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Item 7. Management’s Discussion and Analysis

2024-01-25 compared with 2023-01-26 · 213 added, 237 removed, 395 unchanged (53% of the section changed)

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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;

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

We continue to not anticipate significant adverse financial impacts directly from the ongoing conflict.

We have experienced, and, while difficult to predict, may continue to experience a modest increase in demand for certain of our goods and services directly and indirectly related to the conflict in Ukraine, either through direct sales or if the U.S.

provides increased military assistance and support to Ukraine.

More recently, the hostilities in Israel and the Gaza Strip have further heightened global tensions and instability.

At this time, it is unknown whether hostilities in this region will escalate into an even larger conflict.

The demand for our goods and services may increase, especially if the U.S.

provides increased military assistance and support to Israel.

We do not have a significant business presence in the region, and therefore do not anticipate significant adverse financial impacts directly from the current conflict.

More broadly, the ongoing conflicts in Ukraine and Israel and threats elsewhere, particularly in the Pacific region, have heightened tensions and highlighted security requirements globally, including Europe, the Middle East and the Pacific region, as well as the U.S.

These conflicts may result in increased demand for defense products and services from allies and partner nations, particularly in those areas.

We are actively exploring both opportunities and risks associated with the broader global security environment.

We believe the current global security environment highlights the significant national security threats to the U.S.

and its allies, and the need for strong deterrence and a robust defense capability.

We believe our capabilities, particularly in space, C4ISR, missile defense, battle management, advanced weapons, and 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.

Global Economic Enviro nment

The global economic environment has experienced 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);

business slowdowns or shutdowns;

workforce challenges and labor shortfalls;

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.

Some of these challenges were due, in part, to the global health emergency caused by COVID-19, which the World Health organization declared ended in May 2023.

Direct impacts of COVID-19 on our business during 2023 were limited, and we are not currently expecting significant direct impacts on our business going forward.

The macroeconomic factors have contributed, and we expect will continue to contribute, to increased costs, delays, disruptions and other performance challenges, as well as increased competing demands for limited resources to address such increased costs and other challenges, for our company, our suppliers and partners, and our customers.

We continue to work hard to mitigate 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, 2023.

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.

We cannot clearly predict how long these macroeconomic challenges will continue, 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 and suppliers, our industry and our company in 2024.

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

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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.

continues to face an uncertain and evolving political, budget and regulatory environment.

In particular, it is difficult to predict the specific course of future defense budgets.

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

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

political environment, including the U.S.

election cycle, may also impact defense budgets and priorities, issues related to the national debt, and government spending more broadly.

We anticipate that issues related to budgetary priorities and defense spending levels, the debt ceiling, and the spending caps imposed by the Fiscal Responsibility Act of 2023 (FRA), particularly with respect to discretionary spending, will continue to be a subject of considerable debate, with a potentially significant impact on our programs and the company.

Annual appropriations to fund the federal government for FY 2024 have not been enacted.

Congress continues to pass short-term continuing resolutions (CR) to fund the federal government.

The most recent “laddered” CR passed in January 2024 funds the government through March 2024, depending on the appropriation bill.

If Congress does not pass full year appropriations or an additional CR before current funding expires, the federal government (or select departments) could face a shutdown and cease what are characterized as certain non-essential operations.

Depending on the nature and duration of a potential shutdown, businesses that rely on government funding, including defense contractors, could be significantly impacted.

If the federal government remains under a CR at the end of April 2024, the one percent discretionary spending cuts under the FRA could be triggered, potentially resulting in lower funding on the programs in which we participate.

In December 2023, the president signed the National Defense Authorization Act (NDAA) for FY 2024 which supports approximately $886 billion in FY 2024 funding for national defense, $842 billion of which is for the DoD.

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 conflicts and heightened global tensions, 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.”

We anticipate that the broader macroeconomic environment, with ongoing inflationary pressures, pockets of 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 global security and economic environment and U.S.

political, budget and regulatory environment, including the risks related thereto, see “Liquidity and Capital Resources,” “Quantitative and Qualitative Disclosures About Market Risks” and “Risks Factors” included in this Form 10-K.

Ground-Based Strategic Deterrent (“GBSD” or “Sentinel”) Program Nunn-McCurdy Breach Review

Due in part to the impact of macroeconomic factors, in January 2024 the customer provided congressional notification that the Sentinel program is currently under a Nunn-McCurdy breach review, which is required when total program cost estimates exceed certain defined thresholds.

