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Northrop Grumman 10-K 2012
Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

x  

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2011

or

 

¨  

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to             

Commission file number 1-16411

NORTHROP GRUMMAN CORPORATION

(Exact name of registrant as specified in its charter)

 

DELAWARE   80-0640649

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

2980 Fairview Park Drive, Falls Church, Virginia 22042 (703) 280-2900

(Address and telephone number of principal executive offices)

Securities registered pursuant to section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $1 par value   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes  x                                                                                                                       No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.

Yes  ¨                                                                                                                       No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x                                                                                                                       No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  x                                                                                                                       No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x   Accelerated filer  ¨    Non-accelerated filer  ¨   Smaller reporting company  ¨
  (Do not check if a smaller reporting company)                

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes  ¨                                                                                                                       No  x

As of July 1, 2011, the aggregate market value of the common stock (based upon the closing price of the stock on the New York Stock Exchange) of the registrant held by non-affiliates was approximately $19.5 billion.

As of February 6, 2012, 252,631,776 shares of common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Northrop Grumman Corporation’s Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A for the 2012 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K.

 

 

 


Table of Contents

NORTHROP GRUMMAN CORPORATION

TABLE OF CONTENTS

 

          Page  
   PART I   
Item 1.   

Business

     1   
Item 1A.   

Risk Factors

     8   
Item 1B.   

Unresolved Staff Comments

     20   
Item 2.   

Properties

     20   
Item 3.   

Legal Proceedings

     21   
Item 4.   

Mine Safety Disclosures

     22   
   PART II   
Item 5.   

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     23   
Item 6.   

Selected Financial Data

     26   
Item 7.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     27   
  

OVERVIEW

     27   
  

BUSINESS DISPOSITIONS

     29   
  

CONTRACTS

     30   
  

CRITICAL ACCOUNTING POLICIES, ESTIMATES, AND JUDGMENTS

     31   
  

CONSOLIDATED OPERATING RESULTS

     36   
  

KEY SEGMENT FINANCIAL MEASURES

     42   
  

BACKLOG

     46   
  

LIQUIDITY AND CAPITAL RESOURCES

     48   
  

OTHER MATTERS

     51   
  

GLOSSARY OF PROGRAMS

     52   
Item 7A.   

Quantitative and Qualitative Disclosures about Market Risk

     56   
Item 8.   

Financial Statements and Supplementary Data

     57   
  

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

     57   
  

CONSOLIDATED STATEMENTS OF OPERATIONS

     58   
  

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

     59   
  

CONSOLIDATED STATEMENTS OF CASH FLOWS

     60   
  

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

     62   
  

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     63   
  

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     63   
  

2. ACCOUNTING STANDARDS UPDATES

     69   
  

3. DIVIDENDS ON COMMON STOCK

     69   
  

4. EARNINGS PER SHARE

     69   
  

5. BUSINESS ACQUISITIONS

     70   
  

6. BUSINESS DISPOSITIONS

     70   
  

7. SEGMENT INFORMATION

     72   
  

8. ACCOUNTS RECEIVABLE, NET

     75   
  

9. INVENTORIED COSTS, NET

     76   
  

10. INCOME TAXES

     76   
  

11. GOODWILL AND OTHER PURCHASED INTANGIBLE ASSETS

     79   
  

12. FAIR VALUE OF FINANCIAL INSTRUMENTS

     80   

 

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          Page  
  

13. LONG-TERM DEBT

     82   
  

14. INVESTIGATIONS, CLAIMS AND LITIGATION

     84   
  

15. COMMITMENTS AND CONTINGENCIES

     85   
  

16. RETIREMENT BENEFITS

     87   
  

17. STOCK COMPENSATION PLANS

     95   
  

18. UNAUDITED SELECTED QUARTERLY DATA

     99   
Item 9.   

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     100   
Item 9A.   

Controls and Procedures

     100   
Item 9B.   

Other Information

     100   
  

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

     101   
  

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

     102   
   PART III   
Item 10.   

Directors, Executive Officers, and Corporate Governance

     103   
Item 11.   

Executive Compensation

     105   
Item 12.   

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     105   
Item 13.   

Certain Relationships and Related Transactions, and Director Independence

     105   
Item 14.   

Principal Accountant Fees and Services

     105   
   PART IV   
Item 15.   

Exhibits and Financial Statement Schedules

     106   
  

SIGNATURES

     116   

 

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NORTHROP GRUMMAN CORPORATION

 

PART I

 

Item 1. Business

HISTORY AND ORGANIZATION

History

Northrop Grumman Corporation (herein referred to as “Northrop Grumman,” the “company,” “we,” “us,” or “our”) provides technologically advanced, innovative products, services, and integrated solutions in aerospace, electronics, information and services to our global customers. We participate in many high-priority defense and government services technology programs in the United States (U.S.) and abroad as a prime contractor, principal subcontractor, partner, or preferred supplier. We conduct most of our business with the U.S. Government, principally the Department of Defense (DoD) and intelligence community. We also conduct business with local, state, and foreign governments and domestic and international commercial customers. For a discussion of risks associated with our operations, see Risk Factors in Part I, Item 1A.

The company was originally formed in 1939 as Northrop Corporation and was later reincorporated in Delaware in 1985. Some of the most notable acquisitions during the last two decades included the acquisition of Grumman Corporation (Grumman) in 1994, after which time the company was renamed Northrop Grumman Corporation. Grumman was a premier military aircraft systems integrator and builder of the Lunar Module that first delivered men to the surface of the moon. In 1996, we acquired the defense and electronics businesses of Westinghouse Electric Corporation (Westinghouse), which now forms the nucleus of the Electronics Systems segment. Westinghouse was a world leader in the development and production of sophisticated radar and other electronic systems for the nation’s defense, civil aviation, and other international and domestic applications. In 2001, we acquired Litton Industries, a global electronics and information technology enterprise, and one of the nation’s leading full-service design, engineering, construction, and life cycle supporters of major surface ships for the United States (U.S.) Navy, U.S. Coast Guard, and international navies. Also in 2001, we acquired Newport News Shipbuilding, the nation’s sole designer, builder and refueler of nuclear-powered aircraft carriers and one of only two companies designing and building nuclear-powered submarines. In 2002, we acquired TRW Inc. (TRW), a leading developer of military and civil space systems and satellite payloads, as well as a leading global integrator of complex, mission-enabling systems and services. Other more recent acquisitions included the acquisition of Integic Corporation (2005), an information technology provider specializing in enterprise health and business process management solutions, and Essex Corporation (2007), a signal processing product and services provider to U.S. intelligence and defense customers.

Spin-off of Shipbuilding Business

Effective as of March 31, 2011, the company completed the spin-off to its shareholders of Huntington Ingalls Industries, Inc. (HII). HII operates our former Shipbuilding business. The spin-off was the culmination of the company’s decision to explore strategic alternatives for Shipbuilding, as it was determined to be in the best interests of shareholders, customers, and employees by allowing the company and Shipbuilding to pursue more effectively their respective opportunities to maximize value. As a result of the spin-off, assets, liabilities and results of operations for the former Shipbuilding segment have been reclassified as discontinued operations for all periods presented. See Note 6 to our consolidated financial statements in Part II, Item 8 for further information.

Organization

From time to time, we acquire or dispose of businesses, and realign contracts, programs or business areas among and within our operating segments that possess similar customers, expertise, and capabilities. Internal realignments are designed to more fully leverage existing capabilities and enhance development and delivery of products and services. The operating results for all periods presented have been revised to reflect these changes made through December 31, 2011.

We are currently aligned into four operating segments: Aerospace Systems, Electronic Systems, Information Systems, and Technical Services. See Note 7 to our consolidated financial statements in Part II, Item 8.

 

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AEROSPACE SYSTEMS

Aerospace Systems, headquartered in Redondo Beach, California, is a leader in the design, development, integration and production of manned and unmanned aircraft, spacecraft, high-energy laser systems, microelectronics and other systems and subsystems. Aerospace Systems’ customers, primarily domestic government agencies, use these systems in many different mission areas including intelligence, surveillance and reconnaissance; communications; battle management; strike operations; electronic warfare; missile defense; earth observation; space science; and space exploration. The segment consists of four business areas: Strike & Surveillance Systems; Space Systems; Battle Management & Engagement Systems; and Advanced Programs & Technology.

Strike & Surveillance Systems – designs, develops, manufactures and integrates tactical and long-range strike aircraft systems, unmanned systems, and missile systems. Key programs include the RQ-4 Global Hawk unmanned reconnaissance system, B-2 stealth bomber, F-35 Lightning II (F-35), F/A-18 Super Hornet strike fighter, Minuteman III Intercontinental Ballistic Missile (ICBM), MQ-8B Fire Scout unmanned aircraft system, and Multi-Platform Radar Technology Insertion Program (MP-RTIP).

Space Systems – designs, develops, manufactures, and integrates spacecraft systems, subsystems and electronic and communications payloads. Major programs include the James Webb Space Telescope (JWST), Advanced Extremely High Frequency (AEHF) payload and many restricted programs.

Battle Management & Engagement Systems – designs, develops, manufactures, and integrates airborne early warning, surveillance, battlefield management, and electronic warfare systems. Key programs include the E-2 Hawkeye, Joint Surveillance Target Attack Radar System (Joint STARS), Broad Area Maritime Surveillance (BAMS) unmanned aircraft system, EA-6B Prowler and its next generation platform, the EA-18G Growler, and Long Endurance Multi Intelligence Vehicle (LEMV).

Advanced Programs & Technology – creates advanced technologies and concepts to satisfy existing and emerging customer needs. This business area matures these technologies and concepts to create and capture new programs that other Aerospace Systems business areas can execute. Existing programs include the Navy Unmanned Combat Air System (N-UCAS), and other directed energy and advanced concepts programs.

ELECTRONIC SYSTEMS

Electronic Systems, headquartered in Linthicum, Maryland, is a leader in the design, development, manufacture, and support of solutions for sensing, understanding, anticipating, and controlling the environment for our global military, civil, and commercial customers and their operations. Electronic Systems provides a variety of defense electronics and systems, airborne fire control radars, situational awareness systems, early warning systems, airspace management systems, navigation systems, communications systems, marine systems, space systems, and logistics services. The segment consists of five business areas: Intelligence, Surveillance, & Reconnaissance Systems; Land & Self Protection Systems; Naval & Marine Systems; Navigation Systems; and Targeting Systems.

Intelligence, Surveillance & Reconnaissance (ISR) Systems – delivers products and services for space satellite applications, airborne and ground based surveillance, multi-sensor processing, analysis, and dissemination for combat units and national agencies both domestically and internationally, providing battlespace awareness, missile defense, and command and control. The division continues to develop advanced space-based radar and electro-optical early warning and surveillance systems for strategic, tactical, and weather operations along with systems for enhancing the discovery, sharing, and exploitation of ISR data. Key products include the Space-Based Infrared System (SBIRS), Defense Meteorological Satellite Program (DMSP), Defense Support Program (DSP), ground processing, exploitation and dissemination systems, the TPS-78/703 family of ground based surveillance radars, and the Multi-role Electronically Scanned Array (MESA) radar.

Land & Self Protection Systems – delivers products, systems, and services that support ground-based, helicopter and fixed wing platforms (manned and unmanned) with sensor and protection systems. These systems perform threat detection and countermeasures that defeat infrared and radio frequency (RF) guided missile and tracking systems.

 

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The division also provides integrated electronic warfare capability, communications, and intelligence systems; unattended ground sensors; automatic test equipment; and advanced threat simulators. Key programs include the U.S. Marine Corps Ground/Air Task Oriented Radar (G/ATOR) multi-mission radar; the Large Aircraft Infrared Countermeasures (LAIRCM) system for the U.S. Air Force, U.S. Navy, and strategic international and NATO allies; the AN/ALQ-131(V) electronic countermeasures pod; the LR-100 high-performance radar warning receiver (RWR)/electronic support measures (ESM)/electronic intelligence (ELINT) receiver system; the U.S. Army’s STARLite Synthetic Aperture Radar for Unmanned Aerial Vehicles (UAVs); the U.S. Army Vehicle Intercom Systems (VIC-3 and VIC-5); the U.S. Army Next Generation Automated Test System (NGATS); the U.S. Air Force Joint Threat Emitter (JTE) training range system; and the Vehicle and Dismount Exploitation Radar (VADER) system that enable airborne platforms to track individual persons or vehicles.

Naval & Marine Systems – delivers products and services to defense, civil, and commercial customers supporting smart navigation, shipboard radar surveillance, ship control, machinery control, integrated combat management systems for naval surface ships, high-resolution undersea sensors (for mine hunting, situational awareness, and other applications), unmanned marine vehicles, shipboard missile and encapsulated payload launch systems, propulsion and power generation systems, and nuclear reactor instrumentation and control. Key products include Integrated Bridge and Navigation Systems, Voyage Management System, Integrated Platform Management Systems, Integrated Combat Management System, AN/WSN-7 Inertial Navigator, anti-ship missile defense and surveillance radars (Cobra Judy, AN/SPQ-9B, AN/SPS-74), propulsion equipment, missile launch, and sonar systems for the Virginia-class submarine, and launch system support for the Ohio-class submarine.

Navigation Systems – delivers products and services to defense, civil, and commercial customers supporting situational awareness, inertial navigation in all domains (air, land, sea, and space), embedded Global Positioning Systems, Identification Friend or Foe (IFF) systems, acoustic sensors, cockpit video monitors, mission computing, and integrated avionics and electronics systems. Key products include the Integrated Avionics System, the AN/TYQ-23 Aircraft Command and Control System, Fiber Optic Acoustic Sensors, and a robust portfolio of inertial sensors and navigation systems.

Targeting Systems – delivers products and services supporting airborne combat avionics (fire control radars, multi-function apertures and pods), airborne electro-optical/infrared targeting systems, and laser/electro-optical systems including hand-held, tripod-mounted, and ground or air vehicle mounted systems. Key products include fire control radars for the B-1B, F-16 (worldwide), F-22 U.S. Air Force, and F-35; AN/APN-241 navigation/weather radar; the AN/AAQ-28(V) LITENING family of targeting pods; Distributed Aperture EO/IR systems; and the Lightweight Laser Designator Rangefinder (LLDR).

In addition to the product and service lines discussed above, the Electronic Systems segment also includes the Advanced Concepts & Technologies Division (AC&TD), which develops next-generation systems and architectures to position the segment in key developing markets. AC&TD focuses on understanding customer mission needs; conceiving affordable, innovative and open solutions; and demonstrating the readiness and effectiveness of Electronic Systems’ products, including all types of sensors, microsystems, and associated information systems. The segment uses a “Product Ownership” approach, which guides the transition of new technology from laboratory to market and implements modular open system product families that are readily reconfigurable and scalable to affordably support new requirements, new products, or component obsolescence.

INFORMATION SYSTEMS

Information Systems, headquartered in McLean, Virginia, is a leading provider of advanced solutions for the DoD, national intelligence, federal civilian, state and local agencies, and commercial and international customers. Products and services focus on the fields of command, control, communications, computers (C4) and intelligence; airborne reconnaissance; intelligence processing; air and missile defense; decision support systems; cybersecurity; information technology; and systems engineering and integration. The segment consists of three business areas: Defense Systems; Intelligence Systems; and Civil Systems.

 

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Defense Systems is a major end-to-end provider of net-enabled Battle Management, C4 Intelligence, Surveillance, and Reconnaissance (C4ISR) systems, decision superiority, and mission-enabling solutions and services in support of the national defense and security of our nation and its allies. Defense Systems is a prime developer and integrator of many of the DoD’s programs-of-record, particularly for command and control (C2) and communications for the U.S. Air Force, U.S. Army, U.S. Navy, and Joint Forces. Major products and services include C4ISR Integration, Mission Systems Integration, Military Communications and Networks, Battle Management C2 and Decision Support Systems, Tactical and Operational C2, Ground and Maritime Combat Systems, Air and Missile Defense, Combat Support Solutions and Services, Enterprise Infrastructure and Applications, Defense Logistics Systems, Identity Management and Biometric Solutions, Cloud Computing, Maritime Mission Systems and Force and Critical Infrastructure Protection. Systems are installed in operational and command centers worldwide and across all DoD services and joint commands.

Intelligence Systems is focused on the delivery of intelligence-related systems and services to the U.S. Government and the international security community. Intelligence Systems focuses on several mission areas including Airborne Intelligence, Signals Intelligence (SIGINT) Systems, Cybersecurity, Geospatial Intelligence, Pervasive Intelligence, Surveillance and Reconnaissance (ISR), Ground Systems, Multi-Source Intelligence Data Fusion, and Dynamic Cyber Defense. Major offerings include large-scale intelligence sensing, processing, exploitation and dissemination systems, extremely Large-Scale Data Information Management, Intelligence and Prime Systems Integration, Knowledge Discovery Processes, ISR/Communications Quick Reaction Capability Solutions, Sensor Systems, Support to Special Operations, Cyber-SIGINT Mission Management/Multi-Intelligence, Language Services/Intelligence Analysis, Cyber Exploitation, Satellite Ground Stations, Weather Services, Geospatial Systems, Product Generation and Dissemination, Counter Narco-Terrorism, Drug Enforcement Operations, Geo-Intelligence Tradecraft Training, Enterprise Information Technology, Ground-Based Sensing, Studies and Analysis, Sustainment, Operations and Maintenance.

Civil Systems provides specialized information systems and services in support of critical civilian government missions, such as homeland security, health, cybersecurity, civil financial, law enforcement and public safety. Primary customers are federal civilian agencies with some state and local and international customers. Civil Systems develops and implements solutions that combine a deep understanding of civil government domains with core expertise in prime systems integration, enterprise applications development, and high value information technology service including cybersecurity, advanced networking and cloud computing.

TECHNICAL SERVICES

Technical Services, headquartered in Herndon, Virginia, is a provider of logistics, infrastructure, and sustainment support, while also providing an array of modernization, high technology, and training and simulation services. The segment consists of three business areas: Defense and Government Services; Training Solutions; and Integrated Logistics and Modernization.

Defense and Government Services – provides maintenance, repair, and overhaul (MRO) of combat vehicles, engineering and high technology services for nuclear security and space missions, civil engineering work, military range work, launch services, and range-sensor-instrumentation operations. The division’s customer base includes the U.S. Army, Department of Energy, the DoD, NASA, and the intelligence community.

Training Solutions – provides realistic and comprehensive training to senior military leaders, international and peacekeeping forces. The division designs and develops future conflict training scenarios, and provides warfighters and allies with live, virtual, and constructive training programs. The division has supported the training of America’s senior battlefield commanders for every major contingency beginning with Gulf War I through Operation Iraqi Freedom. The division offers diverse training applications ranging from battle command to professional military education. Primary customers include the DoD, Department of State, and Department of Homeland Security.

Integrated Logistics and Modernization – provides complete life cycle product and weapon system sustainment and modernization. The division is focused on providing direct support to warfighters and delivering aircraft MRO;

 

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subsystem MRO and modernization; supply chain management services, warehousing and inventory transportation, field services and mobilization, sustaining engineering, maintenance, repair and overhaul supplies, and on-going weapons maintenance and technical assistance. The division specializes in quick reaction capability and deployed operations in support of customers. Primary customers include the DoD, as well as international military and commercial customers.

Corporate

Our principal executive offices are located at 2980 Fairview Park Drive, Falls Church, Virginia 22042. Our telephone number is (703) 280-2900 and our home page on the Internet is www.northropgrumman.com. References to our website in this report are provided as a convenience and do not constitute, and should not be viewed as, incorporation by reference of the information contained on, or available through, the website. Such information should not be considered part of this report.

SELECTED FINANCIAL DATA AND SUMMARY SEGMENT FINANCIAL DATA

For a more complete understanding of our business, see Selected Financial Data in Part II, Item 6. For a more complete understanding of our segment financial information, see Segment Operating Results in Part II, Item 7, and Note 7 to the consolidated financial statements in Part II, Item 8.

CUSTOMERS AND REVENUE CONCENTRATION

Our primary customer is the U.S. Government. Revenue from the U.S. Government (which includes Foreign Military Sales – a method to sell U.S. defense equipment, services and training to foreign governments through the DoD) accounted for more than 90 percent of total revenues in each of 2011, 2010, and 2009. No single product or service accounted for more than ten percent of total revenue during any period presented. See Risk Factors in Part I, Item 1A.

PATENTS

The following table summarizes the number of patents we own or have pending as of December 31, 2011:

 

     Owned    Pending    Total

U.S. patents

      2,941          311          3,252  

Foreign patents

      2,181          517          2,698  

Total

      5,122          828          5,950  

Patents developed while under contract with the U.S. Government may be subject to use by the U.S. Government. We license intellectual property to, and from, third parties. We believe our ability to conduct operations would not be materially affected by the loss of any particular intellectual property right. See Risk Factors in Part I, Item 1A.

SEASONALITY

No material portion of our business is considered to be seasonal. Our revenue recognition timing is based on several factors, including the timing of contract awards, the incurrence of contract costs, cost estimation, and in some cases unit deliveries. See Critical Accounting Policies, Estimates, and Judgments – Revenue Recognition in Part II, Item 7.

