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Item 7. Management’s Discussion and Analysis

2023-01-26 compared with 2022-01-27 · 196 added, 172 removed, 436 unchanged (46% of the section changed)

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Management's Discussion and Analysis of Financial Condition and Results of Operations” of our Form 10-K for the year ended December 31, 2021 (“2021 Annual Report on Form 10-K”).

Global Security Environment

and its allies continue to face a global security environment of heightened tensions and instability, threats from state and non-state actors, including in particular major global powers, as well as terrorist organizations, increasing nuclear tensions, diverse regional security concerns and political instability.

The market for defense products, services and solutions globally is driven by these complex and evolving security challenges, considered in the broader context of political and socioeconomic circumstances and priorities.

Our operations and financial performance, as well as demand for our products and services, are impacted by global events, including violence and unrest.

The same is true for our suppliers and other business partners.

The conflict in Ukraine has increased global tensions and instability, highlighted threats and increased global demand, as well as further disrupted global supply chains and added costs.

We have experienced a modest increase in demand for certain of our goods and services directly and indirectly related to the conflict in the Ukraine.

We also have experienced a slight disruption to some of our programs and supply chain, including unanticipated cost growth, as a result of the conflict in Ukraine and economic sanctions.

However, we do not have sizable business dealings in Russia or Ukraine, and do not anticipate significant adverse impacts from the ongoing conflict.

More broadly, the conflict in Ukraine and threats elsewhere have heightened tensions and highlighted security requirements globally, especially in Europe and the Pacific region, as well as the U.S.

We have started to see, and expect to continue to see, increased demand for defense products and services from allies and partner nations, particularly in those areas.

We are actively exploring both opportunities and risks.

For further information on the global security environment, including the risks related thereto, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Liquidity and Capital Resources,” “Quantitative and Qualitative Disclosures About Market Risks” and “Risk Factors.”

Global Health and Economic Environment

Since at least March 2020, when it was first characterized as a global pandemic, COVID-19 has dramatically impacted and continues to impact the global health and economic environments, including millions of confirmed cases and deaths, business slowdowns or shutdowns, labor shortfalls, supply chain challenges, regulatory challenges, inflationary pressures and market volatility.

We discussed in some detail in our Annual Reports on Form 10-K for the fiscal years ended December 31, 2020 and 2021, and subsequent SEC filings, the pandemic, its impacts and risks, and actions taken up to the time of each filing.

In this Form 10-K, we provide a further update.

In 2022, the pandemic continued to have significant adverse impacts on the global health and macroeconomic environments, particularly with the spread of new variants and other viruses and illnesses, ongoing disruption of the labor force and supply chains, continued inflation, and market volatility and uncertainties.

We expect such adverse impacts to continue.

However, with extraordinary efforts by our employees, our governments and customers, our partners and our company, direct COVID-19-related impacts on our business generally declined in 2022.

While we cannot predict the future course of the pandemic or its consequences, we are not currently assuming significant additional direct COVID-19 related impacts on our business.

The company continues to work to monitor and address the pandemic, including its impact on our company, our employees, our customers, our suppliers and our communities.

Our goals have been, and continue to be, to keep our employees safe, to lessen the potential adverse impacts, both health and economic, and to continue to position the company for long-term success.

Like the communities in which we operate, our actions have varied, and will continue to vary, depending on the spread of COVID-19 and other illnesses, applicable government requirements, and the needs of our stakeholders.

Global Economic Environment

In part as a result of the COVID-19 pandemic, the global economic environment has experienced, and continues to experience, extraordinary challenges, including high rates of inflation and inflationary pressures;

widespread delays and disruptions in supply chains;

workforce challenges, including labor shortages (especially in critical skill areas);

and market volatility.

These macroeconomic factors have contributed, and we expect will continue to contribute, to increased costs, delays and other performance challenges, as well as increased competing demands for limited

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resources to address such increased costs and other challenges, for our company, our suppliers and partners, and our customers.

For example, as discussed in greater detail in Note 12 to the consolidated financial statements, our latest estimated cost to complete the low-rate initial production (LRIP) phase of the B-21 program reflects updated estimates for adverse impacts from these macroeconomic factors, as well as potential opportunities to address them.

We continue to work hard to mitigate some of the challenges caused by the current macroeconomic environment on our business, including by taking steps to support our suppliers and small businesses and enhancing our workforce through extensive hiring, development and retention efforts.

However, the broader macroeconomic environment, including inflationary pressures and supply chain challenges, continued adversely to affect the company’s results for the year ended December 31, 2022.

We cannot clearly predict how long these macroeconomic challenges will continue, or how they will change over time, or what additional resources will be available, but we expect to see this challenging macroeconomic environment continue adversely to impact the global economy, our customers, our industry and our company in 2023.

In addition, increased interest rates, raising the cost of borrowing for governments, could further impact government spending priorities (in the U.S.

and allied countries, in particular), including their demand for defense products.

Economic tensions and changes in international trade policies, including higher tariffs on imported goods and materials and renegotiation of free trade agreements, could also further impact the global market for defense products, services and solutions.

Political, Budget and Regulatory Environment

On March 15, 2022, the President signed into law the Consolidated Appropriations Act for FY 2022, which provided full-year funding for federal agencies, including $782 billion for national defense.

This represented an approximately $42 billion or 6 percent increase above the budget for FY 2021, approximately $30 billion more than the Administration had initially requested.

The Pentagon’s portion of the overall national defense budget for FY 2022 was $743 billion.

On March 28, 2022, the President proposed his budget for FY 2023, which included $813 billion for national defense programs, approximately $31 billion or 4 percent higher than what was appropriated in FY 2022.

The Pentagon’s portion of the overall requested national defense budget was $773 billion.

On December 23, 2022, the President signed the National Defense Authorization Act (NDAA) for FY 2023, which supports approximately $858 billion in FY 2023 funding for national defense, $817 billion of which is for the DoD.

In addition, the FY 2023 NDAA grants DoD discretionary authority under limited circumstances to provide extraordinary relief to contractors to address certain inflationary impacts.

Although discussions have occurred, DoD has not yet issued written guidance for how it intends to exercise this authority.

On December 29, 2022, the President signed an Omnibus appropriations act for FY 2023 that provided $858 billion for national defense programs, approximately $45 billion more than the Administration initially requested for FY 2023 and approximately $76 billion or 10 percent higher than what was appropriated in FY 2022.

The Pentagon’s portion of the overall national defense budget for FY 2023 is $817 billion.

It includes up to $1 billion for extraordinary relief in FY 2023.

In addition to the U.S.

national security spending detailed above, the U.S.

has pledged over $100 billion in security assistance to address the ongoing conflict in Ukraine across FY 2022 and FY 2023, including approximately $50 billion in DoD spending.

Assistance includes transfers of weapons systems from U.S.

inventories, orders for production of additional weapons systems, both to backfill U.S.

stockpiles and for Ukraine directly, and assistance from U.S.

capabilities.

It is difficult to predict the specific course of future defense budgets.