This notification, which has been driven primarily by increases in construction and procurement cost projections for the Production and Deployment phases, commences the process to achieve recertification for continuance of the program and update its baseline cost estimates.

We are currently executing under a cost-type contract for the Engineering and Manufacturing Development phase, and the Production and Deployment phases are yet to be priced and negotiated.

We are continuing to partner with our customer to address this critical mission.

For more information, see “Risk Factors”.

Disposition of IT and Mission Support Services Business

Effective January 30, 2021 (the “Divestiture date”), we completed the sale of our IT and mission support services business (the “IT services divestiture”) for $3.4 billion in cash and recorded a pre-tax gain of $2.0 billion.

The IT and mission support services business was comprised of the majority of the former IS&S division of Defense Systems (excluding the Vinnell Arabia business);

select cyber, intelligence and missions support programs, which were part of the former CIMS division of Mission Systems;

The IT and mission support services business was comprised of the majority of the former Information Solutions and Services (IS&S) division of Defense Systems (excluding the Vinnell Arabia business);

select cyber, intelligence and missions support programs, which were part of the former Cyber and Intelligence Mission Solutions (CIMS) division of Mission Systems;

and the former Space Technical Services business unit of Space Systems.

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

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

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therefore, no sales and operating income were recognized for this business during the years ended December 31, 2023 and 2022.

The company recorded sales of $162 million and pre-tax profit of $20 million for the IT and mission support services business during the year ended December 31, 2021.

Operating Performance Assessment and Reporting

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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

For purposes of the operating results discussion below, we assess our performance using certain financial measures that are not calculated in accordance with accounting principles generally accepted in the United States of America (“GAAP” or “FAS”).

Organic sales is defined as total sales excluding sales attributable to the company's IT services divestiture.

This measure may be useful to investors and other users of our financial statements as a supplemental measure in evaluating the company’s underlying sales growth as well as in providing an understanding of our ongoing business and future sales trends by presenting the company’s sales before the impact of divestiture activity.

Transaction-adjusted net earnings and transaction-adjusted earnings per share (transaction-adjusted EPS) exclude impacts related to the IT services divestiture, including the gain on sale of the business, associated federal and state income tax expenses, transaction costs, and the make-whole premium for early debt redemption.

They also exclude the impact of mark-to-market pension and OPB (“MTM”) benefit/(expense) and related tax impacts, which are generally only recognized during the fourth quarter.

These non-GAAP measures may be useful to investors and other users of our financial statements as supplemental measures in evaluating the company’s underlying financial performance by presenting the company’s operating results before the non-operational impact of divestiture activity and pension and OPB actuarial gains and losses.

These measures are also consistent with how management views the underlying performance of the business as the impact of the IT services divestiture and MTM accounting are not considered in management’s assessment of the company’s operating performance or in its determination of incentive compensation awards.

Mark-to-market adjusted net earnings (MTM-adjusted net earnings) and MTM-adjusted earnings per share (MTM-adjusted EPS) exclude MTM pension and OPB (expense)/benefit and related tax impacts, which are generally only recognized during the fourth quarter.

Transaction-adjusted net earnings and transaction-adjusted earnings per share (transaction-adjusted EPS) exclude the MTM impacts noted above, as well as impacts related to the IT services divestiture, including the gain on sale of the business, associated federal and state income tax expenses, transaction costs, and the make-whole premium for early debt redemption.

These non-GAAP measures may be useful to investors and other users of our financial statements as supplemental measures in evaluating the company’s underlying financial performance by presenting the company’s operating results before the non-operational impact of pension and OPB actuarial gains and losses, and with regard to transaction-adjusted net earnings and EPS, the impact of certain divestiture activity.

These measures are also consistent with how management views the underlying performance of the business as the impact of MTM accounting and the IT services divestiture are not considered in management’s assessment of the company’s operating performance or in its determination of incentive compensation awards.

We reconcile these non-GAAP financial measures to their most directly comparable GAAP financial measures below.