BACKLOG

Total backlog includes both funded backlog (firm orders for which funding is contractually obligated by the customer) and unfunded backlog (firm orders for which funding is not currently contractually obligated by the customer). Unexercised contract options and unfunded indefinite delivery indefinite quantity (IDIQ) orders (except for authorized task orders, which are included up to the authorized value) are not included in unfunded

 

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backlog. For multi-year services contracts with non-federal government customers having no stated contract values, backlog includes only the amounts committed by the customer. Backlog is converted into sales as work is performed or deliveries are made. At December 31, 2011, total backlog was $39.5 billion, compared with $46.8 billion at the end of 2010, and includes a $3 billion adjustment for a change in the company’s backlog measurement criteria, which acknowledges, in our judgment, the reduced likelihood of amounts remaining on certain open, but unfulfilled contracts, being realized as future sales. Approximately 59 percent of backlog at December 31, 2011, is expected to be converted into sales in 2012. For backlog by segment, see Backlog in Part II, Item 7.

RAW MATERIALS

While we have generally been able to obtain key raw materials required in our production processes in a timely manner, a significant delay in supply deliveries could have a material adverse effect on the company’s consolidated financial position, results of operations, or cash flows. See Risk Factors in Part I, Item 1A and Overview – Outlook in Part II, Item 7.

GOVERNMENT CONTRACT REGULATION

Our businesses are affected by numerous laws and regulations, including those relating to the award, administration and performance of U.S. Government contracts. See Risk Factors in Part I, Item 1A.

The U.S. Government generally has the ability to terminate our contracts, in whole or in part, without prior notice, for convenience or for default based on performance. If a U.S. Government contract were to be terminated for convenience, we would generally be protected by provisions covering reimbursement for costs incurred on the contracts and profit on those costs, but not the anticipated profit that would have been earned had the contract been completed. In the unusual circumstance where a U.S. Government contract does not have such termination protection, we attempt to mitigate the termination risk through other means. Termination resulting from our default may expose us to liability and could have a material adverse effect on our ability to compete for other contracts. See Risk Factors in Part I, Item 1A.

Certain programs with the U.S. Government that are prohibited by the customer from being publicly discussed in detail are referred to as “restricted” in this Form 10-K. The consolidated financial statements and financial information in this Form 10-K reflect the operating results of restricted programs under accounting principles generally accepted in the United States of America (GAAP).

RESEARCH AND DEVELOPMENT

Our research and development activities primarily include independent research and development (IR&D) efforts related to government programs. IR&D expenses are included in general and administrative expenses and are generally allocated to U.S. Government contracts. Company-sponsored IR&D expenses totaled $543 million, $580 million, and $588 million in 2011, 2010, and 2009, respectively. Expenses for research and development sponsored by the customer are charged directly to the related contracts.

EMPLOYEE RELATIONS

We believe that we maintain good relations with our 72,500 employees, of which approximately 3,400 are covered by 17 collective bargaining agreements. We negotiated or re-negotiated three of our collective bargaining agreements in 2011 and expect to re-negotiate renewals for nine of our collective bargaining agreements in 2012. These negotiations had no material adverse effect on our results of operations. For risks associated with collective bargaining agreements, see Risk Factors in Part I, Item 1A.

ENVIRONMENTAL MATTERS

Our manufacturing operations are subject to and affected by federal, state, foreign, and local laws and regulations relating to the protection of the environment. The estimated cost to complete remediation is accrued when it is probable that the company will incur costs to address environmental impacts at currently or formerly owned or leased operating facilities or at sites where the company has been named a Potentially Responsible Party (PRP) by

 

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the Environmental Protection Agency or similarly designated by other environmental agencies. To assess the potential impact on the company’s financial statements, management estimates the range of reasonably possible remediation costs that could be incurred by the company, taking into account the facts currently available to the company regarding each site as well as the current state of technology and prior experience. These estimates are reviewed periodically and adjusted to reflect changes in facts and circumstances. As of December 31, 2011, management estimates the range of reasonably possible future costs for environmental remediation is $294 million to $752 million. See Risk Factors in Part I, Item 1A.

As of December 31, 2011 and 2010, amounts accrued for probable environmental remediation costs are $322 million and $313 million, respectively. We record accruals for environmental cleanup costs in the accounting period in which we believe it becomes probable we have incurred a liability and the costs can be reasonably estimated, based on facts as then understood by us. These accruals do not include any litigation costs, nor do they include amounts recorded as asset retirement obligations. We record insurance recoveries only when we determine that collection is probable. A portion of the environmental remediation costs is expected to be recoverable through overhead charges on government contracts and, accordingly, such amounts are deferred in inventoried costs (current portion) and miscellaneous other assets (non-current portion) in the consolidated statements of financial position. As of December 31, 2011 and 2010, deferred environmental remediation costs totaled $191 million and $185 million, respectively.

Factors that could result in changes to the company’s estimates include, but are not limited to: modification of planned remedial actions, increases or decreases in the estimated time required to remediate, changes to the determination of responsible parties and their ability to pay, changes in the level of estimated contamination, changes in laws and regulations affecting remediation requirements, improvements in remediation technology and changes in estimated amounts recoverable through overhead charges on government contracts. In addition, there are some potential remediation sites where the costs of remediation cannot be reasonably estimated. Although management cannot predict whether new information gained as projects progress will materially affect the estimated liability accrued, management does not anticipate that future remediation expenditures will have a material adverse effect on the company’s consolidated financial position, results of operations or cash flows.

We could be affected by future laws or regulations, including but not limited to, those enacted in response to climate change concerns and other actions known as “green initiatives.” In 2009, we established a goal of reducing our greenhouse gas emissions over a five-year period through December 31, 2014. In 2010, we established goals for water usage and solid waste generation. To comply with laws, regulations and green initiatives, including our goals, we have incurred and expect to incur capital and operating costs, but at this time, such costs have not had, and we do not expect that such costs will have, a material adverse effect on our consolidated financial position, results of operations or cash flows.

COMPETITIVE CONDITIONS

We compete with many companies in the U.S. defense industry and the information and services markets for a number of programs, both large and small. In the U.S. defense industry, Lockheed Martin Corporation, The Boeing Company, Raytheon Company, General Dynamics Corporation, L-3 Communications Corporation, SAIC, BAE Systems Inc., EADS, and Finmeccanica SpA are our primary competitors. Intense competition and long operating cycles are both key characteristics of our business and the defense industry. It is common in the defense industry for work on major programs to be shared among a number of companies. A company competing to be a prime contractor may, upon ultimate award of the contract to another competitor, become a subcontractor for the ultimate prime contracting company. It is not unusual to compete for a contract award with a peer company and, simultaneously, perform as a supplier to or a customer of that same competitor on other contracts, or vice versa. The nature of major defense programs, conducted under binding contracts, allows companies that perform well to benefit from a level of program continuity, not frequently found in other industries.

Our success in the competitive defense industry depends upon our ability to develop and market our products and services, as well as our ability to provide the people, technologies, facilities, equipment, and financial capacity

 

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needed to deliver those products and services affordably and efficiently. Like most of our competitors, we are vertically integrated but also have a high reliance on the supply chain. We must continue to maintain dependable sources for raw materials, fabricated parts, electronic components, and major subassemblies. In this increasingly complex manufacturing and systems integration environment, effective oversight of subcontractors and suppliers is vital to our success.

Similarly, there is intense competition among many companies in the information and services markets, which are generally more labor intensive with highly competitive margin rates and contract performance periods of shorter duration. Competitors in the information and services markets include the defense industry participants mentioned above as well as many other large and small entities with specialized expertise. Our ability to successfully compete in the information and services markets depends on a number of factors. The most important factor is the ability to deploy skilled professionals, many requiring security clearances, at competitive prices across the diverse spectrum of these markets. Accordingly, we have implemented various workforce initiatives to enhance our success in attracting, developing and retaining these skilled professionals in sufficient numbers to maintain or improve our competitive position within these markets.

In both the U.S. defense industry and information and services markets, the federal government has stressed competition and affordability in connection with its future procurement of products and services. This may lead to fewer sole source awards, as well as more emphasis on cost competitiveness. In addition, the DoD has announced several initiatives to improve efficiency, refocus priorities, modify contract terms, and enhance DoD best practices including those used to procure goods and services from defense contractors. See Overview and the Economic Opportunities, Challenges, and Risks sections in Part II, Item 7, as well as Risk Factors in Part I, Item 1A. These initiatives, when implemented, together with planned reductions in defense spending levels, are likely to result in fewer new opportunities for our industry as a whole with more demanding terms. A reduced opportunity set is likely to intensify competition within the industry as companies compete for a more limited set of new programs.

EXECUTIVE OFFICERS

See Part III, Item 10, for information about our executive officers.

AVAILABLE INFORMATION

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and proxy statement for the annual shareholders’ meeting, as well as any amendments to those reports, are available free of charge through our website as soon as reasonably practicable after we file them with the SEC. You can learn more about us by reviewing our SEC filings on the investor relations page of our web site at www.northropgrumman.com.

The SEC also maintains a website at www.sec.gov that contains reports, proxy statements and other information about SEC registrants, including Northrop Grumman. You may also obtain these materials at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You can obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

References to our website and the SEC’s website in this report are provided as a convenience and do not constitute, and should not be viewed as, incorporation by reference of the information contained on, or available through, such websites.

 

Item1A. Risk Factors

Our consolidated financial position, results of operations and cash flows are subject to various risks, many of which are not exclusively within our control, that may cause actual performance to differ materially from historical or projected future performance. We urge you to carefully consider the risk factors described below in evaluating the information contained in this report.

 

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We depend heavily on a single customer, the U.S. Government, for a substantial portion of our business. Changes in this customer’s priorities and changes affecting its ability to do business with us could have a material adverse effect on our financial position, results of operations, or cash flows.

Our primary customer is the U.S Government, from which we derived more than 90 percent of our total revenues during each of the past several years. The federal government is implementing significant changes and reductions to government spending and other programs. We cannot predict the impact on existing, follow-on or replacement programs from potential changes in priorities due to changes in defense spending levels, military transformation and planning, and/or changes in social-political priorities. A shift in government priorities to programs in which we do not participate and/or reductions in funding for or the termination of programs in which we do participate, unless offset by other programs and opportunities, could have a material adverse effect on our financial position, results of operations, or cash flows. In addition, we believe uncertainty and other concerns resulting from previously announced proposed defense spending reductions and potential additional reductions, including under the Budget Control Act of 2011 (the Budget Control Act), have impacted and are likely to continue to impact the manner in which our U.S. Government customers manage programs and/or make procurement decisions, resulting in delays and reductions in payments and procurements. Similar challenges and uncertainty faced by some of our international government customers could also lead to delays and/or reductions.

In addition, the U.S. Government generally has the ability to terminate contracts, in whole or in part, without prior notice, for its convenience or for default based on performance. In the event of termination for the U.S. Government’s convenience, contractors are generally protected by provisions covering reimbursement for costs incurred on the contracts and profit on those costs but not the anticipated profit that would have been earned had the contract been completed. In some circumstances, however, a U.S. government contract does not have such termination protection. In those cases, we attempt to mitigate the termination risk through other means. To the extent such means are unavailable or do not fully address the costs incurred or profit on those costs, we could face significant losses from the termination for convenience of a contract that lacks termination protection. Termination by the U.S. Government of a contract for convenience could also result in the cancellation of future work on that program. Termination by the U.S. Government of a contract due to our default could require us to pay for re-procurement costs in excess of the original contract price, net of the value of work accepted from the original contract, as well as other damages. Termination of a contract due to our default may expose us to material liability and could have a material adverse effect on our ability to compete for other contracts.

 

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Significant delays or reductions in appropriations for our programs and federal government funding more broadly may negatively impact our business and programs and could have a material adverse effect on our financial position, results of operations or cash flows.

The funding of U.S. Government programs is subject to an annual congressional budget authorization and appropriation processes. For many programs, Congress appropriates funds on a fiscal year basis even though the program performance period may extend typically several years. Consequently, programs are often partially funded initially and additional funds are committed only as Congress makes further appropriations. If we incur costs in excess of funds committed on a contract, we may be at risk for reimbursement of those costs until additional funds are appropriated. We cannot predict the extent to which total funding and/or funding for individual programs will be included, increased or reduced as part of the annual budget process ultimately approved by Congress or in separate supplemental appropriations or continuing resolutions, as applicable. The impact, severity and duration of the current U.S. economic situation and economic plans adopted or to be adopted by the U.S. Government, along with pressures on, and uncertainty surrounding, the federal budget, could adversely affect the funding for individual programs and delay purchasing or payment decisions by our customers. In the event that government funding for any of our programs becomes unavailable, or is reduced or delayed, our contract or subcontract under such program may be terminated or adjusted by the U.S. Government or the prime contractor, which could have a material adverse effect on our financial position, results of operations, and/or cash flows.

 

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In August 2011, Congress enacted the Budget Control Act which, while raising the existing statutory limit on the amount of permissible federal debt, also committed the U.S. Government to significantly reducing the federal deficit over ten years. The Budget Control Act established caps on discretionary spending through 2021, reducing federal spending by approximately $940 billion relative to the fiscal year 2012 Presidential Budget submission. It also established a Joint Committee of Congress (the Joint Committee) that was responsible for identifying an additional $1.2 to $1.5 trillion in deficit reductions by November 23, 2011. The Joint Committee was unable to identify the additional deficit reductions by this deadline thereby triggering a second provision of the Budget Control Act called “sequestration,” which calls for very substantial automatic spending cuts split between defense and non-defense programs scheduled to start in 2013 and continue over a nine-year period. While we believe efforts may be underway to prevent the automatic spending cuts scheduled to begin in 2013, the outcome of these efforts is uncertain, and we are unable to predict the impact that either identified or automatic cuts would have on funding for our individual programs. Long-term funding for certain programs in which we participate is likely to be reduced, delayed or cancelled. In addition, these cuts could adversely affect the viability of the suppliers and subcontractors under our programs. While we believe that our business is well-positioned in areas that the DoD has indicated are areas of focus for future defense spending, the impact of the Budget Control Act remains uncertain and our business and industry could be materially adversely affected. In January 2012, the Secretary of Defense announced a number of program changes and cancellations that are scheduled to take place over the next several years, in part to comply with certain provisions of the Budget Control Act. Certain of these program changes and cancellations are expected to have an impact on programs in which we participate.

 

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As a U.S. Government contractor, we are subject to various procurement regulations and could be adversely affected by changes in regulations or any negative findings from a U.S. Government audit or investigation.

U.S. Government contractors must comply with many significant procurement regulations and other requirements. These regulations and requirements, although customary in government contracts, increase our performance and compliance costs. New regulations or procurement requirements (including, for example, regarding counterfeit parts) or changes to current ones, could increase our costs and risks of compliance and reduce our margins.

We operate in a highly regulated environment and are routinely audited and reviewed by the U.S. Government and its agencies, such as the Defense Contract Audit Agency (DCAA) and Defense Contract Management Agency (DCMA). These agencies review performance under our contracts, our cost structure and our compliance with applicable laws, regulations and standards, as well as the adequacy of, and our compliance with, our internal control systems and policies. Systems that are subject to review include, but are not limited to, our accounting systems, purchasing systems, billing systems, property management and control systems, cost estimating systems, compensation systems and management information systems. Any costs ultimately found to be unallowable or improperly allocated to a specific contract will not be reimbursed or must be refunded if already reimbursed. If an audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties, sanctions or suspension or debarment from doing business with the U.S. Government. Whether or not illegal activities are alleged, the U.S. Government also has the ability to decrease or withhold certain payments when it deems systems subject to its review to be inadequate. In addition, we could suffer serious reputational harm if allegations of impropriety were made against us. If such actions were to result in suspension or debarment, this could have a material adverse effect on our business.

The U.S. Government, from time to time, recommends to its contractors that certain contract prices be reduced, or that costs allocated to certain contracts be disallowed. These recommendations can involve substantial amounts. In the past, as a result of such audits and other investigations and inquiries, we have on occasion reduced our contract prices and the costs allocated to our government contracts.

We are also, from time to time, subject to U.S. Government investigations relating to our operations, and we are subject to or expected to perform in compliance with a vast array of federal laws, including but not limited to the Truth in Negotiations Act, the False Claims Act, the Procurement Integrity Act, Cost Accounting

 

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Standards, Federal Acquisition Regulation (FAR), the International Traffic in Arms Regulations promulgated under the Arms Export Control Act, the Close the Contractor Fraud Loophole Act and the Foreign Corrupt Practices Act. If we are found to have violated the law, or are found not to have acted responsibly as defined by the law, we may be subject to reductions of the value of contracts, contract modifications or termination and the assessment of penalties, fines, or compensatory or treble damages, which could have a material adverse effect on our financial position, results of operations, or cash flows. Such matters could also result in suspension or debarment. Given our dependence on government contracting and authorizations, suspension or debarment could have a material adverse effect on our financial position, results of operations, or cash flows.

 

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Changes to business practices for U.S. government contractors could have a significant adverse effect on current programs, potential new awards and the processes by which procurements are awarded and managed.

Our industry has experienced, and we expect it will continue to experience, significant changes to business practices as a result of an increased focus on affordability, efficiencies, and recovery of costs, among other items, and a reprioritization of available defense funds to key areas for future defense spending. For example, the DoD’s Better Buying Power Initiative is designed to reduce costs, gain efficiencies, refocus priorities and enhance business practices used by the DoD, including those used to procure goods, services and solutions from defense contractors. In addition, the DCAA has implemented cost recovery initiatives designed to prioritize efforts to recover costs and close open audits. More recently, the thresholds for certain allowable costs are being challenged and refined.

These new initiatives have had, and we expect them to continue to have, a significant impact on the contracting environment in which we do business. In support of the implementation of the Better Buying Power initiative, the U.S. Government is issuing a large number of new regulations and statutory requirements which are shifting additional responsibility and performance risks to the contractor. This is also being accomplished by the Government’s increased reliance on the use of fixed price incentive contracts with specifically identified fee share line structures rather than cost type or fixed price contracts. While the full impact to our business as a result of these changes remains uncertain, and subject to the manner in which they are implemented, our business and industry could be materially adversely affected.

 

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Competition within our markets and an increase in bid protests may reduce our revenues and market share.

We operate in highly competitive markets and our competitors may have more extensive or more specialized engineering, manufacturing and marketing capabilities or be able to assume lower costs than we do in some areas or programs. We have seen, and anticipate that we will continue to see, increased competition in some of our core markets, especially as a result of the reduction in budgets for many U.S. Government agencies and fewer new program starts. In addition, as discussed in more detail above, projected U.S. defense spending levels for periods beyond the near-term are uncertain and difficult to predict. Changes in U.S. defense spending may limit certain future market opportunities. We are also facing increasing competition in our domestic and international markets from foreign and multinational firms. Additionally, some customers, including the DoD, may turn to commercial contractors, rather than traditional defense contractors, for information technology and other support work. If we are unable to continue to compete successfully against our current or future competitors, we may experience declines in revenues and market share, which could negatively impact our financial position, results of operations, or cash flows.

We are also experiencing an increasing number of bid protests from unsuccessful bidders on new program awards. Bid protests could result in the award decision being overturned, and a re-bid of the contract. Even where a bid protest does not result in a new award, the resolution can extend the time until the contract activity can begin, and delay potential earnings.

 

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Our future success depends, in part, on our ability to develop new products and new technologies and maintain technologies, facilities, equipment and a qualified workforce to meet the needs of current and future customers.

Many of the markets in which we operate are characterized by rapidly changing technologies. The product, program and service needs of our customers change and evolve regularly. Our success in the competitive

 

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defense industry depends upon our ability to develop and market our products and services, as well as our ability to provide the people, technologies, facilities, equipment and financial capacity needed to deliver those products and services with maximum efficiency. If we fail to maintain our competitive position, we could lose a significant amount of future business to our competitors, which would have a material adverse effect on our ability to generate favorable financial results and maintain market share.

Our operating results are heavily dependent upon our ability to attract and retain sufficient personnel with requisite skills and/or security clearances. If qualified personnel become scarce, we could experience higher labor, recruiting or training costs in order to attract and retain such employees. Failure to maintain a qualified workforce could result in difficulty in performing under our contracts.

Approximately 3,400 of our 72,500 employees are covered by an aggregate of 17 collective bargaining agreements, and we expect to negotiate or re-negotiate renewals for nine of our collective bargaining agreements in 2012. Collective bargaining agreements generally expire after three to five years, and are subject to renegotiation upon expiration. We may experience difficulties with renewals and renegotiations of existing collective bargaining agreements. If we experience such difficulties, we could incur additional expenses and may be subject to work stoppages. Any such expenses or delays could adversely affect programs served by employees who are covered by collective bargaining agreements.

 

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Many of our contracts contain performance obligations that require innovative design capabilities, are technologically complex, require state-of-the-art manufacturing expertise or are dependent upon factors not wholly within our control. Failure to meet these obligations could adversely affect our profitability and future prospects.

We design, develop and manufacture technologically advanced and innovative products and services, which are applied by our customers in a variety of environments. Problems and delays in development or delivery as a result of issues with respect to design, technology, licensing and patent rights, labor, learning curve assumptions, manufacturing materials or components could prevent us from achieving contractual requirements.

