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 2008 Annual Report on Form 10-K, updated by the Current Report on Form 8-K filed on April 22, 2009 (2008 Form 10-K), 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-24 and discussion of results by segment starting on page I-27.

Northrop Grumman provides technologically advanced, innovative products, services, and integrated solutions in information and technical services, aerospace, electronics, and shipbuilding to its global customers. As a prime contractor, principal subcontractor, partner, or preferred supplier, Northrop Grumman participates in many high-priority defense and commercial technology programs in the 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 local, state, and foreign governments and has 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 2008 Form 10-K.

Economic Opportunities, Challenges, and Risks - The President's budget proposal for fiscal year 2010 provides an indication as to the direction of defense spending, and Congress is now weighing in on this proposal. The armed services are well along in their development of the Quadrennial Defense Review and their fiscal year 2011 budget requests, which will provide additional guidance on longer term priorities and plans. Given the current era of irregular warfare, the company expects an increase in investments for intelligence, surveillance and reconnaissance (ISR) systems, cyber-security, and information collection, processing, and distribution for the warfighter to make timely decisions. Battlefield lessons from Iraq and Afghanistan should influence force structure and spending decisions as the DoD looks to enhance current readiness. Many allied countries are focusing their development and procurement efforts on advanced electronics and information systems capabilities to enhance their interoperability with U.S. forces. The size of future U.S. and international defense budgets is expected to remain responsive to the international security environment. The fiscal year 2010 budget submitted by the President of the United States requests $533.7 billion in discretionary authority for the DoD base budget, representing approximately a 4 percent increase over the fiscal 2009 appropriated level. The 2010 budget includes reductions in certain programs in which the company participates or for which the company expects to compete. However, the company believes that spending on recapitalization and modernization of homeland security and defense assets will continue to be a national priority, with particular emphasis on areas involving intelligence, persistent surveillance, directed energy systems, cyber-security, energy-saving technologies and non-conventional warfare capabilities.

Recent Developments in U.S. Cost Accounting Standards (CAS) Pension Recovery Rules - The CAS Board published an Advance Notice of Proposed Rulemaking (ANPRM) on September 2, 2008 and has indicated it will issue a Notice of Proposed Rulemaking ("NPRM" - the last published proposed version in the rulemaking process prior to the issuance of a final CAS rule) in July or August of 2009. The ANPRM described a framework which would partially harmonize the CAS rules with the Pension Protection Act of 2006 (PPA) requirements. The ANPRM included provisions for a transition period from the existing CAS requirement to a partially harmonized CAS requirement. After the PPA effective date for "eligible government contractors" (including Northrop Grumman), which were granted a delay in their PPA effective date, the proposed rule would partially mitigate the near-term mismatch between PPA-amended ERISA minimum contribution requirements which would not yet be recoverable under CAS. However, unless provisions in the ANPRM are revised in the final rule, government contractors maintaining defined benefit pension plans in general would still experience a timing mismatch between required contributions and the CAS recoverable pension costs. It is anticipated that contractors will be entitled to seek an equitable adjustment to prices of previously negotiated contracts subject to

CAS for increased contract costs which result from mandatory changes required by the final rule. The CAS Board is required to issue its final rule no later than January 1, 2010.

Certain notable events or activities during 2009 included the following:

Notable events for the three months ended June 30, 2009

† LHD 8 delivered to the U.S. Navy.

† New York (LPD 21) completed builder's sea trials.

† USS Carl Vinson (CVN 70) completed initial sea trials.

† The Department of Justice microelectronics claim and the company's claim against the U.S. Government for the termination of the TSSAM program were jointly settled at no cost to the company.

† Backlog reduced by $5.1 billion due to termination for convenience of the Kinetic Energy Interceptor program - see page 33.

† Quarterly common stock dividend increased from $.40 per share to $.43 per share.

Notable events for the six months ended June 30, 2009

† Voluntary pension pre-funding contributions totaled $214 million.

† The company repurchased 10 million common shares for $437 million.

† The company streamlined its organizational structure from seven to five operating segments.

† The company realigned certain logistics, services, and technical support programs and assets from Information Systems and Electronic Systems to Technical Services.