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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Operating costs and expenses as a % of sales 93.5 % 90.2 % 89.7 %

Gain on sale of business — 1,980 — NM NM

Gain on sale of business — — 1,980 — % NM

Operating income 2,537 3,601 5,651 (30) % (36) %

Operating margin rate 6.5 % 9.8 % 15.8 %

Mark-to-market pension and OPB benefit (expense) 1,232 2,355 (1,034) (48) % (328) %

Mark-to-market pension and OPB (expense) benefit (422) 1,232 2,355 NM (48) %

Federal and foreign income tax expense 290 940 1,933 (69) % (51) %

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Diluted earnings per share $ 13.53 $ 31.47 $ 43.54 (57) % (28) %

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The tables below reconcile sales to organic sales:

Year Ended December 31

$ in millions Sales IT services sales Organic

sales Sales IT services sales Organic

sales Organic sales % change

Aeronautics Systems $ 10,531 $ — $ 10,531 $ 11,259 $ — $ 11,259 (6) %

Defense Systems 5,579 — 5,579 5,776 (106) 5,670 (2) %

Mission Systems 10,396 — 10,396 10,134 (42) 10,092 3 %

Space Systems 12,275 — 12,275 10,608 (16) 10,592 16 %

Intersegment eliminations (2,179) — (2,179) (2,110) 2 (2,108)

Total $ 36,602 $ — $ 36,602 $ 35,667 $ (162) $ 35,505 3 %

Year Ended December 31

$ in millions Sales IT services sales Organic

sales Sales IT services sales Organic

sales Organic sales % change

Aeronautics Systems $ 11,259 $ — $ 11,259 $ 12,169 $ — $ 12,169 (7) %

Defense Systems 5,776 (106) 5,670 7,543 (1,637) 5,906 (4) %

Mission Systems 10,134 (42) 10,092 10,080 (527) 9,553 6 %

Space Systems 10,608 (16) 10,592 8,744 (182) 8,562 24 %

Intersegment eliminations (2,110) 2 (2,108) (1,737) 17 (1,720)

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

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.

2023 sales increased $2.7 billion, or 7 percent, due to higher sales at all four sectors.

2023 sales reflect continued strong demand for our products and services.

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

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Operating Income and Margin Rate

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.

2023 operating income decreased $1.1 billion, or 30 percent, primarily due to a $1.56 billion charge on the B-21 program at Aeronautics Systems, partially offset by higher operating income at Space Systems and Defense Systems.

The B-21 charge relates to the low-rate initial production (LRIP) phase of the program and is due principally to a change in our assumptions regarding funding to mitigate the impact of macroeconomic disruptions on the program and higher projected manufacturing costs that reflect recent supplier negotiations and our experience in completing the first aircraft.

The decrease was also offset by $311 million of lower unallocated corporate expense, largely due to higher deferred state tax benefits associated with the MTM adjustment and B-21 charge and lower intangible asset amortization and PP&E step-up depreciation, as well as a $118 million reduction in the FAS/CAS operating adjustment.

2023 operating margin rate declined to 6.5 percent from 9.8 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.

2023 G&A costs as a percentage of sales decreased to 10.2 percent from 10.6 percent, primarily due to higher sales, which more than offset our continued 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

The primary components of pre-tax MTM benefit (expense) are presented in the table below:

The primary components of pre-tax MTM (expense) benefit are presented in the table below:

Year Ended December 31

$ in millions 2023 2022 2021

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

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

MTM benefit (expense)

Actuarial (losses) gains on projected benefit obligation $ (1,489) $ 9,662 $ 1,163

Actuarial gains (losses) on plan assets 1,067 (8,430) 1,192

MTM (expense) benefit

$ (422) $ 1,232 $ 2,355

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.

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The 2023 MTM expense of $422 million was primarily driven by a 39 basis point decrease in the discount rate from year end 2022, partially offset by actual net plan asset returns of 11.1 percent compared to our 7.5 percent asset return assumption.

Federal and Foreign Income Taxes

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.

The 2023 effective tax rate (ETR) decreased to 12.4 percent from 16.1 percent in 2022 primarily due to lower earnings before income taxes as a result of the B-21 charge and MTM expense, which collectively reduced the 2023 ETR by 3.8 percentage points.

The 2022 MTM benefit increased the 2022 ETR by 1.2 percentage points.

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

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

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

Year Ended December 31 % Change in

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Net earnings $ 2,056 $ 4,896 $ 7,005 (58) % (30) %

MTM (benefit) expense (1,232) (2,355) 1,034 (48) % (328) %

MTM-related deferred state tax expense (benefit) (1)

65 124 (54) (48) % (330) %

Federal tax expense (benefit) of items above (2)

245 469 (206) (48) % (328) %

MTM adjustment, net of tax (922) (1,762) 774 (48) % (328) %

MTM expense (benefit)

422 (1,232) (2,355) NM (48) %

MTM-related deferred state tax (benefit) expense (1)

(22) 65 124 NM (48) %

Federal tax (benefit) expense of items above (2)

(84) 245 469 NM (48) %

MTM adjustment, net of tax 316 (922) (1,762) NM (48) %

MTM-adjusted net earnings 2,372 3,974 5,243 (40) % (24) %

Gain on sale of business — — (1,980) NM NM

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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.