In addition, our products cannot be tested and proven in all situations and are otherwise subject to unforeseen problems. Examples of unforeseen problems that could negatively affect revenue and profitability include loss on launch of spacecraft, premature failure of products that cannot be accessed for repair or replacement, problems with quality and workmanship, country of origin, delivery of subcontractor components or services and degradation of product performance. These failures could result, either directly or indirectly, in loss of life or property. Among the factors that may affect revenue and profits could be unforeseen costs and expenses not covered by insurance or indemnification from the customer, diversion of management focus in responding to unforeseen problems, loss of follow-on work, and, in the case of certain contracts, repayment to the government customer of contract cost and fee payments we previously received.

Certain contracts, primarily involving space satellite systems, contain provisions that entitle the customer to recover fees in the event of partial or complete failure of the system upon launch or subsequent deployment for less than a specified period of time. Under such terms, we could be required to forfeit fees previously recognized and/or collected. We have not experienced any material losses in the last decade in connection with such contract performance incentive provisions. However, if we were to experience launch failures or complete satellite system failures in the future, for example, such events could have a material adverse effect on our financial position, results of operations, or cash flows.

 

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Contract cost growth on fixed-price and other contracts that cannot be justified as an increase in contract value due from customers exposes us to reduced profitability and the potential loss of future business.

Our operating income is adversely affected when we incur certain contract costs or certain increases in contract costs that cannot be billed to customers. This cost growth can occur if estimates to complete increase due to a variety of reasons including: technical challenges; manufacturing difficulties or delays; or workforce-related issues; and where initial estimates used for calculating the contract cost were incorrect. The cost

 

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estimation process requires significant judgment and expertise. Reasons for cost growth may include unavailability or reduced productivity of labor, the nature and complexity of the work to be performed, the timelines and availability of materials, major subcontractor performance and quality of their products, the effect of any delays in performance, availability and timing of funding from the customer, natural disasters, and the inability to recover any claims included in the estimates to complete, including additional pension-related costs that may arise from the new rule published by the Cost Accounting Standards (CAS) Board discussed further in the pension and medical expenses risk factor below. A significant change in cost estimates on one or more programs could have a material adverse effect on our consolidated financial position, results of operations or cash flows.

Our risk varies with the type of contract. Flexibly priced contracts include both cost-type and fixed-price incentive contracts. Due to their nature, firm fixed-price contracts inherently have more risk than flexibly priced contracts. In 2011, approximately 41 percent of our annual revenues were derived from firm fixed-price contracts. We typically enter into firm fixed-price contracts where costs can be reasonably estimated based on experience. In addition, our contracts contain provisions relating to cost controls and audit rights. Should the terms specified in our contracts not be met, then profitability may be reduced. Fixed-price development work comprises a small portion of our firm fixed-price contracts and inherently has more uncertainty as to future events than production contracts and therefore more variability in estimates of the costs to complete the development stage. As work progresses through the development stage into production, the risks associated with estimating the total costs of the contract are generally reduced. In addition, successful performance of firm fixed-price development contracts that include production units is subject to our ability to control some cost growth in meeting production specifications and delivery rates. While management uses its best judgment to estimate costs associated with fixed-price development contracts, future events could result in either upward or downward adjustments to those estimates.

Under a typical fixed-price incentive contract, the allowable costs incurred by the contractor are subject to reimbursement, but are subject to a cost-share limit, which affects profitability. Under a cost-type contract, the allowable costs incurred by the contractor are also subject to reimbursement plus a fee that represents profit. We typically enter into cost-type contracts for development programs with complex design and technical challenges. These cost-type programs typically have award or incentive fees that are subject to uncertainty and may be earned over extended periods. In these cases, the associated financial risks are primarily in lower profit rates or program cancellation if cost, schedule, or technical performance issues arise.

 

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We use estimates when accounting for contracts. Changes in estimates could affect our profitability and our overall financial position.

When agreeing to contractual terms, our management makes assumptions and projections about future conditions and events, many of which extend over long periods. These projections assess the productivity and availability of labor, complexity of the work to be performed, cost and availability of materials, impact of delayed performance and timing of product deliveries. Contract accounting requires judgment relative to assessing risks, estimating contract revenues and costs, and making assumptions for schedule and technical issues. Due to the size and nature of many of our contracts, the estimation of total revenues and costs at completion is complicated and subject to many variables. For example, assumptions are made regarding the length of time to complete a contract since costs also include expected increases in wages, prices for materials and allocated fixed costs. Similarly, assumptions are made regarding the future impact of our efficiency initiatives and cost reduction efforts. Incentives, awards or penalties related to performance on contracts are considered in estimating revenue and profit rates, and are recorded when there is sufficient information to assess anticipated performance. Suppliers’ assertions are also assessed and considered in estimating costs and profit rates.

Because of the significance of the judgment and estimation processes described above, it is possible that materially different amounts could be obtained if different assumptions were used or if the underlying

 

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circumstances were to change. Changes in underlying assumptions, circumstances or estimates may have a material adverse effect upon the profitability of one or more of the affected contracts, future period financial reporting and performance. See Critical Accounting Policies, Estimates, and Judgments in Part II, Item 7.

 

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Our earnings and margins depend, in part, on subcontractor performance as well as raw material and component availability and pricing.

We rely on other companies to provide raw materials and major components for our products and rely on subcontractors to produce hardware elements and sub-assemblies and perform some of the services that we provide to our customers. Disruptions or performance problems caused by our subcontractors and vendors could have an adverse effect on our ability to meet our commitments to customers. Our ability to perform our obligations on time as a prime contractor could be adversely affected if one or more of the vendors or subcontractors are unable to provide the agreed-upon products or materials or perform the agreed-upon services in a timely and cost-effective manner.

Our costs may increase over the term of our contracts. Through cost escalation provisions contained in some of our U.S. Government contracts, we may be protected from increases in material costs to the extent that the increases in our costs are in line with industry indices. However, the difference in basis between our actual material costs and these indices may expose us to cost uncertainty even with these provisions. A significant delay in supply deliveries of our key raw materials required in our production processes could have a material adverse effect on our financial position, results of operations, or cash flows.

In connection with our government contracts, we are required to procure certain materials, components and parts from supply sources approved by the U.S. Government. Consistent with the industry’s efforts, our procurement practices are intended to reduce the likelihood of our procurement of counterfeit parts or materials. There are currently several components, for which there may only be one supplier. The inability of a sole source supplier to meet our needs or the appearance of counterfeit parts could have a material adverse effect on our financial position, results of operations, or cash flows.

Changes in economic conditions, as well as changes in the defense budget, can adversely affect the ability of our subcontractors and suppliers to perform and further increase this risk.

 

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Changes in future business conditions could cause business investments and/or recorded goodwill and other intangible assets to become impaired, resulting in substantial losses and write-downs that would reduce our operating income.

Goodwill accounts for approximately half of our recorded total assets. We evaluate goodwill amounts for impairment at least annually or more often when we believe potential impairment exists. The annual impairment test is based on several factors requiring judgment. A significant decrease in expected cash flows or changes in market conditions may indicate potential impairment of recorded goodwill. We continue to monitor the recoverability of the carrying value of our goodwill and other long-lived assets.

As part of our overall strategy, we may, from time to time, acquire a minority or majority interest in a business. Even after careful integration efforts, actual operating results may vary significantly from initial estimates and we may experience unforeseen issues that adversely affect the value of our goodwill or intangible assets.

 

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Our international business exposes us to additional risks.

While our international business is not substantial, it remains subject to numerous U.S. and foreign laws and regulations, including, without limitation, regulations relating to import-export control, technology transfer restrictions, repatriation of earnings, exchange controls, the Foreign Corrupt Practices Act and other anti-corruption laws, and the anti-boycott provisions of the U.S. Export Administration Act. Failure by us, our employees,or others working on our behalf to comply with these laws and regulations could result in administrative, civil, or criminal liabilities, including suspension or debarment from government contracts or

 

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suspension of our export privileges, which could have a material adverse effect on us. Changes in regulation or political environment may affect our ability to conduct business in foreign markets, including those regarding investment, procurement and repatriation of earnings. Our international business may also be impacted by changes in foreign national priorities and government budgets and may be further impacted by global economic conditions and fluctuations in foreign currency exchange rates. In addition, our international contracts may include industrial cooperation agreements requiring specific in-country purchases, investments, manufacturing agreements or other financial obligations, known as offset obligations, and provide for penalties if we fail to meet such requirements.

The services and products we provide internationally, including those provided by subcontractors, are sometimes in countries with unstable governments, in areas of military conflict or at military installations. This increases the risk of an incident resulting in harm or loss of life to our employees, subcontractors or other third parties or damage to our products. We maintain insurance and take other steps to mitigate the risk and potential liabilities related to our international operations, but these steps may not be adequate to prevent loss or to cover resulting claims and liabilities, and we may be forced to bear substantial costs (see additional discussion of possible inadequacy of our insurance coverage below). In addition, any accidents or incidents that occur in connection with our international operations could result in negative publicity for the company, which may adversely affect our reputation and make it more difficult for us to compete for future contracts or attract and retain employees or result in the loss of existing and future contracts. The impact of these factors is difficult to predict, but one or more of them could adversely affect our financial position, results of operations, or cash flows.

 

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Our reputation and our ability to do business may be impacted by the improper conduct of employees, agents or business partners.

We have implemented extensive policies, procedures, training and other compliance controls to prevent misconduct by employees, agents or others with whom we are doing business that would violate the applicable laws of the jurisdictions in which we operate, including laws governing improper payments to government officials, the protection of export controlled or classified information, cost accounting and billing, competition and data privacy. However, we cannot ensure that we will prevent all such misconduct committed by our employees, agents or others with whom we are doing business. Such improper actions could subject us to administrative, civil or criminal investigations and monetary and non-monetary penalties, including suspension and debarment,that could negatively impact our reputation and ability to conduct business and could have a material adverse effect on our financial position, results of operations or cash flows.

 

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Our business could be negatively impacted by security threats, including physical and cybersecurity threats, and other disruptions.

As a defense contractor, we face various security threats, including cybersecurity threats to gain unauthorized access to sensitive information; threats to the safety of our directors, officers, and employees; threats to the security of our facilities and infrastructure; and threats from terrorist acts. Although we utilize various procedures and controls to monitor and mitigate these threats, there can be no assurance that these procedures and controls will be sufficient to prevent security threats from materializing. If any of these events were to materialize, they could lead to losses of sensitive information or capabilities, harm to personnel or infrastructure, or damage to our reputation, and could have a material adverse effect on our financial position, results of operations, or cash flows.

Cybersecurity threats are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in mission critical systems, unauthorized release of confidential or otherwise protected information and corruption of data. These events could damage our reputation and lead to financial losses from remedial actions, loss of business or potential liability.

 

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We also manage information technology systems for various customers and other third parties. While we operate under information security policies and procedures for managing these systems, we generally face similar cybersecurity threats for these systems as for our own.

 

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Unforeseen environmental costs could have a material adverse effect on our financial position, results of operations, or cash flows.

Our operations are subject to and affected by a variety of federal, state, local and foreign environmental laws and regulations. In addition, we could be affected by future laws or regulations, including those imposed in response to climate change concerns and other actions commonly referred to as “green initiatives.” Compliance with current and future environmental laws and regulations currently requires and is expected to continue to require significant operating and capital costs.

Environmental laws and regulations provide for substantial fines and criminal sanctions for violations, and may limit our operations or require the installation of costly pollution control equipment or operational changes to limit pollution emissions or discharges and/or decrease the likelihood of accidental hazardous substance releases. We also incur, and expect to continue to incur, costs to comply with current federal and state environmental laws and regulations related to the cleanup of pollutants previously released into the environment. In addition, if we were found to be in violation of the Federal Clean Air Act or the Clean Water Act, the facility or facilities involved in the violation could be placed by the EPA on the “Excluded Parties List” maintained by the General Services Administration. The listing could continue until the EPA concludes that the cause of the violation had been corrected. If we were listed on the Excluded Parties List it could have a material adverse effect on our financial position, results of operations and cash flows. Listed facilities generally cannot be used in performing any U.S. Government contract until the violation is corrected.

The adoption of new laws and regulations, stricter enforcement of existing laws and regulations, imposition of new cleanup requirements, discovery of previously unknown or more extensive contamination, litigation involving environmental impacts, sanctions or penalties, could negatively impact our ability to recover such costs under previously priced contracts or financial insolvency of other responsible parties could cause us to incur costs in the future that could have a material adverse effect on our financial position, results of operations, or cash flows.

 

n  

We are subject to various claims and litigation that could ultimately be resolved against us.

The size, type and complexity of our business make us highly susceptible to claims and litigation. We are and may become subject to various environmental claims, income tax matters, compliance matters, claims, investigations, and administrative, civil or criminal litigation, which could divert financial and management resources and, could lead to fines, penalities, judgements, and other monetary and non-monetary results, including suspension or debarment, and could have a material adverse effect on our financial position, results of operations or cash flows. Any investigation, claim, or litigation, even if fully indemnified or insured, could negatively impact our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future.

 

n  

We may be unable adequately to protect our intellectual property rights, which could affect our ability to compete.

We own many U.S. and foreign patents, trademarks, copyrights, and other forms of intellectual property. The U.S. Government has certain rights to use certain intellectual property that we develop in performance of government contracts, and it may use or authorize others to use certain such intellectual property. Our intellectual property is subject to challenge, invalidation, misappropriation or circumvention by third parties.

We also rely significantly upon proprietary technology, information, processes and know-how that are not protected by patents. We seek to protect this information through trade secret or confidentiality agreements with our employees, consultants, subcontractors and other parties, as well as through other measures. These agreements and other measures may not provide adequate protection for our unpatented proprietary

 

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information. In the event of an infringement of our intellectual property rights, a breach of a confidentiality agreement or divulgence of proprietary information, we may not have adequate legal remedies to maintain our intellectual property. Litigation to determine the scope of intellectual property rights, even if ultimately successful, could be costly and could divert management’s attention away from other aspects of our business. In addition, our trade secrets may otherwise become known or be independently developed by competitors. In some instances, we have licensed the proprietary intellectual property of others, but we may be unable in the future to secure the necessary licenses to use such intellectual property on commercially reasonable terms. If we are unable adequately to protect our intellectual property rights, our business could be adversely affected.

 

n  

Our business is subject to disruption caused by natural disasters, environmental disasters and other factors that could adversely affect our profitability and our overall financial position.

We have significant operations located in regions of the U.S. that may be exposed to earthquakes, damaging storms, and other natural disasters, including environmental disasters. Although preventative measures may help to mitigate damage, the damage and disruption resulting from natural and environmental disasters may be significant. If insurance or other risk transfer mechanisms are unavailable or insufficient to recover all costs, our financial position, results of operations, or cash flows could be materially adversely affected.

Our suppliers and subcontractors are also subject to natural disasters that could affect their ability to deliver or perform under a contract. Performance failures by our subcontractors due to natural and environmental disasters may adversely affect our ability to perform our obligations on the prime contract. This could reduce our profitability due to damages or other costs that may not be fully recoverable from the subcontractor or from the customer, could result in a termination of the prime contract and could have an adverse effect on our ability to compete for future contracts.

Natural disasters could also disrupt our workforce, electrical and other power distribution networks, including computer and internet operation and accessibility, and the critical industrial infrastructure needed for normal business operations. These disruptions could cause adverse effects on our profitability and performance.

 

n  

Our insurance coverage may be inadequate to cover all of our significant risks or our insurers may deny coverage of material losses we incur, which could adversely affect our profitability and overall financial position.

We endeavor to identify and obtain in established markets insurance agreements to cover significant risks and liabilities (including, for example, natural disasters and product liability). Not every risk or liability can be protected by insurance, and, for insurable risks, the limits of coverage reasonably obtainable in the market may not be sufficient to cover all actual losses or liabilities incurred, including for example, a catastrophic earthquake claim.

Additionally, disputes with insurance carriers over coverage may affect the timing of cash flows and, if litigation with the carrier becomes necessary, an outcome unfavorable to us may have a material adverse effect on our financial position, results of operations, or cash flows.

 

n  

Anticipated benefits of mergers, acquisitions, joint ventures, spin-offs or strategic alliances may not be realized.

As part of our overall strategy, we may, from time to time, merge with or acquire businesses, dispose of or spin-off businesses, form joint ventures or create strategic alliances. Whether we realize the anticipated benefits from these transactions depends, in part, upon the integration between the businesses involved, the performance of the underlying products, capabilities or technologies, the management of the operations and market conditions following these transactions. Accordingly, our financial results could be adversely affected from unanticipated performance issues, transaction-related charges, liabilities, amortization of expenses related to intangibles, charges for impairment of long-term assets, guarantees, partner performance and indemnifications. Divestitures may result in continued financial involvement in the divested business, such as through guarantees, indemnifications, or other financial arrangements, following the transaction. Although we have established procedures and processes to mitigate these risks, there is no assurance that these transactions will be successful.

 

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n  

Market volatility and adverse capital and credit market conditions may affect our ability to access cost-effective sources of funding and expose us to risks associated with the financial viability of suppliers and the ability of counterparties to perform on financial instruments.

Domestic and international financial and credit markets have experienced high levels of volatility and disruption, reducing the availability of credit for certain issuers. Historically, we have occasionally accessed these markets to support certain business activities, including acquisitions, capital expansion projects, refinancing existing debt and issuing letters of credit. In the future, we may not be able to obtain capital market financing or bank financing when needed on favorable terms, or at all, which could have a material adverse effect on our financial position, results of operations, or cash flows. We have also executed transactions with counterparties domestically and abroad in the financial services industry, including brokers and dealers, commercial banks, investment banks and other institutional parties. These transactions expose us to potential credit risk in the event of counterparty default.

A tightening of credit could also adversely affect our suppliers’ ability to obtain financing. Delays in suppliers’ ability to obtain financing, or the unavailability of financing, could cause us to be unable to meet our contract obligations and could adversely affect our financial position, results of operations, or cash flows. The inability of our suppliers to obtain financing could also result in the need for us to transition to alternate suppliers, which could result in significant incremental cost and delay or the need for us to provide other supplemental means to support our existing suppliers.

 

n  

Pension and medical expenses associated with our retirement benefit plans may fluctuate significantly depending upon changes in actuarial assumptions, future investment performance of plan assets, future trends in health care costs and legislative or other regulatory actions.

A substantial portion of our current and retired employee population is covered by pension and post-retirement benefit plans, the costs of which are dependent upon our various assumptions, including estimates of rates of return on benefit related assets, discount rates for future payment obligations, rates of future cost growth and trends for future costs. In addition, funding requirements for benefit obligations of our pension and post-retirement benefit plans are subject to legislative and other government regulatory actions. Variances from these estimates could have a material adverse effect on our financial position, results of operations, or cash flows.

Additionally, due to government regulations, pension plan cost recoveries under our government contracts occur in different periods from when those pension costs are recognized for financial statement purposes or when pension funding is made. These timing differences could have a material adverse effect on our cash flow from operations. On December 27, 2011, the CAS Board published a final rule intended to partially harmonize the measurement and period of assignment of defined benefit pension plan costs allocable to U.S. Government contracts and the minimum required contribution under the Employee Retirement Income Security Act of 1974 (ERISA), as amended by the Pension Protection Act (PPA) of 2006. We anticipate that this rule will better align, but not eliminate, mismatches between ERISA funding requirements and CAS pension costs for U.S. Government CAS covered contracts. The rule becomes effective February 27, 2012, with 2013 being the first year of applicability for the revised accounting practices required by the rule. Price proposals for CAS covered contracts awarded on or after the effective date of February 27, 2012 will reflect the effects of the rule. Although we believe that contractors are entitled to an equitable adjustment on CAS covered contracts awarded prior to the February 27, 2012 effective date, the application of this rule on our financial position, results of operations and cash flows could be materially adversely affected if we are unable to successfully recover such equitable adjustment.

 

n  

Unanticipated changes in our tax provisions or exposure to additional income tax liabilities could affect our profitability and cash flow.

We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of business, there are many

 

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transactions and calculations where the ultimate tax determination is uncertain. In addition, timing differences in the recognition of income from contracts for financial statement purposes and for income tax regulations can cause uncertainty with respect to the timing of income tax payments, which can have a significant impact on our cash flow from operations in a particular period. Furthermore, changes in applicable domestic or foreign income tax laws and regulations, or their interpretation, could result in higher or lower income tax rates assessed or changes in the taxability of certain sales or the deductibility of certain expenses, thereby affecting our income tax expense and profitability. The final determination of any tax audits or related litigation could be materially different from our historical income tax provisions and accruals. Additionally, changes in our tax rate as a result of a change in the mix of earnings in countries with differing statutory tax rates, changes in our overall profitability, changes in tax legislation, changes in the valuation of deferred tax assets and liabilities, changes in differences between financial reporting income and taxable income, the results of audits and the examination of previously filed tax returns by taxing authorities and continuing assessments of our tax exposures could impact our tax liabilities and affect our income tax expense, profitability and cash flow.

 

n  

Our nuclear-related operations subject us to various environmental, regulatory, financial and other risks.

Our nuclear-related operations subject us to various risks, including potential liabilities relating to harmful effects on the environment and human health that may result from nuclear-related operations and the storage, handling and disposal of radioactive materials. We are also subject to reputational harm and potential liabilities arising out of a nuclear incident, whether or not it is within our control. The U.S. Government and prime contractors provide certain indemnity protection under certain of our contracts pursuant to, or in connection with, Public Law 85-804 and the Price-Anderson Nuclear Industries Indemnity Act for certain nuclear-related risks. If there was a nuclear incident and that indemnity protection was not available to cover our losses and liabilities, it could have a material adverse effect on our financial position, results of operations, or cash flows.