Current and future requirements related to the conflict in Ukraine, threats in the Pacific regions and other security priorities, as well as global inflation, the national debt, the costs of the pandemic and other domestic priorities, among other things, in the U.S.

and globally, will continue to impact our customers’ budgets and priorities, and our industry.

Current tensions within Congress and the wider U.S.

political environment may also impact defense budgets and government spending more broadly.

We believe the current global security environment highlights the significant national security threats to our nation and our allies, and the need for strong deterrence and a robust defense capability.

We believe that our capabilities, particularly in space, C4ISR, missile defense, battle management, advanced weapons, survivable aircraft and mission systems should help our customers in the U.S.

and globally defend against current and future threats and, as a result, continue to allow for long-term profitable business growth.

The Bipartisan Budget Act of 2019 suspended the debt ceiling through July 31, 2021.

In October 2021, the statutory debt limit was increased by $480 billion and, in December 2021, it was further increased by $2.5 trillion, which is

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currently expected to allow the Treasury Department to finance the government into 2023.

In January 2023, the debt ceiling was reached and the Treasury Department began taking “extraordinary measures” to finance the government and avoid a breach of the debt ceiling.

We expect statutory action will be needed in 2023 to increase or suspend the debt ceiling.

During the third quarter of 2022, the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act of 2022, which includes an advanced manufacturing investment tax credit, among other provisions, and the Inflation Reduction Act of 2022, which includes implementation of a new alternative minimum tax and a one percent excise tax on share repurchases, among other provisions, were signed into law.

We expect the excise tax on share repurchases to impact us beginning in 2023;

however, we do not expect this tax or any other provision of this legislation to have a material impact on our results of operations or cash flows.

More broadly, we have seen, and expect to continue to see, an accelerated pace of new rulemakings, new and expanded uses of existing authorities, changing legal rulings and landscapes, and aggressive enforcement actions.

These changes and the accelerated pace of change, not only impose additional obligations and risk, but also create further uncertainty regarding our operating environment.

The political environment, federal budget, debt ceiling and regulatory environment are expected to continue to be the subject of considerable debate, especially in light of the ongoing conflict in Ukraine, the inflationary environment and political tensions.

The results of those debates could have material impacts on defense spending broadly and the company’s programs in particular.

We anticipate that the broader macroeconomic environment, with ongoing inflationary pressures, labor challenges, and supply chain disruption, among other considerations, will continue to play a significant role in the outcome of these debates and, in turn, on our industry and company.

For further information on the risks we face from the current political and economic environment, see “Risk Factors.”

Disposition of IT and Mission Support Services Business

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Operating results include sales and operating income for the IT and mission support services business prior to the Divestiture date;

See Note 2 to the consolidated financial statements for further information regarding the disposition.

COVID-19 was first reported in late 2019.

In March 2020, the World Health Organization characterized COVID-19 as a global pandemic, and the President declared a national emergency concerning the COVID-19 outbreak.

In the almost two years since then, the pandemic has dramatically impacted the global health and economic environment, including millions of confirmed cases and deaths, business slowdowns or shutdowns, labor shortfalls, supply chain challenges, regulatory challenges, and market volatility.

We discussed in some detail in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, and subsequent SEC filings in 2021, the pandemic, its impacts and risks, and actions taken up to the time of each filing.

In this Form 10-K, we provide a further update.

The company’s leadership, our crisis management and business resumption teams, and local site leadership continue closely to monitor and address the pandemic and related developments, including the impact on our company, our employees, our customers, our suppliers and our communities.

The company has considered and continues to consider and be guided by health data and evolving guidance from the Centers for Disease Control and Prevention (CDC), in particular, as well as other health organizations globally, federal, state and local governmental authorities, and our customers, among others.

We have taken, and continue to take, robust actions to help protect the health, safety and well-being of our employees, to support continued performance, to support our suppliers and local communities, and to continue to serve our customers.

Our goals have been, and continue to be to lessen the potential adverse impacts, both health and economic, and to continue to position the company for long-term success.

Like the communities in which we operate, our actions have varied depending on the spread of COVID-19 and applicable government requirements, the needs of our employees, the needs of our customers and the needs of our business.

Over the course of 2021, COVID-19 case rates and the health and economic impacts of the pandemic fluctuated dramatically in different communities in the U.S.

and globally, particularly with the spread of new variants.

But we continued to see a prolonged impact on the economy, our industry, and our company, with increased challenges for customers and suppliers, labor shortages, supply chain challenges, and increasing inflation, among other impacts.

We expect these and other impacts to continue and they could worsen, depending on the future course of the pandemic and actions taken in connection with it.

In the U.S., the Food and Drug Administration issued emergency use authorization for COVID-19 vaccines and the government began extensive efforts to administer them.

The company also has taken various steps to encourage and facilitate vaccination access for our employees, in accordance with federal guidance.

We have provided paid leave and flexibility for employees to get vaccinated, and strongly encouraged our workforce to take care of themselves and their colleagues.

In September 2021, the White House issued an executive order and guidance from the Safer Federal Workforce Task Force broadly requiring many U.S.-based federal contractors to be fully vaccinated by December 8, 2021 (or to have an approved accommodation).

In early November 2021, the federal government extended that deadline to January 18, 2022.

On December 7, 2021, a federal district judge issued an order, temporarily suspending the government from enforcing the federal contractor mandate.

That order is on appeal.

State and local governments are also taking actions related to the pandemic, imposing additional and varying requirements on industry.

We have taken and are taking steps strongly to encourage our employees to be fully vaccinated (or to have an approved accommodation) to protect our workplace and to position the company to comply with the executive order, guidance, and related contract terms, if and as necessary, as we continue to evaluate the evolving situation and our customers’ requirements.

Evolving government requirements, including regarding a vaccine mandate, along with the broader impacts of the continuing pandemic, could significantly impact

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our workforce and performance, as well as those of our suppliers, and result in costs that we may not be able to recover fully.

The company continues to take robust actions globally to protect the health, safety and well-being of our employees, and to serve our customers with continued performance.

We also continue to take steps to support our suppliers, with a particular focus on critical small and midsized business partners, including passing through increased progress payments from the DoD to our suppliers and accelerating payments to certain suppliers.

The company’s fourth quarter 2021 revenue and operating income were affected by the impact of the COVID-19 pandemic on the company and the broader economic environment, including through a tightened labor market, elevated levels of employee leave, evolving government requirements, and supply chain challenges.

These factors are expected to continue and could worsen and affect further our ability (and that of our suppliers) to maintain a qualified workforce and to perform fully for our customers (including with respect to cost and schedule), with delayed or reduced sales and additional liabilities, losses and costs, that we may not be able to recover fully.

Our employees, customers and suppliers, the company, our economy and our global community face both continuing and new or evolving challenges related to the pandemic, and we cannot predict how this dynamic situation will evolve or the impact it will have on the company, or our financial position, results of operations and/or cash flows.

For further information on the pandemic and the potential impact to the company of COVID-19, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Liquidity and Capital Resources” below and “Risk Factors.”

Global Security and Economic Environment

and its allies continue to face a global security environment of heightened tensions and instability, threats from state and non-state actors, including major global powers, as well as terrorist organizations, emerging nuclear tensions, diverse regional security concerns and political instability.