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.

2023 net earnings decreased $2.8 billion, or 58 percent, principally due to a $1.7 billion decrease in our MTM (expense) benefit, a $975 million reduction in the non-operating FAS pension benefit and the $1.1 billion decrease in operating income described above, partially offset by a $650 million decrease in income tax expense, a $107 million increase in returns on marketable securities related to our non-qualified benefit plans, and a $97 million gain recognized upon the sale of our minority investment in an Australian business.

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Diluted Earnings Per Share

The table below reconciles diluted earnings per share to transaction-adjusted EPS:

The table below reconciles diluted earnings per share to MTM-adjusted EPS and transaction-adjusted EPS:

Year Ended December 31 % Change in

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Diluted earnings per share $ 13.53 $ 31.47 $ 43.54 (57) % (28) %

MTM (benefit) expense per share (7.92) (14.64) 6.17 (46) % (337) %

MTM-related deferred state tax expense (benefit) per share (1)

0.42 0.77 (0.32) (45) % (341) %

Federal tax expense (benefit) of items above per share (2)

1.57 2.92 (1.23) (46) % (337) %

MTM expense (benefit) per share

2.78 (7.92) (14.64) NM (46) %

MTM-related deferred state tax (benefit) expense per share (1)

(0.14) 0.42 0.77 NM (45) %

Federal tax (benefit) expense of items above per share (2)

(0.56) 1.57 2.92 NM (46) %

MTM adjustment per share, net of tax

2.08 (5.93) (10.95) NM (46) %

MTM-adjusted EPS

15.61 25.54 32.59 (39) % (22) %

Gain on sale of business per share — — (12.31) NM NM

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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.

2023 diluted earnings per share decreased $17.94, or 57 percent, reflecting the 58 percent decrease in net earnings described above and a 2 percent decrease in weighted-average diluted shares outstanding.

SEGMENT OPERATING RESULTS

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For a more complete description of each segment’s products and services, see “Business.”

We present our sectors in the following business areas, which are reported in a manner reflecting core capabilities:

Aeronautics Systems Defense Systems Mission Systems Space Systems

Autonomous Systems Battle Management & Missile Systems Airborne Multifunction Sensors Launch & Strategic Missiles

Manned Aircraft Mission Readiness Maritime/Land Systems & Sensors Space

Navigation, Targeting & Survivability

Networked Information Solutions

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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These non-GAAP measures may be useful to investors and other users of our financial statements as supplemental measures in evaluating the financial performance and operational trends of our sectors.

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

These measures may not be

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defined and calculated by other companies in the same manner and should not be considered in isolation or as alternatives to operating results presented in accordance with GAAP.

Year Ended December 31 % Change in

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FAS/CAS operating adjustment 82 200 (130) (59) % (254) %

Gain on sale of business — (1,980) — NM NM

IT services divestiture – unallowable state taxes and transaction costs — 192 — NM NM

Gain on sale of business — — (1,980) — % NM

IT services divestiture – unallowable state taxes and transaction costs — — 192 — % NM

Intangible asset amortization and PP&E step-up depreciation 122 242 254 (50) % (5) %

MTM-related deferred state tax expense (benefit) (1)

Deferred state tax (benefit) expense (1) of MTM adjustment

(22) 65 124 (134) % (48) %

Deferred state tax benefit of B-21 charge (1)

(82) — — NM NM

Other unallocated corporate expense 123 145 106 (15) % 37 %

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Segment operating margin rate 7.0 % 11.6 % 11.8 %

(1) Represents the deferred state tax benefit associated with MTM benefit (expense), which is recorded in Unallocated corporate expense consistent with other changes in deferred state taxes.

(1) Represents the deferred state tax (benefits) expenses associated with MTM (expense) benefit and the B-21 charge, which are recorded in Unallocated corporate expense (income) consistent with other changes in deferred state taxes.

Segment Operating Income and Margin Rate

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.

2023 segment operating income decreased $1.5 billion, or 35 percent, and segment operating margin rate decreased to 7.0 percent primarily due to the B-21 charge at Aeronautics Systems.

Operating income at Space Systems and Defense Systems was higher than in the prior year period.

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.

The decrease in our 2023 FAS/CAS operating adjustment is primarily due to lower FAS pension service expense resulting from changes in certain actuarial assumptions as of December 31, 2022.

