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 operating results starting on page 25 and discussion of segment operating results starting on page 28.

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 - Congress will soon be finalizing the fiscal year 2010 budgets for the DoD and other federal agencies, providing program-specific allocations and a blueprint for defense spending in the coming years. Following an overhaul by the Secretary of Defense of weapons priorities to reorient the Pentagon toward winning unconventional conflicts, the fiscal year 2010 defense budget that Congress ultimately produces will likely reflect more investment in non-traditional, irregular capabilities. The fiscal year 2011 defense budget, being currently developed in concert with the 2010 Quadrennial Defense Review, will provide additional guidance on longer-term priorities and plans. Given the current focus on irregular warfare, the company expects an increase in investments for intelligence, surveillance and reconnaissance (ISR) platforms and systems - including unmanned, cyber-security, and information collection, processing, and distribution to enable the warfighter to make more accurate and 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. While this budget will likely begin to slow the growth of military program spending, 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. 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.

Certain notable events or activities during 2009 included the following:

Notable events for the three months ended September 30, 2009
† Awarded a contract valued up to $2.4 billion contract for USS Theodore Roosevelt refueling and complex overhaul.

† Launched two Space Tracking and Surveillance System (STSS) Demonstrator satellites aboard a Delta II rocket.

† Delivered Dewey (DDG 105) and New York (LPD 21) to the U.S. Navy.

† Completed National Security Cutter Waesche builders' sea trials.

† Contributed voluntary pension pre-funding amounts totaling $586 million.

† Issued $850 million of unsecured senior obligations - see page 36.

† Reached final settlement with the Internal Revenue Service (IRS) Office of Appeals on tax returns for the years ended 2001 - 2003.

Notable events for the nine months ended September 30, 2009
† Delivered Makin Island (LHD 8) to the U.S. Navy.

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

† Completed USS Carl Vinson (CVN 70) initial sea trials and re-delivered to the U.S. Navy.

† Delivered USS George H. W. Bush (CVN 77) to the U.S. Navy.

† Contributed voluntary pension pre-funding amounts totaling $800 million.

† Repurchased 14.7 million common shares for $663 million.

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

† Reduced backlog by $5.1 billion due to termination for convenience of the Kinetic Energy Interceptor program - see page 34.

† Increased quarterly common stock dividend from $.40 per share to $.43 per share.

† Streamlined the company's organizational structure from seven to five operating segments.

† 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

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              Nine Months Ended
                                                               September 30                    September 30
$ in millions, except per share                             2009            2008           2009             2008
Sales and service revenues                               $  8,726         $ 8,381       $ 26,003         $ 24,733
Cost of sales and service revenues                          7,303           6,825         21,749           20,372
General and administrative expenses                           768             785          2,291            2,320
Operating income                                              655             771          1,963            2,041
Interest expense                                              (76 )           (74 )         (219 )           (223 )
Other, net                                                     41              45             62               72
Federal and foreign income taxes                              133             233            536              635
Diluted earnings per share from continuing operations        1.52            1.50           3.89             3.65
Net cash provided by operating activities                     544           1,373          1,202            2,174

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


                                        Three Months Ended         Nine Months Ended
                                           September 30              September 30
        $ in millions                    2009         2008         2009         2008
        Product sales                 $  4,982      $ 4,808     $ 14,972     $ 14,051
        Service revenues                 3,744        3,573       11,031       10,682

        Sales and service revenues    $  8,726      $ 8,381     $ 26,003     $ 24,733

Sales and service revenues for the three and nine months ended September 30, 2009, increased $345 million and $1.3 billion, respectively, as compared with the same periods in 2008, reflecting higher sales in all operating segments. 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         Nine Months Ended
                                                 September 30              September 30
   $ in millions                               2009         2008         2009         2008
   Cost of Sales and Service Revenues
   Cost of product sales                    $  4,027      $ 3,682     $ 12,007     $ 11,204
   % of product sales                           80.8 %       76.6 %       80.2 %       79.7 %
   Cost of service revenues                    3,276        3,143        9,742        9,168
   % of service revenues                        87.5 %       88.0 %       88.3 %       85.8 %
   General and administrative expenses           768          785        2,291        2,320
   % of total sales and service revenues         8.8 %        9.4 %        8.8 %        9.4 %

   Cost of sales and service revenues       $  8,071      $ 7,610     $ 24,040     $ 22,692

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 September 30, 2009, as compared with the same period in 2008, is primarily due to higher pension costs and lower program performance at Electronic Systems and Shipbuilding. The increase in cost of product sales as a percentage of product sales for the nine months ended September 30, 2009, as compared with the same period in 2008, is primarily due to higher pension costs, partially offset by improved program performance at Shipbuilding.

The decrease in cost of service revenues as a percentage of service revenues for the three months ended September 30, 2009, as compared with the same period in 2008, is primarily due to higher program performance at Information Systems and Technical Systems. The increase in cost of service revenue as a percentage of service revenues for the nine months ended September 30, 2009, as compared with the same period in 2008, is primarily due to higher pension costs, partially offset by performance improvements at Information Systems and Technical Services. See the Segment Operating Results section below for further information.

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 from 9.4 percent for the three and nine months ended September 30, 2008, to 8.8 percent for the comparable periods in 2009 primarily due to lower corporate overhead costs and for the nine month period, a gain resulting from a legal 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. generally accepted accounting principles (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          Nine Months Ended
                                          September 30               September 30
        $ in millions                  2009           2008         2009         2008
        Segment operating income     $   786        $   768      $  2,296     $ 2,010
        Unallocated expense              (55 )          (20 )         (87 )       (95 )
        Net pension adjustment           (72 )           64          (224 )       192
        Royalty income adjustment         (4 )          (41 )         (22 )       (66 )

        Total operating income       $   655        $   771      $  1,963     $ 2,041

Segment Operating Income - Segment operating income for the three months ended September 30, 2009, increased $18 million, or 2 percent, as compared with the same period in 2008. Segment operating income was 9.0 percent and 9.2 percent of sales and service revenues for the three months ended September 30, 2009, and 2008, respectively. The increase in segment operating income is primarily due to higher operating income in Information Systems and Aerospace Systems, partially offset by lower operating income in Electronic Systems. See the Segment Operating Results section below for further information.

