate above the current statutory rate.See Note 3 to the financial statements for additional information.

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Year to Date

The year to date 2022 ETR decreased to 17.1 percent from 25.2 percent in the prior year period. The year to date 2021 ETR was impacted by additional federal income taxes resulting from the IT services divestiture, as well as the change in tax revenue recognition on certain contracts described above. 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 June 30												%			Six Months Ended June 30												%
$ in millions			2022						2021						Change			2022						2021						Change
Net earnings			$	946					$	1,037					(9)		%	$	1,901					$	3,232					(41)		%
Gain on sale of business			—						—						NM			—						(1,980)						NM
State tax impact1			—						—						NM			—						160						NM
Transaction costs			—						—						NM			—						32						NM
Make-whole premium			—						—						NM			—						54						NM
Federal tax impact of items above2			—						—						NM			—						614						NM
Transaction adjustment, net of tax			$	—					$	—					NM			$	—					$	(1,120)					NM
Transaction-adjusted net earnings			$	946					$	1,037					(9)		%	$	1,901					$	2,112					(10)		%

**(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.

Current Quarter

Second quarter 2022 net earnings decreased $91 million, or 9 percent, primarily due to the lower operating income described above and $60 million of lower returns on marketable securities related to our non-qualified benefit plans and other non-operating assets, partially offset by a lower effective tax rate.

Year to Date

Year to date 2022 net earnings decreased $1.3 billion, or 41 percent, primarily due to a $1.1 billion after-tax decline associated with the IT services divestiture. Transaction-adjusted net earnings decreased $211 million, or 10 percent, primarily due to the lower operating income described above and $93 million of lower returns on marketable securities related to our non-qualified benefit plans and other non-operating assets, partially offset by a lower effective tax rate.

Diluted Earnings Per Share

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

			Three Months Ended June 30												%			Six Months Ended June 30												%
			2022						2021						Change			2022						2021						Change
Diluted EPS			$	6.06					$	6.42					(6)		%	$	12.16					$	19.89					(39)		%
Gain on sale of business per share			—						—						NM			—						(12.18)						NM
State tax impact per share1			—						—						NM			—						0.98						NM
Transaction costs per share			—						—						NM			—						0.20						NM
Make-whole premium per share			—						—						NM			—						0.33						NM
Federal tax impact of line items above per share2			—						—						NM			—						3.78						NM
Transaction adjustment per share, net of tax			$	—					$	—					NM			$	—					$	(6.89)					NM
Transaction-adjusted EPS			$	6.06					$	6.42					(6)		%	$	12.16					$	13.00					(6)		%

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

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**(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.

Current Quarter

Second quarter 2022 diluted earnings per share decreased 6 percent, reflecting a 9 percent decrease in net earnings and a 3 percent reduction in weighted-average diluted shares outstanding.

Year to Date

Year to date 2022 diluted earnings per share decreased 39 percent, principally due to a $6.89 after-tax decrease associated with the IT services divestiture. Transaction-adjusted earnings per share decreased $0.84, or 6 percent, reflecting a 10 percent decrease in transaction-adjusted net earnings and a 4 percent reduction in weighted-average diluted shares outstanding.

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).

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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 June 30												%						Six Months Ended June 30												%
$ in millions			2022						2021						Change						2022						2021						Change
Operating income			$	954					$	1,044					(9)		%				$	1,851					$	3,866					(52)		%
Reconciliation to segment operating income:
CAS pension expense			$	(41)					$	(121)					(66)		%				$	(87)					$	(244)					(64)		%
FAS pension service expense			92						103						(11)		%				184						207						(11)		%
FAS/CAS operating adjustment			51						(18)						NM						97						(37)						NM
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			61						64						(5)		%				121						129						(6)		%
Other unallocated corporate expense			7						27						(74)		%				41						42						(2)		%
Unallocated corporate expense (income)			68						91						(25)		%				162						(1,617)						NM
Segment operating income			$	1,073					$	1,117					(4)		%				$	2,110					$	2,212					(5)		%
Segment operating margin rate			12.2		%				12.2		%										12.0		%				12.1		%

Current Quarter

Second quarter 2022 segment operating income decreased $44 million, or 4 percent due to lower sales. Second quarter 2022 segment operating margin rate was comparable to the prior year period and reflects higher operating margin rates at Mission Systems and Defense Systems, offset by lower operating margin rates at Space Systems and Aeronautics Systems.

