OVERVIEW

The following discussion should be read along with the unaudited Condensed Consolidated Financial Statements included in this Form 10-Q, as well as the company's 2007 Annual Report on Form 10-K, updated by the Form 8-K dated July 29, 2008, filed with the Securities and Exchange Commission, which provides a more thorough discussion of the company's products and services, industry outlook, and business trends. See discussion of consolidated results starting on page I-23 and discussion of results by segment starting on page I-26.

Northrop Grumman provides technologically advanced, innovative products, services, and solutions in information and services, aerospace, electronics, and shipbuilding. As a prime contractor, principal subcontractor, partner, or preferred supplier, Northrop Grumman participates in many high-priority defense and commercial technology programs in the United States (U.S.) and abroad. Northrop Grumman conducts most of its business with the U.S. Government, principally the Department of Defense (DoD). The company also conducts business with foreign governments and makes domestic and international commercial sales.

Business Outlook and Operational Trends - There have been no material changes to the company's products and services, industry outlook, or business trends from those disclosed in the company's 2007 Annual Report on Form 10-K, updated by the Form 8-K filed on July 29, 2008. The company's shipyard operations in the Gulf Coast continue to be impacted from workforce shortages resulting from hurricanes in 2005.

Notable Events - Notable events or activity during the three months ended June 30, 2008, affecting the company's consolidated financial results included the following:

† Contract award of $1.16 billion by U.S. Navy for a Broad Area Maritime Surveillance Unmanned Aircraft System currently under protest - see page I-35.

Other notable events or activity during the six months ended June 30, 2008, included the following:

† Contract award of $1.5 billion by U.S. Air Force to replace its aerial refueling tanker fleet. Decision by Government Accountability Office to uphold protest of aerial refueling tanker award - see page I-35.

† Pre-tax charge of $326 million associated with the LHD-8 and other ships - see page I-33 and Note 6 to the Condensed Consolidated Financial Statements in Part I, Item 1.

† Conversion and redemption of 3.5 million shares of mandatorily redeemable convertible preferred stock to 6.4 million shares of common stock - see Note 4 to the Condensed Consolidated Financial Statements in Part I, Item 1.

† Sale of Electro-Optical Systems - see Note 5 to the Condensed Consolidated Financial Statements in Part I, Item 1.

CRITICAL ACCOUNTING POLICIES, ESTIMATES, AND JUDGMENTS

Use of Estimates - The company's financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). The preparation of the financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Estimates have been prepared on the basis of the most current and best available information. Actual results could differ materially from those estimates.

NORTHROP GRUMMAN CORPORATION


CONSOLIDATED OPERATING RESULTS

Selected financial highlights are presented in the table below.


                                                            Three Months Ended                Six Months Ended
                                                                 June 30,                         June 30,
$ in millions, except per share                             2008            2007             2008           2007
Sales and service revenues                               $  8,628         $ 7,878         $ 16,352       $ 15,192
Cost of sales and service revenues                          7,822           7,115           15,082         13,739
Operating income                                              806             763            1,270          1,453
Interest expense                                              (72 )           (83 )           (149 )         (172 )
Federal and foreign income taxes                              256             199              402            405
Diluted earnings per share from continuing operations        1.40            1.35             2.15           2.46
Net cash provided by operating activities                     607             741              801          1,141

Sales and Service Revenues
Sales and service revenues consist of the following:


                                        Three Months Ended         Six Months Ended
                                             June 30,                  June 30,
        $ in millions                    2008         2007         2008         2007
        Product sales                 $  4,849      $ 4,460     $  9,243     $  8,646
        Service revenues                 3,779        3,418        7,109        6,546

        Sales and service revenues    $  8,628      $ 7,878     $ 16,352     $ 15,192

Sales and service revenues for the three and six months ended June 30, 2008, increased $750 million and $1.2 billion, respectively, as compared with the same periods in 2007, reflecting higher sales in all operating segments. Sales and service revenues were impacted by a sales step back of $134 million on the LHD-8 program recorded in the first quarter of 2008. See the Segment Operating Results section below for further information.