CRITICAL ACCOUNTING POLICIES, ESTIMATES, AND JUDGMENTS

Use of Estimates - There have been no material changes to the company's critical accounting policies, estimates, or judgments from those discussed in the company's 2008 Form 10-K.

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                             2009            2008           2009             2008
Sales and service revenues                               $  8,957         $ 8,628       $ 17,277         $ 16,352
Cost of sales and service revenues                          7,530           7,025         14,446           13,547
General and administrative expenses                           774             797          1,523            1,535
Operating income                                              653             806          1,308            1,270
Interest expense                                              (70 )           (72 )         (143 )           (149 )
Other, net                                                     13               5             21               27
Federal and foreign income taxes                              202             256            403              402
Diluted earnings per share from continuing operations        1.21            1.40           2.38             2.15
Net cash provided by operating activities                     830             607            658              801

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


                                        Three Months Ended         Six Months Ended
                                             June 30                    June 30
        $ in millions                    2009         2008         2009         2008
        Product sales                 $  5,420      $ 4,849     $  9,990     $  9,243
        Service revenues                 3,537        3,779        7,287        7,109

        Sales and service revenues    $  8,957      $ 8,628     $ 17,277     $ 16,352

Sales and service revenues for the three and six months ended June 30, 2009, increased $329 million and $925 million, respectively, as compared with the same periods in 2008, reflecting higher sales in all operating segments except Shipbuilding. Sales and service revenues at Shipbuilding for the three and six month periods were reduced by $100 million for revised estimates to complete LPD-class ships and LHA 6. 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                               2009         2008         2009         2008
   Cost of Sales and Service Revenues
   Cost of product sales                    $  4,345      $ 3,793     $  7,980     $  7,522
   % of product sales                           80.2 %       78.2 %       79.9 %       81.4 %
   Cost of service revenues                    3,185        3,232        6,466        6,025
   % of service revenues                        90.0 %       85.5 %       88.7 %       84.8 %
   General and administrative expenses           774          797        1,523        1,535
   % of total sales and service revenues         8.6 %        9.2 %        8.8 %        9.4 %

   Cost of sales and service revenues       $  8,304      $ 7,822     $ 15,969     $ 15,082

Cost of Product Sales and Service Revenues - The increase in cost of product sales as a percentage of product sales for the three months ended June 30, 2009, as compared with the same period in 2008, is primarily due to a $105 million pre-tax charge at Shipbuilding for cost growth on LPD-class ships and LHA 6. The decrease in cost of product sales as a percentage of product sales for the six months ended June 30, 2009, as compared to the same period in 2008, is primarily due to a $326 million pre-tax charge at Shipbuilding in the first quarter of

2008, offset by a partial reversal of this charge in the first quarter 2009. See the Segment Operating Results section below for further information.

The increase in cost of service revenues as a percentage of service revenues for the three and six months ended June 30, 2009, as compared to the same periods in 2008, is primarily due to lower performance results on service programs.

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 include this cost component as an element of cost. General and administrative expenses primarily relate to segment operations. General and administrative expenses as a percentage of total sales and service revenues decreased to 8.6 percent and 8.8 percent, respectively, for the three and six months ended June 30, 2009, primarily due to the recognition of a net gain from a litigation settlement.

Operating Income
The company considers operating income to be an important measure for evaluating its operating performance and, as is typical in the industry, 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.

Management of the company internally manages its operations by reference to "segment operating income." Segment operating income is defined as operating income before unallocated expenses and net pension adjustment, neither of which affect the segments, and the reversal of royalty income, which is classified as other income for financial reporting purposes. Segment operating income is one of the key metrics management uses to evaluate operating performance. Segment operating income is not, however, a measure of financial performance under U.S. GAAP, and may not be defined and calculated by other companies in the same manner.