Year to Date

Year to date 2022 segment operating income decreased $102 million, or 5 percent. Year to date 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. Year to date 2022 segment operating margin rate decreased to 12.0 percent from 12.1 percent and reflects a lower operating margin rate at Space Systems, partially offset by higher operating margin rates at each of the other sectors.

FAS/CAS Operating Adjustment

Second quarter 2022 and year to date 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)

Current Quarter

The decrease in second quarter 2022 unallocated corporate expense is primarily due to a reduction in corporate unallowable costs.

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Year to Date

The change in year to date 2022 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 June 30												Six Months Ended June 30
$ in millions			2022						2021						2022						2021
Favorable EAC adjustments			$	317					$	309					$	674					$	657
Unfavorable EAC adjustments			(225)						(155)						(409)						(313)
Net EAC adjustments			$	92					$	154					$	265					$	344

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

			Three Months Ended June 30												Six Months Ended June 30
$ in millions			2022						2021						2022						2021
Aeronautics Systems			$	(9)					$	32					$	94					$	69
Defense Systems			50						28						75						58
Mission Systems			29						61						86						149
Space Systems			31						33						23						70
Eliminations			(9)						—						(13)						(2)
Net EAC adjustments			$	92					$	154					$	265					$	344

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 June 30												%						Six Months Ended June 30												%
$ in millions			2022						2021						Change						2022						2021						Change
Sales			$	2,534					$	2,913					(13)		%				$	5,237					$	5,903					(11)		%
Operating income			258						300						(14)		%				565						608						(7)		%
Operating margin rate			10.2		%				10.3		%										10.8		%				10.3		%

Sales

Current Quarter

Second quarter 2022 sales decreased $379 million, or 13 percent, due to lower volume in both Manned Aircraft and Autonomous Systems, including restricted programs, F-35, Global Hawk, and the NATO Alliance Ground Surveillance (AGS) program, as Full System Handover occurred early in the second quarter of 2022.

Year to Date

Year to date 2022 sales decreased $666 million, or 11 percent, due to lower volume in both Manned Aircraft and Autonomous Systems, including restricted programs and the E-2, Global Hawk, F-35 and Triton programs.

Operating Income

Current Quarter

Second quarter 2022 operating income decreased $42 million, or 14 percent, primarily due to lower sales. Operating margin rate decreased to 10.2 percent from 10.3 percent primarily due to lower net EAC adjustments, principally associated with restricted work and close-out of an international program, partially offset by a $38 million gain on a property sale.

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Year to Date

Year to date 2022 operating income decreased $43 million, or 7 percent, due to lower sales, partially offset by a higher operating margin rate. Operating margin rate increased to 10.8 percent from 10.3 percent primarily due to a $38 million gain on a property sale and higher net favorable EAC adjustments. Higher net favorable EAC adjustments reflect 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 lower net EAC adjustments associated with other restricted work. Prior year results include the previously described overhead rate benefit to fixed price contracts.

DEFENSE SYSTEMS			Three Months Ended June 30												%						Six Months Ended June 30												%
$ in millions			2022						2021						Change						2022						2021						Change
Sales			$	1,294					$	1,427					(9)		%				$	2,577					$	2,989					(14)		%
Operating income			168						177						(5)		%				323						354						(9)		%
Operating margin rate			13.0		%				12.4		%										12.5		%				11.8		%

Sales

Current Quarter

Second quarter 2022 sales decreased $133 million, or 9 percent, primarily due to completion of a Joint Services support program, lower scope on an international training program, and wind down of the UKAWACS and JSTARS programs.