Cost of Sales and Service Revenues

Cost of sales and service revenues is comprised of the following:


                                              Three Months Ended         Six Months Ended
                                                   June 30,                  June 30,
   $ in millions                               2008         2007         2008         2007
   Cost of product sales                    $  3,793      $ 3,486     $  7,522     $  6,696
   % of product sales                           78.2 %       78.2 %       81.4 %       77.4 %
   Cost of service revenues                    3,232        2,821        6,025        5,528
   % of service revenues                        85.5 %       82.5 %       84.8 %       84.4 %
   General and administrative expenses           797          808        1,535        1,515
   % of total sales and service revenues         9.2 %       10.3 %        9.4 %       10.0 %

   Cost of sales and service revenues       $  7,822      $ 7,115     $ 15,082     $ 13,739

Cost of Product Sales and Service Revenues - Cost of product sales as a percentage of product sales for the three months ended June 30, 2008, as compared to the same period in 2007, remained essentially unchanged. The increase in cost of product sales as a percentage of product sales for the six months ended June 30, 2008, as compared to the same period in 2007, is primarily due to a $272 million pre-tax charge at Shipbuilding in the first quarter of 2008 for cost growth on the LHD-8 contract and an additional $54 million, primarily for schedule impacts on other ships and impairment of purchased intangibles at the Gulf Coast shipyard.

NORTHROP GRUMMAN CORPORATION

Cost of service revenues as a percentage of service revenues for the three and six months ended June 30, 2008, as compared to the same periods in 2007, increased primarily at Mission Systems, Information Technology and Shipbuilding due to contract mix.

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 and such costs, for most components of the company, are allocated to contracts in progress on a systematic basis, and contract performance factors include this cost component as an element of cost. General and administrative expenses primarily relate to segment operations. The decrease in general and administrative expenses as a percentage of total sales and service revenues for the three and six months ended June 30, 2008, is primarily due to the higher sales volume as compared with the same periods in 2007.

Operating Income
The company considers operating income to be an important measure for evaluating its operating performance and defines "operating income" as revenues less the related cost of producing the revenues and general and administrative expenses. Operating income for the company is further evaluated for each of the business segments in which the company operates, and "segment operating income" is one of the key metrics used by management of the company to internally manage its operations.

The table below reconciles segment operating income to total operating income:

                                        Three Months Ended          Six Months Ended
                                              June 30                   June 30
         $ in millions                  2008           2007         2008        2007
         Segment operating income     $   784        $   798      $ 1,242     $ 1,490
         Unallocated expenses             (43 )          (64 )        (75 )       (96 )
         Net pension adjustment            69             28          128          61
         Royalty income adjustment         (4 )            1          (25 )        (2 )

         Total operating income       $   806        $   763      $ 1,270     $ 1,453

Segment Operating Income - Segment operating income for the three months ended June 30, 2008, decreased $14 million, or 2 percent, as compared to the same period in 2007. Total segment operating income was 9.1 percent and 10.1 percent of total sales and service revenues for the three months ended June 30, 2008, and 2007, respectively. Segment operating income for the six months ended June 30, 2008, decreased $248 million, or 17 percent, as compared to the same period in 2007. Total segment operating income was 7.6 percent and 9.8 percent of total sales and service revenues for the six months ended June 30, 2008, and 2007, respectively. The decrease in operating income in 2008 includes pre-tax charges totaling $326 million at Shipbuilding in the first quarter of 2008 stemming from cost growth, schedule delays and impairment of purchased intangibles at the Gulf Coast shipyards. See the Segment Operating Results section below and Note 6 to the Condensed Consolidated Financial Statements in Part I, Item 1 for further information.

Unallocated Expenses - Unallocated expenses include the portion of corporate expenses not considered allowable or allocable under applicable U.S. Government Cost Accounting Standards (CAS) regulations and the Federal Acquisition Regulation, and therefore not allocated to the segments, such as management and administration, legal, environmental, certain compensation and retiree benefits, and other expenses. Unallocated expenses for the three and six months ended June 30, 2008, decreased $21 million in each period, or 33 percent and 22 percent, respectively, as compared to the same periods in 2007, primarily due to $50 million in legal and investigative provisions recorded in the second quarter of 2007, partially offset by increased other corporate unallocated costs.

Net Pension Adjustment - Net pension adjustment reflects the difference between pension expense determined in accordance with GAAP and pension expense allocated to the operating segments determined in accordance with

NORTHROP GRUMMAN CORPORATION

CAS. For the three months ended June 30, 2008, and 2007, pension expense determined in accordance with GAAP was $57 million and $87 million, respectively, and pension expense determined in accordance with CAS amounted to $126 million and $115 million, respectively. For the six months ended June 30, 2008, and 2007, pension expense determined in accordance with GAAP was $113 million and $174 million, respectively, and pension expense determined in accordance with CAS amounted to $241 million and $235 million, respectively. The reduction in GAAP pension expense in 2008 is primarily the result of better than estimated investment returns in 2007, a higher discount rate assumption and pension plan design changes that took effect in 2008.

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

Interest Expense
Interest expense for the three and six months ended June 30, 2008, decreased $11 million and $23 million, respectively, as compared with the same periods in 2007, primarily due to the conversion and redemption of the mandatorily redeemable convertible preferred stock, which reduced the dividends paid during the 2008 periods.