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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The decrease in 2023 unallocated corporate expense is primarily due to higher deferred state tax benefits associated with the MTM adjustment and B-21 charge and lower intangible asset amortization and PP&E step-up depreciation.

Net Estimate-At-Completion (EAC) Adjustments - We record changes in estimated contract earnings at completion (net EAC adjustments) using the cumulative catch-up method of accounting.

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Net EAC adjustments $ 84 $ 360 $ 527

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Net EAC adjustments by segment are presented in the table below:

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Net EAC adjustments $ 84 $ 360 $ 527

For purposes of the discussion in the remainder of this Segment Operating Results section, references to operating income and operating margin rate reflect segment operating income and segment operating margin rate, respectively.

AERONAUTICS SYSTEMS

Aeronautics Systems is a leader in the design, development, production, integration, sustainment and modernization of military aircraft systems for the U.S.

Air Force, the U.S.

Navy, other U.S.

government agencies, and international customers.

Major products include strategic long-range strike aircraft;

tactical fighter and air dominance aircraft;

airborne battle management and command and control systems;

and unmanned autonomous aircraft systems, including high-altitude long-endurance (HALE) strategic intelligence, surveillance and reconnaissance (ISR) systems and vertical take-off and landing (VTOL) tactical ISR systems.

Year Ended December 31 % Change in

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Sales $ 10,786 $ 10,531 $ 11,259 2 % (6) %

Operating income 1,116 1,093 1,206 2 % (9) %

Operating (loss) income

(473) 1,116 1,093 NM 2 %

Operating margin rate (4.4) % 10.6 % 9.7 %

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.

2023 sales increased $255 million, or 2 percent, primarily due to higher volume on restricted programs, partially offset by a $191 million decrease on the F/A-18 program largely due to post Multi-Year Procurement 4 (MYP4) contract award timing, a $131 million decrease on the Joint Surveillance and Target Attack Radar System (JSTARS) program as that program nears completion and a decrease on the E-2 program largely related to higher material volume in the prior year.

Operating Income

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.

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2023 operating income decreased $1.6 billion and operating margin rate decreased to (4.4) percent primarily due to the previously described $1.56 billion charge recorded on the LRIP phase of the B-21 program, inclusive of a $143 million unfavorable EAC adjustment for the first LRIP lot.

The prior year period includes $133 million of favorable EAC adjustments on the engineering, manufacturing and development phase of the B-21 program and a $38 million gain on a property sale.

Apart from the B-21 EAC adjustments noted above, net EAC adjustments across the sector were $58 million higher than in the prior year.

DEFENSE SYSTEMS

Defense Systems is a leader in the design, development, integration and production of advanced tactical weapons and missile defense solutions, and a provider of sustainment, modernization and training services for manned and unmanned aircraft and electronics systems for the U.S.

military and a broad range of international customers.

Major products and services include integrated, all-domain command and control (C2) battle management systems, precision strike weapons;

advanced propulsion, including high speed air-breathing and hypersonic systems;

high-performance gun systems, ammunition, precision munitions and advanced fuzes;

aircraft and mission systems logistics support, sustainment, operations and modernization;

and warfighter training.

Year Ended December 31 % Change in

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Operating margin rate 12.1 % 11.9 % 12.0 %

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.

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2023 sales increased $283 million, or 5 percent, primarily due to higher volume on several programs, including ammunition programs, Guided Multiple Launch Rocket System (GMLRS), an international training program, Hypersonic Attack Cruise Missile (HACM), and Stand-in Attack Weapon (SiAW).

Operating Income

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.

2023 operating income increased $46 million, or 7 percent, due to higher sales and a higher operating margin rate.

Operating margin rate increased to 12.1 percent from 11.9 percent primarily due to the write-down of an unconsolidated joint venture investment in the prior year.

MISSION SYSTEMS

Mission Systems is a leader in advanced mission solutions and multifunction systems, primarily for the U.S.

defense and intelligence community, and international customers.

Major products and services include command, control, communications and computers, intelligence, surveillance and reconnaissance (C4ISR) systems;

radar, electro-optical/infrared (EO/IR) and acoustic sensors;

electronic warfare systems;

advanced communications and network systems;

full spectrum cyber solutions;

intelligence processing systems;

advanced microelectronics;

navigation and positioning sensors;

and maritime power, propulsion and payload launch systems.

Year Ended December 31 % Change in

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Operating margin rate 14.8 % 15.6 % 15.6 %

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.