 

n  

If all or any portion of the spin-off of our former Shipbuilding business or certain internal transactions undertaken in anticipation of the spin-off transaction are determined to be taxable for U.S. federal income tax purposes, we and our shareholders that are subject to U.S. federal income tax may incur significant U.S. federal income tax liabilities.

In connection with the spin-off of our former shipbuilding business, we received a letter ruling from the IRS and an opinion of counsel confirming that we and our shareholders would not recognize any taxable income, gain or loss for U.S. federal income tax purposes as a result of the merger, the internal reorganization or the distribution, except that our shareholders who receive cash in lieu of fractional shares would recognize gain or loss with respect to such cash. The ruling and the opinion relied on certain facts, assumptions, representations and undertakings from us and HII regarding the past and future conduct of the companies’ respective businesses and other matters.

We are not aware of any facts or circumstances that would cause any of the factual statements or representations in the IRS ruling or the opinion to be incomplete or untrue at the time of the spin-off transaction. Nevertheless, if the IRS determines that any of the factual statements or representations that the IRS ruling or the opinion was based on were incomplete or untrue, or if certain facts or circumstances upon which the IRS ruling or the opinion was based were materially different from those at the time of the spin-off, we and our shareholders may not be able to rely on the IRS ruling or the opinion of counsel and could be subject to significant tax liabilities.

Even if the spin-off transaction otherwise qualifies as tax-free for U.S. federal income tax purposes, the internal reorganization and distribution may be taxable to us (but not to our shareholders) if certain events occur, including, if within two years following the spin-off there are one or more acquisitions (including issuances) of the stock of either us or HII, representing 50% or more of the then-outstanding stock of either corporation and the acquisition or acquisitions are deemed to be part of a plan or series of related transactions that include the distribution; we cease to engage appropriately in the conduct of a substantial part of our existing business; or, we or HII repurchase shares in excess of specified levels over a two-year period (which substantially exceed

 

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our historical repurchase activity level). If such tax were incurred, the tax liability would be substantial. HII has agreed not to undertake transactions that would reasonably be expected to trigger such tax, and we intend to avoid any such transactions.

 

n  

The spin-off of our former Shipbuilding business may expose us to potential claims and liabilities.

In connection with the spin-off transaction, we entered into a number of agreements with HII setting forth certain rights and obligations of the parties after the separation. For example, under the Separation and Distribution Agreement, from and after the spin-off transaction, each of HII and Northrop Grumman is generally responsible for the debts, liabilities and other obligations related to the business or businesses that it owns and operates following the consummation of the spin-off. It is possible that a court would disregard the allocation agreed to between us and HII, and require that we assume responsibility for certain obligations allocated to HII (for example, tax and/or environmental liabilities), particularly if HII were to refuse or were unable to pay or perform such obligations.

In addition, third parties could seek to hold us responsible for any of the liabilities or obligations for which HII has agreed to be responsible and/or to indemnify us. The indemnity rights we have under our agreements with HII may not be sufficient to protect us against such liabilities. Even if we ultimately succeed in recovering from HII any amounts for which we are held liable, we may be required to record these losses ourselves until such time as the indemnity contribution is paid. In addition, certain indemnities that we may be required to provide HII are not subject to a cap, may be significant, and could negatively impact our business. These risks could negatively affect our business and could have a material adverse effect on our financial position, results of operations or cash flows.

 

Item 1B. Unresolved Staff Comments

No information is required in response to this item.

FORWARD-LOOKING STATEMENTS AND PROJECTIONS

This Form 10-K and the information we are incorporating by reference contain statements, other than statements of historical fact, that constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “expect,” “intend,” “may,” “could,” “plan,” “project,” “forecast,” “believe,” “estimate,” “outlook,” “anticipate,” “trends” and similar expressions generally identify these forward-looking statements. Forward-looking statements are based upon assumptions, expectations, plans and projections that we believe to be reasonable when made. These statements are not guarantees of future performance and inherently involve a wide range of risks and uncertainties that are difficult to predict. Specific factors that could cause actual results to differ materially from those expressed or implied in the forward-looking statements include, but are not limited to, those identified under Risk Factors in Part I, Item 1A and other important factors disclosed in this report and from time to time in our other filings with the SEC.

You are urged to consider the limitations on, and risks associated with, forward-looking statements and not unduly rely on the accuracy of predictions contained in such 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.

 

Item 2. Properties

At December 31, 2011, we owned or leased approximately 37 million square feet of floor space at approximately 655 separate locations, primarily in the U.S., for manufacturing, warehousing, research and testing, administration and various other uses. At December 31, 2011, we leased to third parties approximately 469,000 square feet of our owned and leased facilities, and had vacant floor space of approximately 403,000 square feet.

 

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At December 31, 2011, we had major operations at the following locations:

Aerospace Systems – Carson, El Segundo, Manhattan Beach, Mojave, Palmdale, Redondo Beach, and San Diego, CA; Melbourne and St. Augustine, FL; Bethpage, NY; and Clearfield, UT.

Electronic Systems – Azusa, Sunnyvale and Woodland Hills, CA; Norwalk, CT; Apopka, FL; Rolling Meadows, IL; Annapolis, Elkridge, Linthicum and Sykesville, MD; Williamsville, NY; Cincinnati, OH; Salt Lake City, UT; and Charlottesville, VA. Locations outside the U.S. include United Kingdom, France, Germany, and Italy.

Information Systems – Huntsville, AL; Carson, McClellan, Redondo Beach, San Diego, and San Jose, CA; Aurora and Colorado Springs CO; and Annapolis Junction, MD; Bellevue, NE; and Chantilly, Chester, Dahlgren, Fairfax, Herndon, McLean, Reston, and Richmond, VA.

Technical Services – Sierra Vista, AZ; Warner Robins, GA; Lake Charles, LA; and Herndon, VA.

Corporate and other locations – Falls Church and Lebanon, VA; and Irving, TX.

The following is a summary of our floor space at December 31, 2011:

 

Square feet (in thousands)   Owned    Leased    U.S. Government
Owned/Leased
   Total

Aerospace Systems

      6,358          5,635          1,914          13,907  

Electronic Systems

      8,220          3,113               11,333  

Information Systems

      651          7,461               8,112  

Technical Services

      128          2,202               2,330  

Corporate

      746          969                     1,715  

Total

      16,103          19,380          1,914          37,397  

We maintain our properties in good operating condition and believe that the productive capacity of our properties is adequate to meet current contractual requirements and those for the foreseeable future.

In the fourth quarter of 2010, we purchased an existing 334,407 square foot building located at 2980 Fairview Park Drive, Falls Church, Virginia, as the new location for our principal executive offices. In August 2011, we relocated our corporate office in Los Angeles, California and corporate employees in Rosslyn, Virginia to our new corporate office in Falls Church, Virginia. We believe this move will enable us to better serve our customers.

 

Item 3. Legal Proceedings

We have provided information about certain legal proceedings in which we are involved in Note 14 to the consolidated financial statements in Part II, Item 8.

As disclosed elsewhere in this report, we completed the spin-off of HII effective as of March 31, 2011, and our former Shipbuilding business is now reported as discontinued operations. As provided in the Separation and Distribution Agreement with HII described in Note 6 of the consolidated financial statements in Part II, Item 8, HII generally is responsible for investigations, claims and litigation matters related to the Shipbuilding business. The company has therefore excluded from this report certain previously disclosed Shipbuilding-related investigations, claims and litigation matters for which HII has lead responsibility.

In addition to the matters specifically disclosed in Note 14, we are a party to various investigations, lawsuits, claims and other legal proceedings, including government investigations and claims, that arise in the ordinary course of our business. These types of matters could result in fines, penalties, compensatory or treble damages or non-monetary relief. U.S. Government regulations also provide that certain allegations against a contractor may lead to suspension or debarment from future U.S. Government contracts or the loss of export privileges for the company or one or more of its components. Suspension or debarment could have a material adverse effect on the

 

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company because of the company’s reliance on government contracts and authorizations. Based on the information available to us to date, we do not believe that the outcome of any matter pending against the Company, including the matters specifically identified in Note 14, is likely to have a material adverse effect on the company’s consolidated financial position as of December 31, 2011 or its annual results of operations or cash flows. For further information on the risks we face from existing and future investigations, lawsuits, claims and other legal proceedings, please see Risk Factors in Part I, Item 1A, of this report.

 

Item 4. Mine Safety Disclosures

Not applicable

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

(a) Market Information.

Our common stock is listed on the New York Stock Exchange and trades under symbol NOC.

The following table sets forth, for the periods indicated, the high and low closing sale prices of our common stock as reported in the consolidated reporting system for the New York Stock Exchange Composite Transactions. The stock prices listed in the table below for quarter-end prices prior to March 31, 2011 have not been adjusted for the impact of the Shipbuilding spin-off.

 

     2011    2010

January to March

    $ 62.71  to $71.87        $ 55.63 to $66.25  

April to June

      60.42  to   70.33          54.10  to  69.38  

July to September

      49.24  to   70.00          54.12  to  60.63  

October to December

      50.87  to   59.45          60.11  to  65.34  

 

(b) Holders.

The approximate number of common stockholders was 30,908 as of February 6, 2012.

 

(c) Dividends.

Quarterly dividends per common share for the most recent two years are as follows:

 

     2011    2010

January to March

    $ 0.47        $ 0.43  

April to June

      0.50          0.47  

July to September

      0.50          0.47  

October to December

      0.50          0.47  
      $ 1.97        $ 1.84  

Common Stock

We have 800,000,000 shares authorized at a $1 par value per share, of which 253,889,622 shares and 290,956,752 shares were outstanding as of December 31, 2011, and 2010, respectively.

Preferred Stock

We have 10,000,000 shares authorized at a $1 par value per share, of which no shares were issued and outstanding as of December 31, 2011, and 2010.

 

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(d) Stock Performance Graph.

Comparison of Cumulative Five Year Total Return

Among Northrop Grumman Corporation, the S&P 500 Index,

and the S&P Aerospace & Defense Index

LOGO

 

  (1) Assumes $100 invested at the close of business on December 31, 2006, in Northrop Grumman Corporation common stock, Standard & Poor’s (S&P) 500 Index, and the S&P Aerospace & Defense Index.

 

  (2) The cumulative total return assumes reinvestment of dividends. In March 2011, we completed the HII spin-off. Our shareholders received one share of HII common stock for every six shares of our common stock held on the record date. The effect of the spin-off is reflected in the cumulative total return as a reinvested dividend.

 

  (3) The S&P Aerospace & Defense Index is comprised of The Boeing Company, General Dynamics Corporation, Goodrich Corporation, Honeywell International Inc., L-3 Communications, Lockheed Martin Corporation, Northrop Grumman Corporation, Precision Castparts Corporation, Raytheon Company, Rockwell Collins, Inc., Textron, Inc., and United Technologies Corporation.

 

  (4) The total return is weighted according to market capitalization of each company at the beginning of each year.

 

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(e) Purchases of Equity Securities by the Issuer and Affiliated Purchasers.

The table below summarizes our repurchases of common stock during the three months ended December 31, 2011:

 

Period   Total Number
of Shares
Purchased
(1)
   Average Price
Paid per
Share
(2)
   Total Numbers
of Shares
Purchased
as Part
of Publicly
Announced
Plans or
Programs
   Approximate
Dollar Value
of Shares
that May
Yet Be
Purchased
Under the
Plans or
Programs
($ in millions)

October 1 through October 31, 2011

      6,461,209        $ 54.04          6,461,209        $ 2,003  

November 1 through November 30, 2011

      2,329,649          56.39          2,329,649          1,871  

December 1 through December 31, 2011

      2,978,115          56.65          2,978,115          1,703  

Ending balance

      11,768,973        $ 55.17          11,768,973        $ 1,703 (1)

 

  (1) On June 16, 2010, the company’s board of directors authorized a share repurchase program of up to $2 billion of the company’s common stock. On April 25, 2011, after the company had repurchased shares totaling $245 million, the company’s board of directors authorized an increase to the remaining share repurchase authorization to $4.0 billion. As of December 31, 2011, the company had $1.7 billion remaining for share repurchases under this authorization.

 

  (2) Includes commissions paid and calculated as the average price paid per share under the respective repurchase programs.

Share repurchases take place at management’s discretion or under pre-established, non-discretionary programs, depending on market conditions, in the open market, and in privately negotiated transactions. We retire our common stock upon repurchase and have not made any purchases of common stock other than in connection with publicly announced repurchase program authorizations. In connection with the spin-off of the Shipbuilding business, we obtained a Private Letter Ruling (“PLR”) from the Internal Revenue Service that limits our share repurchases to approximately 88 million shares within two years of the spin-off (a maximum of 30 percent of outstanding shares at the time of the separation). Due to share repurchases subsequent to the spin-off, the remaining number of shares that we can repurchase under this share repurchase limitation as of December 31, 2011, is approximately 48 million shares. Cash available from unusual transactions, such as the disposition of significant assets, should they arise, can be used to repurchase additional shares.

 

(f) Securities Authorized for Issuance Under Equity Compensation Plans.

For a description of securities authorized under our equity compensation plans, see Note 17 to the consolidated financial statements in Part II, Item 8.

 

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Item 6. Selected Financial Data

The data presented in the following table is derived from the audited consolidated financial statements and other information adjusted to reflect the effects of discontinued operations. See also Business Dispositions in Part II, Item 7.

Selected Financial Data

 

    Year Ended December 31
$ in millions, except per share amounts   2011    2010    2009    2008    2007

Sales and Service Revenues

                       

U.S. Government

    $ 23,905        $ 25,507        $ 24,955        $ 23,274        $ 21,687  

Other customers

      2,507          2,636          2,695          2,977          2,957  

Total revenues

    $ 26,412        $ 28,143        $ 27,650        $ 26,251        $ 24,644  

Operating income

    $ 3,276        $ 2,827        $ 2,274        $ 2,076        $ 2,464  

Earnings from continuing operations

      2,086          1,904          1,434          1,018          1,448  

Basic earnings per share, from continuing operations

    $ 7.54        $ 6.41        $ 4.49        $ 3.04        $ 4.24  

Diluted earnings per share, from continuing operations

      7.41          6.32          4.44          2.98          4.09  

Cash dividends declared per common share

      1.97          1.84          1.69          1.57          1.48  

Year-End Financial Position

                       

Total assets(1)

    $ 25,411        $ 31,410        $ 30,297        $ 30,077        $ 33,252  

Notes payable to banks and long-term debt

      3,948          4,724          4,011          3,661          3,772  

Total long-term obligations and preferred stock(2)

      8,940          7,947          8,959          8,926          7,278  

Financial Metrics

                       

Cash provided by continuing operations

    $ 2,347        $ 2,056        $ 1,995        $ 2,705        $ 2,050  

Free cash flow from continuing operations(3)

      1,855          1,471          1,454          2,132          1,478  

Other Information

                       

Company-sponsored research and development expenses

    $ 543        $ 580        $ 588        $ 543        $ 502  

Maintenance and repairs

      364          369          371          314          216  

Payroll and employee benefits

      10,275          10,861          11,119          10,127          9,616  

Number of employees at year-end

      72,500          79,600          81,800          81,418          79,818  

 

(1) Total assets as of December 31, 2007 – 2010 have been reduced by $121 million as a result of the correction of deferred tax assets described in Note 10 in Part II, Item 8.

 

(2) In 2008, all of the outstanding shares of preferred stock were converted or redeemed. Total long-term obligations includes the long-term portions of debt, pension and post-retirement plan liabilities, environmental liabilities, deferred compensation and other long-term obligations.

 

(3) Free cash flow from continuing operations is a non-GAAP financial measure and is calculated as cash provided by continuing operations less capital expenditures and outsourcing contract and related software costs. Outsourcing contract and related software costs are similar to capital expenditures in that the contract costs represent incremental external costs or certain specific internal costs that are directly related to the contract acquisition and transition/set-up. These outsourcing contract and related software costs are deferred and expensed over the contract’s period of performance. See Liquidity and Capital Resources – Free Cash Flow from Continuing Operations in Part II, Item 7 for more information on this measure.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

Notable Events

Certain notable events or activities affecting our 2011 consolidated financial results included the following:

Significant financial events for the year ended December 31, 2011:

 

  n  

We completed the spin-off of our Shipbuilding business (Huntington Ingalls Industries or HII), which is now reported within discontinued operations.

 

  n  

In connection with the spin-off of HII, we received cash of $1.4 billion.

 

  n  

We reduced our participation in the National Security Technologies (NSTec) joint venture, which resulted in a $1.7 billion reduction in contract backlog and a $579 million reduction in 2011 revenues.

 

  n  

We repaid notes with a face value of $768 million.

 

  n  

We made voluntary pension funding contributions totaling $1.0 billion.

 

  n  

We repurchased 40.2 million shares of common stock for a total of $2.3 billion.

 

  n  

In the second quarter of 2011, we increased the quarterly stock dividend from $0.47 per share to $0.50 per share.

 

  n  

We paid $543 million in cash dividends.

Other notable events for the year ended December 31, 2011:

 

  n  

We relocated our corporate offices in Los Angeles, California and in Rosslyn, Virginia to our new corporate office in Falls Church, Virginia.

 

  n  

We increased the authorization for share repurchases by approximately $2.2 billion.

Political and Economic Environment

The U.S. and global economies have experienced a period of substantial economic uncertainty and turmoil, with high levels of national debt, and the related financial markets have been characterized by significant volatility.

Current levels of deficit spending in the U.S. could prove to be unsustainable over the long term. Although defense spending is expected to remain a national priority within future federal budgets, the passage of the Budget Control Act of 2011 (the Budget Control Act) in August 2011 marked a growing political acceptance of cutting planned defense spending as part of a deficit reduction solution. Some allied government defense spending has also come under increasing pressure as governments search for ways to reduce their deficits and national debts.

The Administration and Congress will likely continue to debate the size of the new defense budget plan for the next decade, but spending over the next several years is expected to drop measurably from previously planned levels, absent a significant national security event. Future defense plans and changes in defense spending levels could adversely affect the individual programs and delay purchasing by our customers, which could have a material adverse effect on the company’s consolidated financial position, results of operations, and/or cash flows. While these significant budgetary considerations put downward pressure on growth in our industry, we believe that our business is well positioned in areas that the DoD has indicated are areas of focus for future defense spending to help the DoD meet its critical future capability requirements for protecting U.S. security and the security of our allies in the years to come.

The Budget Control Act raised the statutory limit on the amount of permissible federal debt and committed the U.S. Government to reduce significantly the federal deficit in the coming decade. The Budget Control Act consists of two parts, both of which could impact future defense spending levels. The first part mandates a total reduction of $940 billion to the fiscal year 2012 Presidential Budget submission as part of established caps on discretionary spending through 2021. Of this total reduction, approximately $490 billion is expected to come from defense spending. The Budget Control Act also set up a Joint Committee of Congress (the Joint Committee) that

 

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was responsible for identifying an additional $1.2 to $1.5 trillion in deficit reductions by November 23, 2011. The Joint Committee was unable to identify the additional deficit reductions by this deadline thereby triggering a second provision of the Budget Control Act called “sequestration,” which calls for very substantial automatic spending cuts split between defense and non-defense programs that will start in 2013 and continue over a nine-year period. Both the Administration and many members of Congress have indicated that sequestration is not the preferred path to deficit reduction and that alternative steps should be pursued. While we believe efforts may be underway to prevent the automatic spending cuts scheduled to begin in 2013, the outcome of these efforts is uncertain.

The fiscal year 2012 defense budget provides a nominal increase in base funding over fiscal year 2011 levels. We anticipate continued debate over defense spending with the President’s Budget request for fiscal year 2013 and the subsequent Congressional budget process. The forthcoming general election in November is expected to generate significant additional political dialogue centered around the federal deficit and potential cuts in government spending. Budget decisions made in this environment could have long-term consequences for our company and the entire defense industry.

We expect U.S. force levels and budget resources tied to current hostilities to continue to draw down. As overall defense spending is reduced, the DoD is re-evaluating the role and structure of the military. The DoD recently released a new defense strategy that resulted from a comprehensive review intended to guide its priorities and budgeting decisions. The new guidance indicates the U.S. military needs to project power globally and operate effectively in all domains, including cybersecurity, and it places particular emphasis on the Asia Pacific region as an area of strategic focus.

In January 2012, the Secretary of Defense announced a number of program changes and cancellations that are scheduled to take place over the next several years in part to comply with certain provisions of the Budget Control Act. Certain of these program changes and cancellations will have an impact on programs in which we participate.

The U.S. is expected to continue to maintain a range of powerful military capabilities to support U.S. national security interests, even amidst economic difficulties and reductions in defense spending levels, and consequently we expect the U.S. will continue to need many of the sophisticated capabilities that we provide. We believe our portfolio aligns well with the DoD’s indicated requirements, and, as a result, we believe we are well positioned to help the DoD meet its critical future capability requirements for protecting U.S. security in the years ahead.