Global threats persist across all domains, from undersea to space to cyber.

The global geopolitical and economic environments also continue to be impacted by uncertainty.

Geopolitical relationships are changing and global economic growth is expected to remain in the low single digits in 2022 reflecting the impact of and uncertainty surrounding geopolitical tensions globally and financial market volatility and the COVID-19 pandemic.

The global economy may also be affected by the residual legal, regulatory and economic impacts of Britain’s exit from the European Union, the full impacts of which are complex and gradually becoming evident.

Rising inflation also could lead to increased interest rates, raising the cost of borrowing for the federal government, which could impact other spending priorities.

Additionally, economic tensions and changes in international trade policies, including higher tariffs on imported goods and materials and renegotiation of free trade agreements, could impact the global market for defense products, services and solutions.

Political and Economic Environment

On May 28, 2021, the Administration released its budget request for FY 2022.

The budget proposed $753 billion for national defense programs and $770 billion in non-defense discretionary funding.

It continues to be the subject of debate in Congress.

The Administration’s budget request included funding for an infrastructure and economic recovery plan and an education and economic support plan.

On November 15, 2021, the President signed into law the $1.2 trillion Infrastructure and Investment and Jobs Act.

Enactment of the infrastructure plan and any future spending plans, as well as the costs of the pandemic (as discussed more above), may have broader implications for the defense industry, our customers’ budgets and priorities, and the overall economic environment, including the national debt.

It is difficult to predict the specific course of future defense budgets.

However, the threat to U.S.

national security remains very substantial.

We believe that our capabilities, particularly in space, missiles, missile defense, hypersonics, counter-hypersonics, survivable aircraft and mission systems should help our customers defend against future threats and, as a result, continue to allow for long-term profitable growth in our business.

FY 2022 appropriations have not been enacted to date.

On September 30, 2021, a continuing resolution was enacted, providing funding generally at FY 2021 levels through December 3, 2021;

the continuing resolution was further extended through February 18, 2022.

Congressional deliberations over FY 2022 appropriations have demonstrated broad support for national security, with increased funding proposed in certain areas for national defense above the Administration’s budget request.

It remains uncertain whether and, if so, when the government will approve FY 2022 appropriations, with which programs funded at what levels, and for how long the government will operate under a continuing resolution, with potential impacts on our programs and new starts, in particular.

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The Bipartisan Budget Act of 2019 suspended the debt ceiling through July 31, 2021.

In October 2021, the statutory debt limit was increased by $480 billion and, in December 2021, was further increased by $2.5 trillion, which is currently expected to allow the Treasury Department to finance the government into 2023.

The political environment, federal budget and debt ceiling are expected to continue to be the subject of considerable debate, which could have material impacts on defense spending broadly and the company’s programs in particular.

For further information on the risks we face from the current political and economic environment, see “Risk Factors.”

therefore, no sales and operating income were recognized for this business during the year ended December 31, 2022.

The company recorded pre-tax profit of the IT and mission support services business of $20 million and $247 million for the years ended December 31, 2021 and 2020, respectively.

Operating Performance Assessment and Reporting

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Changes in sales are generally described in terms of volume, while changes in operating margin rates are generally described in terms of performance and/or contract mix.

For purposes of this discussion, volume generally refers to increases or decreases in sales or cost from production/service activity levels and performance generally refers to non-volume related changes in profitability.

Contract mix generally refers to changes in the ratio of contract type and/or life cycle (e.g., cost-type, fixed-price, development, production, and/or sustainment).

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CONSOLIDATED OPERATING RESULTS

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These non-GAAP measures may not be defined and calculated by other companies in the same manner and should not be considered in isolation or as an alternative to operating results presented in accordance with GAAP.

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Selected financial highlights are presented in the table below:

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Diluted earnings per share $ 31.47 $ 43.54 $ 19.03 (28) % 129 %

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The tables below reconcile sales to organic sales:

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Total $ 35,667 $ (162) $ 35,505 $ 36,799 $ (2,329) $ 34,470 3 %

2021 sales decreased $1.1 billion, or 3 percent, due to a $2.2 billion reduction in sales related to the IT services divestiture.

2021 organic sales increased $1.0 billion, or 3 percent due to higher sales at Space and Mission Systems, partially offset by lower sales at Aeronautics Systems and Defense Systems.

2020 sales included a $444 million sale of equipment to a restricted customer at Aeronautics Systems.

2022 sales increased $935 million and 2022 organic sales increased $1.1 billion, or 3 percent, due to higher sales at Space Systems and Mission Systems, partially offset by lower sales at Aeronautics Systems and Defense Systems.

2022 sales reflect strong demand, the timing of material receipts and improving trends in labor availability during the second half of the year.

See “Segment Operating Results” below for further information by segment and “Product and Service Analysis” for product and service detail.

See Note 16 to the consolidated financial statements for information regarding the company’s sales by customer type, contract type and geographic region for each of our segments.

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Operating Income and Margin Rate

2021 operating income increased $1.6 billion, or 39 percent, primarily due to the IT services divestiture, including the $2.0 billion pre-tax gain on sale and $192 million of unallocated corporate expense for unallowable state taxes and transaction costs, partially offset by a $288 million reduction in the FAS/CAS operating adjustment.

Lower non-divestiture-related unallocated corporate expenses were partially offset by higher deferred state taxes principally related to the company’s 2021 MTM benefit.

2021 operating margin rate increased to 15.8 percent from 11.0 percent reflecting the items above.

2021 G&A costs as a percentage of sales increased to 10.1 percent from 9.3 percent, primarily due to an increase in investments for future business opportunities and a lower G&A cost mix in the divested IT services business.

2022 operating income decreased $2.1 billion, or 36 percent, primarily due to a $2.0 billion pre-tax gain on sale and $192 million of unallocated corporate expenses recognized in the prior year associated with the IT services divestiture.

Operating income also decreased due to a $330 million reduction in the FAS/CAS operating adjustment, which more than offset higher segment operating income and lower non-divestiture-related unallocated corporate expense.

2022 operating margin rate declined to 9.8 percent from 15.8 percent reflecting the items above.

2022 G&A costs as a percentage of sales increased to 10.6 percent from 10.1 percent, primarily due to an increase in investments for future business opportunities.

For further information regarding product and service operating costs and expenses, see “Product and Service Analysis” below.

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Mark-to-Market Pension and OPB Benefit/Expense

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Actuarial gains (losses) on projected benefit obligation $ 9,662 $ 1,163 $ (3,570)

Actuarial gains on plan assets 1,192 2,536 3,066

Actuarial (losses) gains on plan assets (8,430) 1,192 2,536

MTM benefit (expense)

$ 1,232 $ 2,355 $ (1,034)

2021 MTM benefit of $2.4 billion was primarily driven by a 30 basis point increase in the discount rate from year end 2020 and actual net plan asset returns of approximately 10.9 percent compared to our 7.5 percent asset return assumption.