2023 sales increased $499 million, or 5 percent, primarily due to higher restricted sales on advanced microelectronics programs, as well as a $165 million increase on marine systems programs.

These increases were partially offset by a $107 million decrease on the Ground/Air Task Oriented Radar (G/ATOR) program largely driven by the timing of material receipts and full-rate production (FRP) 5 contract award, as well as lower volume on airborne radar programs.

Operating Income

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.

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2023 operating income decreased $9 million, or 1 percent, due to a lower operating margin rate, which more than offset higher sales.

Operating margin rate decreased to 14.8 percent from 15.6 percent primarily due to a prior year $33 million benefit recognized in connection with a contract-related legal matter, as well as changes in contract mix toward more cost-type content.

SPACE SYSTEMS

Space Systems is a leader in delivering end-to-end mission solutions through the design, development, integration, production and operation of space, missile defense, launch and strategic missile systems for national security, civil government, commercial and international customers.

Major products include satellites and spacecraft systems, subsystems, sensors and payloads;

ground systems;

missile defense systems and interceptors;

launch vehicles and related propulsion systems;

and strategic missiles.

Year Ended December 31 % Change in

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Operating margin rate 8.7 % 9.4 % 10.6 %

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.

2023 sales increased $1.7 billion, or 14 percent, primarily due to higher volume on restricted programs and ramp-up on development programs, including increases of $426 million on the Ground Based Strategic Deterrent (GBSD) program, $333 million on the Next-Generation Overhead Persistent Infrared Polar (NextGen Polar) program, $219 million on the Next Generation Interceptor (NGI) program, $119 million on the Space Development Agency (SDA) Tranche 1 Tracking Layer program and $102 million on the SDA Tranche 2 Transport Layer program.

These increases were partially offset by a $172 million decrease for Commercial Resupply Services (CRS) missions and a $109 million decrease on the Habitation and Logistics Outpost (HALO) program.

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Operating Income

2023 operating income increased $54 million, or 5 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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Operating margin rate decreased to 8.7 percent from 9.4 percent primarily due to a prior year $96 million gain recognized in connection with a land exchange transaction, as well as lower net EAC adjustments driven by $100 million of unfavorable EAC adjustments on the HALO program in 2023.

These decreases were partially offset by a $42 million benefit from insurance recoveries in our commercial space business during 2023.

PRODUCT AND SERVICE ANALYSIS

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Total Space Systems 13,946 12,734 12,275 11,117 10,608 9,487

Segment Totals

Total Product $ 30,897 $ 29,293 $ 28,522 $ 25,292 $ 27,868 $ 24,692

Total Service 8,393 7,237 8,080 7,057 7,799 6,758

Total Segment (1)

Total Company

$ 39,290 $ 36,530 $ 36,602 $ 32,349 $ 35,667 $ 31,450

(1) A reconciliation of segment operating income to total operating income is included in “Segment Operating Results.”

Product Sales and Costs

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.

2023 product sales increased $2.4 billion, or 8 percent, due to an increase in product sales at all four sectors.

The increase was principally driven by higher volume on restricted programs, GBSD and NGI at Space Systems, higher restricted sales at Mission Systems and Aeronautics Systems, and higher volume on ammunition programs, GMLRS, IBCS and HACM at Defense Systems.

2023 product costs increased $4.0 billion, or 16 percent, consistent with the higher product sales described above and reflect a lower operating margin rate principally due to the previously described $1.56 billion charge on the B-21 program at Aeronautics Systems and lower net EAC adjustments on Space Systems production programs.

Service Sales and Costs

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.

2023 service sales increased $313 million, or 4 percent, due to an increase in service sales at all four sectors.

The increase was principally driven by higher restricted sales at Space Systems and Aeronautics Systems, higher volume on restricted programs and F-35 sustainment at Mission Systems, and higher volume on an international training program at Defense Systems.

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2023 service costs increased $180 million, or 3 percent, consistent with the higher service sales described above and reflects a higher operating margin rate on Space Systems service programs.

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.

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2023 net awards totaled $44.8 billion.

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).

Significant 2023 new awards include $15.5 billion for restricted programs (primarily at Space Systems, Aeronautics Systems and Mission Systems), $2.1 billion for F-35 programs (primarily at Aeronautics Systems and Mission Systems), $1.7 billion for E-2, $1.5 billion for Triton, $1.4 billion for SDA Tranche 2 Transport Layer, and $0.8 billion for GMLRS.