Segment operating income for the nine months ended September 30, 2009, increased $286 million, or 14 percent, as compared with the same period in 2008. Segment operating income was 8.8 percent and 8.1 percent of sales and service revenues for the nine months ended September 30, 2009, and 2008, respectively. The increase in segment operating income is primarily due to higher operating income in all operating segments. The 2008 operating income includes a $57 million negative performance adjustment in Information Systems,

partially offset by $60 million royalty income from patent infringement settlements in Electronic Systems. Operating income also reflects lower negative performance adjustments in Shipbuilding of $127 million in 2009 as compared with $326 million in 2008. See the Segment Operating Results section below for further information.

Unallocated Expense - Unallocated 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 expense for the three months ended September 30, 2009, increased $35 million from $20 million for the same period in 2008, primarily due to higher costs related to increased environmental remediation accruals and post-retirement employee benefits. Unallocated expenses for the nine months ended September 30, 2009, decreased $8 million, or 8 percent, as compared with the same period in 2008, primarily due to a gain resulting from a legal settlement, net of legal provisions and related expenses, partially offset by higher costs related to environmental remediation and post-retirement employee benefits.

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 September 30, 2009, and 2008, pension expense determined in accordance with U.S. GAAP was $210 million and $57 million, respectively, and pension expense determined in accordance with CAS was $138 million and $121 million, respectively. For the nine months ended September 30, 2009, and 2008, pension expense determined in accordance with U.S. GAAP was $629 million and $170 million, respectively, and pension expense determined in accordance with CAS was $405 million and $362 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 months ended September 30, 2009, increased $2 million as compared with the same period in 2008, primarily due to interest related to $850 million in unsecured senior notes issued in July 2009. Interest expense for the nine months ended September 30, 2009, decreased $4 million as compared with the same period in 2008. The decrease is primarily due to lower interest rates from the interest rate swaps and lower average debt balance.

Other, net
Other, net for the three and nine months ended September 30, 2009, decreased $4 million and $10 million, respectively, as compared with the same periods in 2008. The decreases are primarily due to 2008 royalty income of $40 million and $60 million (for the three and nine month periods, respectively) as a result of patent infringement settlements, partially offset by positive mark-to-market adjustments on investments in marketable securities used as a funding source for nonqualified employee benefit plans and a gain for the recovery of a loan to an affiliate.

Federal and Foreign Income Taxes
The company's effective tax rate on earnings from continuing operations for the three months ended September 30, 2009, was 21.5 percent compared with 31.4 percent for the same period in 2008. For the nine months ended September 30, 2009, the company's effective tax rate on earnings from continuing operations was 29.7 percent compared with 33.6 percent for the same period in 2008. In the third quarter of 2009, the company recognized net tax benefits of approximately $75 million primarily as a result of a final settlement with the Internal Revenue Service (IRS) Office of Appeals related to the company's tax returns for the years ended 2001-2003. In the third quarter of 2008, the company recognized net tax benefits of $21 million, which were primarily attributable to a settlement agreement with the IRS' Joint Committee on Taxation with respect to the audit of TRW's 1999 - 2002 tax returns.

Discontinued Operations
Discontinued operations for the three and nine months ended September 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 September 30, 2009, were $1.52 per share, as compared with $1.50 per share in the same period in 2008. Earnings per share are based on weighted average diluted shares outstanding of 320.6 million for the three months ended September 30, 2009, and 340.1 million for the same period in 2008.

Diluted earnings per share from continuing operations for the nine months ended September 30, 2009, were $3.89 per share, as compared with $3.65 per share in the same period in 2008. Earnings per share are based on weighted average diluted shares outstanding of 326.1 million for the nine months ended September 30, 2009, and 344.5 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 September 30, 2009, net cash provided by operating activities was $544 million as compared with $1.4 billion for the same period in 2008. The decrease of $829 million was primarily due to voluntary pension contributions of $586 million and higher trade working capital requirements in the 2009 period.

For the nine months ended September 30, 2009, net cash provided by operating activities was $1.2 billion as compared with $2.2 billion for the same period in 2008. The decrease of $972 million was primarily due to voluntary pension contributions of $800 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         Nine Months Ended
                                              September 30              September 30
     $ in millions                          2009         2008         2009         2008
     Sales and Service Revenues
     Aerospace Systems                   $  2,527      $ 2,417     $  7,656     $  7,250
     Electronic Systems                     1,839        1,808        5,594        5,018
     Information Systems                    2,513        2,410        7,589        7,220
     Shipbuilding                           1,650        1,451        4,549        4,403
     Technical Services                       692          665        2,026        1,857
     Intersegment eliminations               (495 )       (370 )     (1,411 )     (1,015 )

     Total sales and service revenues    $  8,726      $ 8,381     $ 26,003     $ 24,733

     Segment Operating Income
     Aerospace Systems                   $    265      $   233     $    780     $    721
     Electronic Systems                       215          261          695          671
     Information Systems                      206          156          633          575
     Shipbuilding                             113          118          211           26
     Technical Services                        41           39          121          110
     Intersegment eliminations                (54 )        (39 )       (144 )        (93 )

     Total segment operating income      $    786      $   768     $  2,296     $  2,010

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 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 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 . . .