2022 MTM benefit (expense) of $1.2 billion was primarily driven by a 256 basis point increase in the discount rate from year end 2021, partially offset by losses of 15.4 percent on plan assets compared to our 7.5 percent asset return assumption.

Federal and Foreign Income Taxes

The 2021 effective tax rate (ETR) increased to 21.6 percent from 14.5 percent in the prior year period primarily due to federal income taxes resulting from the IT services divestiture, including $250 million of income tax expense related to $1.2 billion of nondeductible goodwill in the divested business.

The company’s 2021 MTM benefit did not significantly impact the 2021 ETR;

however, MTM expense in 2020 reduced the 2020 ETR by 1.3 percentage points.

The 2022 effective tax rate (ETR) decreased to 16.1 percent from 21.6 percent primarily due to an $86 million benefit resulting from the resolution of the IRS examination of certain legacy OATK tax returns, as well as additional federal income taxes in the prior year resulting from the IT services divestiture.

The company’s 2022 MTM benefit increased the 2022 ETR by 1.2 percentage points;

however, the 2021 MTM benefit did not significantly impact the 2021 ETR.

See Note 7 to the consolidated financial statements for additional information.

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The table below reconciles net earnings to transaction-adjusted net earnings:

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Transaction-adjusted net earnings $ 3,974 $ 4,123 $ 3,963 (4) % 4 %

(1) The deferred state tax impact was calculated using the company’s blended state tax rate of 5.25 percent in 2021 and 2020 and 4.50 percent in 2019 and is included in Unallocated corporate expense within operating income.

(1) The deferred state tax impact in each period was calculated using the company’s blended state tax rate of 5.25 percent and is included in Unallocated corporate expense within operating income.

(2) The federal tax impact in each period was calculated by subtracting the deferred state tax impact from MTM benefit (expense) and applying the 21 percent federal statutory rate.

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(4) The federal tax impact was calculated by applying the 21 percent federal statutory rate to the adjustment items and also includes $250 million of incremental tax expense related to $1.2 billion of nondeductible goodwill in the divested business.

2021 net earnings increased $3.8 billion, or 120 percent, principally due to a $2.5 billion increase in our MTM benefit, net of tax, and a $1.1 billion increase associated with the IT services divestiture, net of tax.

Transaction-adjusted net earnings increased $160 million, or 4 percent, primarily due to lower unallocated corporate expense and higher segment operating income, partially offset by higher income tax expense.

2022 net earnings decreased $2.1 billion, or 30 percent, principally due to a $1.1 billion decrease associated with the IT services divestiture, net of tax, and an $840 million decrease in our MTM benefit (expense), net of tax.

Transaction-adjusted net earnings decreased $149 million, or 4 percent, primarily due to a $330 million reduction in the FAS/CAS operating adjustment and $97 million of lower returns on marketable securities, partially offset by lower income tax and interest expense and higher segment operating income.

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Transaction-adjusted EPS $ 25.54 $ 25.63 $ 23.65 — % 8 %

(1) The deferred state tax impact in each period was calculated using the company’s blended state tax rate of 5.25 percent and is included in Unallocated corporate expense within operating income.

(2) The federal tax impact in each period was calculated by subtracting the deferred state tax impact from MTM benefit (expense) and applying the 21 percent federal statutory rate.

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2021 diluted earnings per share increased $24.51, or 129 percent, principally due to a $15.57 increase in our 2021 MTM benefit, net of tax, and a $6.96 increase associated with the IT services divestiture, net of tax.

Transaction-adjusted EPS increased $1.98, or 8 percent, reflecting a 4 percent increase in transaction-adjusted net earnings and a 4 percent decrease in weighted-average diluted shares outstanding.

2022 diluted earnings per share decreased $12.07, or 28 percent, principally due to a $6.96 decrease associated with the IT services divestiture, net of tax, and a $5.02 decrease in our 2022 MTM benefit, net of tax.

Transaction-adjusted EPS was comparable with the prior year and reflects a 4 percent reduction in transaction-adjusted net earnings and a 3 percent decrease in weighted-average diluted shares outstanding.

SEGMENT OPERATING RESULTS

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Networked Information Solutions

Effective during the first quarter of 2021 within Mission Systems, the businesses of the former CIMS business area that remained with Northrop Grumman after the IT services divestiture were merged with the Communications business unit and F-35 Communications, Navigation and Identification programs within the former Airborne, Sensors & Networks business area to form the Networked Information Solutions business area.

The Airborne Sensors & Networks business area was then renamed the Airborne Multifunction Sensors business area to better reflect its new portfolio.

This change had no impact on the segment operating results of Mission Systems as a whole.

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This section discusses segment sales, operating income and operating margin rate.

A reconciliation of segment operating income to total operating income is provided below.

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Segment Operating Income and Margin Rate

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Operating income $ 3,601 $ 5,651 $ 4,065 (36) % 39 %

Operating margin rate 9.8 % 15.8 % 11.0 %

Reconciliation to segment operating income:

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Other unallocated corporate expense 145 106 273 37 % (61) %

Unallocated corporate (income) expense $ (1,304) $ 541 $ 474 (341) % 14 %

Unallocated corporate expense (income) 452 (1,304) 541 (135) % (341) %

Segment operating income $ 4,253 $ 4,217 $ 4,188 1 % 1 %

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Segment Operating Income and Margin Rate

2021 segment operating income increased $29 million, or 1 percent.

Higher operating income at Space Systems and Mission Systems was driven by increased volume and improved performance.

Lower operating income at Defense Systems is due to the impact of the IT services divestiture and lower operating income at Aeronautics Systems principally relates to net unfavorable EAC adjustments on F-35.

2021 segment operating income from the IT services business was $20 million as compared to $247 million in 2020.

Segment operating income includes a first quarter 2021 benefit of approximately $100 million due to the impact of lower overhead rates on the company’s fixed price contracts.

Segment operating margin rate increased to 11.8 percent from 11.4 percent and reflects higher operating margin rates at Mission Systems, Defense Systems and Space Systems.

2022 segment operating income increased $36 million, or 1 percent, due to higher operating income at Mission Systems, Space Systems and Aeronautics Systems, partially offset by lower operating income at Defense Systems due, in part, to the impact of the IT services divestiture.

2021 segment operating income included $20 million from the IT services business, as well as a benefit of approximately $100 million due to the impact of lower overhead rates on the company’s fixed price contracts.

Segment operating margin rate decreased to 11.6 percent from 11.8 percent principally due to lower net EAC adjustments due, in part, to macroeconomic impacts, including inflationary pressures and supply chain challenges.

FAS/CAS Operating Adjustment

The decrease in our 2022 FAS/CAS operating adjustment is due to lower CAS pension expense resulting from favorable plan asset returns in 2021 and changes in certain CAS actuarial assumptions as of December 31, 2021.

Unallocated Corporate Income (Expense)

The increase in 2021 unallocated corporate income (expense) is primarily due to a $2.0 billion pre-tax gain on the sale of our IT services business, partially offset by $192 million of unallowable state taxes and transaction costs associated with the divestiture.