Year to Date

Year to date 2022 sales decreased $412 million, or 14 percent, due, in part, to a $106 million reduction in sales related to the IT services divestiture. Year to date 2022 organic sales decreased $306 million, or 11 percent, principally due to lower scope on an international training program, completion of a Joint Services support program, and lower volume on the Advanced Anti-Radiation Guided Missile (AARGM).

Operating Income

Current Quarter

Second quarter 2022 operating income decreased $9 million, or 5 percent, due to lower sales, partially offset by a higher operating margin rate. Operating margin rate increased to 13.0 percent from 12.4 percent primarily due to improved performance in Battle Management and Missile Systems.

Year to Date

Year to date 2022 operating income decreased $31 million, or 9 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 12.5 percent from 11.8 percent primarily due to improved performance in Battle Management and Missile Systems.

MISSION SYSTEMS			Three Months Ended June 30												%						Six Months Ended June 30												%
$ in millions			2022						2021						Change						2022						2021						Change
Sales			$	2,516					$	2,588					(3)		%				$	5,013					$	5,177					(3)		%
Operating income			413						408						1		%				798						805						(1)		%
Operating margin rate			16.4		%				15.8		%										15.9		%				15.5		%

Sales

Current Quarter

Second quarter 2022 sales decreased $72 million, or 3 percent, primarily due to lower volume on Navigation, Targeting and Survivability programs, the Joint Counter Radio-Controlled Improvised Explosive Device Electronic Warfare (JCREW) program, and airborne radar programs. These decreases were partially offset by an increase in restricted sales in the Networked Information Solutions business area and higher volume on Ground/Air Task-Oriented Radar (G/ATOR) and Surface Electronic Warfare Improvement Program (SEWIP).

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Year to Date

Year to date 2022 sales decreased $164 million, or 3 percent, due, in part, to a $42 million reduction in sales related to the IT services divestiture. Year to date 2022 organic sales decreased $122 million, or 2 percent, primarily due to lower volume on Navigation, Targeting and Survivability programs, the JCREW program and airborne radar programs. These decreases were partially offset by an increase in restricted sales in the Networked Information Solutions business area and higher volume on G/ATOR and SEWIP.

Operating Income

Current Quarter

Second quarter 2022 operating income increased $5 million, or 1 percent, due to a higher operating margin rate. Operating margin rate increased to 16.4 percent from 15.8 percent principally due to a $33 million benefit recognized in connection with a contract-related legal matter, partially offset by lower net EAC adjustments at Maritime/Land Systems and Sensors.

Year to Date

Year to date 2022 operating income decreased $7 million, or 1 percent, principally due to lower sales, partially offset by a higher operating margin rate. Operating margin rate increased to 15.9 percent from 15.5 percent principally due to a $33 million benefit recognized in connection with a contract-related legal matter, partially offset by the previously described overhead rate benefit to fixed price contracts in the prior year.

SPACE SYSTEMS			Three Months Ended June 30												%						Six Months Ended June 30												%
$ in millions			2022						2021						Change						2022						2021						Change
Sales			$	2,979					$	2,748					8		%				$	5,834					$	5,269					11		%
Operating income			310						301						3		%				571						577						(1)		%
Operating margin rate			10.4		%				11.0		%										9.8		%				11.0		%

Sales

Current Quarter

Second quarter 2022 sales increased $231 million, or 8 percent, primarily due to higher sales in the Launch & Strategic Missiles business area due to ramp-up on development programs, including a $123 million increase on the Next Generation Interceptor (NGI) program and a $95 million increase on the Ground Based Strategic Deterrent (GBSD) program. Sales in the Space business area were comparable with the prior year period and reflect higher volume on restricted programs and the Space Development Agency (SDA) Tranche 1 Transport Layer (T1TL) program, partially offset by lower volume on the James Webb Space Telescope after its successful launch in December 2021.

Year to Date

Year to date 2022 sales increased $565 million, or 11 percent, and includes a $16 million reduction in sales related to the IT services divestiture. Year to date 2022 organic sales increased $581 million, or 11 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 $253 million increase on NGI and a $212 million increase on GBSD. Sales in the Space business area were driven by higher volume on restricted programs, SDA T1TL, and the Commercial Resupply Services program, partially offset by lower volume on the James Webb Space Telescope and other commercial space programs.