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

                                         Three Months Ended          Six Months Ended
                                               June 30                   June 30
       $ in millions                     2009           2008         2009        2008
       Segment operating income        $   719        $   784      $ 1,510     $ 1,242
       Unallocated income (expense)         21            (43 )        (32 )       (75 )
       Net pension adjustment              (76 )           69         (152 )       128
       Royalty income adjustment           (11 )           (4 )        (18 )       (25 )

       Total operating income          $   653        $   806      $ 1,308     $ 1,270

Segment Operating Income - Segment operating income for the three months ended June 30, 2009, decreased $65 million, or 8 percent, as compared to the same period in 2008. Segment operating income was 8.0 percent and 9.1 percent of sales and service revenues for the three months ended June 30, 2009, and 2008, respectively. The decrease in segment operating income is primarily due to a $105 million pre-tax charge at Shipbuilding for cost growth on LPD-class ships and LHA 6. See Segment Operating Results section below for more information.

Segment operating income for the six months ended June 30, 2009, increased $268 million, or 22 percent, as compared to the same period in 2008. Segment operating income was 8.7 percent and 7.6 percent of sales and service revenues for the six months ended June 30, 2009, and 2008, respectively. The increase in segment operating income is primarily due to the first quarter 2008 pre-tax charge of $326 million at Shipbuilding on the LHD 8 and other programs and margin on increased sales volume at all other operating segments, partially offset by the $105 million pre-tax charge at Shipbuilding for cost growth on LPD-class ships and LHA 6. Segment operating income at Shipbuilding for the six-month period in 2009 also included cost growth of $38 million each on the DDG 51 and LPD programs, offset by a $54 million favorable adjustment on the LHD 8 for risk retirement and increased escalation recovery. See the Segment Operating Results section below.

Unallocated Income (Expense) - Unallocated income (expense) generally includes the portion of corporate expenses not considered allowable or allocable under applicable CAS regulations and the Federal Acquisition Regulation (FAR), and therefore not allocated to the segments, such as management and administration, legal, environmental, certain compensation and retiree benefits, and other expenses. Unallocated income (expense) for the three months ended June 30, 2009, decreased $64 million, as compared to the same period in 2008. Unallocated expenses for the six months ended June 30, 2009, decreased $43 million, or 57 percent, as compared to the same period in 2008. The decrease for the three and six month periods ended June 30, 2009, is primarily due to a gain resulting from a legal settlement, net of other legal provisions and related expenses.

Net Pension Adjustment - Net pension adjustment reflects the difference between pension expense determined in accordance with U.S. GAAP and pension expense allocated to the operating segments determined in accordance with CAS. For the three months ended June 30, 2009, and 2008, pension expense determined in accordance with U.S. GAAP was $209 million and $57 million, respectively, and pension expense determined in accordance with CAS was $133 million and $126 million, respectively. For the six months ended June 30, 2009, and 2008, pension expense determined in accordance with U.S. GAAP was $419 million and $113 million, respectively, and pension expense determined in accordance with CAS was $267 million and $241 million, respectively. The increases in U.S. GAAP and CAS pension expense are primarily the result of negative returns on plan assets in 2008.

Royalty Income Adjustment - Royalty income is included in segment operating income and reclassified to other income for financial reporting purposes. See Other, net below.

Interest Expense
Interest expense for the three and six months ended June 30, 2009, decreased $2 million and $6 million, respectively, as compared with the same period in 2008. The decrease is primarily due to a lower average debt balance.

Other, net
Other, net for the three and six months ended June 30, 2009, increased $8 million and decreased $6 million, respectively, as compared with the same periods in 2008. The increase for the three-month period is primarily due to increased royalty income at Aerospace Systems. The decrease for the six-month period is primarily due to lower royalty income at Electronic Systems. 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, 2009, was 33.9 percent compared with 34.6 percent for the same period in 2008. For the six months ended June 30, 2009, the company's effective tax rate on earnings from continuing operations was 34.0 percent compared with 35.0 percent for the same period in 2008.

Discontinued Operations
Discontinued operations for the three and six months ended June 30, 2008, represents the net operating results of the Electro-Optical Systems business formerly reported in the Electronic Systems segment. See Note 5 to the condensed consolidated financial statements in Part I, Item 1.