Although reductions to individual programs in which we participate or for which we expect to compete are always possible (such as the recent announcements regarding the Block 30 Global Hawk and F-35 programs), we believe that spending on recapitalization, modernization and maintenance of defense, intelligence, and homeland security assets will continue to be a national priority. Future defense spending is expected to include the development and procurement of new manned and unmanned military platforms and systems along with advanced electronics and software to enhance the capabilities of individual systems and provide real-time integration of individual surveillance, information management, strike, and battle management platforms. Given the current era of irregular warfare, we expect increased investment in persistent awareness with intelligence, surveillance and reconnaissance (ISR) systems, cyber warfare, and an expansion of information available for the warfighter to make timely decisions. We expect other significant new competitive opportunities to include long range strike, directed energy applications, missile defense, satellite communications systems, restricted programs, cybersecurity, technical services and information technology contracts, and numerous international and homeland security programs.

We believe that the U.S. Government will continue to place a high priority on defense spending and national security, as well as economic challenges, and will continue to invest in sophisticated systems providing long-range surveillance and intelligence, battle management, precision strike, and strategic agility. In addition, the U.S. Government continues to face challenges with recapitalizing equipment and rebuilding readiness while also pursuing modernization and reducing overhead and inefficiency.

See Risk Factors located in Part I, Item 1A for a more complete description of risks we face.

 

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Cybersecurity

Our industry and the broader national security community are subject to various cybersecurity threats including, but not limited to, attempts to gain unauthorized access to sensitive information. We proactively work to assess and mitigate the evolving risks. In addition, we have partnered with various industry and government participants, including the DoD, to collaborate around increased awareness and enhanced protections against cybersecurity threats. See Risk Factors located in Part I, Item 1A for a more complete description of the risks that we face due to security threats, including cybersecurity threats.

Green Initiatives

We could be affected by future laws or regulations, including but not limited to, those enacted in response to climate change concerns and other actions known as “green initiatives.” In 2009, we established a goal of reducing our greenhouse gas emissions over a five-year period through December 31, 2014. In 2010, we established goals for water usage and solid waste generation. To comply with laws, regulations, and green initiatives, including our goals, we have incurred and expect to incur capital and operating costs, but at this time, such costs have not had, and we do not expect that such costs will have, a material adverse effect on the company’s consolidated financial position, results of operations or cash flows.

BUSINESS DISPOSITIONS

2011 – We completed the spin-off to our shareholders of HII effective March 31, 2011. HII operates the business that was previously the Shipbuilding segment (Shipbuilding) of the company prior to the spin-off. The spin-off was the culmination of the company’s decision to explore strategic alternatives for Shipbuilding as it was determined to be in the best interests of shareholders, customers, and employees to allow both the company and Shipbuilding to pursue more effectively their respective opportunities to maximize value. We made a pro rata distribution to our shareholders of one share of HII common stock for every six shares of our common stock held on the record date of March 30, 2011, or 48.8 million shares of HII common stock. There was no gain or loss recognized by the company as a result of the spin-off transaction. In connection with the spin-off, HII issued senior notes and entered into a credit facility with third-party lenders, and HII used a portion of the proceeds of the notes and credit facility to fund a $1.4 billion cash contribution to us. Sales for Shipbuilding for the three months ended March 31, 2011, were $1.6 billion and sales for the years ended December 31, 2010 and 2009, were $6.7 billion and $6.2 billion, respectively. The assets, liabilities and operating results of this business unit are reported as discontinued operations in the consolidated financial statements for all periods presented.

2009 – We sold our Advisory Services Division (ASD) in December 2009, for $1.65 billion in cash to an investor group led by General Atlantic, LLC and affiliates of Kohlberg Kravis Roberts & Co. L.P., and recognized a gain of $15 million, net of taxes. ASD was a business unit comprised of the assets and liabilities of TASC, Inc., its wholly owned subsidiary TASC Services Corporation, and certain contracts carved out from other businesses also in Information Systems that provide systems engineering technical assistance (SETA) and other analysis and advisory services. Sales for ASD in the year ended December 31, 2009 was approximately $1.5 billion.

 

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Discontinued Operations – Earnings for the businesses classified within discontinued operations for the dispositions discussed above were as follows:

 

    Year Ended December 31
$ in millions           2011                   2010               2009

Sales and service revenues

    $ 1,646       $ 6,711       $ 7,740  

Earnings from discontinued operations

      59         229         345  

Income tax expense

      (28 )       (95 )       (111 )

Earnings, net of tax

      31         134         234  

Gain on divestitures

      2         10         446  

Income tax (expense) benefit

      (1 )       5         (428 )

Gain on divestitures, net of tax

      1         15         18  

Earnings from discontinued operations, net of tax

    $ 32       $ 149       $ 252  

CONTRACTS

We generate the majority of our business from long-term government contracts for development, production, and support activities. Government contracts typically include the following major cost elements: material, labor, overhead, subcontract costs, and general and administrative costs. Unless otherwise specified in a contract, costs billed to contracts with the U.S. Government are determined under the requirements of the Federal Acquisition Regulation (FAR) and CAS regulations as allowable and allocable costs. Examples of costs incurred by us and not billed to the U.S. Government in accordance with the requirements of the FAR and CAS regulations include, but are not limited to, certain legal costs, lobbying costs, charitable donations, interest expense and advertising costs.

Our long-term contracts typically fall into one of two broad categories:

Flexibly Priced Contracts – Flexibly priced contracts include both cost-type and fixed-price incentive contracts. Cost-type contracts provide for reimbursement of the contractor’s allowable costs incurred plus a fee that represents profit. Cost-type contracts generally require that the contractor use its best efforts to accomplish the scope of the work within some specified time and some stated dollar limitation. Fixed-price incentive contracts also provide for reimbursement of the contractor’s allowable costs up to a ceiling amount, but are subject to a cost-share limit that affects profitability. Fixed-price incentive contracts effectively become firm fixed-price contracts once the cost-share limit is reached.

Firm Fixed-Price Contracts – A firm fixed-price contract is a contract in which the specified scope of work is agreed to for a price that is a pre-determined, negotiated amount and not generally subject to adjustment regardless of costs incurred by the contractor. Time-and-materials contracts are considered firm fixed-price contracts as they specify a fixed hourly rate for each labor hour charged.

The following table summarizes 2011 revenue recognized by contract type and customer:

 

($ in millions)   U.S.
Government
   Other
Customers
   Total    Percent
of Total

Flexibly priced contracts

    $ 15,413        $ 237        $ 15,650          59%   

Firm fixed-price contracts

      8,492          2,270          10,762          41%   

Total sales and service revenues

    $ 23,905        $ 2,507        $ 26,412          100%   

 

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Contract Fees – Negotiated contract fee structures, for both flexibly priced and fixed-price contracts include, but are not limited to: fixed-fee amounts, cost sharing arrangements to reward or penalize for either under or over cost target performance, positive award fees, and negative penalty arrangements. Profit margins may vary materially depending on the negotiated contract fee arrangements, the achievement of performance objectives, and the stage of performance at which the right to receive fees, particularly under incentive and award fee contracts, is finally determined.

Award Fees – Certain contracts contain provisions consisting of award fees based on performance criteria such as cost, schedule, quality, and technical performance. Award fees are determined and earned based on an evaluation by the customer of the company’s performance against negotiated criteria. Award fees that can reasonably be estimated and are deemed reasonably assured, are recorded over the performance period of the contract. Award fee contracts are used in certain of our operating segments.

Compliance and Monitoring – We monitor our policies and procedures with respect to our contracts on a regular basis to enhance consistent application under similar terms and conditions, as well as compliance with all applicable government regulations and laws. In addition, costs incurred and allocated to contracts with the U.S. Government are routinely audited by the Defense Contract Audit Agency.

CRITICAL ACCOUNTING POLICIES, ESTIMATES, AND JUDGMENTS

Revenue Recognition

Overview – We derive the majority of our business from long-term contracts for the production of goods and services provided to the federal government, which are accounted for in conformity with accounting principles generally accepted in the United States of America (GAAP) for construction-type and production-type contracts and federal government contractors. We classify contract revenues as product sales or service revenues depending on the predominant attributes of the relevant underlying contract. We also enter into contracts that are not associated with the federal government, such as contracts to provide certain services to non-federal government customers. We account for those contracts in accordance with the relevant GAAP revenue recognition principles.

We consider the nature of these contracts and the types of products and services provided when determining the proper accounting method for a particular contract.

Percentage-of-Completion Accounting – We generally recognize revenues from our long-term contracts under the cost-to-cost or the units-of-delivery measures of the percentage-of-completion method of accounting. The percentage-of-completion method recognizes income as work on a contract progresses. For most contracts, sales are calculated based on the percentage of total costs incurred in relation to total estimated costs at completion of the contract. The units-of-delivery measure is a modification of the percentage-of-completion method, which recognizes revenues as deliveries are made to the customer generally using unit sales values in accordance with the contract terms. Under percentage-of-completion accounting, we estimate profit as the difference between total estimated revenue and total estimated cost of a contract and recognize that profit over the life of the contract based on each contract’s percentage-of-completion.

The use of the percentage-of-completion method requires us to make reasonably dependable cost estimates for the design, manufacture, and delivery of our products and services. The cost estimation process is based upon the professional knowledge of our engineers, program managers and financial professionals, and draws on their significant experience and judgment. Such costs are typically incurred over a period of several years, and estimation of these costs requires the use of judgment.

Many contracts contain positive and negative profit incentives based upon performance relative to predetermined targets that may occur during or subsequent to delivery of the product. These incentives take the form of potential additional fees to be earned or penalties to be incurred. Incentives and award fees that can be reasonably assured and reasonably estimated are recorded over the performance period of the contract. Incentives and award fees that are not reasonably assured or cannot be reasonably estimated are recorded when awarded or at such time as we believe a reasonable estimate can be made.

 

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Changes in estimates of contract sales, costs, and profits are recognized using the cumulative catch-up method of accounting. This method recognizes in the current period the cumulative effect of the changes on current and prior periods. Hence, the effect of the changes on future periods of contract performance is recognized as if the revised estimate had been the original estimate. A significant change in an estimate on one or more contracts could have a material effect on our consolidated financial position, results of operations and/or cash flows.

Certain Service Contracts – We generally recognize revenue under contracts to provide services to non-federal government customers when services are performed. Service contracts include operations and maintenance contracts, and outsourcing-type arrangements, primarily in Technical Services and Information Systems. We generally recognize revenue under such contracts on a straight-line basis over the period of contract performance, unless evidence suggests that the revenue is earned or the obligations are fulfilled in a different pattern. Costs incurred under these service contracts are expensed as incurred, except that direct and incremental set-up costs are capitalized and amortized over the life of the agreement. Operating profit related to such service contracts may fluctuate from period to period, particularly in the earlier phases of the contract.

Contracts that include more than one type of product or service are accounted for under the relevant GAAP guidance for revenue arrangements with multiple-elements. Accordingly, for applicable arrangements, revenue recognition includes the proper identification of separate units of accounting and the allocation of revenue across all elements based on relative fair values.

Cost Estimation – The cost estimation process is based upon the professional knowledge of our engineers, program managers and financial professionals, and draws on their significant experience and judgment. Factors that are considered in estimating the work to be completed and ultimate contract recovery include the availability, productivity and cost of labor, the nature and complexity of the work to be performed, the effect of change orders, the availability of materials, the effect of any delays in performance, the availability and timing of funding from the customer, and the recoverability of any claims included in the estimates to complete. A significant change in an estimate on one or more contracts could have a material effect on our consolidated financial position, results of operations and/or cash flows. We update our contract cost estimates at least annually and more frequently as determined by events or circumstances. We generally review and reassess our cost and revenue estimates for each significant contract on a quarterly basis.

We record a provision for the entire loss on the contract in the period the loss is determined when estimates of total costs to be incurred on a contract exceed estimates of total revenue to be earned. We offset loss provisions first against costs that are included in unbilled accounts receivable or inventoried assets, with any remaining amount reflected in liabilities.

Purchase Accounting

Overview – We allocate the purchase price of an acquired business to the underlying tangible and intangible assets acquired and liabilities assumed based upon their respective fair market values, with the excess recorded as goodwill. Such fair market value assessments require judgments and estimates that can be affected by contract performance and other factors over time, which may cause final amounts to differ materially from original estimates. Adjustments to the fair value of purchased assets and liabilities after the initial measurement period are recognized in net earnings.

Acquisition Accruals – We establish certain accruals in connection with indemnities and other contingencies from our acquisitions and divestitures. We have recorded these accruals and subsequent adjustments during the purchase price allocation period for acquisitions and as events occur for divestitures. The accruals are determined based upon the terms of the purchase or sales agreements and, in most cases, involve a significant degree of judgment. We record these accruals based on our interpretation of the terms of the purchase or sale agreements, known facts, and an estimation of probable future events based on our experience, which may cause final amounts to differ materially from original estimates.

 

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Goodwill and Other Intangible Assets

We perform an annual impairment test of our goodwill and intangible assets with indefinite lives as of November 30th, or between annual tests if events occur or circumstances change which suggest that the goodwill or indefinite-lived intangible assets should be evaluated. Intangible assets with finite lives are tested for impairment, whenever events or circumstances indicate that the carrying value may not be recoverable. When testing goodwill, we compare the fair value of the reporting unit to its carrying value.

To determine the fair value of our reporting units, we primarily use the income approach based on the cash flows that the reporting unit expects to generate in the future. This income valuation method requires management to project revenues, operating expenses, working capital investment, capital spending and cash flows for the reporting units over a multi-year period, as well as determine the weighted-average cost of capital (WACC) used as a discount rate and the terminal value assumptions. The WACC takes into account the relative weights of each component of our consolidated capital structure (equity and debt) and represents the expected cost of new capital adjusted as appropriate to consider lower risk profiles associated with longer-term contracts and barriers to market entry. The terminal value assumptions are applied to the final year of the discounted cash flow model. Impairment assessment inherently involves management judgments as to assumptions about expected future cash flows and the impact of market conditions on those assumptions. Due to the many variables inherent in the estimation of a business’s fair value and the relative size of our recorded goodwill, differences in assumptions may have a material effect on the results of our impairment analysis. We also corroborate the fair values determined under the income approach using the market valuation method to estimate the fair value of our reporting units by utilizing industry multiples (including relevant control premiums) of operating earnings. When calculating impairment for intangible assets with indefinite lives, we compare the fair value of these assets, as determined based on the income and market valuation methods, to the carrying value. If the carrying value exceeds the fair value, we determine the fair value of the reporting unit’s individual assets and liabilities and calculate the implied fair value of goodwill.

In the fourth quarter of 2011, we performed our annual goodwill impairment evaluation. The results of our annual goodwill impairment test as of November 30, 2011, indicated that the estimated fair value of each reporting unit exceeds its carrying value. There were no impairment charges recorded in the years ended December 31, 2011, 2010 and 2009.

Litigation, Commitments, and Contingencies

We are subject to a range of claims, investigations, lawsuits, environmental matters, income tax matters, and administrative proceedings that arise in the ordinary course of business. Estimating liabilities and costs associated with these matters requires judgment based upon professional knowledge and experience of management and our internal and external legal counsel. In accordance with our practices relating to accounting for contingencies, we determine whether to record a charge to earnings and, if so, what amount based on consideration of the facts and circumstances of each matter as then known to us, including any settlement offers, and our assessment of the probability of the liabilities and whether the amount of the loss can be reasonably estimated. The ultimate resolution of any such exposure to us may vary materially from earlier estimates as further facts and circumstances develop or become known to us. When we believe, based on the facts available to us, that a liability is probable and the loss is reasonably estimable, we record our best estimate of the amount of the ultimate loss. When a range of costs is reasonably estimable, but no amount within that range is a better estimate than another, we record what we estimate as the lower end of the range. For further information on the treatment of these contingencies, see Note 1, Note 14 and Note 15 to the consolidated financial statements in Part II, Item 8.

U.S. Government Cost Claims

From time to time, our customers advise us of ordinary course claims and penalties concerning certain potential disallowed costs. When such findings are presented, we engage U.S. Government representatives in discussions to enable us to evaluate the merits of these claims, as well as to assess the amounts being claimed. Where appropriate, provisions are made to reflect our expected exposure to matters raised by the U.S. Government representatives.

 

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Income Taxes

Provisions for federal, foreign, state, and local income taxes are calculated on reported financial statement pre-tax income based on current tax law and include the cumulative effect of any changes in tax rates from those used previously in determining deferred tax assets and liabilities. Such provisions differ from the amounts currently payable because certain items of income and expense are recognized in different time periods for financial reporting purposes than for income tax purposes. State and local income and franchise tax provisions are allocable to contracts in process and, accordingly, are included in operating income.

Uncertain Tax Positions – Tax positions that meet the more-likely-than-not recognition threshold may be recognized or continue to be recognized in the financial statements. If a tax position does not meet the minimum statutory threshold to avoid payment of penalties, the company recognizes an expense for the amount of the penalty in the period it is determined. The company recognizes federal interest accrued related to unrecognized tax benefits within income tax expense. Federal penalties are recognized as a component of income tax expense. See Note 10 to the consolidated financial statements in Part II, Item 8.

Retirement Benefits

Overview – We record our employee pension and other post-retirement plans in accordance with US GAAP under Financial Accounting Standards (FAS) and charge the costs of these plans to our contracts with customers in accordance with the FAR and the related Cost Accounting Standards (CAS) that govern such plans. In measuring periodic pension cost, both FAS and CAS recognize a normal services cost component, but there are differences in the way the remaining components of annual pension costs are calculated under each method, including the assumptions and methods used for measuring the plan obligations. As a result, retiree benefit plan expense amounts for FAS purposes are different from the amounts for CAS purposes. Further, differences result from different methodologies in how estimated earnings on pension assets and interest expense on the pension obligations are measured, and the measurement and allocation periods over which gains/losses related to pension assets and actuarial changes are determined. CAS pension expense is allocated to our segments and is included in their measurement of segment operating income, and the difference between the CAS and FAS pension expense is recorded in operating income at the consolidated company level.

Recent Developments in U.S. Government Cost Accounting Standards Pension Recovery Rules – On December 27, 2011 the CAS Board published a final rule revising CAS 412, “Composition and Measurement of Pension Cost,” and CAS 413, “Adjustment and Allocation of Pension Cost.” These revisions are intended to partially harmonize the measurement and period of assignment of defined benefit pension plan costs allocable to U.S. Government contracts, and the minimum required contribution under the Employee Retirement Income Security Act of 1974 (ERISA), as amended by the Pension Protection Act (PPA) of 2006. We anticipate that the rule will better align, but not eliminate, mismatches between ERISA funding requirements and CAS pension costs for U.S. Government CAS covered contracts. Under the final rule, there is a five-year transition period, during which an increasing percentage of the harmonization effect is to be recognized, starting from 0% in the first year to 100% in the fifth year and thereafter. The rule becomes effective February 27, 2012, with 2013 being the first year of applicability for the revised accounting practices required by the rule. Price proposals for CAS covered contracts awarded on or after the effective date of February 27, 2012, will reflect the effects of the rule. We believe for CAS covered contracts awarded prior to the effective date, contractors will be entitled to an equitable adjustment for any additional CAS basis contract costs resulting from implementation of the final rule.

FAS Benefit Plan Assumptions – We perform an annual evaluation of the assumptions used in determining projected benefit obligations and the fair values of plan assets for our pension plans and other post-retirement benefit plans in consultation with our outside actuaries. In the event that we determine that plan amendments or changes in the assumptions are warranted, future pension and post-retirement benefit expenses could increase or decrease. The principal assumptions that have a significant effect on our consolidated financial position and results of operations are the discount rate, the expected long-term rate of return on plan assets, the health care cost trend rate and the estimated fair market value of plan assets. For certain plan assets where the fair market value is not readily determinable, such as real estate, private equity, and hedge funds, estimates of fair value are determined using the best information available.

 

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Discount Rate – The discount rate represents the interest rate that is used to determine the present value of future cash flows currently expected to be required to settle the pension and post-retirement benefit obligations. The discount rate is generally based on the yield of high-quality corporate fixed-income investments. At the end of each year, the discount rate is primarily determined using a portfolio of high quality bonds matching the notional cash inflows with the expected benefit payments for each significant benefit plan. Taking into consideration the factors noted above, our weighted-average pension composite discount rate was 5.03 percent at December 31, 2011, and 5.75 percent at December 31, 2010. Holding all other assumptions constant, and since net actuarial gains and losses were in excess of the 10 percent accounting corridor in 2011, an increase or decrease of 25 basis points in the discount rate assumption for 2011 would have decreased or increased pension and post-retirement benefit expense for 2011 by approximately $77 million, of which $2 million relates to post-retirement benefits, and decreased or increased the amount of the benefit obligation recorded at December 31, 2011, by approximately $800 million, of which $55 million relates to post-retirement benefits. The effects of hypothetical changes in the discount rate for a single year may not be representative and may be asymmetrical or nonlinear for future years because of the application of the accounting corridor. The accounting corridor is a defined range within which amortization of net gains and losses is not required.

Expected Long-Term Rate of Return – The expected long-term rate of return on plan assets represents the average rate of earnings expected on the funds invested in a specified target asset allocation to provide for anticipated future benefit payment obligations. For 2011 and 2010, we assumed an expected long-term rate of return on plan assets of 8.5 percent. An increase or decrease of 25 basis points in the expected long-term rate of return assumption for 2011, holding all other assumptions constant, would increase or decrease our pension and post-retirement benefit expense for 2011 by approximately $52 million, of which $2 million relates to post-retirement benefits. For 2012 pension and post-retirement benefit plan purposes, we have assumed an expected long-term rate of return on plan assets of 8.25 percent.