Other, Net
Other, net for the three and six months ended June 30, 2008, increased $14 million and $37 million, respectively, as compared with the same periods in 2007, primarily due to gains recorded on the sale of assets in 2008 as compared with losses recorded on the sale of assets in 2007. Other, net for the six months ended June 30, 2008, also includes higher royalty income than in the prior year period. Other, net includes interest income for all periods presented.

Federal and Foreign Income Taxes
The company's effective tax rate on earnings from continuing operations for the three months ended June 30, 2008, was 34.6 percent compared with 29.7 percent for the same period in 2007. For the six months ended June 30, 2008, the company's effective tax rate on earnings from continuing operations was 35.0 percent compared with 31.9 percent for the same period in 2007. During the second quarter of 2007, the company entered into a partial settlement agreement with the Internal Revenue Service regarding its audits for the year ended December 31, 2001 through the year ended December 31, 2003. As a result of the settlement, the company recognized tax benefits of $16 million.

Discontinued Operations
Discontinued operations for the three and six months ended June 30, 2008, and 2007, primarily represents the net operating results and after-tax gain on sale of the Electro-Optical Systems business formerly reported in the Electronics segment. The 2007 periods also include the net operating results of Interconnect Technologies. See Note 5 to the Condensed Consolidated Financial Statements in

Diluted Earnings Per Share
Diluted earnings per share from continuing operations for the three months ended June 30, 2008, were $1.40 per share, as compared with $1.35 per share in the same period in 2007. Earnings per share are based on weighted-average diluted shares outstanding of 344.1 million for the three months ended June 30, 2008, and 355.3 million for the same period in 2007.

Diluted earnings per share from continuing operations for the six months ended June 30, 2008, were $2.15 per share, as compared with $2.46 per share in the same period in 2007. Earnings per share are based on weighted-average diluted shares outstanding of 346.7 million for the six months ended June 30, 2008, and 356.8 million for the same period in 2007.

Diluted earnings per share from continuing operations and the weighted-average diluted shares outstanding include the dilutive effects of the mandatorily redeemable convertible preferred stock. A substantial portion of the mandatorily redeemable convertible preferred stock was converted to common stock in the first quarter of 2008, with the remainder converted or redeemed in April 2008.

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See Notes 4 and 7 to the Condensed Consolidated Financial Statements in Part I, Item 1.

Net Cash Provided by Operating Activities For the three months ended June 30, 2008, net cash provided by operating activities was $607 million compared to $741 million for the same period in 2007. The decrease of $134 million, or 18 percent, was primarily due to the receipt of $125 million of insurance proceeds related to Katrina in 2007.

For the six months ended June 30, 2008, net cash provided by operating activities was $801 million compared to $1.1 billion for the same period in 2007. The decrease of $340 million, or 30 percent, was primarily due to higher cash paid to suppliers as compared to cash received from customers in the 2008 period of $284 million, and lower cash insurance proceeds of $120 million, partially offset by a slight improvement in other cash receipts.

SEGMENT OPERATING RESULTS

Basis of Presentation
During the second quarter of 2008, the company transferred certain programs and assets from the missiles business in the Mission Systems segment to the Space Technology segment. This transfer allows Mission Systems to focus on the rapidly growing command, control, communications, computers, intelligence, surveillance, and reconnaissance (C4ISR) business, and the missiles business will be an integrated element of the company's Aerospace business growth strategy.

In January 2008, the Newport News and Ship Systems businesses were realigned into a single segment called Northrop Grumman Shipbuilding. Previously, these businesses were separate operating segments which were aggregated into a single segment for financial reporting purposes. In addition, certain Electronics businesses were transferred to Mission Systems during the first quarter of 2008.

In January 2007, certain programs and business areas were transferred between Information Technology, Mission Systems, Space Technology, and Technical Services.

Sales and segment operating income information in the following tables have been revised, where applicable, to reflect the above realignments for all periods presented.

For presentation purposes, the company's seven segments are categorized into four primary businesses. The Mission Systems, Information Technology and Technical Services segments are presented as Information & Services. The Integrated Systems and Space Technology segments are presented as Aerospace. The Electronics and Shipbuilding segments are presented as separate businesses.