Subsequent Event – In January 2024, the company received a termination for convenience in our restricted Space business.

The company expects to reduce backlog by approximately $2 billion during the first quarter of 2024 related to the termination.

LIQUIDITY AND CAPITAL RESOURCES

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At December 31, 2023, there were no borrowings outstanding under these credit facilities.

In February 2023, we issued $2.0 billion of unsecured senior notes for general corporate purposes, including debt repayment, share repurchases and working capital.

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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At this time, we are unable to estimate the timing and amount of any future cash outflows related to these uncertain tax positions.

Refer to the respective notes to the consolidated financial statements for further information about our share repurchase programs (Note 3), commercial paper, credit facilities and long-term debt (Note 10), standby letters of credit and guarantees (Note 12), future minimum contributions for the company’s pension and OPB plans (Note 13), and lease payment obligations (Note 15).

COVID-19 and the CARES Act

The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) established a program with provisions to allow U.S.

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 was

NORTHROP GRUMMAN CORPORATION

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.

credit and guarantees (Note 12), future minimum contributions for the company’s pension and OPB plans (Note 13), and lease payment obligations (Note 15).

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.

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

As we finalized our 2022 federal tax return along with our continued analysis of research and development expenditures, we reduced the previously estimated impact of Section 174 on our tax liability for 2022 and 2023 to approximately $700 million and $500 million, respectively.

Congress is considering 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.

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Operating Cash Flow

The table below summarizes key components of cash flow provided by operating activities:

The table below summarizes key components of cash provided by operating activities:

Year Ended December 31

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Gain on sale of business — — (1,980)

B-21 charge 1,559 — —

Non-cash items (1)

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Net cash provided by operating activities $ 3,875 $ 2,901 $ 3,567

(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.

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.

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

2023 cash provided by operating activities increased $974 million, or 34 percent, principally due to improved trade working capital largely driven by increased billings and cash collections, partially offset by higher supplier payments.

Adjusted Free Cash Flow

Adjusted free cash flow, as reconciled in the table below, is a non-GAAP measure defined as net cash provided by or used in operating activities, less capital expenditures, plus proceeds from the sale of equipment to a customer (not otherwise included in net cash provided by or used in operating activities) and the after-tax impact of discretionary pension contributions.

Adjusted free cash flow includes proceeds from the sale of equipment to a customer as such proceeds were generated in a customer sales transaction.

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Proceeds from sale of equipment to a customer — 155 84 (100) % 85 %

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

Adjusted free cash flow $ 2,100 $ 1,621 $ 2,236 30 % (28) %

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.

2023 adjusted free cash flow increased $479 million, or 30 percent, principally due to higher net cash provided by operating activities, partially offset by an increase in capital expenditures.

Investing Cash Flow

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.

2023 net cash used in investing activities increased $341 million principally due to higher capital expenditures.

Proceeds from the sale of minority investments in 2023 were largely offset by cash received in 2022 from the sale of equipment to a customer.

Financing Cash Flow

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

2023 net cash used in financing activities decreased $852 million principally due to the issuance of $2.0 billion in long-term debt, partially offset by $1.05 billion in debt repayments.

Cash returned to shareholders through share repurchases and dividends totaled $2.6 billion in each period.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our consolidated financial statements are prepared in conformity with GAAP, which requires us to make estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements.

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Due to the long-term nature of our contracts, we generally recognize revenue over time using the cost-to-cost method, which requires us to make reasonably dependable estimates regarding the revenue and cost associated with the design, manufacture and delivery of our products and services.

Contract sales may include estimates of variable consideration, including cost or performance incentives (such as award and incentive fees), contract claims and requests for equitable adjustment (REAs).

Contract sales may include estimates of variable consideration, including cost or performance incentives (such as award and incentive fees), un-priced change orders, REAs and contract claims.

Variable consideration is included in total estimated sales to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.

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We prepare EACs for our contracts and calculate an estimated contract profit based on total estimated contract sales and cost.

Since our contracts typically span a period of several years, estimation of revenue, cost, and progress toward completion requires the use of judgment.

Since our contracts often span a period of several years, estimation of revenue, cost, and progress toward completion requires the use of judgment.

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.

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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.

These assessments require judgments and estimates that can be affected by any number of these factors over time, which may cause actual results to differ materially from those estimates as facts and circumstances change or become known to us.

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.

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

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.

When 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 materially.

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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Interest is credited monthly using the current 30-Year Treasury bond rate.

The interest crediting rate is part of the cash balance formula and independent of actual pension investment earnings.