Operating Income

Current Quarter

Second quarter 2022 operating income increased $9 million, or 3 percent, due to higher sales, partially offset by a lower operating margin rate. Operating margin rate decreased to 10.4 percent from 11.0 percent primarily due to higher volume on early-stage development programs, such as NGI and GBSD.

Year to Date

Year to date 2022 operating income decreased $6 million, or 1 percent, due to a lower operating margin rate, partially offset by higher sales. Operating margin rate decreased to 9.8 percent from 11.0 percent primarily due to lower net EAC adjustments and higher volume on early-stage development programs. Prior year results include the previously described overhead rate benefit to fixed price contracts.

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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 June 30															Six Months Ended June 30
$ in millions			2022						2021									2022						2021
Segment Information:			Sales			Operating Costs and Expenses			Sales			Operating Costs and Expenses						Sales			Operating Costs and Expenses			Sales			Operating Costs and Expenses
Aeronautics Systems
Product			$	1,916		$	1,733		$	2,484		$	2,230					$	3,961		$	3,537		$	5,008		$	4,504
Service			560			497			384			342						1,153			1,030			806			711
Intersegment eliminations			58			46			45			41						123			105			89			80
Total Aeronautics Systems			2,534			2,276			2,913			2,613						5,237			4,672			5,903			5,295
Defense Systems
Product			598			515			641			560						1,208			1,042			1,321			1,155
Service			522			457			591			517						996			882			1,288			1,141
Intersegment eliminations			174			154			195			173						373			330			380			339
Total Defense Systems			1,294			1,126			1,427			1,250						2,577			2,254			2,989			2,635
Mission Systems
Product			1,748			1,473			1,774			1,515						3,510			2,982			3,534			3,008
Service			509			412			560			451						998			808			1,152			948
Intersegment eliminations			259			218			254			214						505			425			491			416
Total Mission Systems			2,516			2,103			2,588			2,180						5,013			4,215			5,177			4,372
Space Systems
Product			2,517			2,250			2,294			2,045						4,941			4,445			4,352			3,874
Service			431			391			423			374						831			762			847			755
Intersegment eliminations			31			28			31			28						62			56			70			63
Total Space Systems			2,979			2,669			2,748			2,447						5,834			5,263			5,269			4,692
Segment Totals
Total Product			$	6,779		$	5,971		$	7,193		$	6,350					$	13,620		$	12,006		$	14,215		$	12,541
Total Service			2,022			1,757			1,958			1,684						3,978			3,482			4,093			3,555
Total Segment**(1)**			$	8,801		$	7,728		$	9,151		$	8,034					$	17,598		$	15,488		$	18,308		$	16,096

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

Product Sales and Costs

Current Quarter

Second quarter 2022 product sales decreased $414 million, or 6 percent, primarily due to a decrease in product sales at Aeronautics Systems, partially offset by an increase in product sales at Space Systems. The decrease at Aeronautics Systems was principally due to lower volume on restricted programs, as well as the F-35, Global Hawk and NATO AGS programs. The increase at Space Systems was driven by ramp-up on development programs including NGI and GBSD.

Second quarter 2022 product costs decreased $379 million, or 6 percent, consistent with the lower product sales.

Year to Date

Year to date 2022 product sales decreased $595 million, or 4 percent, primarily due to a decrease in product sales at Aeronautics Systems, partially offset by an increase 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, Global Hawk, and F-35 programs. The increase at Space Systems is principally related to ramp-up on development programs including NGI and GBSD, as well as higher volume on restricted space programs.

Year to date 2022 product costs decreased $535 million, or 4 percent, consistent with the lower product sales.

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Service Sales and Costs

Current Quarter

Second quarter 2022 service sales increased $64 million, or 3 percent, primarily due to an increase in service sales at Aeronautics Systems, partially offset by a decrease in service sales at Defense Systems. The increase at Aeronautics Systems was principally due to higher service volume on restricted programs. The decrease at Defense Systems was primarily driven by the completion of a Joint Services support program and lower volume on an international training program.