Diluted Earnings Per Share
Diluted earnings per share from continuing operations for the three months ended June 30, 2009, were $1.21 per share, as compared with $1.40 per share in the same period in 2008. Earnings per share are based on weighted average diluted shares outstanding of 325.8 million for the three months ended June 30, 2009, and 344.1 million for the same period in 2008.

Diluted earnings per share from continuing operations for the six months ended June 30, 2009, were $2.38 per share, as compared with $2.15 per share in the same period in 2008. Earnings per share are based on weighted average diluted shares outstanding of 328.9 million for the six months ended June 30, 2009, and 346.7 million for the same period in 2008. See Note 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, 2009, net cash provided by operating activities was $830 million as compared with $607 million for the same period in 2008. The increase of $223 million was primarily due to lower working capital requirements in the 2009 period.

For the six months ended June 30, 2009, net cash provided by operating activities was $658 million as compared with $801 million for the same period in 2008. The decrease of $143 million was primarily due to discretionary pension contributions of $214 million and higher trade working capital requirements in the 2009 period.

SEGMENT OPERATING RESULTS

Basis of Presentation
In January 2009, the company streamlined its organizational structure by reducing the number of operating segments from seven to five. The five segments are Aerospace Systems, which combines the former Integrated Systems and Space Technology segments; Electronic Systems; Information Systems, which combines the former Information Technology and Mission Systems segments; Shipbuilding; and Technical Services. Creation of the Aerospace Systems and Information Systems segments is intended to strengthen alignment with customers, improve the company's ability to execute on programs and win new business, and enhance cost competitiveness.

During the first quarter of 2009, the company realigned certain logistics, services, and technical support programs and transferred assets from the Information Systems and Electronic Systems segments to the Technical Services segment. This realignment is intended to strengthen the company's core capability in aircraft and electronics maintenance, repair and overhaul, life cycle optimization, and training and simulation services.

The sales and segment operating income in the following tables have been revised to reflect the above realignments for all periods presented.

During the first quarter of 2009, the company transferred certain optics and laser programs from the Information Systems segment to the Aerospace Systems segment. As the operating results of this business were not considered material, the prior year sales and segment operating income in the following tables were not reclassified to reflect this business transfer.

                                           Three Months Ended         Six Months Ended
                                                June 30                    June 30
     $ in millions                          2009         2008         2009         2008
     Sales and Service Revenues
     Aerospace Systems                   $  2,673      $ 2,472     $  5,129     $  4,833
     Electronic Systems                     1,967        1,665        3,755        3,210
     Information Systems                    2,585        2,512        5,076        4,810
     Shipbuilding                           1,524        1,688        2,899        2,952
     Technical Services                       702          634        1,334        1,192
     Intersegment eliminations               (494 )       (343 )       (916 )       (645 )

     Total sales and service revenues    $  8,957      $ 8,628     $ 17,277     $ 16,352

     Segment Operating Income (Loss)
     Aerospace Systems                   $    257      $   236     $    515     $    488
     Electronic Systems                       251          201          480          410
     Information Systems                      204          207          427          419
     Shipbuilding                              14          126           98          (92 )
     Technical Services                        43           42           80           71
     Intersegment eliminations                (50 )        (28 )        (90 )        (54 )

     Total segment operating income      $    719      $   784     $  1,510     $  1,242

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 process. Based on this approach and the nature of the company's operations, the discussion of results of operations generally focuses around the company's five segments versus distinguishing between products and services. Product sales are predominantly generated in the Aerospace

Systems, Electronic Systems and Shipbuilding segments, while the majority of the company's service revenues are generated by the Information 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 reported revenues incurred due to varying production activity levels, 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 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 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 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. 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 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), the 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-36.

AEROSPACE SYSTEMS

Business Description
Aerospace Systems is a premier developer, integrator, producer and supporter of manned and unmanned aircraft, spacecraft, high-energy laser systems, microelectronics and other systems and subsystems critical to maintaining the nation's security and leadership in aerospace science and technology. These systems are used, primarily by government customers, 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 areas of business: Strike and Surveillance Systems (S&SS); Space Systems (SS); Battle Management and Engagement Systems (BM&ES); and Advanced Programs and Technology (AP&T).

. . .