Health Care Cost Trend Rates – The health care cost trend rates represent the annual rates of change in the cost of health care benefits based on external estimates of health care inflation, changes in health care utilization or delivery patterns, technological advances, and changes in the health status of the plan participants. Using a combination of market expectations and economic projections including the effect of health care reform, we selected an expected initial health care cost trend rate of 7.5 percent for 2012 and an ultimate health care cost trend rate of 5 percent reached in 2017. In 2010, we assumed an expected initial health care cost trend rate of 8 percent for 2011 and an ultimate health care cost trend rate of 5 percent reached in 2017. Although our actual cost experience is much lower at this time, market conditions and the potential effects of health care reform are expected to increase medical cost trends in the next one to three years thus our past experience may not reflect future conditions.

Differences in the initial through the ultimate health care cost trend rates within the range indicated below would have had the following impact on 2011 post-retirement benefit results:

 

$ in millions   1-Percentage-
Point Increase
  1-Percentage-
Point Decrease

Increase (Decrease) From Change In Health Care Cost Trend Rates To

       

Post-retirement benefit expense

    $ 5       $ (6 )

Post-retirement benefit liability

      64         (75 )

 

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CONSOLIDATED OPERATING RESULTS

Selected financial highlights are presented in the table below:

 

    Year Ended December 31
$ in millions           2011                 2010         2009  

Sales and service revenues

    $ 26,412       $ 28,143       $ 27,650  

Cost of sales and service revenues

      (20,786 )       (22,849 )       (22,805 )

General and administrative expenses

      (2,350 )       (2,467 )       (2,571 )

Operating income

      3,276         2,827         2,274  

Interest expense

      (221 )       (269 )       (269 )

Charge on debt redemption

          (229 )    

Federal and foreign income tax expense

      (997 )       (462 )       (636 )

Cash provided by continuing operations

      2,347         2,056         1,995  

Operating Performance Assessment and Reporting

We manage and assess the performance of our businesses based on our performance on individual contracts and programs (two or more closely-related contracts) generally obtained from government organizations using the financial measures referred to below, with consideration given to the Critical Accounting Policies, Estimates and Judgments described above in Part II, Item 7. As indicated in our discussion on “Contracts” above in Part II, Item 7, our portfolio of long-term contracts is largely flexibly-priced, which means that sales tend to fluctuate in concert with costs across our large portfolio of active contracts, with operating income being a critical measure of operational performance. Due to FAR rules that govern our business, most types of costs are allowable, and we do not focus on individual cost groupings (such as manufacturing, engineering, and design labor costs, subcontractor costs, material costs, overhead costs, and general and administrative costs), as much as we do on total contract costs, which is the key driver of both revenue and operating income.

In any given reporting period, each of our segments manages numerous contracts that provide for the delivery of products or services to our customers. Our contract management process involves the use of contract estimates-at-completion (EACs) that are generally prepared and evaluated on a bottoms-up basis at least annually and reviewed on a quarterly basis over the performance period of the contract. These EACs include an estimated contract operating income margin rate based initially on the contract award amount, adjusted to reflect estimated risks related to contract performance. These risks typically include technical risk, schedule risk and performance risk based upon our evaluation of the contract effort. Similarly, the EACs include identified opportunities for operating income margin rate improvement. Over the performance period of the contract, our program management organizations perform recurring evaluations of contract performance and adjust the contract revenue and cost estimates over the life of the contract to reflect the latest reliable information available. Our business and program management organizations are comprised of a large cadre of skilled professional managers who utilize our contract administration and management control systems with the objective of successfully overseeing our contract performance to satisfy the customer’s expectations, deliver high quality products and services, and manage contract risks and opportunities to achieve an appropriate operating income margin rate on the contract. Our comprehensive business and contract management process involves personnel from the planning, production control, contracts, cost management, supply chain and program and business management functions. As part of this overall contract management function, these personnel monitor compliance with our critical accounting policies related to contract accounting and compliance with U. S. Government regulations. As a result, contract operating income and period-to-period contract operating income margin rates are adjusted over the contract performance period to reflect changes in the risks and opportunities affecting the contract, and adjustments may have a favorable or unfavorable effect on operating income margin depending upon the specific conditions affecting each contract.

 

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In evaluating our operating performance, we look primarily at changes in sales and service revenues, and operating income, including the effects of meaningful changes in operating income as a result of changes in contract estimates and the use of the cumulative catch-up method of accounting in accordance with GAAP. Where applicable, unusual fluctuations in operating performance attributable to 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 generally focuses around our four segments versus distinguishing between products and services.

Sales and Service Revenues

Sales and service revenues consist of the following:

 

    Year Ended December 31
$ in millions           2011                    2010            2009

Product sales

    $ 15,073        $ 16,091        $ 16,004  

Service revenues

      11,339          12,052          11,646  

Sales and service revenues

    $ 26,412        $ 28,143        $ 27,650  

2011 – Sales and service revenues for 2011 decreased $1,731 million, or 6 percent, as compared to 2010, reflecting lower sales at all four operating segments.

Product sales for 2011 decreased $1,018 million, or 6 percent, as compared to 2010, primarily due to lower sales volume on space and manned aircraft programs at Aerospace Systems and lower sales volume in Land and Self Protection Systems at our Electronic Systems segment. Service revenues for 2011 decreased $713 million, or 6 percent, as compared to 2010, primarily due to the reduced participation by the Technical Services segment in the NSTec joint venture effective January 1, 2011, resulting in no sales recorded for the joint venture in 2011, compared to $579 million in 2010, and lower sales volume on defense and civil systems at the Information Systems segment.

2010 – Sales and service revenues for the year ended December 31, 2010, increased $493 million, or 2 percent, as compared to 2009, reflecting higher sales at Aerospace Systems and Technical Services, partially offset by lower sales at Information Systems and Electronic Systems.

Product sales for the year ended December 31, 2010, increased $87 million, or 1 percent, as compared to 2009, primarily due to sales growth in Aerospace Systems partially offset by lower product sales in Electronic Systems and Information Systems. Service revenues for the year ended December 31, 2010, increased $406 million, or 3 percent, as compared to 2009, primarily due to sales growth in Technical Services largely related to the KC-10 Contractor Logistics Support (KC-10) program.

See the Segment Operating Results section below for further information.

 

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The first table below presents cost of sales and service revenues and general and administrative expenses on a consolidated basis while the second table presents our cost of sales and service revenues on a segment-by-segment basis, and with the impact of non-segment factors:

Cost of Sales and Service Revenues and General Administrative Expenses(1)

 

    Year Ended December 31
$ in millions           2011                   2010                   2009    

Cost of sales and service revenues

           

Cost of product sales

    $ 11,491       $ 12,558       $ 12,648  

% of product sales

      76.2 %       78.0 %       79.0 %

Cost of service revenues

      9,295         10,291         10,157  

% of service revenues

      82.0 %       85.4 %       87.2 %

General and administrative expenses

      2,350         2,467         2,571  

% of total sales and service revenues

      8.9 %       8.8 %       9.3 %

Cost of sales and service revenues and general and administrative expenses

    $ 23,136       $ 25,316       $ 25,376  

 

(1) As of December 31, 2011, the company revised its reporting of intersegment cost of sales. See Note 7 to the consolidated financial statements.

 

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For ease of understanding the items that drive changes in our consolidated cost of sales, we have presented below an analysis of sales and cost of sales by segment and the non-segment factors that impact our consolidated amounts:

Cost of Sales Elements by Segment and Non-Segment Factors:

 

    Year Ended December 31
$ in millions   2011   2010   2009
Segment Information:   Sales   Cost of
Sales
  Sales   Cost of
Sales
  Sales   Cost of
Sales

Aerospace Systems

                       

Product

    $ 9,179       $ 8,058       $ 9,779       $ 8,676       $ 9,346       $ 8,370  

Services

      1,279         1,139         1,131         978         1,073         978  

Electronic Systems

                       

Product

      6,041         5,161         6,410         5,479         6,543         5,642  

Services

      1,331         1,141         1,203         1,111         1,128         1,060  

Information Systems

                       

Product

      486         430         535         476         687         613  

Services

      7,435         6,725         7,860         7,163         7,849         7,299  

Technical Services

                       

Product

      23         20         20         19         17         16  

Services

      2,676         2,463         3,210         3,005         2,759         2,599  

Segment Totals

                       

Total Product

    $ 15,729       $ 13,669       $ 16,744       $ 14,650       $ 16,593       $ 14,641  

Total Services

      12,721         11,468         13,404         12,257         12,809         11,936  

Intersegment eliminations

      (2,038 )       (1,780 )       (2,005 )       (1,774 )       (1,752 )       (1,562 )

Total Segment

    $ 26,412       $ 23,357       $ 28,143       $ 25,133       $ 27,650       $ 25,015  

Non-segment Factors:

                       

Unallocated corporate expenses

          166             182             100  

Net pension adjustment

          (400 )           (10 )           237  

Royalty income adjustment

                13                   11                   24  

Consolidated total

    $ 26,412       $ 23,136       $ 28,143       $ 25,316       $ 27,650       $ 25,376  

Cost of Segment Product Sales

2011 – Cost of segment product sales in 2011 decreased by $981 million and a 60 basis point reduction as a percentage of product sales as compared to 2010, due to the overall decline in sales for the period across all of the segments other than Technical Services. Aerospace Systems’ sales volume declined by $600 million largely due to sales declines in Space Systems ($388 million) and Strike & Surveillance Systems ($255 million), partially offset by sales increases in Battle Management & Engagement Systems and Advanced Programs & Technology (approximately $90 million each). Margin rates improved at Aerospace Systems by 90 basis points primarily due to net favorable performance improvements on programs and lower amortization of purchased intangibles in 2011. Sales volume at Electronic Systems decreased $369 million largely due to lower volume in the Land & Self Protection and Navigation Systems business areas. Margin rates at Electronic Systems remained consistent in 2011, primarily due to performance improvements on programs nearing completion in the Land & Self Protection and Intelligence and Surveillance business areas, offset by provisions for workforce reductions.

2010 – Cost of segment product sales of $14.7 billion in 2010 was flat versus 2009 consistent with the relatively flat year-over-year segment sales. Cost of product sales at Aerospace Systems increased due to sales volume increases at Strike and Surveillance of $218 million and Battle Management and Engagement Systems of $517 million, offset by volume decreases at the Advanced Programs & Technology business area of $315 million.

 

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Product sales at Information Systems decreased in volume by approximately 22% primarily due to $210 million in sales volume that transitioned from product to service activity in 2010. Electronic Systems product sales volume decreased $133 million during the period, and product cost of sales decreased by $163 million reflecting performance improvement in land and self protection programs, higher volume in Targeting Systems, and lower operating loss provisions in postal automation programs.

Cost of Segment Service Revenues

2011 – Cost of service revenues in 2011 decreased by $789 million and 130 basis points as a percentage of service revenues as compared to 2010, due to the overall decline in sales for the period and margin rate improvements at Information Systems, Technical Services and Electronic Systems, offset somewhat by an unfavorable margin rate change at Aerospace Systems. Contributing to the overall decline in revenues was the company’s participation in the NSTec joint venture, which resulted in the deconsolidation of this business in 2011. NSTec contributed revenues of $579 million and segment cost of sales of $559 million in 2010 when it was included in Technical Service’s sales, thus driving a 80 basis point improvement in margin rate for this segment. More modest margin rate improvements at Electronic Systems and Information Systems effectively offset the decline in margin rate at the Aerospace Systems business.

2010 – Cost of segment service revenues of $12.3 billion in 2010 was up over 2009 by $321 million due to increased volume, which resulted in an increase in sales from $12.8 billion in 2009 to $13.4 billion in 2010. The sales volume increase was due principally to Technical Services’ contract volume, driven by the KC-10 and C-20 contracts, which together increased by $307 million. Segment service margin rates across all segments improved in 2010, with Information Systems being the primary contributor as it experienced higher margin rates at its Civil Systems division, and due to the absence of non-recurring costs of $37 million from the sale of ASD in 2009. Overall, Information Systems experienced a 186 basis point margin rate improvement.

Unallocated Corporate Expenses

Unallocated corporate expenses generally include the portion of corporate expenses not considered allowable or allocable under applicable CAS and FAR rules, and therefore not allocated to the segments, such as management and administration, legal, environmental, certain compensation and retiree benefits, and other expenses. Unallocated corporate expenses for 2011 decreased $16 million, or 9 percent, as compared with 2010, primarily due to a decrease in stock-based compensation. Unallocated corporate expenses for 2010 increased $82 million, or 82 percent, as compared with 2009, primarily due to inclusion of a $64 million net gain from a legal settlement in 2009, as well as an increase in environmental, health and welfare, and stock-based compensation expenses in 2010.

Net Pension Adjustment

Net pension adjustment reflects the difference between pension expenses determined in accordance with GAAP and pension expense allocated to the operating segments determined in accordance with CAS. For 2011 and 2010, the net pension adjustment resulted in income of $400 million and $10 million, respectively. The increase in net pension adjustment for both years is due to decreased GAAP pension expense, primarily resulting from higher estimated returns on higher pension plan assets as of the beginning of the year.

Royalty Income Adjustment

Royalty income is included in segment operating income and reclassified to other income for financial reporting purposes.

General and Administrative Expenses

In accordance with industry practice and the regulations that govern the cost accounting requirements for government contracts, most general corporate expenses incurred at both the segment and corporate locations are considered allowable and allocable costs on government contracts. For most components of the company, these costs are allocated to contracts in progress on a systematic basis and contract performance factors therefore include this cost component as an element of cost. General and administrative expenses primarily relate to segment operations.

 

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2011 – General and administrative expenses for 2011 decreased $117 million, or 5 percent, compared to 2010, primarily due to overall reductions in administrative costs due to cost reduction initiatives, lower bid and proposal costs and lower research and development expenses. General and administrative expenses as a percentage of total sales and service revenues was 9 percent for 2011, consistent with 2010.

2010 – General and administrative expenses for 2010 decreased $104 million, or 4 percent, compared to 2009 primarily due to the disposition of ASD in 2009 at Information Systems. The decrease in general and administrative expenses as a percentage of total sales and service revenues for 2010, as compared to 2009, is primarily due to cost reductions realized from the 2009 streamlining of our organizational structure, which reduced the number of operating segments.

Interest Expense

2011 – Interest expense for 2011 decreased $48 million, as compared to 2010, primarily due to a lower weighted average interest rate resulting from our debt refinancing in November 2010.

2010 – Interest expense in 2010 was comparable to 2009.

Charge on Debt Redemption

2010 – In November 2010, we repurchased outstanding debt and recorded a pre-tax charge of $229 million as other expense primarily related to premiums paid on the debt tendered. See Liquidity and Capital Resources below and Note 13 to our consolidated financial statements in Part II, Item 8.

Federal and Foreign Income Taxes

2011 – Our effective tax rate on earnings from continuing operations for 2011 was 32.3 percent, as compared with 19.5 percent in 2010. In 2010, we recognized net tax benefits of $298 million to reflect the final approval from the IRS and the U.S. Congressional Joint Committee on Taxation (Joint Committee) of the IRS’ examination of our tax returns for the years 2004 through 2006.

2010 – Our effective tax rate on earnings from continuing operations for 2010, was 19.5 percent compared with 30.7 percent in 2009. In 2010, we recognized net tax benefits of $298 million to reflect the final approval of the IRS’s examination of our tax returns for years 2004 through 2006, as discussed above. In 2009, we recognized net tax benefits of $75 million primarily as a result of a final settlement with the IRS Office of Appeals and the Joint Committee related to our tax returns for years ended 2001 through 2003.

Excluding the effects of the $298 million net tax benefit in 2010 and the $75 million net tax benefit in 2009, our effective tax rates would have been 32.1 percent and 34.3 percent in 2010 and 2009, respectively.

Cash Provided by Operating Activities

2011 – Cash provided by continuing operations in 2011 was $2.3 billion, as compared with $2.1 billion in 2010, and reflects lower tax payments and timing of trade working capital. In 2011, we contributed $1.1 billion to our pension plans, of which $1.0 billion was voluntarily pre-funded, as compared with $789 million in 2010, of which $728 million was voluntarily pre-funded. Income taxes paid, net of refunds, was $810 million in 2011, as compared with $1.1 billion in 2010. Cash provided by continuing operations for 2011 included $30 million of federal and state income tax refunds and $9 million of interest income received.

2010 – Cash provided by continuing operations in 2010 was $2.1 billion as compared with $2 billion in 2009, and reflects higher cash paid to our suppliers offset by lower tax payments, primarily due to $508 million for taxes paid in 2009 related to the sale of ASD. In 2010, we contributed $789 million to our pension plans, of which $728 million was voluntarily pre-funded, as compared with $657 million in 2009, of which $601 million was voluntarily pre-funded. Income taxes paid, net of refunds, was $1.1 billion in 2010, as compared with $1.3 billion in 2009. Cash provided by continuing operations for 2010 included $94 million of federal and state income tax refunds and $11 million of interest income received.

 

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SEGMENT OPERATING RESULTS

Basis of Presentation

We are aligned into four reportable segments: Aerospace Systems, Electronic Systems, Information Systems and Technical Services. See Note 7 in Part II, Item 8 for more information about our segments.

In January 2010, we transferred our internal information technology services unit from the Information Systems segment to our corporate shared services group. The intersegment sales and operating income for this unit that were previously recognized in the Information Systems segment are immaterial and have been eliminated for the years presented.

 

    Year ended December 31
$ in millions           2011                   2010           2009

Sales and Service Revenues

           

Aerospace Systems

    $ 10,458       $ 10,910       $ 10,419  

Electronic Systems

      7,372         7,613         7,671  

Information Systems

      7,921         8,395         8,536  

Technical Services

      2,699         3,230         2,776  

Intersegment eliminations

      (2,038 )       (2,005 )       (1,752 )

Total sales and service revenues

    $ 26,412       $ 28,143       $ 27,650  

 

    Year ended December 31
$ in millions           2011                   2010           2009

Operating Income

           

Aerospace Systems

    $ 1,261       $ 1,256       $ 1,071  

Electronic Systems

      1,070         1,023         969  

Information Systems

      766         756         624  

Technical Services

      216         206         161  

Intersegment eliminations

      (258 )       (231 )       (190 )

Total Segment Operating Income

      3,055         3,010         2,635  

Non-segment factors affecting operating income

           

Unallocated corporate expenses

      (166 )       (182 )       (100 )

Net pension adjustment

      400         10         (237 )

Royalty income adjustment

      (13 )       (11 )       (24 )

Total operating income

    $ 3,276       $ 2,827       $ 2,274  

KEY SEGMENT FINANCIAL MEASURES

Sales and Service Revenues

Period-to-period sales reflect performance under new and ongoing contracts. Changes in sales and service revenues are typically expressed in terms of volume. Unless otherwise described, volume generally refers to increases (or decreases) in reported revenues incurred due to varying production activity levels, delivery rates, or service levels on individual contracts. Volume changes will typically carry a corresponding operating income change based on the margin rate for a particular contract.

Segment Operating Income

Segment operating income reflects the aggregate performance results of contracts within a business area or segment. Excluded from this measure are certain costs not directly associated with contract performance, including

 

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the portion of corporate expenses such as management and administration, legal, environmental, certain compensation costs and other retiree benefits, and other expenses not considered allowable or allocable under applicable CAS regulations and the FAR, and therefore not allocated to the segments. Changes in segment operating income are typically expressed in terms of volume, as discussed above, or performance.

Performance refers to changes in contract margin rates for the period. These changes typically relate to profit recognition associated with revisions to total estimated costs at completion of the contract (EAC) that reflect improved (or deteriorated) operating performance on a particular contract. Operating income changes are accounted for on a cumulative catch-up basis at the time an EAC change is recorded. We identify favorable and unfavorable adjustments to determine our qualitative discussion of performance results and, where meaningful, we disclose the effects of such adjustments on a contract or program basis.

Operating income may also be affected by, among other things, the effects of workforce stoppages, natural disasters (such as earthquakes), resolution of disputed items with the customer, recovery of insurance proceeds, and other discrete events. At the completion of a long-term contract, any originally estimated costs not incurred or reserves not fully utilized (such as warranty reserves) could also impact contract earnings. Where such items have occurred and the effects are meaningful, a separate description is provided.

Changes in estimates related to our contracts accounted for using the percentage-of-completion method are recorded using the cumulative catch-up method of accounting. The aggregate effects of these favorable and unfavorable changes across our portfolio of numerous contracts can have a significant effect upon our reported sales and operating income in each of our reporting periods. In 2011, 2010 and 2009, we recognized favorable operating income adjustments of $1.1 billion, $945 million and $758 million, and unfavorable operating income adjustments of $385 million, $270 million and $337 million, respectively, consisting of cumulative catch-up adjustments from the use of the percentage-of-completion method of accounting.

For a more complete understanding of each segment’s product and services, see the business descriptions in Part I, Item 1.

Program Descriptions

For convenience, a brief description of certain programs discussed in this Form 10-K are included in the “Glossary of Programs” at the end of Part II, Item 7.