Lower non-divestiture-related unallocated corporate expense reflects a $60 million benefit from insurance settlements related to shareholder litigation involving the former Orbital ATK prior to the company’s acquisition, that was resolved in June 2019, as well as benefits recognized during the year associated with changes in deferred state taxes, partially offset by higher deferred state tax expense related to the company’s 2021 MTM benefit.

Unallocated Corporate Expense (Income)

The change in 2022 unallocated corporate expense (income) is primarily due to the prior year $2.0 billion pre-tax gain on sale and $192 million of unallowable state taxes and transaction costs associated with the IT services divestiture.

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Operating margin rate 10.6 % 9.7 % 9.9 %

2021 sales decreased $910 million, or 7 percent, due to lower volume in both Manned Aircraft and Autonomous Systems.

Lower sales reflect a $444 million sale of equipment to a restricted customer in 2020, $150 million of lower F-35 sales, lower A350 production activity, and lower volume on the B-2 Defensive Management Systems Modernization (DMS) program and certain Global Hawk programs.

2022 sales decreased $728 million, or 6 percent, due to lower volume in both Manned Aircraft and Autonomous Systems, including restricted programs, a $180 million decrease on the Global Hawk program, a $159 million decrease on the E-2 program and a $119 million decrease on the JSTARS program as it nears completion.

Operating Income

2021 operating income decreased $113 million, or 9 percent, principally due to lower sales.

2021 operating margin rate decreased to 9.7 percent from 9.9 percent due to lower net favorable EAC adjustments, driven by F-35, partially offset by improved performance on Autonomous Systems programs.

2022 operating income increased $23 million, or 2 percent, due to a higher operating margin rate, partially offset by lower sales.

2022 operating margin rate increased to 10.6 percent from 9.7 percent primarily due to higher net favorable EAC adjustments and a $38 million gain on a property sale.

Higher net favorable EAC adjustments reflect $133 million of positive adjustments on the engineering, manufacturing and development phase of the B-21 program, partially offset by lower net EAC adjustments associated with other restricted work, as well as $135 million of unfavorable EAC adjustments on F-35 in the prior year.

The prior year operating margin rate also reflects a $21 million benefit associated with favorable overhead rate performance.

NORTHROP GRUMMAN CORPORATION

DEFENSE SYSTEMS

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Operating margin rate 11.9 % 12.0 % 11.2 %

2021 sales decreased $1.8 billion, or 23 percent, primarily due to a $1.5 billion reduction in sales related to the IT services divestiture.

2021 organic sales decreased $236 million, or 4 percent, due to $397 million lower sales in connection with the close-out of the contract at the Army’s Lake City ammunition plant (Lake City) and lower volume on an international training program, partially offset by higher volume on several programs including Republic of Korea Global Hawk Contractor Logistics Support (ROK Global Hawk CLS), U.S.

Customs and Border Protection P-3 (CBP P-3), GMLRS, B-2 sustainment and advanced fuzes.

NORTHROP GRUMMAN CORPORATION

2022 sales decreased $197 million, or 3 percent, due, in part, to a $106 million reduction in sales related to the IT services divestiture.

2022 organic sales decreased $91 million, or 2 percent, principally due to a $154 million decrease from lower scope on an international training program, completion of a Joint Services support program and wind-down of the UKAWACS and JSTARS programs, partially offset by a $144 million increase from ramp-up on the Integrated Air and Missile Defense Battle Command System (IBCS) program, as well as higher volume on the Special Ammunition and Weapon Systems (SAWS) and NATO Alliance Ground Surveillance In-Service Support (NATO AGS ISS) programs.

Operating Income

2021 operating income decreased $150 million, or 18 percent, due to the impact of the IT services divestiture.

Operating margin rate increased to 12.0 percent from 11.2 percent and reflects improved performance at Battle Management and Missile Systems due to changes in mix as a result of recent contract completions.

2022 operating income decreased $32 million, or 5 percent, due, in part, to a $14 million reduction in operating income related to the IT services divestiture, as well as lower sales.

Operating margin rate was comparable with the prior year.

MISSION SYSTEMS

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Operating margin rate 15.6 % 15.6 % 14.5 %

2021 sales increased $54 million, or 1 percent, due to higher volume across the sector, partially offset by a $485 million reduction in sales related to the IT services divestiture.

2021 organic sales increased $539 million, or 6 percent.

Maritime/Land Systems and Sensors sales increased primarily due to $137 million higher volume on G/ATOR and higher marine systems volume.

Airborne Multifunction Sensors sales increased principally due to $105 million higher volume on airborne radar programs, including SABR, and higher restricted sales, partially offset by lower volume on airborne electronic warfare programs.

Navigation, Targeting and Survivability sales increased principally due to $124 million higher intercompany volume largely related to GBSD ramp-up.

Networked Information Solutions sales increased principally due to higher volume on electronic warfare programs, including JCREW, and higher intercompany volume, partially offset by lower volume on F-35 CNI programs.

2022 sales increased $262 million, or 3 percent, and includes a $42 million reduction in sales related to the IT services divestiture.

2022 organic sales increased $304 million, or 3 percent, primarily due to higher restricted sales in the Networked Information Solutions business area, $107 million of higher volume on airborne radar programs and a $107 million increase on the Surface Electronic Warfare Improvement Program (SEWIP).

These increases were partially offset by a $231 million decrease on Navigation, Targeting and Survivability programs and a $118 million decrease on the Joint Counter Radio-Controlled Improvised Explosive Device Electronic Warfare (JCREW) program.

Operating Income

2021 operating income increased $120 million, or 8 percent, due to a higher operating margin rate and higher sales.

Operating margin rate increased to 15.6 percent from 14.5 percent due to higher net favorable EAC adjustments, which reflect improved performance and the first quarter 2021 reduction in overhead rates, the favorable resolution of certain government accounting matters in the second quarter of 2021 and mix changes largely related to the IT services divestiture.

2022 operating income increased $39 million, or 2 percent, due to higher sales.

Operating margin rate was comparable with the prior year and reflects a $33 million benefit recognized in connection with a contract-related legal matter, partially offset by the previously described overhead rate benefit to fixed price contracts in the prior year.

NORTHROP GRUMMAN CORPORATION

SPACE SYSTEMS

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Operating margin rate 9.4 % 10.6 % 10.2 %

2021 sales increased $1.9 billion, or 21 percent, due to higher volume in both the Launch & Strategic Missiles and Space business areas, partially offset by a $166 million reduction in sales related to the IT services divestiture.

2021 organic sales increased $2.0 billion, or 24 percent.

Launch & Strategic Missiles sales increased primarily due to ramp-up on development programs, including a $1.1 billion increase on GBSD and a $206 million increase on NGI.

Space sales were driven by higher volume on restricted programs and increases of $192 million on Artemis and $140 million on Next Gen OPIR.

2022 sales and organic sales increased $1.7 billion, or 16 percent, due to higher sales in both business areas.

Launch & Strategic Missiles sales increased primarily due to ramp-up on development programs, including a $454 million increase on the Ground Based Strategic Deterrent (GBSD) program and a $449 million increase on the Next Generation Interceptor (NGI) program, as well as higher volume on the GEM63 program in support of Amazon’s Project Kuiper.