Second quarter 2022 service costs increased $73 million, or 4 percent, due to higher service sales, partially offset by lower margins on Space Systems service programs.

Year to Date

Year to date 2022 service sales decreased $115 million, or 3 percent, primarily due to the IT services divestiture as well as lower volume on an international training program and completion of a Joint Services support 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.

Year to date 2022 service costs decreased $73 million, or 2 percent, due to lower services sales, partially offset by higher margins on Mission Systems service programs.

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 June 30, 2022 and December 31, 2021:

						June 30, 2022																		December 31, 2021
$ in millions						Funded						Unfunded						Total Backlog						Total Backlog						% Change in 2022
Aeronautics Systems						$	9,466					$	10,482					$	19,948					$	18,277					9		%
Defense Systems						5,522						826						6,348						6,349						—		%
Mission Systems						10,557						4,224						14,781						14,306						3		%
Space Systems						8,850						30,054						38,904						37,114						5		%
Total backlog						$	34,395					$	45,586					$	79,981					$	76,046					5		%

New Awards

Second quarter and year to date 2022 net awards totaled $13.0 billion and $21.5 billion, respectively, and backlog totaled $80.0 billion. Significant second quarter new awards include $3.5 billion for F-35 at Aeronautics Systems, largely related to Lots 15-17, $2.2 billion for restricted programs (at Aeronautics Systems, Space Systems and Mission Systems), $2.1 billion for GEM63 solid rocket boosters, largely related to Amazon’s Project Kuiper, and $0.5 billion for Triton.

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 June 30, 2022, we had $1.2 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

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aggregate principal amount of $2.0 billion, and in April 2022, we renewed our one-year $500 million uncommitted credit facility. At June 30, 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.

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. 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. We have made federal tax payments of approximately $450 million related to Section 174 during the six months ended June 30, 2022.

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 (used in) provided by operating activities:

															Six Months Ended June 30												%
$ in millions																					2022						2021						Change
Net earnings																					$	1,901					$	3,232					(41)		%
Gain on sale of business																					—						(1,980)						NM
Non-cash items(1)																					(321)						(33)						873		%
Pension and OPB contributions																					(71)						(74)						(4)		%
Changes in trade working capital																					(2,261)						(164)						1,279		%
Other, net																					67						(19)						(453)		%
Net cash (used in) provided by operating activities																					$	(685)					$	962					(171)		%

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

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Year to date 2022 net cash used in operating activities was $685 million compared to net cash provided by operating activities of $962 million in the prior year period. This change reflects increases in trade working capital due, in part, to unexpected delays in the timing of customer payments near the end of the quarter, which pushed certain cash receipts into the early part of the third quarter. In the second quarter of 2022, the company made $450 million of federal tax payments related to the current provisions of IRC Section 174. In the second quarter of 2021, the company made $390 million of tax payments related to the IT services divestiture.

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.

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

															Six Months Ended June 30												%
$ in millions																					2022						2021						Change
Net cash (used in) provided by operating activities																					$	(685)					$	962					(171)		%
Capital expenditures																					(507)						(435)						17		%
Proceeds from sale of equipment to a customer																					—						56						NM
Adjusted free cash flow																					$	(1,192)					$	583					(304)		%

Year to date 2022 adjusted free cash flow decreased $1.8 billion, 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

Year to date 2022 net cash used in investing activities was $468 million compared to net cash provided by investing activities of $3.0 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

Year to date 2022 net cash used in financing activities decreased $3.7 billion, as compared with the same period in 2021, principally due to a $2.2 billion decrease in debt repayments and a $1.5 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

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“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, including as a result of labor shortages and/or inflationary pressures

• 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

• our ability to attract and retain a qualified workforce with the required security clearances and requisite skills to meet our performance obligations

• 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

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• 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, gains or losses associated with changes in valuation of marketable securities related to our non-qualified benefit plans, 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

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.