The interest crediting rate is part of the cash balance formula and independent of actual pension investment returns.

The cash balance crediting rate used for FAS purposes tends to move in concert with the discount rate but has an offsetting effect on pension benefit obligations and the related MTM expense (benefit).

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

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.

The cash balance crediting rate assumption has been set to 4.02 percent for all years.

Holding all other assumptions constant, an increase or decrease of 25 basis points in the December 31, 2023 cash balance crediting rate assumption would have the following estimated effects on the 2023 pension benefit obligation, which would be reflected in the 2023 MTM expense (benefit), and 2024 expected pension expense:

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2023 pension obligation and MTM expense (benefit)

$ (105) $ 108

2024 pension (benefit) expense

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EROA is a long-term assumption, which we review annually and adjust to reflect changes in our long-term view of expected market returns and/or significant changes in our plan asset investment policy.

Due to the inherent uncertainty of this assumption, we consider multiple data points at the measurement date including the plan’s target asset allocation, historical asset returns and third party projection models of expected long-term returns for each of the plans’ strategic asset classes.

Due to the inherent uncertainty of this assumption, we consider multiple data points at the measurement date including the plan’s target asset allocation, historical plan asset returns and third party projection models of expected long-term returns for each of the plans’ strategic asset classes.

In addition to the data points themselves, we consider trends in the data points, including changes from the prior measurement date.

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Our average annual rate of return from 1976 to 2023 was approximately 10.7 percent and our 20-year and 30-year rolling average rates of return were approximately 7.9 percent and 8.7 percent, respectively, each determined on an arithmetic basis and net of expenses.

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

Our 2023 return on plan assets, net of expenses, were approximately 11.1 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 2023 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 7.23 percent.

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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.

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.

The RPEC did not release a MP-2022 or MP-2023 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, we adopted the full MP-2021 projection scale while continuing to use the Pri-2012 White Collar table, supplemented 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, to develop our mortality assumptions used in calculating our pension and OPB obligations recognized at December 31, 2023, and the amounts estimated for our 2024 pension and OPB expense.

For further information regarding our pension and OPB plans, see “Risk Factors” and Notes 1 and 13 to the consolidated financial statements.

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

As of December 31, 2023, we expect approximately 90 percent of the company’s environmental remediation costs to be recoverable;

however, to the extent our judgments on the recoverability of our environmental remediation costs change or the unallowable portion of our environmental

NORTHROP GRUMMAN CORPORATION

remediation costs otherwise increase, there could be a significant impact on our consolidated financial position, annual results of operations and/or cash flows.

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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When it is more likely than not that a tax position will be sustained, we record the largest amount of tax benefit with a greater than 50 percent likelihood of being realized upon ultimate settlement with a taxing authority.

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.

As of December 31, 2023, we have approximately $2.0 billion in unrecognized tax benefits.

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.

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Adjustments to the fair value of purchased assets and liabilities after the initial measurement period are recognized in net earnings.

We recognize purchased intangible assets in connection with our business acquisitions at fair value on the acquisition date.

The most significant purchased intangible assets recognized from our acquisitions are generally customer-related intangible assets, including customer contracts and commercial customer relationships.

We determine the fair value of those customer-related intangible assets based on estimates and judgments, including the amount and timing of expected future cash flows, long-term growth rates and discount rates.

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.

The cost of PP&E utilized in support of our government contracts is generally allowable and allocable cost in accordance with applicable FAR and CAS requirements, which limits our risk of impairment on those assets.

However, the cost of PP&E utilized in support of our commercial business, including approximately $500 million of PP&E used in our commercial space business, is not allocable to government contracts and is therefore subject to greater recoverability risk.

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

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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

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 long-lived 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

NORTHROP GRUMMAN CORPORATION

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.

operating cash flows of the related asset group.

If such projections indicate that future undiscounted cash flows are not sufficient to recover the carrying amount, we recognize a non-cash impairment charge to reduce the carrying amount to fair value.

1 unchanged sentence

Impairment assessment inherently involves management judgments as to assumptions about expected future cash flows and the impact of market conditions on those assumptions.

Due to the many variables inherent in the estimation of a business’ fair value and the relative size of our recorded goodwill and other purchased intangible assets, differences in assumptions may have a material effect on the results of our impairment analysis.

Due to the many variables inherent in developing the estimates used in our impairment analyses, differences in assumptions may have a material effect on the results of those impairment analyses.

NORTHROP GRUMMAN CORPORATION

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