Sales in the Space business area were driven by a $320 million increase due to ramp-up on the Space Development Agency (SDA) Tranche 1 Transport and Tracking Layer programs awarded earlier this year, higher volume on restricted programs and a $134 million increase in sales on the Commercial Resupply Services (CRS) program, partially offset by a $149 million decrease in sales for the James Webb Space Telescope after its successful launch in December 2021.

Operating Income

2021 operating income increased $228 million, or 26 percent, due to higher sales and a higher operating margin rate.

Operating margin rate increased to 10.6 percent from 10.2 percent primarily due to higher net favorable EAC adjustments, which were largely driven by improved performance on commercial space programs and the first quarter 2021 reduction in overhead rates.

2022 operating income increased $37 million, or 3 percent, due to higher sales, partially offset by a lower operating margin rate.

Operating margin rate decreased to 9.4 percent from 10.6 percent primarily due to lower net EAC adjustments and a $45 million write-down of commercial inventory, partially offset by a $96 million gain recognized in connection with a land exchange transaction.

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Product Sales and Costs

2021 product sales increased $853 million, or 3 percent, due to ramp-up on development programs including GBSD and NGI at Space Systems, as well as higher volume on airborne radar and land systems programs at Mission Systems.

The increase was partially offset by lower restricted sales and lower net favorable EAC adjustments at Aeronautics Systems as well as close-out of the Lake City contract at Defense Systems.

2022 product sales increased $654 million, or 2 percent, primarily due to an increase in product sales at Space Systems, partially offset by a decrease in product sales at Aeronautics Systems.

The increase at Space Systems was driven by ramp-up on development programs including GBSD and NGI, as well as higher volume on the SDA Tranche 1 Transport Layer and Tranche 1 Tracking Layer programs.

The decrease at Aeronautics Systems was principally due to lower volume on restricted programs, as well as the Global Hawk and E-2 programs.

2022 product costs increased $600 million, or 2 percent, consistent with the higher product sales described above.

Service Sales and Costs

2021 service sales decreased $2.0 billion, or 20 percent, primarily due to the IT services divestiture.

Year to date 2021 sales from the IT services business, which were largely included in service sales, were $162 million as compared to $2.3 billion in the prior year period.

The reductions associated with the IT services divestiture were partially offset by higher volume on the ROK Global Hawk CLS and CBP P-3 programs at Defense Systems.

2021 service costs decreased $1.8 billion, or 21 percent, consistent with the lower service sales described above.

2022 service sales increased $281 million, or 4 percent, primarily due to an increase in service sales at Aeronautics Systems, principally on restricted programs, partially offset by a decrease in service sales at Defense Systems.

The decrease at Defense Systems was driven by lower scope on an international training program, the impact of the IT services divestiture, completion of a Joint Services support program and wind-down of the UKAWACS program.

Sales from the divested IT services business, which were largely included in service sales, were $162 million in the prior year.

2022 service costs increased $299 million, or 4 percent, consistent with the higher service sales described above.

NORTHROP GRUMMAN CORPORATION

Backlog represents the future sales we expect to recognize on firm orders received by the company and is equivalent to the company’s remaining performance obligations at the end of each period.

It comprises both funded backlog (firm orders for which funding is authorized and appropriated) and unfunded backlog.

Unexercised contract options

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and indefinite delivery indefinite quantity (IDIQ) contracts are not included in backlog until the time the option or IDIQ task order is exercised or awarded.

Unexercised contract options and indefinite delivery indefinite quantity (IDIQ) contracts are not included in backlog until the time the option or IDIQ task order is exercised or awarded.

Backlog is converted into sales as costs are incurred or deliveries are made.

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2022 net awards totaled $39.3 billion.

Significant 2021 new awards include $6.1 billion for restricted programs (primarily at Space Systems, Mission Systems and Aeronautics Systems), $3.2 billion for the SLS Booster Production and Operations Contract, $2.6 billion for NGI, $2.2 billion for F-35, $1.0 billion for E-2 and $0.9 billion for NASA’s HALO module.

In connection with the IT services divestiture, the company reduced backlog by $1.4 billion during the first quarter of 2021 ($1.0 billion at Defense Systems, $0.2 billion at Mission Systems and $0.2 billion at Space Systems).

Significant 2022 new awards include $10.6 billion for restricted programs (principally at Aeronautics Systems, Mission Systems and Space Systems), $5.3 billion for F-35, $2.1 billion for GEM63 solid rocket boosters, largely related to Amazon's Project Kuiper, $1.5 billion for the SDA Tranche 1 Transport and Tracking Layer programs, $1.3 billion for Commercial Resupply Services (CRS) missions and $1.3 billion for Ground-based Midcourse Defense (GMD).

LIQUIDITY AND CAPITAL RESOURCES

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The company has a five-year senior unsecured credit facility in an aggregate principal amount of $2.5 billion, and in April 2022, we renewed our one-year $500 million uncommitted credit facility.

At December 31, 2021, there was no balance outstanding under these credit facilities.

At December 31, 2022, there were no borrowings outstanding under these credit facilities.

The company’s principal contractual commitments include purchase obligations, repayments of long-term debt and related interest, and payments under operating leases.

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companies to defer the employer’s portion of social security taxes between March 27, 2020 and December 31, 2020 and pay such taxes in two installments in 2021 and 2022.

Our first installment of deferred social security taxes of $200 million was paid in the fourth quarter of 2021 and the second installment of $200 million is due in the fourth quarter of 2022.

Under Section 3610, the CARES Act also authorized the government to reimburse qualifying contractors for certain costs of providing paid leave to employees as a result of COVID-19.

The company continues to seek, and anticipates continuing to seek, recovery for certain COVID-19-related costs under Section

Our first installment of deferred social security taxes of $200 million was paid in the fourth quarter of 2021 and the second installment of $200 million was

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3610 of the CARES Act and through our contract provisions, though it is unclear what funds will be available and how much we will be able to recover.

In addition, the DoD has, to date, taken steps to increase the rate for certain progress payments from 80 percent to 90 percent for costs incurred and work performed on relevant contracts;

it is unclear what steps the DoD will continue to take.

paid in the fourth quarter of 2022.

Under Section 3610, the CARES Act also authorized the government to reimburse qualifying contractors for certain costs of providing paid leave to employees as a result of COVID-19.

The company has sought and may continue to seek recovery for certain COVID-19-related costs under Section 3610 of the CARES Act and through our contract provisions, though it is unclear what funds will be available and how much we will be able to recover.

In addition, the DoD has taken steps to increase the rate for certain progress payments from 80 percent to 90 percent for costs incurred and work performed on relevant contracts;

it is unclear how long the 90 percent progress payment rate will remain in place and whether the DoD will take any further steps.

Internal Revenue Code (IRC) Section 174

Beginning in 2022, the Tax Cuts and Jobs Act of 2017 (“TCJA”) eliminated the option to deduct research and development expenditures in the current year and requires taxpayers to amortize them over five years pursuant to IRC Section 174.

Our 2022 cash from operations were reduced by approximately $900 million for federal tax payments we made related to Section 174.