NORTHROP GRUMMAN CORPORATION


                                         Three Months Ended         Six Months Ended
                                              June 30                    June 30
       $ in millions                      2008         2007         2008         2007
       Sales and Service Revenues
       Information & Services
       Mission Systems                 $  1,388      $ 1,288     $  2,686     $  2,447
       Information Technology             1,215        1,143        2,300        2,181
       Technical Services                   572          551        1,077        1,071

       Total Information & Services       3,175        2,982        6,063        5,699

       Aerospace
       Integrated Systems                 1,358        1,225        2,698        2,506
       Space Technology                   1,118        1,067        2,140        2,057

       Total Aerospace                    2,476        2,292        4,838        4,563

       Electronics                        1,675        1,628        3,230        3,156
       Shipbuilding                       1,688        1,359        2,952        2,515
       Intersegment eliminations           (386 )       (383 )       (731 )       (741 )

       Sales and service revenues      $  8,628      $ 7,878     $ 16,352     $ 15,192

       Segment Operating Income
       Information & Services
       Mission Systems                 $    133      $   142     $    261     $    245
       Information Technology                82           90          171          176
       Technical Services                    36           32           62           60

       Total Information & Services         251          264          494          481

       Aerospace
       Integrated Systems                   143          149          313          309
       Space Technology                      93           90          175          163

       Total Aerospace                      236          239          488          472

       Electronics                          202          189          411          381
       Shipbuilding                         126          134          (92 )        213
       Intersegment eliminations            (31 )        (28 )        (59 )        (57 )

       Segment operating income        $    784      $   798     $  1,242     $  1,490

Operating Performance Assessment and Reporting - The company manages and assesses the performance of its businesses based on its performance on individual contracts and programs obtained generally from government organizations using the financial measures referred to below, with consideration given to the company's critical accounting policies and estimation processes. Based on this approach and the nature of the company's operations, the discussion of results of operations generally focuses around the company's seven segments versus distinguishing between products and services. Product sales are predominantly generated in the Electronics, Integrated Systems, Space Technology and Shipbuilding segments, while the majority of the company's service revenues are generated by the Information Technology, Mission Systems and Technical Services segments.

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 revenues incurred due to varying production activity levels,

NORTHROP GRUMMAN CORPORATION

delivery rates, or service levels on individual contracts. Volume changes will typically carry a corresponding income change based on the margin rate for a particular contract.

Segment Operating Income - Segment operating income reflects the performance of segment contracts and programs. Excluded from this measure are certain costs not directly associated with contract performance, including the portion of corporate expenses such as management and administration, legal, environmental, certain compensation and other retiree benefits, and other expenses not considered allowable or allocable under applicable CAS regulations and the Federal Acquisition Regulation, 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. These changes typically relate to profit recognition associated with revisions to total costs estimated at completion (EAC) of the contract that reflect either improved (or deteriorated) operating performance or management's view of risk on a particular contract. Operating income changes on contracts are accounted for on a cumulative-to-date basis at the time an EAC change is recorded.

Operating income may also be affected by, among other things, the effects of workforce stoppages, the effects of natural disasters (such as hurricanes and 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 material, a separate description is provided.

Contract Descriptions
For convenience, a brief description of certain programs discussed in this Form 10-Q is included in the "Glossary of Programs" beginning on page I-38.

INFORMATION & SERVICES

Business Descriptions
Mission Systems - A leading global system integrator of complex, mission-enabling systems for government, military, and commercial customers. Products and services are grouped into the following business areas: Command, Control and Communications (C3); and Intelligence, Surveillance and Reconnaissance (ISR).

Information Technology - A premier provider of advanced information technology (IT) solutions, engineering, and business services for government and commercial customers. Products and services are grouped into the following business areas:
Intelligence; Civilian Agencies; Commercial, State & Local (CS&L); and Defense.

Technical Services - A leading provider of logistics, infrastructure, and sustainment support, and also provides a wide-array of technical services including training and simulation. Services are grouped into the following business areas: Systems Support (SSG); Life Cycle Optimization and Engineering (LCOE); and Training and Simulation.

                                               Three Months Ended June 30                                                Six Months Ended June 30
                                       2008                                 2007                                2008                                 2007
                                      Operating     % of                  Operating      % of                  Operating     % of                  Operating      % of
$ in millions              Sales       Income       Sales      Sales       Income       Sales       Sales       Income       Sales      Sales       Income       Sales
Mission Systems          $ 1,388      $    133       9.6 %   $ 1,288      $    142       11.0 %   $ 2,686      $    261       9.7 %   $ 2,447      $    245       10.0 %
Information Technology     1,215            82       6.7 %     1,143            90        7.9 %     2,300           171       7.4 %     2,181           176        8.1 %
Technical Services           572            36       6.3 %       551            32        5.8 %     1,077            62       5.8 %     1,071            60        5.6 %

Information & Services   $ 3,175      $    251       7.9 %   $ 2,982      $    264        8.9 %   $ 6,063      $    494       8.1 %   $ 5,699      $    481        8.4 %

Sales and Service Revenues
Mission Systems
Revenue for the three months ended June 30, 2008, increased $100 million, or 8 percent, as compared with the same period in 2007. The increase was primarily due to $77 million higher sales in ISR, and $11 million higher

NORTHROP GRUMMAN CORPORATION

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