AEROSPACE SYSTEMS

 

    Year Ended December 31
$ in millions   2011   2010   2009

Sales and service revenues

    $ 10,458       $ 10,910       $ 10,419  

Segment operating income

      1,261         1,256         1,071  

As a percentage of segment sales

      12.1 %       11.5 %       10.3 %

Sales and Service Revenues

2011 – Aerospace Systems revenue decreased $452 million, or 4 percent, as compared with 2010. The decrease is primarily due to $388 million lower sales in Space Systems (SS) and $255 million lower sales in Strike & Surveillance Systems (S&SS), partially offset by $90 million higher sales in Battle Management & Engagement Systems (BM&ES) and $87 million higher sales in Advanced Programs & Technology (AP&T). The lower sales at SS are primarily due to reduced funding for weather satellite programs and the James Webb Space Telescope (JWST), as well as lower volume for several other space programs. The lower sales at S&SS are primarily due to lower volume on the F-35 Lightning II (F-35) manned aircraft program, which transitioned to a units-of-delivery revenue recognition method beginning with low rate initial production lot 5, and the completion of the aerial targets program. The higher sales at BM&ES are primarily due to higher volume on Long Endurance Multi-Intelligence Vehicle (LEMV) and Joint Surveillance Target Attack Radar System (JSTARS), partially offset by lower volume on EA-18G. The higher sales at AP&T are primarily due to increased volume on restricted programs.

 

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2010 – Aerospace Systems revenue increased $491 million, or 5 percent, as compared with 2009. The increase is primarily due to $517 million higher sales in BM&ES and $218 million higher sales in S&SS, partially offset by $315 million lower sales in AP&T. The increase at BM&ES is due to higher sales volume on the Broad Area Maritime Surveillance (BAMS) Unmanned Aircraft System, EA-6B, EA-18G, E-2 Hawkeye, and LEMV programs. The increase at S&SS is primarily due to higher sales volume associated with manned and unmanned aircraft programs, such as the Global Hawk High-Altitude Long-Endurance (HALE) Systems, the F-35, B-2 Stealth Bomber and F/A-18, partially offset by the termination of the Kinetic Energy Interceptor (KEI) program in 2009 and decreased activity on the Intercontinental Ballistic Missile (ICBM) program. The decrease at AP&T is primarily due to lower sales volume on restricted programs and the Navy Unmanned Combat Air System (N-UCAS) program.

Segment Operating Income

2011 – Aerospace Systems operating income increased $5 million, or less than 1 percent, as compared with 2010. The increase is primarily due to improved performance across several programs at Aerospace Systems and lower amortization expense on purchased intangibles, partially offset by an unfavorable adjustment for performance incentives on a space program at SS and overall lower sales volume discussed above.

2010 – Aerospace Systems operating income increased $185 million, or 17 percent, as compared with 2009, and as a percentage of sales increased 120 basis points. The increase is primarily due to net performance improvements across various programs, principally within SS, and the higher sales volume discussed above.

ELECTRONIC SYSTEMS

 

    Year Ended December 31
$ in millions           2011                   2010                   2009     

Sales and service revenues

    $ 7,372       $ 7,613       $ 7,671  

Segment operating income

      1,070         1,023         969  

As a percentage of segment sales

      14.5 %       13.4 %       12.6 %

Sales and Service Revenues

2011 – Electronic Systems revenue decreased $241 million, or 3 percent, as compared with 2010. The decrease was primarily due to $325 million lower sales in Land & Self Protection Systems, partially offset by $65 million higher sales in Advanced Concepts & Technologies (AC&T). The lower sales in Land & Self Protection Systems are primarily due to fewer deliveries on Large Aircraft Infrared Countermeasures (LAIRCM) and Vehicular Intercommunications Systems (VIS) programs. The higher sales in AC&T are primarily due to increased volume on restricted programs.

2010 – Electronic Systems revenue decreased $58 million, or less than 1 percent, as compared with 2009. The decrease is primarily due to $150 million lower sales in Land & Self Protection Systems, $84 million lower sales in Intelligence, Surveillance & Reconnaissance (ISR) Systems and $82 million lower sales in Naval & Marine Systems, partially offset by $186 million higher sales in Targeting Systems and $72 million higher sales in Advanced Concepts & Technologies. The decrease in Land & Self Protection Systems is due to lower sales volume on the Ground/Air Task Oriented Radar (G/ATOR) program as it transitions from the development phase to the integration and test phase and lower unit deliveries on the VIS program. The decrease in ISR Systems is due to lower sales volume on the Space Based Infrared Systems (SBIRS) program as it transitions to follow-on production, postal automation programs and various international programs. The decrease in Naval & Marine Systems is due to lower volume on the ship-board Cobra Judy replacement radar program. The increase in Targeting Systems is due to higher sales volume on the F-35, various laser systems and restricted programs and increased unit deliveries of the LITENING targeting pod system. The increase in Advanced Concepts & Technologies is primarily due to volume on restricted programs.

 

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Segment Operating Income

2011 – Electronic Systems operating income increased $47 million, or 5 percent, as compared to 2010, and as a percentage of sales increased 110 basis points. The higher operating income is primarily due to performance improvements on several contracts nearing completion in Land & Self Protection Systems and Intelligence, Surveillance & Reconnaissance programs. The improved program performance was partially offset by reserves established in 2011 for reductions in workforce and a reserve on a program related to outstanding contractual issues as the contract nears completion, and overall lower sales volume described above.

2010 – Electronic Systems operating income increased $54 million, or 6 percent, as compared with 2009. The increase is primarily due to net performance improvements in land and self protection programs, higher volume in Targeting Systems, and lower operating loss provisions in postal automation programs.

INFORMATION SYSTEMS

 

    Year Ended December 31
$ in millions           2011                   2010                   2009      

Sales and service revenues

    $ 7,921       $ 8,395       $ 8,536  

Segment operating income

      766         756         624  

As a percentage of segment sales

      9.7 %       9.0 %       7.3 %

Sales and Service Revenues

2011 – Information Systems revenue decreased $474 million, or 6 percent, as compared with 2010. The decrease is primarily due to $327 million lower sales in Defense Systems and $99 million lower sales in Civil Systems. The decrease in Defense Systems is primarily due to lower sales volume from Force Protection Security System (FPS2), Saudi Arabian American Oil Company (ARAMCO), Netcents DKO, F-22 and several other programs, partially offset by higher volume on Encore II and Trailer Mounted Support System (TMSS) programs. The lower sales volume in Civil Systems is primarily due to the sale of the County of San Diego contract, which reduced sales by $70 million as compared to the same period in 2010, lower volume on the Enterprise Network Management program, and completion of the Treasury Communications System program in 2010.

2010 – Information Systems revenue decreased $141 million, or 2 percent, as compared with 2009. The decrease is primarily due to $130 million lower sales in Intelligence Systems and $57 million lower sales in Civil Systems, partially offset by $55 million higher sales in Defense Systems. The decrease in Intelligence Systems is primarily due to lower sales volume on restricted programs and the loss of the Navstar Global Positioning System Operational Control Segment (GPS OCX) program. The decrease in Civil Systems is primarily due to lower sales volume on the New York City Wireless (NYCWiN) and Armed Forces Health Longitudinal Technology Application (AHLTA) programs. The increase in Defense Systems is primarily due to program growth on Battlefield Airborne Communications Node (BACN), Joint National Integration Center Research and Development Contract (JRDC) and Integrated Battle Command System (IBCS) activities, partially offset by lower sales volume on the TMSS program as it nears completion, and decreased Systems and Software Engineer Support activities.

Segment Operating Income

2011 – Information Systems operating income increased $10 million, or 1 percent, as compared with 2010. The increase is primarily driven by improved performance on several civil systems programs, including the Virginia IT Outsource (VITA) contract and the effect of the sale of the County of San Diego contract, partially offset by the lower sales volume primarily at Defense Systems described above.

2010 – Information Systems operating income increased $132 million, or 21 percent, as compared with 2009 and as a percentage of sales increased 170 basis points. The increase is primarily due to performance improvements on Civil Systems programs. In 2009, operating income included $37 million of non-recurring costs associated with the sale of ASD.

 

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TECHNICAL SERVICES

 

    Year Ended December 31
$ in millions           2011                   2010                   2009     

Sales and service revenues

    $ 2,699       $ 3,230       $ 2,776  

Segment operating income

      216         206         161  

As a percentage of segment sales

      8.0 %       6.4 %       5.8 %

Sales and Service Revenues

2011 – Technical Services revenue decreased $531 million, or 16 percent, as compared with 2010. The decrease is primarily due to $626 million lower sales in Defense and Government Services Division (DGSD) and $87 million lower sales in Training Solutions Division (TSD), partially offset by higher sales of $182 million in Integrated Logistics and Modernization Division (ILMD). The lower sales in DGSD are primarily due to the reduced participation in the NSTec joint venture. Effective January 1, 2011, the company reduced its participation in this joint venture, resulting in no sales recorded for the joint venture for 2011, compared with sales of $579 million in 2010. The lower sales in TSD are primarily due to lower volume on the Joint Warfighting Center and Africa Contingency Operations Training & Assistance programs and lower volume on completion of the Global Linguists Solutions program. The higher sales in ILMD are primarily due to increased activity on the KC-10 program, which began in February 2010.

2010 – Technical Services revenue increased $454 million, or 16 percent, as compared with 2009. The increase is primarily due to $379 million higher sales in the ILMD. The increase in ILMD is primarily due to the continued ramp-up of the recently awarded KC-10 and C-20 programs.

Segment Operating Income

2011 – Operating income at Technical Services increased $10 million, or 5 percent, as compared with 2010 and as a percentage of sales increased 160 basis points. The increase is primarily due to effects of the change in participation in the NSTec joint venture and performance improvements on several ILMD and DGSD programs, partially offset by unfavorable program performance on KC-10 and lower sales volume on certain TSD programs.

2010 – Operating income at Technical Services increased $45 million, or 28 percent, as compared with 2009. The increase is primarily due to the higher sales volume discussed above. Operating income as a percentage of sales increased 60 basis points and reflects improved program performance and business mix changes.

BACKLOG

Definition

Total backlog at December 31, 2011, was approximately $39.5 billion. Total backlog includes both funded backlog (firm orders for which funding is contractually obligated by the customer) and unfunded backlog (firm orders for which funding is not currently contractually obligated by the customer). Unfunded backlog excludes unexercised contract options and unfunded indefinite delivery indefinite quantity (IDIQ) orders (except for authorized task orders, which are included up to the authorized value). For multi-year services contracts with non-federal government customers having no stated contract values, backlog includes only the amounts committed by the customer.

 

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The following table presents funded and unfunded backlog by segment for the year ended December 31, 2011 and total backlog for the year ended December 31, 2010:

 

    2011    2010
$ in millions   Funded    Unfunded    Total
Backlog
   Total
Backlog

Aerospace Systems

    $ 9,614        $ 9,623        $ 19,237        $ 20,868  

Electronic Systems

      7,307          1,816          9,123          10,147  

Information Systems

      4,123          4,440          8,563          10,590  

Technical Services

      2,156          436          2,592          5,237  

Total backlog

    $ 23,200        $ 16,315        $ 39,515        $ 46,842  

Backlog is converted into the following years’ sales as costs are incurred or deliveries are made. Approximately 59 percent of the $39.5 billion total backlog at December 31, 2011, is expected to be converted into sales in 2012. Total U.S. Government orders, including those made on behalf of foreign governments, comprised 87 percent of the total backlog at the end of 2011. Total foreign customer orders accounted for 7 percent of the total backlog at the end of 2011. Domestic commercial backlog represented 6 percent of total backlog at the end of 2011.

Backlog Adjustments

In the fourth quarter of 2011, we changed our backlog measurement criteria to include a valuation adjustment for open, unfulfilled contracts that in our judgment, may not be converted to future sales, but which have not been closed or de-obligated by the customer. Under our prior criteria, backlog represented remaining work effort to be incurred on signed contracts in process; or open contract value generally related to either: 1) work scope not fully utilized by the customer, and 2) open contract value related to the close-out of overhead claim years. Based on this prior criteria, backlog was reduced as revenue was recognized or as the customer took contract action to close contracts and/or de-obligate funds. Our recent experience indicates that our customers have not been timely in taking the aforementioned contract actions. Accordingly, effective December 31, 2011, we have modified our criteria to include the recognition of a valuation reserve to adjust our outstanding backlog to reflect our future contract revenue expectations. The effects of this change in procedures reduced December 31, 2011 backlog by $3 billion, including a reduction in the backlog at Information Systems by $2.3 billion and Technical Services by $725 million.

2011 – Total backlog was reduced by $1.7 billion at Technical Services to reflect a change in the company’s participation in the NSTec joint venture effective January 1, 2011, at which time the NSTec joint venture results were no longer consolidated into the company’s consolidated financial statements. Total backlog was also reduced by an aggregate of $1.5 billion at Aerospace Systems to reflect restructuring and termination of certain space programs.

2010 – A $1.1 billion reduction in backlog was recorded in 2010 as a result of the restructure of the NPOESS program at our Aerospace Systems segment.

Backlog was also impacted in 2010 by an agreement we reached with the Commonwealth of Virginia related to the VITA contract. The agreement defined minimum revenue amounts for the remaining years under the base contract and extended the contract for three additional years through 2019. We recorded a favorable backlog adjustment of $824 million for the definitization of the base contract revenues for years 2011 through 2016, while the contract extension and 2010 portion of the base contract revenues, totaling $802 million, were recorded as new awards in the period in our Information Systems segment.

 

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New Awards

2011 –The estimated value of contract awards added to backlog during the year ended December 31, 2011, is $25.3 billion. Significant new awards during this period include $2.0 billion for F/A-18 program, $1.1 billion for E2-D Advanced Hawkeye program, $1.0 billion for Global Hawk program, $1.1 billion for B-2 program , $886 million for F-35 program, and $404 million for KC-10 program.

2010 –The estimated value of contract awards added to backlog during the year ended December 31, 2010, was $26.4 billion. Significant new awards during this period include $1.2 billion for the Global Hawk HALE program, $979 million for the E-2 Hawkeye programs, $942 million for the AEHF program, $802 million for the VITA program, $677 million for the Joint National Integration Center Research and Development contract, $656 million for the F/A 18 Hornet Strike Fighter program, $654 million for the ICBM program, $631 million for the B-2 Stealth Bomber programs, $579 million for the F-35 program, $565 million for the NSTec program, $507 for the KC-10 program, $505 million for the Large Aircraft Infrared Counter-measures programs and various restricted awards.

LIQUIDITY AND CAPITAL RESOURCES

We endeavor to ensure the most efficient conversion of operating results into cash for deployment in growing our businesses and maximizing shareholder value. We actively manage our capital resources through working capital improvements, capital expenditures, strategic business acquisitions and divestitures, debt issuance and repayment, required and voluntary pension contributions, returning cash to our shareholders through dividend payments, and repurchases of common stock. In addition to our cash position, we use various financial measures to assist in capital deployment decision-making, including, but not limited to, cash provided by operations, free cash flow, and debt-to-EBITDA ratio. We believe these measures are useful to investors in assessing our financial performance.

As of December 31, 2011, the amount of cash, cash equivalents, and marketable securities held outside of the U.S. by foreign subsidiaries was $546 million. At the present time, we do not anticipate repatriating these balances to fund domestic operations.

The table below summarizes key components of operating cash flow for continuing operations:

 

    Year Ended December 31
$ in millions           2011                   2010                2009 

Net earnings

    $ 2,118       $ 2,053       $ 1,686  

Earnings from discontinued operations, net of tax

      (32 )       (134 )       (234 )

Gain on sale of business

          (10 )       (446 )

Charge on debt redemption

          229      

Other non-cash items(1)

      1,108         758         857  

Retiree benefit funding less than (in excess of) expense

      (904 )       (354 )       60  

Trade working capital change

      57         (486 )       72  

Cash provided by continuing operations

    $ 2,347       $ 2,056       $ 1,995  

 

(1) Includes depreciation and amortization, stock based compensation expense and deferred taxes.

Free Cash Flow

Free cash flow from continuing operations is a non-GAAP financial measure and is calculated as cash provided by operating activities from continuing operations less capital expenditures and outsourcing contract and related software costs. Outsourcing contract and related software costs are similar to capital expenditures in that the contract costs represent incremental external costs or certain specific internal costs that are directly related to the contract acquisition and transition/set-up. These outsourcing contract and related software costs are deferred and expensed over the contract’s period of performance. We believe free cash flow from continuing operations is a useful measure for investors to consider. This measure is a key factor in our planning for and consideration of strategic acquisitions, stock repurchases and the payment of dividends.

 

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Free cash flow from continuing operations is not a measure of financial performance under GAAP, and may not be defined and calculated by other companies in the same manner. This measure should not be considered in isolation, as a measure of residual cash flow available for discretionary purposes, or as an alternative to operating results presented in accordance with GAAP as indicators of performance.

The table below reconciles cash provided by continuing operations to free cash flow from continuing operations:

 

     Year Ended December 31
$ in millions        2011         2010        2009

Cash provided by continuing operations

         $ 2,347                 $ 2,056                 $ 1,995  

Less:

              

Capital expenditures

       (488)               (579)               (473 )

Outsourcing contract and related software costs

       (4)               (6)               (68 )

Free cash flow from continuing operations

         $ 1,855                 $ 1,471                 $ 1,454  

Cash Flows

The following is a discussion of our major operating, investing and financing activities from continuing operations for each of the three years in the period ended December 31, 2011, as classified on the consolidated statements of cash flows in Part II, Item 8.

Operating Activities

2011 – Cash provided by continuing operations in 2011 increased $291 million, as compared to 2010, primarily due to lower tax payments and changes in trade working capital, partially offset by higher pension plan contributions. In 2011, pension plan contributions totaled $1.1 billion, of which $1 billion was voluntarily pre-funded.

In 2012, we expect to contribute the required minimum funding level of approximately $65 million to our pension plans and approximately $120 million to our other post-retirement benefit plans. We expect our cash on hand and cash generated from operations for 2012 to be sufficient to service debt and contract obligations, finance capital expenditures, continue acquisition of shares under the share repurchase program, and continue paying dividends to our shareholders. Although 2012 cash from operations is expected to be sufficient to service these obligations, we may borrow under credit facilities to accommodate timing differences in cash flows. We have an aggregate commitment of $2 billion available under two revolving credit facilities that can be accessed on a same-day basis. Both facilities are currently undrawn and had no borrowings during the year ended December 31, 2011. Additionally, we believe we could access capital markets for debt financing for longer-term funding, under current market conditions, if needed.

2010 – Cash provided by continuing operations in 2010 increased $61 million as compared with 2009, primarily the result of lower tax payments. Pension plan contributions totaled $789 million in 2010, of which $728 million was voluntarily pre-funded. In 2009, cash provided by continuing operations included $508 million for taxes paid related to the sale of ASD.

2009 – Cash provided by continuing operations in 2009 decreased $710 million as compared with 2008, reflecting higher voluntary pension contributions and increased income taxes paid resulting from the sale of ASD. Pension plan contributions totaled $657 million in 2009, of which $601 million was voluntarily pre-funded.

Investing Activities

2011 – Net cash provided by investing activities of continuing operations was $743 million in 2011, reflecting a $1.4 billion contribution received from the spin-off of Shipbuilding business in 2011, partially offset by $488 million of capital expenditures and a $250 million investment in short term investments. Capital expenditure commitments at December 31, 2011, of approximately $293 million are expected to be paid with cash on hand.

 

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2010 – Net cash used in investing activities by continuing operations was $571 million in 2010 and reflects $579 million of capital expenditures, which includes $57 million of capitalized software costs.

2009 – Cash provided by investing activities by continuing operations was $1.1 billion in 2009. During 2009, we received $1.65 billion in proceeds from the sale of ASD (see Note 6 to our consolidated financial statements in Part II, Item 8), paid $68 million for outsourcing costs related to outsourcing services contracts, and paid $33 million to acquire Sonoma Photonics, Inc. and the assets from Swift Engineering’s Killer Bee Unmanned Air Systems product line (see Note 5 to our consolidated financial statements in Part II, Item 8). Capital expenditures in 2009 were $473 million, which includes $36 million of capitalized software costs.

Financing Activities

2011 – Net cash used in financing activities by continuing operations in 2011 was $3.5 billion and reflects $2.3 billion in repurchases of common stock, $768 million in debt payments, and $543 in cash dividends paid.

2010 – Net cash used in financing activities by continuing operations in 2010 was $1.1 billion and reflects $1.2 billion in repurchases of common stock, $1 billion in debt payments, including the redemption of $682 million of higher coupon debt and $229 million of fees and associated premiums paid to the tendering holders of these debt securities, and $545 million in cash dividends paid. These financing related cash outflows were partially offset by $1.5 billion in net proceeds from new debt issuances. See Note 13 to the consolidated financial statements in Part II, Item 8.

2009 – Net cash used in financing activities by continuing operations in 2009 was $1.2 billion and reflects $1.1 billion in repurchases of common stock, $539 million in cash dividends paid, and $474 million in debt payments. These financing related cash outflows were partially offset by $843 million in net proceeds from new debt issuance in 2009.

Share Repurchases – We repurchased 40.2 million, 19.7 million, and 23.1 million shares in 2011, 2010, and 2009, respectively. See Purchases of Equity Securities by Issuer and Affiliated Purchasers in Part II, Item 5 and Note 4 to the consolidated financial statements in Part II, Item 8 for a discussion concerning our common stock repurchases.