In the future, Congress may consider legislation that would defer the amortization requirement to later years, possibly with retroactive effect.

In the meantime, we expect to continue to make additional federal tax payments based on the current Section 174 tax law.

The impact of Section 174 on our cash from operations depends on the amount of research and development expenditures incurred by the company and whether the IRS issues guidance on the provision which differs from our current interpretation, among other things.

Cash Flow Measures

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

2021 cash provided by operating activities decreased $738 million principally due to federal and state taxes of $785 million paid in connection with the IT services divestiture.

Lower 2021 pension and OPB contributions were largely offset by the impact of CARES Act social security tax deferrals and the 2020 increase in DoD progress payment rates.

2022 cash provided by operating activities decreased $666 million principally due to lower CAS pension recoveries and changes in trade working capital, including approximately $900 million of federal tax payments related to the Section 174 tax legislation described above.

The prior year included $785 million of tax payments related to the IT services divestiture.

Adjusted Free Cash Flow

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This non-GAAP measure may be useful to investors and other users of our financial statements as a supplemental measure of our cash performance, but should not be considered in isolation, as a measure of residual cash flow available for discretionary purposes, or as an alternative to operating cash flows presented in accordance with GAAP.

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The table below reconciles net cash provided by operating activities to adjusted free cash flow:

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Capital expenditures (1,435) (1,415) (1,420) 1 % — %

Proceeds from sale of equipment to a customer 84 205 — (59) % NM

After-tax discretionary pension contributions — 593 95 (100) % 524 %

Proceeds from sale of equipment to a customer 155 84 205 85 % (59) %

After-tax discretionary pension contributions — — 593 NM (100) %

Adjusted free cash flow $ 1,621 $ 2,236 $ 3,683 (28) % (39) %

2021 adjusted free cash flow decreased $1.4 billion, principally due to federal and state taxes of $785 million paid related to the IT services divestiture as well as the impact of CARES Act social security tax deferrals and the 2020 increase in DoD progress payment rates.

NORTHROP GRUMMAN CORPORATION

2022 adjusted free cash flow decreased $615 million principally due to lower net cash provided by operating activities, partially offset by an increase in proceeds from the sale of equipment to a customer.

Investing Cash Flow

2021 net cash provided by investing activities was $2.1 billion compared to net cash used in investing activities of $1.2 billion in the prior year, principally due to $3.4 billion in cash received from the sale of our IT services business during the first quarter of 2021.

2022 net cash used in investing activities was $1.2 billion compared to net cash provided by investing activities of $2.1 billion in the prior year, principally due to $3.4 billion in cash received from the sale of our IT services business during the first quarter of 2021.

Financing Cash Flow

2021 net cash used in financing activities increased $6.6 billion, principally due to an increase of $3.2 billion in share repurchases and $1.2 billion in debt repayments.

2020 net cash used in financing activities included $2.2 billion of net proceeds from the issuance of long-term debt.

2022 net cash used in financing activities decreased $4.4 billion principally due to a $2.2 billion decrease in debt repayments and a $2.2 billion reduction in share repurchases.

CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS

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Factors considered in these estimates include our historical performance, the availability, productivity and cost of labor, the nature and complexity of work to be performed, the effect of change orders, availability and cost of materials, components and subcontracts, the effect of any delays in performance and the level of indirect cost allocations.

We also consider the impact of macroeconomic factors on our estimates, in particular on contract EACs that span several years.

For example, during 2022, we included in our EACs management’s best estimate of the impact inflation has had and may continue to have on our contracts.

We also included our current best estimate of the impact on our EACs of disruptions we have experienced and continue to experience in the supply chain.

The volatility of the recent macroeconomic environment has added complexity to our estimation process and may result in our year end 2022 contract EACs having more variability in the future than they might otherwise have had if the estimates had been prepared in a more stable macroeconomic environment.

NORTHROP GRUMMAN CORPORATION

We generally review and reassess our sales, cost and profit estimates for each significant contract at least annually or more frequently as determined by the occurrence of events, changes in circumstances and evaluations of contract performance to reflect the latest reliable information available.

The company performs on a broad portfolio of long-term contracts, including the development of complex and customized military platforms and systems, as well as advanced electronic equipment and software, that often include technology at the forefront of science.

Cost estimates on fixed-price development contracts are inherently more uncertain as to future events than production contracts, and, as a result, there is typically more variability in those estimates, as well as financial risk associated with unanticipated cost growth.

Cost estimates on fixed-price development contracts and early-stage/low-rate production contracts are inherently more uncertain as to future events than on mature, full-rate production contracts.

As a result, there is typically more variability in those estimates and greater financial risk associated with unanticipated cost growth on fixed-price development contracts and early-stage/low-rate production contracts.

Changes in estimates occur for a variety of reasons, including changes in contract scope, the resolution of risk at lower or higher cost than anticipated, unanticipated performance and other risks affecting contract costs, performance issues with subcontractors or suppliers, changes in indirect cost allocations, such as overhead and G&A costs, and changes in estimated award and incentive fees.

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We perform an annual review of our actuarial assumptions in consultation with our actuaries.

As we determine changes in the

NORTHROP GRUMMAN CORPORATION

assumptions are warranted, or as a result of plan amendments, future pension and OPB expense and our projected benefit obligation could increase or decrease.

As we determine changes in the assumptions are warranted, or as a result of plan amendments, future pension and OPB expense and our projected benefit obligation could increase or decrease.

The principal estimates and assumptions that have a significant effect on our consolidated financial position and annual results of operations are the discount rate, cash balance crediting rate, expected long-term rate of return on plan assets, estimated fair market value of plan assets, and the mortality rate of those covered by our pension and OPB plans.

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2023 pension and OPB (benefit) expense

NORTHROP GRUMMAN CORPORATION

Cash Balance Crediting Rate – A portion of the company’s pension obligation and resulting pension expense is based on a cash balance formula, where participants’ hypothetical account balances are accumulated over time with pay-based credits and interest.

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The minimum cash balance crediting rate allowed under the plan is 2.25 percent.

The cash balance crediting rate assumption has been set to the minimum threshold of 2.25 percent as of December 31, 2021, and will remain at 2.25 percent through 2027.

The cash balance crediting rate assumption has been set to its current level of 3.96 percent as of December 31, 2022, declining to 3.88 percent by 2028.

Holding all other assumptions constant, an increase or decrease of 25 basis points in the December 31, 2022 cash balance crediting rate assumption would have the following estimated effects on the 2022 pension benefit obligation, which would be reflected in the 2022 MTM expense (benefit), and 2023 expected pension expense:

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however, we reduce the EROA for OPB plans to allow for the impact of tax on investment earnings, as certain Voluntary Employee Beneficiary Association trusts are taxable.

During 2021, the Investment Committee of the company’s benefit plans reviewed and approved the plans’ major asset class allocations.

The current asset allocation is approximately 40% public equities, 30% fixed-income, 25%

NORTHROP GRUMMAN CORPORATION

alternatives and 5% cash.