Credit Facilities

In September 2011, the company entered into two senior unsecured credit facilities (the Credit Agreements) in an aggregate principal amount of $2 billion. The first Credit Agreement amended the company’s $2 billion five-year credit facility dated August 10, 2007, by reducing the aggregate principal amount available under the facility by $500 million to $1.5 billion and extending the maturity date to September 2016. The second Credit Agreement is a new 364-day revolving credit facility in an aggregate principal amount of $500 million.

The Credit Agreements contain covenants substantially similar to those of the previous five-year credit facility, which restrict the company’s ability to sell all or substantially all of its assets, merge or consolidate with another entity or undertake other fundamental changes and incur liens. The company also cannot permit the ratio of its consolidated debt to capitalization (as set forth in the Credit Agreements) to exceed 65 percent. The company is in compliance with all covenants under the Credit Agreements. At December 31, 2011, there was no balance outstanding under either of these credit facilities.

Other Sources and Uses of Capital

Additional Capital – We believe we can obtain additional capital, if necessary for long-term liquidity, from such sources as the public or private capital markets, the sale of assets, sale and leaseback of operating assets, and leasing rather than purchasing new assets. We have an effective shelf registration statement on file with the SEC.

We expect that cash on hand at the beginning of the year plus cash generated from continuing operations supplemented by borrowings under credit facilities and in the capital markets, if needed, will be sufficient in 2012 to service debt and contract obligations, finance capital expenditures, pay federal, foreign, and state income taxes, fund required and voluntary pension and other post retirement benefit plan contributions, continue acquisition of

 

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shares under the share repurchase program, and continue paying dividends to shareholders. We will continue to assess potential ramifications of the U.S. Government’s spending reduction initiatives as previously discussed. These reductions could have a significant impact on our business and our overall financial results.

Financial Arrangements – In the ordinary course of business, the company uses standby letters of credit and guarantees issued by commercial banks and surety bonds issued principally by insurance companies to guarantee the performance on certain obligations. At December 31, 2011, there were $195 million of stand-by letters of credit, $186 million of bank guarantees, and $139 million of surety bonds outstanding.

Contractual Obligations

The following table presents our contractual obligations as of December 31, 2011, and the estimated timing of future cash payments:

 

$ in millions           Total                   2012            2013 -
2014
   2015 -
2016
  2017 and
beyond

Long-term debt

    $ 3,929       $ 5        $ 358        $ 611       $ 2,955  

Interest payments on long-term debt

      2,692         207          414          374         1,697  

Operating leases

      1,219         297          442          312         168  

Purchase obligations(1)

      6,992         4,554          1,719          580         139  

Other long-term liabilities(2)

      877         97          223          114         443  

Total contractual obligations

    $ 15,709       $ 5,160        $ 3,156        $ 1,991       $ 5,402  

 

(1) A “purchase obligation” is defined as an agreement to purchase goods or services that is enforceable and legally binding on us and that specifies all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum, or variable price provisions; and the approximate timing of the transaction. These amounts are primarily comprised of open purchase order commitments to vendors and subcontractors pertaining to funded contracts.

 

(2) Other long-term liabilities primarily consist of total accrued environmental reserves, deferred compensation, and other miscellaneous liabilities, of which $86 million is related to environmental reserves recorded in other current liabilities. It excludes obligations for uncertain tax positions of $135 million, as the timing of such payments, if any, cannot be reasonably estimated.

The table above also excludes estimated minimum funding requirements for retiree benefit plans as set forth by ERISA in relation to the company’s pension and postretirement benefit obligations totaling approximately $3.5 billion over the next five years: $185 million in 2012, $421 million in 2013, $1.2 billion in 2014, $1 billion in 2015, and $702 million in 2016. The company also has payments due under plans that are not required to be funded in advance, but are funded on a pay-as-you-go basis. See Note 16 to the consolidated financial statements in Part II, Item 8.

Further details regarding long-term debt and operating leases can be found in Notes 13 and 15, respectively, to the consolidated financial statements in Part II, Item 8.

OTHER MATTERS

Accounting Standards Updates

The Financial Accounting Standards Board has issued new accounting standards which are not effective until after December 31, 2011. For further discussion of new accounting standards, see Note 2 to the consolidated financial statements in Part II, Item 8.

Off-Balance Sheet Arrangements

As of December 31, 2011, we had no significant off-balance sheet arrangements other than operating leases. For a description of our operating leases, see Note 15 to the consolidated financial statements in Part II, Item 8.

 

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GLOSSARY OF PROGRAMS

Listed below are brief descriptions of the programs discussed in Segment Operating Results of this Form 10-K.

 

Program Name      Program Description
Advanced Extremely High Frequency (AEHF)      Provide the communication payload for the nation’s next generation military strategic and tactical satellite relay systems that will deliver survivable, protected communications to U.S. forces and selected allies worldwide.

Africa Contingency

Operations Training &

Assistance (ACOTA)

     Provide peacekeeping training to militaries in African nations via the Department of State. The program is designed to improve the ability of African governments to respond quickly to crises by providing selected militaries with the training and equipment required to execute humanitarian or peace support operations.

Armed Forces Health

Longitudinal Technology

Application (AHLTA)

     An enterprise-wide medical and dental clinical information system that provides secure online access to health records.
B-2 Stealth Bomber      Maintain and upgrade the fleet of strategic, long-range multi-role bomber with war-fighting capability that combines long range, large payload, all-aspect stealth, and near-precision weapons in one aircraft.

Battlefield Airborne

Communications Node (BACN)

     Install the BACN system in three Bombardier BD-700 Global Express aircraft for immediate fielding and install the BACN system into two Global Hawk Block 20 unmanned aerial vehicles.
Broad Area Maritime Surveillance (BAMS) Unmanned Aircraft Systems      A maritime derivative of the Global Hawk that provides persistent maritime ISR data collection and dissemination capability to the Maritime Patrol and Reconnaissance Force.
Cobra Judy      The Cobra Judy Replacement program will replace the current U.S. Naval Ship (USNS) Observation Island and its aged AN/SPQ-11 Cobra Judy ballistic missile tracking radar. Northrop Grumman will provide the S-band phased-array radar for use in technical data collection against ballistic missiles in flight.
C-20      Contractor Logistics Services contract supporting the U.S. Air Force, Army, Navy and Marine Corps C-20 aircraft including depot maintenance, contractor operational and maintained base supply, flight line maintenance and field team support at multiple main operating bases, located in the United States and overseas.
County of San Diego IT Outsourcing      Provide high-level IT consulting and services to San Diego County including data center, help desk, desktop, network, applications and cross-functional services.
Defense Weather Satellite System (DWSS)      Design, develop, integrate, test and operate two satellites with sensors that will provide global and regional weather and environmental data for the DoD.
EA-6B      The EA-6B (Prowler) primary mission is to jam enemy radar and communications, thereby preventing them from directing hostile surface-to-air missiles at assets the Prowler protects. When equipped with the improved ALQ-218 receiver and the next generation ICAP III (Improved Capability) Airborne Electronic Attack (AEA) suite the Prowler is able to provide rapid detection, precise classification, and highly accurate geolocation of electronic emissions and counter modern, frequency-hopping radars.

 

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Program Name      Program Description
EA-18G      The armed services’ only offensive tactical radar jamming aircraft. The Improved Capability (ICAP) III mission system capability, developed for the EA-6B Prowler, is being incorporated into an F/A-18 platform (designated the EA-18G).
E-2 Hawkeye      Develop the next generation capabilities for the U.S. Navy’s airborne battle management command and control mission system platform that provides airborne early warning detection, identification, tracking, targeting, and communication capabilities, including radar, mission computer, vehicle, and other system enhancements, to support the U.S Naval Battle Groups and Joint Forces, called the E-2D Advanced Hawkeye.
Encore II      Provide Military Agencies, the DoD, and other agencies of the Federal Government IT services and associated enabling products to satisfy IT activities at all operating levels, including hardware and software incidental to an overall IT solution.
Enterprise Network Management      Maintain and improve the Department of States’ enterprise-wide IT infrastructure.
F-16 Block 60      Direct commercial firm fixed-price program with Lockheed Martin Aeronautics Company to develop and produce 80 Lot systems for aircraft delivery to the United Arab Emirates Air Force as well as test equipment and spares to be used to support in-country repairs of sensors.
F-22      Joint venture with Raytheon to design, develop and produce the F-22 radar system. Northrop Grumman is responsible for the overall design of the AN/APG-77 and AN/APG-77(V) 1 radar systems, including the control and signal processing software and responsibility for the AESA radar systems integration and test activities. In addition, Northrop Grumman is responsible for overall design and integration of the F-22 Communication, Navigation, and Identification (CNI) system.
F-35 Lightning II (F-35)      Design, integration, and development of the center fuselage and weapons bay, communications, navigations, identification subsystem, systems engineering, and mission systems software and sensors, as well as provide ground and flight test support, modeling, simulation activities, and training courseware.
F/A-18      Produce the center and aft fuselage sections, twin vertical stabilizers, and integrate all associated subsystems for the F/A-18 Hornet strike fighters.
Flat Sequencing System (FSS)      Build systems for the U.S. Postal Service designed to further automate the flat mail stream, which includes large envelopes, catalogs and magazines.
Force Protection Security System (FPS2)      Follow-on to the Integrated Base Defense Security System (IBDSS) program to provide the U.S. Air Force and other DoD customers with force protection security solutions, utilizing comprehensive and integrated technology to satisfy a wide array of security concerns both within and outside the continental U.S.

 

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Program Name      Program Description
Ground / Air Task Oriented Radar (G/ATOR)      A development program to provide the next generation ground based multi-mission radar for the USMC. Provides Short Range Air Defense, Air Defense Surveillance, Ground Weapon Location and Air Traffic Control. Replaces five existing USMC single-mission radars.
Global Hawk High-Altitude Long-Endurance (HALE) Systems      Develop, deliver and sustain the Global Hawk HALE unmanned aerial system and its derivatives to both domestic and international customers for ISR, including deployment of assets to support the global war on terror.
Global Linguists Solutions      Provide interpretation, translation and linguist services in support of Operation Iraqi Freedom.
Integrated Battle Command System (IBCS)      The Integrated Air & Missile Defense, Battle Command System (IBCS) component concept provides for a common battle management, command, control, communications, computers and intelligence capability with integrated fire control hardware/software product design, integration, and development that supports initial operational capability of the Joint Integrated Air and Missile Defense Increment 2.
Intercontinental Ballistic Missile (ICBM)      Maintain readiness of the nation’s ICBM weapon system.
James Webb Space Telescope (JWST)      Design, develop, integrate and test a space-based infrared telescope satellite to observe the formation of the first stars and galaxies in the universe.
Joint National Integration Center Research and Development Contract (JRDC)      Support the development and application of modeling and simulation, war gaming, test and analytic tools for air and missile defense.
Joint Surveillance Target Attack Radar System (Joint STARS)      Detect, locate, classify, track, and target hostile ground movements, while communicating real-time information through secure data links with U.S. Air Force and Army command posts.
Joint Warfighting Center (JWFC)      Provide non-personal general and technical support to the USJFCOM Joint Force Trainer / JWFC to ensure the successful worldwide execution of the Joint Training and Transformation missions.
KC-10 Contractor Logistics Support (KC-10)      Provide support to the U.S. Air Force KC-10 tanker fleet, including depot maintenance, supply chain management, and maintenance and management at locations in the United States and worldwide.
Kinetic Energy Interceptor (KEI)      Develop mobile missile-defense system with the unique capability to destroy a hostile missile during its boost, ascent or midcourse phase of flight. This program was terminated for the U.S. government’s convenience in 2009.

 

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Program Name      Program Description
Large Aircraft Infrared Countermeasures (LAIRCM)      Provide support and hardware for infrared countermeasures systems for the C-17 and C-130 aircrafts. The IDIQ contract will further allow for the purchase of LAIRCM hardware for foreign military sales and other government agencies.
Long Endurance Multi-Intelligence Vehicle (LEMV)      Northrop was awarded the contract by the U.S. Army Space and Missile Defense Command for the development, fabrication, integration, certification and performance of one LEMV system. It is a state-of-the-art, lighter-than-air airship designed to provide ground troops with persistent surveillance. Development and demonstration of the first airship is scheduled to be completed June 2012. The contract also includes options for 2 additional airships and in-country support.
LITENING Gen 4      Design and develop self-contained multi-sensor targeting and surveillance system that enables aircrews to detect, acquire, auto-track and identify targets at extremely long ranges for weapons delivery and non-traditional ISR missions.
National Security Technologies (NSTec)      Participate in a joint venture that manages and operates the Nevada National Security Site, providing infrastructure support, including oversight of the nuclear explosives safety team, supporting hazardous chemical spill testing, emergency response training and conventional weapons testing.
Navstar Global Positioning System Operational Control Segment (GPS OCX)      Operational control system for existing and future GPS constellation. Includes all satellite C2, mission planning, constellation management, external interfaces, monitoring stations, and ground antennas. Phase A effort includes effort to accomplish a System Requirements Review (SRR), System Design Review (SDR), and development of a Mission Capabilities Engineering Model (MCEM) prototype.
Navy Unmanned Combat Air System (N-UCAS)      Design, develop and demonstrate the first unmanned jet aircraft able to take off and land aboard an aircraft carrier. N-UCAS will demonstrate that a long-range, low-observable, unmanned aircraft can operate safely from aircraft carriers and refuel in-flight to achieve ultra-long endurance for several missions including strike and ISR.
Network Centric Solutions Defense Knowledge Online (Netcents DKO)      Maintain and enhance key user services such as Portal, E-mail, IM, Directory, Search, Go Mobile, SSO, Database, Army Home Page in support of the 2.3 million Army and DoD users.
New York City Wireless (NYCWiN)      Provide New York City’s broadband public-safety wireless network.
Postal Automation      Supports sequencing and sorting of flats with the United States Postal Service (USPS) and both letters and flats within the international market. Postal Automation also supports the USPS to ensure the safety of the mail through its Biohazard Detection equipment.
Saudi Arabian American Oil Company (ARAMCO)      Provide an integrated security system at multiple sites with C2 connectivity to various regional C2 centers within Saudi Arabia.

 

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Program Name      Program Description
Space-Based Infrared System (SBIRS)      Design and develop space-based surveillance systems for missile warning, missile defense, battlespace characterization and technical intelligence.
Trailer Mounted Support System (TMSS)      Trailer Mounted Support System is a key part of the Army’s Standard Integrated Command Post System program providing workspace, power distribution, lighting, environmental conditioning (heating and cooling) tables and a common grounding system for commanders and staff at all echelons.
Treasury Communication System (TCS)      Provide telecommunications infrastructure for collaboration, communication and computing as required by the U.S. Department of Treasury.
Vehicular Intercommunications Systems (VIS)      Provide clear and noise-free communications between crewmembers inside combat vehicles and externally over as many as six combat net radios for the Army. The active noise-reduction features of VIS provide significant improvement in speech intelligibility, hearing protection, and vehicle crew performance.
Virginia Class Submarine (VCS)      Produce power and control systems along with advanced surveillance arrays for all Virginia Class Submarines. The Virginia Class is an advanced stealth multimission nuclear-powered submarine for deep ocean anti-submarine warfare and littoral operations.
Virginia IT Outsource (VITA)      Provide high-level IT consulting, IT infrastructure and services to Virginia state and local agencies including data center, help desk, desktop, network, applications and cross-functional services.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Market Risk –We are exposed to market risk with respect to our portfolio of trading and available-for-sale marketable securities with a fair value of $223 million at December 31, 2011.

Interest Rate Risk – We are exposed to interest rate risk with respect to our holdings of cash and cash equivalents of $3.0 billion at December 31, 2011, and we are also exposed to interest rate risk on variable-rate short-term credit facilities for which there were no borrowings outstanding at December 31, 2011. At December 31, 2011, we have $3.9 billion of long-term debt, primarily consisting of fixed rate debt, with a fair value of approximately $4.7 billion.

Derivatives – We do not hold or issue derivative financial instruments for trading purposes. From time to time, we may enter into interest rate swap agreements to manage our exposure to interest rate fluctuations. At December 31, 2011, we have no interest rate swap agreements in effect.

Foreign Currency Risk – We are exposed to foreign currency risk with respect to our foreign operations. We enter into foreign currency forward contracts to manage a portion of the exchange rate risk related to receipts from customers and payments to suppliers denominated in foreign currencies. At December 31, 2011, foreign currency forward contracts with a notional amount of $233 million were outstanding.

Inflation Risk – We have generally been able to anticipate increases in costs when pricing our contracts. Bids for longer-term firm fixed-price contracts typically include labor and other cost escalations in amounts that historically have been sufficient to cover cost increases over the period of performance.

A 10 percent change in interest rates or foreign currency exchange rates would not have a material impact to our consolidated financial position or results of operations.

 

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Item 8. Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

Northrop Grumman Corporation

Falls Church, Virginia

We have audited the accompanying consolidated statements of financial position of Northrop Grumman Corporation and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Northrop Grumman Corporation and subsidiaries at December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 7, 2012 expressed an unqualified opinion on the Company’s internal control over financial reporting.

 

/s/ Deloitte & Touche LLP

McLean, Virginia

February 7, 2012

 

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CONSOLIDATED STATEMENTS OF OPERATIONS

 

    Year Ended December 31
$ in millions, except per share amounts         2011   2010   2009

Sales and Service Revenues

           

Product sales

    $ 15,073       $ 16,091       $ 16,004  

Service revenues

      11,339         12,052         11,646  

Total sales and service revenues

      26,412         28,143         27,650  

Cost of Sales and Service Revenues

           

Cost of product sales

      11,491         12,558         12,648  

Cost of service revenues

      9,295         10,291         10,157  

General and administrative expenses

      2,350         2,467         2,571  

Operating income

      3,276         2,827         2,274  

Other (expense) income

           

Interest expense

      (221 )       (269 )       (269 )

Charge on debt redemption

          (229 )    

Other, net

      28         37         65  

Earnings from continuing operations before income taxes

      3,083         2,366         2,070  

Federal and foreign income tax expense

      997         462         636  

Earnings from continuing operations

      2,086         1,904         1,434  

Earnings from discontinued operations, net of tax

      32         149         252  

Net earnings

    $ 2,118       $ 2,053       $ 1,686  

Basic Earnings Per Share

           

Continuing operations

    $ 7.54       $ 6.41       $ 4.49  

Discontinued operations

      .11         .50         .79  

Basic earnings per share

    $ 7.65       $ 6.91       $ 5.28  

Weighted-average common shares outstanding, in millions

      276.8         296.9         319.2  

Diluted Earnings Per Share

           

Continuing operations

    $ 7.41       $ 6.32       $ 4.44  

Discontinued operations

      .11         .50         .77  

Diluted earnings per share

    $ 7.52       $ 6.82       $ 5.21  

Weighted-average diluted shares outstanding, in millions

      281.6         301.1         323.3  

Net earnings (from above)

    $ 2,118       $ 2,053       $ 1,686  

Other comprehensive (loss) income

           

Change in cumulative translation adjustment

      (4 )       (41 )       31  

Change in unrealized (loss) gain on marketable securities and cash flow hedges, net of tax benefit (expense) of $2 in 2011, $0 in 2010, and $(23) in 2009

      (4 )       1         36  

Change in unamortized benefit plan costs, net of tax benefit (expense) of $823 in 2011, $(183) in 2010, and $(374) in 2009

      (1,249 )       297         561  

Other comprehensive (loss) income, net of tax

      (1,257 )       257         628  

Comprehensive income

    $ 861       $ 2,310       $ 2,314  

The accompanying notes are an integral part of these consolidated financial statements.

 

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CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

 

    December 31
$ in millions   2011         2010

Assets

       

Current Assets

       

Cash and cash equivalents

    $ 3,002       $ 3,701  

Accounts receivable, net of progress payments

      2,964         3,329  

Inventoried costs, net of progress payments

      873         896  

Deferred tax assets

      496         392  

Prepaid expenses and other current assets

      411         244  

Assets of discontinued operations

                5,212  

Total current assets

      7,746         13,774  

Property, Plant, and Equipment

       

Land and land improvements

      375         363  

Buildings and improvements

      1,433         1,363  

Machinery and other equipment

      4,143         3,972  

Capitalized software costs

      444         451  

Leasehold improvements

      585         608  

Property, plant, and equipment, cost

      6,980         6,757  

Accumulated depreciation

      (3,933 )       (3,712 )

Property, plant, and equipment, net

      3,047         3,045  

Other Assets

       

Goodwill

      12,374         12,376  

Other purchased intangibles, net of accumulated amortization of $1,650 in 2011 and $1,613 in 2010

      155         192  

Pension and post-retirement plan assets

      153         320  

Long-term deferred tax assets

      900         628  

Miscellaneous other assets

      1,036         1,075  

Total other assets

      14,618         14,591  

Total assets

    $ 25,411       $ 31,410  

Liabilities and Shareholders’ Equity

       

Current Liabilities

       

Notes payables to banks and current portion of long-term debt

    $ 13       $ 784  

Trade accounts payable

      1,481         1,573  

Accrued employees’ compensation

      1,196         1,146  

Advance payments and billings in excess of costs incurred