During 2022, the Investment Committee of the company’s benefit plans reviewed the plans’ major asset class allocations and approved an update to increase the target fixed-income asset allocation from 30% to 40%.

The current asset allocation is now approximately 35% fixed-income, 30% public equities, 30% alternatives and 5% cash.

At this time, the Investment Committee is not planning any significant changes to that mix.

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Our average annual rate of return from 1976 to 2022 was approximately 10.7 percent and our 20-year and 30-year rolling average rates of return were approximately 8.6 percent and 8.8 percent, respectively, each determined on an arithmetic basis and net of expenses.

Our 2021 actual net plan asset returns were approximately 10.9 percent.

Our 2022 losses on plan assets, net of expenses, were approximately 15.4 percent.

Consistent with our past practice, we obtained long-term capital market forecasting models from several third parties and, using our target asset allocation, developed an expected rate of return on plan assets from each model.

We considered not only the specific returns projected by those third party models, but also changes in the models year-to-year when developing our EROA.

Despite the change in our target asset allocation described above, these models show a year-over-year increase in the expected rate of return on plan assets largely due to recent increases in interest rates, which more than offset the downward pressure on our EROA caused by the change in asset mix.

For determining 2022 FAS expense, we assumed an expected long-term rate of return on pension plan assets of 7.5 percent and an expected long-term rate of return on OPB plan assets of 7.19 percent.

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2023 pension and OPB expense (benefit)

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In addition, holding all other assumptions constant, an increase or decrease of 100 basis points in actual versus expected return on plan assets would have the following estimated effects on our 2023 MTM expense (benefit):

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In October 2021, the RPEC released a new projection scale (MP-2021) that included additional underlying data for 2019, which included an increase in life expectancies relative to the prior year.

After considering the information released by the RPEC in October 2021 as well as the company’s recent mortality experience in light of the COVID-19 pandemic, we adopted the full MP-2021 projection scale while continuing to use the Pri-2012 White Collar table.

The RPEC did not release a MP-2022 projection scale citing complexities in incorporating the substantial number of “excess deaths” in 2020 into their existing model and uncertainties about future expectations primarily related to COVID-19.

As such, after considering the information released by the RPEC in October 2021 as well as the company’s recent mortality experience in light of the COVID-19 pandemic, we adopted the full MP-2021 projection scale while continuing to use the Pri-2012 White Collar table.

While the amounts and structure of the PRI-2012 base mortality table with the MP-2021 projection scale continues to reflect a reasonable estimate of mortality, we supplemented the table with 50% of the Gradual Wear-Off illustration as outlined in the RPEC’s 2022 Mortality Improvement Update paper to reflect the future impacts of COVID-19.

Accordingly, we updated the mortality assumptions used in calculating our pension and OPB obligations recognized at December 31, 2022, and the amounts estimated for our 2023 pension and OPB expense.

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We determine whether to record a reserve and, if so, what amount based on consideration of the facts and circumstances of each matter as then known to us.

Determinations regarding whether to record a reserve and, if so, of what amount, reflect management’s assessment regarding what is

NORTHROP GRUMMAN CORPORATION

likely to occur;

Determinations regarding whether to record a reserve and, if so, of what amount, reflect management’s assessment regarding what is likely to occur;

they do not necessarily reflect what management believes should occur.

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Portions of the company’s environmental liabilities we do not expect to be recoverable have been expensed.

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Income Tax Matters – The evaluation of tax positions taken in a filed tax return, or planned to be taken in a future tax return or claim, requires the use of judgment.

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The company follows a recognition and measurement approach, considering the facts, circumstances, and information available at the reporting date.

Judgment is exercised by the company in determining the level of evidence necessary and appropriate to support its assessment using all available information.

We exercise judgment in determining the level of evidence necessary and appropriate to support our assessment using all available information.

The technical merits of a given tax position are derived from sources of authority in the tax law and their applicability to the facts and circumstances of the position.

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To the extent we prevail in matters for which reserves have been established or are required to pay amounts in excess of reserves, there could be a significant impact on our consolidated financial position and annual results of operations.

Our 2021 increase in unrecognized tax benefits of $149 million was primarily related to our methods of accounting associated with the timing of revenue recognition and related costs and the 2017 Tax Cuts and Jobs Act, which includes related final revenue recognition regulations issued in December 2020 under IRC Section 451(b) and procedural guidance issued in August 2021.

For further information on litigation, commitments and contingencies, see “Risk Factors” and Note 1, Note 7, Note 11 and Note 12 to the consolidated financial statements.

Goodwill and Other Purchased Intangible Assets

Goodwill and Long-Lived Assets

Overview – We allocate the purchase price of acquired businesses to the underlying tangible and intangible assets acquired and liabilities assumed based upon their respective fair values, with the excess recorded as goodwill.

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In some cases, we use discounted cash flow analyses, which are based on estimates of future sales, earnings and cash flows after considering such factors as general market conditions, customer budgets, existing firm and future orders, changes in working capital, long term business plans and recent operating performance.

We record property, plant and equipment (PP&E) for capital assets used in operating our business.

Depreciation expense associated with our PP&E is generally an allowable and allocable cost in accordance with applicable FAR and CAS requirements.

However, depreciation expense associated with PP&E used in our commercial businesses, as well as the additional depreciation expense related to the step-up in fair value of PP&E acquired through business combinations, is not allocable to government contracts and is therefore subject to greater recoverability risk than the PP&E for which depreciation expense is recovered through our U.S.

government contracts.

Impairment Testing – We test for impairment of goodwill annually at each of our reporting units, which comprise our operating segments.

The results of our annual goodwill impairment tests as of December 31, 2021 and 2020, respectively, indicated that the estimated fair value of each reporting unit exceeded its respective carrying value.

The results of our annual goodwill impairment tests as of December 31, 2022 and 2021, respectively, indicated that the estimated fair value of each reporting unit significantly exceeded its respective carrying value.

There were no impairment charges recorded in the years ended December 31, 2022, 2021 and 2020.

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In addition to performing an annual goodwill impairment test, we may perform an interim impairment test if events occur or circumstances change that suggest goodwill in any of our reporting units may be impaired.

Such indicators may include, but are not limited to, the loss of significant business, significant reductions in federal government appropriations or other significant adverse changes in industry or market conditions.

During 2021, we considered COVID-19-related impacts on our business and determined there were no impairment indicators requiring us to perform an interim goodwill impairment test.

During 2022, we determined there were no impairment indicators requiring us to perform an interim goodwill impairment test.

When testing goodwill for impairment, we compare the fair values of each of our reporting units to their respective carrying values.

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The terminal value assumptions are applied to the final year of the discounted cash flow model.

We use industry multiples (including relevant control premiums) of operating earnings to corroborate the fair values of our reporting units determined under the market valuation method of the income approach.

We test for impairment of our purchased intangible assets when events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable.

We use industry multiples (including relevant control premiums) of operating earnings to

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corroborate the fair values of our reporting units determined under the market valuation method of the income approach.

We test for impairment of our long-lived assets, including PP&E and purchased intangible assets, when events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable.

Our assessment is based on our projection of the undiscounted future operating cash flows of the related asset group.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis