10-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________ 
FORM 10-K
_____________________ 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2015
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to            Commission file number 1-16411
NORTHROP GRUMMAN CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE
 
80-0640649
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
 
 
 
2980 Fairview Park Drive
Falls Church, Virginia
 
22042
(Address of principal executive offices)
 
(Zip code)
(703) 280-2900
(Registrant's telephone number, including area code)
Securities registered pursuant to section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, $1 par value
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes x
  
No *

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Yes *
  
No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x
  
No *
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x
  
No *
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
  
Accelerated filer *
  
Non-accelerated filer *
  
Smaller reporting company *
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes *
  
No x
As of June 30, 2015, the aggregate market value of the common stock (based upon the closing price of the stock on the New York Stock Exchange) of the registrant held by non-affiliates was approximately $29.8 billion.
As of January 28, 2016, 180,943,220 shares of common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Northrop Grumman Corporation’s Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A for the 2016 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K.



NORTHROP GRUMMAN CORPORATION

 TABLE OF CONTENTS
 
 
 
Page
 
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
 
 
Item 5.
Item 6.
Item 7.
 
 
 
 
 
 
 
 
Item 7A.
Item 8.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


i


 
 
Page
 
 
 
 
 
 
Item 9.
Item 9A.
Item 9B.
 
 
 
 
 
 
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
 
 
Item 15.
 
 



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NORTHROP GRUMMAN CORPORATION


PART I
Item 1. Business
HISTORY AND ORGANIZATION
History
Northrop Grumman Corporation (herein referred to as “Northrop Grumman,” the “company,” “we,” “us,” or “our”) is a leading global security company. We offer a broad portfolio of capabilities and technologies that enable us to deliver innovative products, systems and solutions for applications that range from undersea to outer space and into cyberspace. We provide products, systems and solutions in unmanned systems; cyber; command, control, communications and computers (C4), intelligence, surveillance, and reconnaissance (C4ISR); strike aircraft; and logistics and modernization to government and commercial customers worldwide. We participate in many high-priority defense and government programs in the United States (U.S.) and abroad. We conduct most of our business with the U.S. Government, principally the Department of Defense (DoD) and intelligence community. We also conduct business with foreign, state and local governments and commercial customers. For a discussion of risks associated with our operations, see Risk Factors in Part I, Item 1A.
The company originally was formed in Hawthorne, California in 1939, as Northrop Aircraft Incorporated and was reincorporated in Delaware in 1985, as Northrop Corporation. Northrop Aircraft Incorporated was a principal developer of flying wing technology, including the B-2 Stealth Bomber. The company developed into one of the largest defense contractors in the world through a series of acquisitions, as well as organic growth. In 1994, we acquired Grumman Corporation (Grumman), after which time the company was renamed Northrop Grumman Corporation. Grumman was a premier military aircraft systems integrator and builder of the Lunar Module that first delivered humans to the surface of the moon. In 1996, we acquired the defense and electronics businesses of Westinghouse Electric Corporation, a world leader in the development and production of sophisticated radar and other electronic systems for the nation’s defense, civil aviation, and other U.S. and international applications. In 2001, we acquired Litton Industries, a global electronics and information technology company, and one of the nation's leading full service shipbuilders. In 2002, we acquired TRW Inc., a leading developer of military and civil space systems and satellite payloads, as well as a leading global integrator of complex, mission-enabling systems and services. In 2011, the company completed the spin-off to its shareholders of Huntington Ingalls Industries, Inc. (HII). HII operates our former Shipbuilding business, which was acquired in 2001, through the acquisitions of Newport News Shipbuilding and Litton Industries.
Organization
At December 31, 2015, the company was aligned into four sectors: Aerospace Systems, Electronic Systems, Information Systems, and Technical Services.
Subsequent Realignment - Effective January 1, 2016, the company streamlined our sectors from four to three to better align our business with the evolving needs of our customers and enhance innovation across the company. Two new sectors were created by merging elements of our former Electronic Systems, Information Systems and Technical Services sectors. The new Mission Systems sector is composed of the majority of our former Electronic Systems sector and the businesses from our former Information Systems sector focused on the development of new capabilities for our military and intelligence customers. The services portfolio in the former Information Systems sector was combined with the former Technical Services sector to form the new Technology Services sector. Among other operations that were realigned, the military and civil space hardware business in Azusa, California, previously reporting to the Electronic Systems sector, moved to the Aerospace Systems sector, and the electronic attack business previously in the Aerospace Systems sector moved to the Mission Systems sector. This realignment is not reflected in the business descriptions below or in any of the financial information contained in this report.
AEROSPACE SYSTEMS
Aerospace Systems, headquartered in Redondo Beach, California, is a leader in the design, development, integration and production of manned aircraft, unmanned systems, spacecraft, high-energy laser systems, microelectronics and other systems and subsystems. Aerospace Systems' customers, primarily U.S. Government agencies, use these systems in mission areas including intelligence, surveillance and reconnaissance (ISR), communications, battle management, strike operations, electronic warfare, earth observation, satellite communications, space science and space exploration. The segment consists of four business areas: Unmanned Systems, Military Aircraft Systems, Space Systems, and Strategic Programs & Technology.
Unmanned Systems - designs, develops, manufactures, and integrates ISR unmanned systems for tactical and strategic missions. Key ISR programs include the RQ-4 Global Hawk reconnaissance system, a proven high-altitude

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long-endurance system providing near real-time high resolution imagery of large geographical areas; the Triton aircraft system providing real-time ISR over vast ocean and coastal regions; the trans-Atlantic North Atlantic Treaty Organization (NATO) Alliance Ground Surveillance (AGS) system for multinational theater operations, peacekeeping missions, and disaster relief efforts; the Fire Scout aircraft system providing unprecedented situational awareness and precision targeting support; the Navy Unmanned Combat Air System demonstrating an unmanned combat air vehicle for carrier-based operations; and the Common Mission Management System, providing high performance service based on ground control solutions enabling unmanned mission capabilities.
Military Aircraft Systems - designs, develops, manufactures, and integrates airborne C4ISR, electronic warfare mission systems, and long range strike and tactical aircraft systems. Key airborne C4ISR programs include the E-2D Advanced Hawkeye and Joint Surveillance Target Attack Radar System (JSTARS). Electronic warfare includes the EA-18G Growler and EA-6B Prowler airborne electronic attack weapon systems in addition to the design, development, and integration of laser weapon systems for air, sea, and ground platforms. This business area also designed, developed and manufactured the B-2 Spirit bomber and now provides sustainment and modernization services for the B-2, the nation's most advanced long range strike aircraft system. Tactical aircraft includes the design, development, manufacture and integration of F/A-18 aft sections and F-35 center sections.
Space Systems - designs, develops, manufactures, and integrates spacecraft systems, subsystems, sensors and communications payloads in support of space science and C4ISR. Key programs include the James Webb Space Telescope, a large infrared telescope being built for the National Aeronautics and Space Administration that will be deployed in space to study the origins of the universe; Advanced Extremely High Frequency payloads providing survivable, protected communications to U.S. forces; and restricted programs.
Strategic Programs & Technology - creates and matures advanced technologies and innovative concepts to provide affordable solutions addressing current and future customer needs. This business area maintains a broad portfolio of contracts ranging from basic research to the development of technologies, components, prototypes, and initial operational systems across the air, land and space domains.
ELECTRONIC SYSTEMS
Electronic Systems, headquartered in Linthicum, Maryland, is a leader in the design, development, manufacture and support of solutions for sensing, understanding, anticipating and controlling the operating environment for our global military, civil and commercial customers. Electronic Systems provides a variety of defense electronics and systems, airborne fire control radars, situational awareness systems, early warning systems, electronic warfare systems, air defense radars and management systems, navigation systems, communications systems, marine power and propulsion systems, space systems and logistics services. The segment consists of four business areas: Airborne Intelligence, Surveillance, Reconnaissance & Targeting Systems, Space Intelligence, Surveillance, & Reconnaissance Systems, Land & Self Protection Systems, and Navigation & Maritime Systems.
Airborne Intelligence, Surveillance, Reconnaissance & Targeting Systems - delivers products and services for airborne and ground-based surveillance, multi-sensor processing, analysis and dissemination for combat units and national agencies, both U.S. and international. These systems provide battle space awareness, command and control, combat avionics (fire control radars, multi-function apertures and pods), and airborne electro-optical/infrared (EO/IR) targeting systems. Key programs include airborne fire control radars such as the Scalable Agile Beam Radar (SABR), which provides Active Electronically Scanned Array (AESA) capabilities for U.S. and international fighters; the F-35 fire control radar, a multi-function AESA radar for the U.S. Armed Forces and a large number of international partners; electro-optical infrared (EO/IR) systems such as the LITENING targeting pod and the Distributed Aperture System (DAS), a 360 degree spherical situational awareness system; and airborne surveillance radars such as the Multirole and Electronically Scanned Array (MESA) for Airborne Early Warning & Control (AEW&C), which provides air-to-air and air-to-surface coverage.
Space Intelligence, Surveillance, & Reconnaissance Systems - delivers products and services for radar and EO/IR space satellite applications for the DoD and national intelligence agencies. These systems provide missile warning, missile defense, situational awareness, and ground software systems for intelligence community decision makers. Key programs include space systems such as the Space-Based Infrared System (SBIRS), which provides data for missile surveillance, missile defense, technical intelligence and battlespace characterization; Advanced Technology Microwave Sounder (ATMS) for environmental sensing on JPSS satellites; Joint Tactical Army Ground Station (JTAGS), Joint OPIR Ground (JOG) solutions; and a large number of restricted programs for the intelligence community.

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Land & Self Protection Systems - delivers products, systems and services that support ground-based, helicopter and fixed wing platforms (manned and unmanned) with sensor and protection systems. A major product line of this business area consists of systems that perform threat detection and countermeasures that defeat infrared and radio frequency (RF) guided missile and tracking systems. This business area also provides integrated electronic warfare capability, communications and intelligence systems, unattended ground sensors, automatic test equipment, advanced threat simulators, ground-based air defense and multi-function radars, situational awareness systems, laser/electro-optical systems and digitized and open architecture cockpits and applications. Key programs include the Ground/Air Task Oriented Radar (G/ATOR), which is a ground-based multi-mission radar designed to detect and track a wide variety of threats; the TPS-78 ground-based radar, which provides air defense and air surveillance for the global market; the Large Aircraft Infrared Countermeasures (LAIRCM), which is an infrared countermeasure system designed to protect aircraft against man-portable (shoulder-launched) infrared-guided surface-to-air missiles; and the AN/APR-39, which provides rapid identification and continuous radar threat warning for today's complex battlefields.
Navigation & Maritime Systems - delivers products and services to U.S. and international defense, civil and commercial customers supporting smart navigation, shipboard radar surveillance, ship control, machinery control and integrated combat management systems for naval surface ships; high-resolution undersea sensors for mine hunting, situational awareness and other applications; unmanned marine vehicles; shipboard missile and encapsulated payload launch systems, propulsion and power generation systems, nuclear reactor instrumentation and control and acoustic sensors for submarines and aircraft carriers; inertial navigation systems for all domains (air, land, sea, and space); embedded Global Positioning Systems; and postal automation systems. Key programs include the AN/SPQ-9B Anti-Ship Missile Defense radar, which provides the US Navy’s cruisers and destroyers with situational awareness and contact information from aircraft, cruise missiles, surface vessels and periscope detection; and inertial navigation and positioning products for a range of platforms including ships, aircraft, spacecraft and weapons systems.
In addition to the product and service lines discussed above, our Electronic Systems segment also includes Advanced Concepts & Technologies (AC&T), which develops next-generation systems to position the segment in key developing markets. AC&T focuses on understanding customer mission needs; conceiving affordable, innovative and open solutions; and demonstrating the readiness and effectiveness of Electronic Systems' products. AC&T focuses on the following enterprise-wide and cross cutting technology development thrust areas: RF systems; EO/IR systems; multi-function systems; modular open systems architectural approaches and designs; precision navigation and timing capabilities; and secure and trusted solutions.
INFORMATION SYSTEMS
Information Systems, headquartered in McLean, Virginia, is a leading provider of advanced solutions for the DoD, national intelligence, federal civilian, state, international and commercial customers. Products and services focus on the fields of command and control (C2), communications, cyber, air and missile defense, intelligence processing, civil security, health technology and government support systems. The segment consists of seven business areas: Cyber, C2, Communications, ISR, Integrated Air and Missile Defense (IAMD), Civil and Health.
Cyber - provides full spectrum solutions that address cyber security threats, cyber mission management and special cyber systems. Cyber offerings span intelligence, defense, federal, state, international and commercial customers, providing dynamic cyber defense and specialized cyber systems and services in support of critical government missions. This business specializes in active defense, malware detection, analytics platforms and large scale cyber solutions for national security applications.
C2 - provides net-enabled C2, battle management, command center integration, combat support systems, mission-enabling solutions and critical infrastructure protection systems. C2 systems support operations, managing assets and forces employed to accomplish national and military missions, and optimizing legacy platforms, sensors and weapons systems. These systems are installed in operational and command centers world-wide and across DoD services, joint commands and the international security community.
Communications - provides the underlying networks, network management, gateway systems and radio frequency devices that support national military C4ISR missions and help make C4ISR more integrated and interoperable. Communications capabilities include gateways and products for aircraft interoperability, multi-function avionics, software defined radios and protected communications.
ISR - delivers systems and services in Signals Intelligence (SIGINT), airborne reconnaissance, geospatial intelligence and data fusion, specializing in the collection, processing, and exploitation of data to achieve a deep

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NORTHROP GRUMMAN CORPORATION


understanding of the environment. Offerings include intelligence integration, large scale information processing, multi-source intelligence, big data applications and geo-location techniques.
IAMD - provides integration and interoperability of net-enabled battle management, sensors, targeting and surveillance systems, air and missile defense C2, missile warning systems and critical situational awareness for weapons and fire control systems. This business provides solutions for both U.S. and international customers, advanced IAMD integration with land and air assets, and cost effective flexible architectures.
Civil - provides civilian information technology (IT) solutions, civil financial operations, public safety systems, law enforcement and state programs. This business is a provider in global homeland security and public safety, federal law enforcement information sharing and analysis, and IT systems and services that enable civil missions and satisfy infrastructure and back office requirements.
Health - provides healthcare expertise combined with IT capabilities to support effective healthcare services and efficient health and human services systems. Capabilities include benefits management, population health, clinical data integration and health analytics. This business provides system engineering and integration, affordable national healthcare IT, and solutions to meet health and human services challenges.
Key programs for the Information Systems segment include the Joint National Integration Center Research and Development (JRDC) contract, which supports the technical infrastructure, modeling and simulation, test and evaluation, and management of the Missile Defense Agency network at multiple sites; the Battlefield Airborne Communications Node (BACN), a high-altitude, airborne communications and information gateway system that provides situational awareness and C2 coordination between warfighters and commanders; the Communications, Navigation and Identification (CNI) integrated avionics system for the F-35 Joint Strike Fighter based on software-defined technology with advanced capabilities for interoperability; and the Integrated Air and Missile Defense Battle Command System (IBCS), a C2 system that delivers a single, unambiguous view of the battlespace with enhanced aircraft and missile tracking improving the ability of combatant commanders and air defenders to make critical decisions within seconds.
TECHNICAL SERVICES
Technical Services, headquartered in Herndon, Virginia, is a leader in innovative logistics, modernization and sustainment and also provides an array of other advanced technology and engineering services, including space, missile defense, nuclear security, training and simulation. The segment consists of two business areas: Integrated Logistics and Modernization and Mission Solutions and Readiness.
Integrated Logistics and Modernization - provides complete life cycle support and weapon system sustainment and modernization products and services, and provides direct support to warfighters while delivering aircraft and subsystem maintenance, repair and overhaul (MRO). Competencies include aircraft and electronics sustaining engineering, supply chain management services, manned and unmanned weapons systems deployed logistics support, field services and on-going maintenance and technical assistance, and delivering rapid response in support of global customers. Key programs include KC-10 Contractor Logistics Support (CLS), which provides total weapons systems CLS to the Air Force for the entire fleet of 59 KC-10 aircraft; Intercontinental Ballistic Missile (ICBM) Systems, which provides systems engineering and integration for the land-based leg of the U.S. nuclear deterrent force; UK Airborne Warning and Control System (AWACS), which provides through life management of the UK Royal Air Force fleet of E-3D AWACS aircraft; KC-30A Multi-Role Tanker Transport (MRTT), which provides through life support for the Royal Australian Air Force (RAAF) KC-30A air to air refueling aircraft; MQ5B Hunter Contractor Logistics Support (CLS), which provides maintenance and continuous modernization of the Army’s fielded Hunter Unmanned Aerial Vehicles (UAV); and AAQ24 LAIRCM, which provides repair, testing, component spare procurement, logistics, and data collection related to directional infrared counter measures systems used on multiple fixed and rotary wing aircraft.
Mission Solutions and Readiness - provides realistic and comprehensive training through live, virtual and constructive domains, innovative and diverse training applications ranging from battle command to professional military education, sustainment and modernization of tactical vehicles, high technology and engineering services in the areas of nuclear security, space and launch services, civil engineering and military range-sensor-instrumentation operations. Key programs include Ministry of the National Guard Training Support (MNG TSC), through our interest in a joint venture for which we consolidate the financial results, which provides equipment fielding, training and maintenance, simulator training and operations, tactical exercise development, logistics and operations support and English language training to the Saudi Arabian National Guard; the Mission Command Training Program (MCTP), the Army's premier leadership and staff training exercise program at the tactical and operational level; and

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Fort Irwin Logistics Services Support, which provides a full range of logistics support services and operates a large-scale maintenance and repair program of both tracked and tactical wheeled vehicles.
SELECTED FINANCIAL DATA AND SEGMENT OPERATING RESULTS
For a more complete understanding of our business, see Selected Financial Data in Part II, Item 6. For a more complete understanding of our segment financial information, see Segment Operating Results in Part II, Item 7 and Note 3 to the consolidated financial statements in Part II, Item 8.
CUSTOMER CONCENTRATION
Our largest customer is the U.S. Government. Sales to the U.S. Government accounted for 83 percent, 84 percent and 86 percent of sales during the years ended December 31, 2015, 2014 and 2013, respectively. For further information on sales by customer category, see Note 1 to the consolidated financial statements in Part II, Item 8. No single program accounted for more than ten percent of total sales during any period presented. See Risk Factors in Part I, Item 1A.
COMPETITIVE CONDITIONS
We compete with many companies in the defense, intelligence and federal markets. BAE Systems, Boeing, Booz Allen Hamilton, Finmeccanica, General Dynamics, Harris, L-3 Communications, Leidos, Lockheed Martin, Raytheon and Thales are some of our primary competitors. Key characteristics of our industry include long operating cycles and intense competition, which is evident through the number of bid protests (competitor protests of U.S. Government procurement awards) and the number of competitors bidding on program opportunities.
It is common in the defense industry for work on major programs to be shared among a number of companies. A company competing to be a prime contractor may, upon ultimate award of the contract to another competitor, become a subcontractor for the ultimate prime contracting company. It is not unusual to compete for a contract award with a peer company and, simultaneously, perform as a supplier to or a customer of that same competitor on other contracts, or vice versa.
SEASONALITY
No material portion of our business is considered to be seasonal.
BACKLOG
At December 31, 2015, total backlog was $35.9 billion, compared with $38.2 billion at the end of 2014. For further information, see Backlog in Part II, Item 7.
RESEARCH AND DEVELOPMENT
See Note 1 to the consolidated financial statements in Part II, Item 8.
INTELLECTUAL PROPERTY
We routinely apply for and own a number of U.S. and foreign patents related to the products and services we provide. We also develop and protect intellectual property as trade secrets. In addition to owning a large portfolio of proprietary intellectual property, we license some intellectual property rights to and from third parties. The U.S. Government typically holds licenses to patents developed in the performance of U.S. Government contracts and may use or authorize others to use the inventions covered by these patents for certain purposes. See Risk Factors in Part I, Item 1A.
RAW MATERIALS
We have not experienced significant delays in the supply or availability of raw materials, nor have we experienced a significant price increase for raw materials. See Risk Factors in Part I, Item 1A.
EMPLOYEE RELATIONS
We believe that we maintain good relations with our approximately 65,000 employees. Approximately 2,600 are covered by 12 collective agreements in the U.S., of which we negotiated renewals of four in 2015 and expect to negotiate renewals of five in 2016. See Risk Factors in Part I, Item 1A.
REGULATORY MATTERS
Government Contract Security Restrictions
Certain programs with the U.S. Government that are prohibited by the customer from being publicly discussed are generally referred to as “restricted” in this Annual Report on Form 10-K. The consolidated financial statements and

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NORTHROP GRUMMAN CORPORATION


financial information in this Annual Report on Form 10-K reflect the operating results of our entire company, including restricted programs, under accounting principles generally accepted in the United States of America (GAAP).
Contracts
We generate the majority of our business from long-term contracts with the U.S. Government for development, production and support activities. Unless otherwise specified in a contract, allowable and allocable costs are billed to contracts with the U.S. Government under the requirements of the Federal Acquisition Regulation (FAR) and U.S. Government Cost Accounting Standards (CAS). Examples of costs incurred by us and not billed to the U.S. Government in accordance with the FAR and CAS include, but are not limited to, lobbying costs, certain legal costs, charitable donations, advertising costs, interest expense and unallowable employee compensation and benefits costs.
Our long-term contracts typically fall into one of two broad categories:
Cost-type contracts – Cost-type contracts include cost plus fixed fee, award fee and/or incentive fee contracts. Cost-type contracts provide for reimbursement of the contractor’s allowable costs incurred plus fee. Cost-type contracts generally require that the contractor use its best efforts to accomplish the scope of the work within some specified time and some stated dollar limitation. Fees on cost-type contracts can be fixed in terms of dollar value or percentage of costs. Award and incentive fees are generally based on performance criteria such as cost, schedule, quality and/or technical performance. Award fees are determined and earned based on customer evaluation of the company's performance against contractual criteria, and are intended to provide motivation for excellence in contract performance. Incentive fees that are based on cost provide for an initially negotiated fee to be adjusted later, typically using a formula to measure performance against the associated criteria, based on the relationship of total allowable costs to total target costs. Award and incentive fees that can reasonably be estimated and are deemed reasonably assured are recorded over the performance period of the contract.
Fixed-price contracts – A firm fixed-price contract is a contract in which the specified scope of work is agreed to for a price that is a pre-determined, negotiated amount and not generally subject to adjustment regardless of costs incurred by the contractor, absent changes in scope by the customer. Certain fixed-price incentive fee contracts provide for reimbursement of the contractor’s allowable costs plus a fee up to a cost ceiling amount, typically through a cost-sharing ratio that affects profitability. These types of fixed-price incentive fee contracts effectively become firm fixed-price contracts once the cost-share ceiling is reached. Time-and-materials contracts are considered fixed-price contracts as they specify a fixed hourly rate for each labor hour charged.
See Note 1 to the consolidated financial statements in Part II, Item 8 and Risk Factors in Part I, Item 1A.
The following table summarizes sales for the year ended December 31, 2015, recognized by contract type and customer:
($ in millions)
 
U.S.
Government(1)
 
International and Other Customers(2)
 
Total
 
Percentage
of Total Sales
Cost-type contracts
 
$
11,558

 
$
641

 
$
12,199

 
52
%
Fixed-price contracts
 
7,900

 
3,427

 
11,327

 
48
%
Total sales
 
$
19,458

 
$
4,068

 
$
23,526

 
100
%
(1) 
Sales to the U.S. Government include sales from contracts for which Northrop Grumman is the prime contractor, as well as those for which the company is a subcontractor and the ultimate customer is the U.S. Government. Each of the company's segments derives substantial revenue from the U.S. Government.  
(2) Sales to International and Other Customers include foreign military sales contracted through the U.S. Government, direct commercial sales with governments outside the U.S., sales to state and local governments, and sales to commercial customers.
Profit margins may vary materially depending on, among other things, negotiated contract fee arrangements, achievement of performance objectives and the stage of performance at which the right to receive fees, particularly under incentive and award fee contracts, is determined.
We monitor our policies and procedures with respect to our contracts on a regular basis to enhance consistent application under similar terms and conditions, as well as compliance with applicable government regulations and laws. In addition, costs incurred and allocated to contracts with the U.S. Government are routinely audited by the Defense Contract Audit Agency.

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Environmental
Our operations are subject to and affected by federal, state, local and foreign laws and regulations relating to the protection of the environment. In 2010, we established goals for the reduction of greenhouse gas emissions and implementation of best management practices for water use and solid waste; those goals were achieved as of December 31, 2014. In 2015, we announced our 2020 environmental sustainability goals: to reduce absolute greenhouse gas emissions by 30 percent from 2010 levels; to reduce potable water use by 20 percent from 2014 levels; and achieve a 70 percent solid waste diversion rate (from landfills).
We have recorded liabilities and have incurred and expect to continue to incur capital and operating costs to comply with applicable environmental laws and regulations and to achieve our environmental sustainability commitments. See Risk Factors in Part I, Item 1A and Notes 1 and 11 to the consolidated financial statements in Part II, Item 8.
EXECUTIVE OFFICERS
See Part III, Item 10, for information about our executive officers.
AVAILABLE INFORMATION
Our principal executive offices are located at 2980 Fairview Park Drive, Falls Church, Virginia 22042. Our telephone number is (703) 280-2900 and our home page on the Internet is www.northropgrumman.com.
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy statement for the annual shareholders’ meeting, as well as any amendments to those reports, are available free of charge through our website as soon as reasonably practicable after we file them with the Securities and Exchange Commission (SEC). You can learn more about us by reviewing our SEC filings on the investor relations page of our website.
The SEC also maintains a website at www.sec.gov that contains reports, proxy statements and other information about SEC registrants, including Northrop Grumman Corporation. You may also obtain these materials at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You can obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
References to our website and the SEC’s website in this report are provided as a convenience and do not constitute, and should not be viewed as, incorporation by reference of the information contained on, or available through, such websites. Such information should not be considered a part of this report, unless otherwise expressly incorporated by reference in this report.
Item 1A. Risk Factors
Our consolidated financial position, results of operations and cash flows are subject to various risks, many of which are not exclusively within our control, that may cause actual performance to differ materially from historical or projected future performance. We urge you to consider carefully the risk factors described below in evaluating the information contained in this report as the outcome of one or more of these risks could have a material adverse effect on our financial position, results of operations and/or cash flows.
We depend heavily on a single customer, the U.S. Government, for a substantial portion of our business. Changes in this customer’s priorities and spending could have a material adverse effect on our financial position, results of operations and/or cash flows.
Our primary customer is the U.S. Government, from which we derived 83 percent, 84 percent and 86 percent of our sales during the years ended December 31, 2015, 2014 and 2013, respectively. The U.S. Government has been implementing significant reductions in government spending and other significant program changes. We cannot predict the impact on existing, follow-on, replacement or future programs from potential changes in priorities due to changes in defense spending levels, military strategy and planning and/or changes in social-political priorities.
The U.S. Government generally has the ability to terminate contracts, in whole or in part, without prior notice, for its convenience or for default based on performance. In the event of termination for the U.S. Government’s convenience, contractors are generally protected by provisions covering reimbursement for costs incurred on the contracts and profit on those costs up to the amount authorized under the contract, but not the anticipated profit that would have been earned had the contract been completed. Termination by the U.S. Government of a contract due to our default could require us to pay for re-procurement costs in excess of the original contract price, net of the value of work accepted from the original contract, as well as other damages. Termination of a contract due to our default could have a material adverse effect on our reputation and our ability to compete for other contracts.

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The U.S. Government also has the ability to stop work under a contract for a limited period of time for its convenience. It is possible that the U.S. Government could invoke this ability across a limited or broad number of contracts. In the event of a stop work order, contractors are typically protected by provisions covering reimbursement for costs incurred on the contract to date and for costs associated with the temporary stoppage of work on the contract. However, such temporary stoppages and delays could introduce inefficiencies and result in financial and other damages for which we may not be able to negotiate full recovery from the U.S. Government. They could also ultimately result in termination for convenience or reduced future orders.
A significant shift in government priorities to programs in which we do not participate and/or reductions in funding for or the termination of programs in which we do participate, unless offset by other programs and opportunities, could have a material adverse effect on our financial position, results of operations and/or cash flows.
Significant delays or reductions in appropriations for our programs and U.S. Government funding more broadly may negatively impact our business and programs and could have a material adverse effect on our financial position, results of operations and/or cash flows.
U.S. Government programs are subject to annual congressional budget authorization and appropriation processes. For many programs, Congress appropriates funds on a fiscal year basis even though the program performance period may extend over several years. Consequently, programs are often partially funded initially and additional funds are committed only as Congress makes further appropriations. If we incur costs in excess of funds obligated on a contract, we may be at risk for reimbursement of those costs unless and until additional funds are obligated to the contract. We cannot predict the extent to which total funding and/or funding for individual programs will be included, increased or reduced as part of the annual budget process ultimately approved by Congress or in separate supplemental appropriations or continuing resolutions, as applicable. Laws and plans adopted by the U.S. Government relating to, along with pressures on and uncertainty surrounding the federal budget, sequestration, the appropriations process, use of continuing resolutions (with restrictions, e.g., on new starts) and the permissible federal debt limit, could adversely affect the funding for individual programs and delay purchasing or payment decisions by our customers. In the event government funding for our significant programs becomes unavailable, or is reduced or delayed, our contract or subcontract under such programs may be terminated or adjusted by the U.S. Government or the prime contractor.
On November 2, 2015, the President signed the Bipartisan Budget Act of 2015 (the Budget Act). The Budget Act raises the statutory limit on the amount of permissible federal debt (the debt ceiling) until March 2017 and raises the sequester caps imposed by the Budget Control Act of 2011 (the Budget Control Act) by $80 billion, split equally between defense and domestic spending, over the next two years ($50 billion in FY 2016 and $30 billion in FY 2017). However, unforeseen circumstances could cause an extended debt ceiling breach, which could negatively affect the U.S. Government's timely payment of our billings, resulting in delayed cash collection, and have significant consequences for our company, our employees, our suppliers and the defense industry. On December 18, 2015, Congress passed and the President signed the Consolidated Appropriations Act of 2016, which provides funding for the U.S. government for FY 2016, providing $1.1 trillion in discretionary funding for federal agencies through September 2016.
The budget environment, including sequestration as currently mandated, and uncertainty surrounding the appropriations processes, remain significant long-term risks. Considerable uncertainty exists regarding how future budget and program decisions will unfold, what challenges budget reductions (required by the Budget Control Act and otherwise) will present for the defense industry and whether an annual appropriations bill will be enacted for FY 2017. If an annual appropriations bill is not enacted for FY 2017 or beyond, the U.S. Government may operate under a continuing resolution, restricting new contract or program starts and we may face a government shutdown of unknown duration. Adverse consequences from operating under a continuing resolution may be greater if the company has a higher percentage of development programs. We believe continued budget pressures will have serious negative consequences for the security of our country, the defense industrial base, including Northrop Grumman, and the customers, employees, suppliers, investors, and communities that rely on companies in the defense industrial base. It is likely budget and program decisions made in this environment will have long-term implications for our company and the entire defense industry.
Long term funding for certain programs in which we participate may be reduced, delayed or cancelled. In addition, budget cuts globally could adversely affect the viability of our subcontractors and suppliers, and our employee base. While we believe that our business is well-positioned in areas that the Department of Defense (DoD) and other customers have indicated are areas of focus for future defense spending, the long-term impact of the Budget Control Act, other defense spending cuts, and the ongoing fiscal debates remain uncertain.

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Significant delays or reductions in appropriations; long term funding under a continuing resolution; an extended debt ceiling breach or government shutdown; and/or future budget and program decisions, among other items, may negatively impact our business and programs and could have a material adverse effect on our financial position, results of operations and/or cash flows.
We are subject to various investigations, claims and litigation that could ultimately be resolved against us.
The size, nature and complexity of our business make us susceptible to investigations, claims, and litigation, particularly those involving governments. We are and may become subject to investigations, claims and administrative, civil or criminal litigation globally and across a broad array of matters, including, but not limited to, government contracts, false claims, products liability, fraud, environmental, intellectual property, tax, export/import, anti-corruption, labor, health and safety, employee benefits and plans, including plan administration, and improper payments. These matters could divert financial and management resources; result in fines, penalties, compensatory, treble or other damages or non-monetary relief; and otherwise disrupt our business. Government regulations also provide that certain allegations against a contractor may lead to suspension or debarment from government contracts or suspension of export privileges for the company or one or more of its components. Suspension or debarment could have a material adverse effect on the company because of our reliance on government contracts and export authorizations. An investigation, claim or litigation, even if fully indemnified or insured, could also negatively impact our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future. Investigations, claims or litigation could have a material adverse effect on our financial position, results of operations and/or cash flows.
Our international business exposes us to additional risks.
Sales to customers outside the U.S. are an increasingly important component of our strategy. Our international business (including joint ventures) is subject to numerous political and economic factors, legal requirements, cross-cultural considerations and other risks associated with doing business in foreign countries. These risks differ in some respects from those associated with our U.S. business and our exposure to such risks may increase if our international business continues to grow as we anticipate.
Our international business is subject to both U.S. and foreign laws and regulations, including, without limitation, regulations relating to import-export controls, technology transfer restrictions, repatriation of earnings, data privacy and protection, investment, exchange controls, the Foreign Corrupt Practices Act (FCPA) and other anti-corruption laws, the anti-boycott provisions of the U.S. Export Administration Act, labor and employment, works councils and other labor groups, taxes, security restrictions and intellectual property. Failure by us, our employees, or others working on our behalf to comply with these laws and regulations could result in administrative, civil, or criminal liabilities, including suspension or debarment from government contracts or suspension of our export privileges.
Changes in regulations, political leadership and environment, or security risks may dramatically affect our ability to conduct or continue to conduct business in international markets. Our international business may also be impacted by changes in foreign national policies and priorities, government budgets, and economic factors more generally, any of which could impact funding for programs or delay purchasing or payment decisions by customers. Global economic conditions and fluctuations in foreign currency exchange rates could further impact our international business. Our international contracts may also include industrial cooperation agreements requiring specific in-country purchases, investments, manufacturing agreements or other financial obligations, known as offset obligations, and provide for significant penalties if we fail to meet such requirements. Our ability to sell products outside the U.S. could be adversely affected if we are unable to design our products for export on a cost effective basis or to obtain all necessary export licenses and authorizations on a timely basis. Our ability to conduct business outside of the U.S. also depends on our ability to attract and retain sufficient qualified personnel with the skills and/or security clearances in the markets in which we do business.
The products and services we provide internationally, including those provided by subcontractors and joint ventures in which we have an interest, are sometimes in countries with unstable governments and/or developing legal systems, in areas of military conflict or at military installations. This increases the risk of political dynamics or an incident resulting in harm or loss of life to our employees, subcontractors or other third parties, or in loss of property or damage to our products. It also exposes the company to additional financial, contractual and legal risks. Accidents or incidents that occur in connection with our international operations could also result in negative publicity, which could adversely affect our reputation and make it more difficult for us to compete for future contracts or attract and retain employees or result in the loss of existing and future contracts.

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The occurrence and impact of these factors is difficult to predict, but one or more of them could have a material adverse effect on our financial position, results of operations and/or cash flows.
Our reputation and our ability to do business may be impacted by the improper conduct of employees, agents, business partners or joint ventures in which we participate.
We have implemented extensive policies, procedures, training and other compliance controls to prevent misconduct by employees, agents or others working on our behalf or with us that would violate the applicable laws of the jurisdictions in which we operate, including laws governing improper payments to government officials, the protection of export controlled or classified information, cost accounting and billing, competition and data privacy. However, we cannot ensure that we will prevent all such misconduct committed by our employees, agents, subcontractors or others working on our behalf or with us, and this risk of improper conduct may increase as we expand globally. In the ordinary course of our business we form and are members of joint ventures. We may be unable to prevent misconduct or other violations of applicable laws by these joint ventures. Improper actions by our employees, agents, subcontractors, business partners or joint ventures could subject us to administrative, civil or criminal investigations and monetary and non-monetary penalties, including suspension and debarment, which could negatively impact our reputation and ability to conduct business and could have a material adverse effect on our financial position, results of operations and/or cash flows.
We use estimates when accounting for contracts. Contract cost growth or changes in estimated contract revenues and costs could affect our profitability and our overall financial position.
Contract accounting requires judgment relative to assessing risks, estimating contract revenues and costs, and making assumptions for schedule and technical issues. Due to the size and nature of many of our contracts, the estimation of total revenues and costs at completion is complicated and subject to many variables. Incentives, awards or penalties related to performance on contracts are considered in estimating revenue and profit rates when there is sufficient information to assess anticipated performance. Suppliers’ assertions are also assessed and considered in estimating costs and profitability.
Our operating income can be adversely affected when we experience increased estimated contract costs. Reasons for estimated contract cost growth may include: design issues; changes in estimates of the nature and complexity of the work to be performed, including technical or quality issues or requests to perform additional work at the direction of the customer; production challenges, including those resulting from the availability and timeliness of customer funding, unavailability or reduced productivity of labor or the effect of any delays in performance; the availability, performance, quality or financial strength of significant subcontractors; supplier issues, including the costs, timeliness and availability of materials and components; the effect of any changes in laws or regulations; actions deemed necessary for long-term customer satisfaction; and natural disasters or environmental matters. We may file requests for equitable adjustment or claims to seek recovery in whole or in part for our increased costs.
Our risk varies with the type of contract. Due to their nature, fixed-price contracts inherently tend to have more risk than cost type contracts. In 2015, approximately half of our sales were derived from fixed-price contracts. We typically enter into fixed-price contracts where costs can be more reasonably estimated based on actual experience, such as for mature production programs. In addition, our contracts contain provisions relating to cost controls and audit rights. If the terms specified in our contracts are not met, our profitability may be reduced and we may incur a loss. Our fixed-priced contracts may include fixed-price development work. This type of work is inherently more uncertain as to future events than production contracts, and, as a result, there is typically more variability in estimates of the costs to complete the development stage. As work progresses through the development stage into production, the risks associated with estimating the total costs of the contract are typically reduced. While management uses its best judgment to estimate costs associated with fixed price development contracts, future events could result in either upward or downward adjustments to those estimates. Under cost type contracts, allowable costs incurred by the contractor are generally subject to reimbursement plus a fee. We often enter into cost type contracts for development programs with complex design and technical challenges. These cost type programs typically have award or incentive fees that are subject to uncertainty and may be earned over extended periods or towards the end of the contract. In these cases, the associated financial risks are primarily in recognizing profit, which ultimately may not be earned, or program cancellation if cost, schedule, or technical performance issues arise.
Because of the significance of the judgment and estimation processes described above, it is possible that materially different amounts could be obtained if different assumptions were used or if the underlying circumstances were to change. Changes in underlying assumptions, circumstances or estimates, and the failure to prevail on claims for equitable adjustments could have a material adverse effect upon the profitability of one or more of the affected

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contracts and on our overall financial position, results of operations and/or cash flows. See Critical Accounting Policies, Estimates and Judgments in Part II, Item 7.
Our business could be negatively impacted by cyber and other security threats or disruptions.
As a defense contractor, we face various cyber and other security threats, including attempts to gain unauthorized access to sensitive information and networks; insider threats; threats to the safety of our directors, officers and employees; threats to the security of our facilities and infrastructure; and threats from terrorist acts or other acts of aggression. Our customers and partners (including subcontractors and joint ventures) face similar threats. Although we utilize various procedures and controls to monitor and mitigate the risk of these threats, there can be no assurance that these procedures and controls will be sufficient. These threats could lead to losses of sensitive information or capabilities, harm to personnel, infrastructure or products, and/or damage to our reputation as well as our partners' ability to perform on our contracts.
Cyber threats are evolving and include, but are not limited to, malicious software, destructive malware, attempts to gain unauthorized access to data, disruption or denial of service attacks, and other electronic security breaches that could lead to disruptions in mission critical systems, unauthorized release of confidential, personal or otherwise protected information (ours or that of our employees, customers or partners), and corruption of data, networks or systems. In addition, we could be impacted by cyber threats or other disruptions or vulnerabilities found in products we use or in our partners’ or customers’ systems that are used in connection with our business. These events, if not prevented or effectively mitigated, could damage our reputation, require remedial actions and lead to loss of business, regulatory actions, potential liability and other financial losses.
We provide systems, products and services to various customers (government and commercial) who also face cyber threats. Our systems, products and services may themselves be subject to cyber threats and/or they may not be able to detect or deter threats, or effectively to mitigate resulting losses. These losses could adversely affect our customers and our company.
The impact of these factors is difficult to predict, but one or more of them could result in the loss of information or capabilities, harm to individuals or property, damage to our reputation, loss of business, regulatory actions and potential liability, any one of which could have a material adverse effect on our financial position, results of operations and/or cash flows.
Pension and medical liabilities and related expenses in our financial statements that have been recorded in connection with our retirement benefit plans may fluctuate significantly depending upon future investment performance of plan assets, changes in actuarial assumptions, and legislative or other regulatory actions.
A substantial portion of our current and retired employee population is covered by pension and other post-retirement benefit plans. Pension and medical liabilities and related expenses in our financial statements that have been recorded in connection with these plans are primarily dependent upon future investment performance of plan assets and various assumptions, including discount rates applied to future payment obligations, mortality assumptions, estimated long term rates of return on plan assets, rates of future cost growth and trends for future costs. In addition, funding requirements for benefit obligations of our pension and other post-retirement benefit plans are subject to legislative and other government regulatory actions.
In accordance with government regulations, pension plan cost recoveries under our U.S. Government contracts occur in different periods from when those pension costs are recognized for financial statement purposes or when pension funding is made. These timing differences could have a material adverse effect on our cash flows. The cost accounting rules have been revised in order to partially harmonize the measurement and period of assignment of defined benefit pension plan costs allocable to U.S. Government contracts and the minimum required contribution under the Employee Retirement Income Security Act of 1974 (ERISA), as amended by the Pension Protection Act (PPA) of 2006. These rules better align, but do not eliminate, mismatches between ERISA funding requirements and CAS pension costs for U.S. Government CAS covered contracts.
Future investment performance of plan assets and changes in assumptions associated with our pension and other post-retirement benefit plans could have a material adverse effect on our financial position, results of operations and/or cash flows.
Our earnings and profitability depend, in part, on subcontractor performance and financial viability as well as raw material and component availability and pricing.
We rely on other companies to provide raw materials and major components and subsystems for our products and to produce hardware elements and sub-assemblies, provide intellectual property, and perform some of the services we

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provide to our customers, and to do so in compliance with all applicable laws and regulations. Disruptions or performance problems caused by our subcontractors and suppliers, or a misalignment between our contractual obligations to our customers and our agreement with our subcontractors and suppliers, could have an adverse effect on our ability to meet our commitments to customers.
Our ability to perform our obligations on time could be adversely affected if one or more of our subcontractors or suppliers were unable to provide the agreed-upon products or materials or perform the agreed-upon services in a timely, compliant and cost-effective manner or otherwise to meet the requirements of the contract. Changes in economic conditions, including changes in defense budgets or credit availability, could adversely affect the financial stability of our subcontractors and suppliers and/or their ability to perform. The inability of our suppliers to perform could also result in the need for us to transition to alternate suppliers, which could result in significant incremental cost and delay or the need for us to provide other supplemental means to support our existing suppliers.
In connection with our U.S. Government contracts, we are required to procure certain materials, components and parts from supply sources approved by the customer. In some cases, there may be only one supplier for certain components. If a sole source supplier cannot meet our needs or is otherwise unavailable, we may be unable to find a suitable alternative.
Our procurement practices are intended to reduce the likelihood of our procurement of counterfeit, unauthorized or otherwise non-compliant parts or materials. We rely on our subcontractors and suppliers to comply with applicable laws and regulations regarding the parts or materials we procure from them; in some circumstances, we rely on certifications provided by our subcontractors and suppliers regarding their compliance.
If we are unable to procure or experience significant delays in supplier deliveries of needed materials, components, intellectual property or parts; if our subcontractors or suppliers do not comply with all applicable laws and regulations; if the certifications we receive from them are inaccurate; or if what we receive is counterfeit or otherwise improper, it could have a material adverse effect on our financial position, results of operations and/or cash flows.
Competition within our markets and an increase in bid protests may affect our ability to win new contracts and result in reduced revenues and market share.
We operate in highly competitive markets and our competitors may have more extensive or specialized engineering, manufacturing, or marketing capabilities in some areas or financial capacity, or be willing to accept more risk or lower profitability in competing for contracts. We have seen, and anticipate we will continue to see, increased competition in some of our core markets, especially as a result of budget reductions for many customers, a continued focus on affordability and competition, and our own success in winning business. We are facing increasing competition in our U.S. and international markets from U.S., foreign and multinational firms. Additionally, some customers, including the DoD, may turn to commercial contractors, rather than traditional defense contractors, for some products and services, or may utilize small business contractors or determine to source work internally rather than hiring a contractor.
We also are seeing an increasing number of bid protests from unsuccessful bidders on new program awards. Bid protests could result in contract modifications or the award decision being reversed and loss of the contract award. Even where a bid protest does not result in the loss of an award, the resolution can extend the time until the contract activity can begin, and delay earnings.
If we are unable to continue to compete successfully against our current or future competitors, or prevail in protests, we may experience declines in future revenues and market share, which could, over time, have a material adverse effect on our financial position, results of operations and/or cash flows.
As a U.S. Government contractor, we and our partners are subject to various procurement and other laws and regulations applicable to our industry and we could be adversely affected by changes in such laws and regulations or any negative findings by the U.S. Government as to our compliance with them. We also may be adversely affected by changes in our customers' business practices globally.
U.S. Government contractors (including their subcontractors and others with whom they do business) must comply with many significant procurement regulations and other specific legal requirements. These regulations and other requirements, although customary in government contracts, increase our performance and compliance costs and risks and are regularly evolving. New laws, regulations or procurement requirements or changes to current ones (including, for example, regulations related to limits on recovery of employee compensation costs, counterfeit parts, specialty metals and conflict minerals) can significantly increase our costs and risks and reduce our profitability.

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We operate in a highly regulated environment and are routinely audited and reviewed by the U.S. Government and its agencies, such as the Defense Contract Audit Agency (DCAA), Defense Contract Management Agency (DCMA) and the DoD Inspector General. These agencies review performance under our contracts, our cost structure and our compliance with applicable laws, regulations and standards, as well as the adequacy of our systems and processes in meeting government requirements. Costs ultimately found to be unallowable or improperly allocated to a specific contract will not be reimbursed or must be refunded if already reimbursed. If an audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties, sanctions, forfeiture of profits or suspension or debarment. Whether or not illegal activities are alleged, the U.S. Government has the ability to decrease or withhold certain payments when it deems systems subject to its review to be inadequate, with significant financial impact. In addition, we could suffer serious reputational harm if allegations of impropriety were made against us.
Our industry has experienced, and we expect it will continue to experience, significant changes to business practices globally as a result of an increased focus on affordability, efficiencies, recovery of costs and a reprioritization of available defense funds to key areas for future defense spending. As a result of certain of these initiatives, we have experienced and may continue to experience an increased number of audits and/or a lengthened period of time required to close open audits. More recently, the thresholds for certain allowable costs in the U.S., including compensation costs, have been significantly reduced; the allowability of other types of costs are being challenged, debated and, in certain cases, modified, all with potentially significant financial costs to the company. In connection with these cost reduction initiatives, the U.S. Government is also pursuing alternatives to shift additional responsibility and performance risks to the contractor.
We (again, including our subcontractors and others with whom we do business) also are subject to and expected to perform in compliance with a vast array of federal laws, including but not limited to the Truth in Negotiations Act, the False Claims Act, the Procurement Integrity Act, CAS, FAR, the International Traffic in Arms Regulations promulgated under the Arms Export Control Act, the Close the Contractor Fraud Loophole Act and the FCPA. If we are found to have violated the law, or are found not to have acted responsibly as defined by the law, we may be subject to reductions of the value of contracts; contract modifications or termination; the withholding of payments from our customer; the loss of export privileges; the assessment of penalties, fines, or compensatory, treble or other damages; or suspension or debarment.
If we do not comply with the laws, regulations and processes to which we are subject or if customer business practices change significantly, including with respect to the thresholds for allowable costs, it could have a material adverse effect on our financial position, results of operations and/or cash flows.
Our business is subject to disruption caused by natural and/or environmental disasters that could adversely affect our profitability and our overall financial position.
We have significant operations located in regions that may be exposed to earthquakes, damaging storms and other natural disasters. Our business also may be subject to environmental disasters. Our subcontractors and suppliers are also subject to natural and environmental disasters that could affect their ability to deliver or perform under a contract. Although preventative measures may help to mitigate damage, the damage and disruption resulting from natural and environmental disasters may be significant.
Natural and environmental disasters could also disrupt our and our subcontractors’ and suppliers’ workforce and the critical industrial infrastructure needed for normal business operations.
If insurance or other risk transfer mechanisms are unavailable or insufficient to recover all costs or if we experience a significant disruption to our business due to a natural or environmental disaster, it could have a material adverse effect on our financial position, results of operations and/or cash flows.
Our insurance coverage, customer indemnifications or other liability protections may be inadequate to cover all of our significant risks or our insurers may deny coverage of or be unable to pay for material losses we incur, which could adversely affect our profitability and overall financial position.
We endeavor to obtain insurance agreements from financially solid, highly rated counterparties in established markets to cover significant risks and liabilities (including, for example, natural disasters and product liability). Not every risk or liability can be insured, and, for risks that are insurable, the policy limits and terms of coverage reasonably obtainable in the market may not be sufficient to cover all actual losses or liabilities incurred. Even if insurance coverage is available, we may not be able to obtain it at a price or on terms acceptable to us. Disputes with insurance carriers over policy terms or the insolvency of one or more of our insurers may significantly affect the amount or timing of cash flows and, if litigation over coverage terms with the insurer becomes necessary, an outcome unfavorable to us may adversely affect us.

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In some circumstances we may be entitled to certain legal protections or indemnifications from our customers through contractual provisions, laws, regulations or otherwise. However, these protections are not always available, are typically subject to certain terms or limitations and may not be sufficient to cover all losses or liabilities incurred.
If available insurance coverage, customer indemnifications and/or other legal protections are not sufficient to cover our risks or losses, it could have a material adverse effect on our financial position, results of operations and/or cash flows.
We provide products and services related to hazardous and high risk operations, which subjects us to various environmental, regulatory, financial, reputational and other risks.
We provide products and services related to hazardous and high risk operations. Among other such operations, our products and services are used in nuclear-related activities (including nuclear-powered platforms) and in support of nuclear-related operations of third parties. This subjects us to various extraordinary risks, including potential liabilities relating to nuclear-related incidents and the harmful effects on the environment and human health that may result from such nuclear-related activities, operations or incidents, as well as the storage, handling and disposal of radioactive materials. We may be subject to reputational harm and potential liabilities arising out of a nuclear incident, whether or not the cause was within our control. Under some circumstances, the U.S. Government and prime contractors provide for certain indemnification and other protection under certain of our government related contracts, including pursuant to, or in connection with, Public Law 85-804, the Price-Anderson Nuclear Industries Indemnity Act and the Terrorism Risk Insurance Reauthorization Act, for certain nuclear-related risks.
In addition, our customers may otherwise use our products and services in connection with hazardous activities, or in ways that can be unusually hazardous or risky, creating potential liabilities to our customers and/or our company as the provider of such products and services. In the event of an incident, if our customers fail to use our products properly or if our products or services do not operate as intended, we could be subject to reputational harm and potential liabilities.
If there was a nuclear incident or other nuclear-related damages, or incident or other damages related to or caused by the hazardous use of our products and services, and if indemnification or other protection was not available to cover our losses and liabilities, it could adversely affect our reputation and have a material adverse effect on our financial position, results of operations and/or cash flows.
Changes in future business conditions could cause business investments and/or recorded goodwill and other long-lived assets to become impaired, resulting in substantial losses and write-downs that would reduce our operating income.
Goodwill accounts for approximately half of our total assets. Market-based inputs to the calculations in our goodwill impairment test, such as weighted average cost of capital and terminal value (based on market comparisons) could change significantly from our current assumptions. Additionally, the carrying values of our reporting units are significantly influenced by a number of factors, particularly the discount rate used to determine our net pension liability. We continue to monitor the recoverability of the carrying value of our goodwill and other long-lived assets. Significant write-offs of goodwill or other long-lived assets could have a material adverse effect on our financial condition and/or results of operations.
Our future success depends, in part, on our ability to develop new products and new technologies and maintain technologies, facilities, equipment and a qualified workforce to win new competitions and meet the needs of our customers.
Many of the markets in which we operate are characterized by rapidly changing technologies. The product, program and service needs of our customers change and evolve regularly. Our success in the competitive defense industry depends upon our ability to develop technologically advanced, innovative and cost-effective products and services and market these products and services to our customers in the U.S. and internationally. Our success depends on our continued access to assured suppliers of important technologies and components. Our success also depends on our ability to provide the people, technologies, facilities, equipment and financial capacity needed to deliver those products and services with maximum efficiency. If we fail to maintain our competitive position, we could lose a significant amount of future business to our competitors, which would negatively impact our ability to generate favorable financial results and maintain market share.
Our operating results are heavily dependent upon our ability to attract and retain sufficient personnel with requisite skills and/or security clearances, globally. If qualified personnel become scarce or difficult to attract or retain or if we experience a high level of attrition for geographic, compensation-related or other reasons, or if such personnel

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are unable to obtain security clearances on a timely basis, we could experience higher labor, recruiting or training costs in order to attract and retain necessary employees. Failure to maintain a qualified workforce would result in significant difficulty in performing under our contracts.
Certain of our employees are covered by collective agreements. We generally have been able to renegotiate renewals to expiring agreements without significant disruption of operating activities. If we experience difficulties with renewals and renegotiations of existing collective agreements or if our employees pursue new collective representation, we could incur additional expenses and may be subject to work stoppages. Any such expenses or delays could adversely affect our programs served by employees who are covered by such agreements or representation.
If we are unable to develop new products and technologies or attract and retain a qualified workforce, we may be unable to maintain our competitive position and our future success could be adversely affected.
Many of our contracts contain performance obligations that require innovative design capabilities, are technologically complex, require state-of-the-art manufacturing expertise or are dependent upon factors not wholly within our control. Failure to meet these obligations could adversely affect our profitability and future prospects.
We design, develop and manufacture technologically advanced and innovative products and services, which are applied by our customers in a variety of environments. Problems and delays in development or delivery, or system failures, as a result of issues with respect to design, technology, intellectual property rights, labor, inability to achieve learning curve assumptions, inability to manage effectively a broad array of programs, manufacturing materials or components could prevent us from meeting requirements and create significant risk.
In addition, our products cannot be tested and proven in all situations and are otherwise subject to unforeseen problems. Examples of unforeseen problems that could negatively affect revenue and profitability include loss on launch of spacecraft, loss of aviation platforms, premature failure of products that cannot be accessed for repair or replacement, problems with design, quality and workmanship, country of origin of procured materials, delivery of subcontractor components or services and degradation of product performance. These failures could result, either directly or indirectly, in loss of life or property. Among the factors that may affect revenue and profitability could be inaccurate cost estimates, design issues, human factors, unforeseen costs and expenses not covered by insurance or indemnification from the customer, diversion of management focus in responding to unforeseen problems, loss of follow-on work, and, in the case of certain contracts, repayment to the government customer of contract cost and fee payments we previously received.
Certain contracts, primarily involving space satellite systems, contain provisions that entitle the customer to recover fees in the event of failure of the system upon launch or subsequent deployment for less than a specified period of time. Under such terms, we could be required to forfeit fees previously recognized and/or collected.
If we are unable to meet our performance obligations due to issues regarding the design, development or manufacture of our products or services, or we experience launch, platform or satellite system failures, it could have an adverse impact on our current and future business.
Unforeseen environmental costs could have an adverse effect on our financial position, results of operations and/or cash flows.
Our operations are subject to and affected by a variety of federal, state, local and foreign environmental laws and regulations. In addition, we could be affected by future laws or regulations, including those imposed in response to climate change concerns and other actions. Compliance with current and future environmental laws and regulations currently requires, and is expected to continue to require, significant operating and capital costs. We may be required to incur additional costs in excess of those anticipated as a result of, among other things, new laws and regulations, stricter enforcement of existing laws and regulations, imposition of new cleanup requirements, discovery of previously unknown or more extensive contamination, litigation involving environmental impacts or sanctions or penalties or a determination that certain environmental costs are unallowable. In addition, if other identified responsible parties are insolvent or otherwise unable to pay their share of such costs, we may be required to incur additional costs in excess of those anticipated.
Environmental laws and regulations provide for substantial fines and criminal sanctions for violations. These laws and regulations may limit our operations or require the installation of costly pollution control equipment or operational changes to limit pollution emissions or discharges and/or decrease the likelihood of accidental hazardous substance releases. We also incur, and expect to continue to incur, costs to comply with current environmental laws and regulations related to the cleanup of pollutants previously released into the environment. In addition, if we were

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NORTHROP GRUMMAN CORPORATION


found to be in violation of the Federal Clean Air Act or the Clean Water Act, the facility or facilities involved in the violation could be placed by the Environmental Protection Agency on a list maintained by the General Services Administration of facilities that generally cannot be used in performing on U.S. Government contracts until the violation is corrected.
The impact of these factors is difficult to predict, but one or more of them could have an adverse effect on our financial position, results of operations and/or cash flows.
We may be unable adequately to protect our intellectual property rights, which could affect our ability to compete.
We own many U.S. and foreign patents, trademarks, copyrights, and other forms of intellectual property, and we license certain intellectual property rights to and from third parties. The U.S. Government generally holds licenses to certain intellectual property that we develop in performance of government contracts, and it may use or authorize others to use certain such intellectual property, typically for government purposes. More recently, we believe the U.S. Government has asserted or sought to obtain more extensive rights in intellectual property. The U.S. Government's efforts could result in a decrease in our ability to control the use of certain of our intellectual property rights in a government contracting environment. Our intellectual property is also subject to challenge, invalidation, misappropriation or circumvention by third parties.
We also rely significantly upon proprietary technology, information, processes and know-how that are not protected by patents. We seek to protect this information through trade secret or confidentiality agreements with our employees, consultants, subcontractors and other parties, as well as through other measures. These agreements and other measures may not provide adequate protection for our unpatented proprietary information. In the event of an infringement of our intellectual property rights, a breach of a confidentiality agreement or divulgence of proprietary information, we may not have adequate legal remedies to maintain our intellectual property. Litigation to determine the scope of intellectual property rights, even if ultimately successful, could be costly and could divert management’s attention away from other aspects of our business. In addition, our trade secrets may otherwise become known or be independently developed by competitors. In some instances, we have licensed the proprietary intellectual property of others, but we may be unable in the future to secure the necessary licenses to use such intellectual property on commercially reasonable terms. Moreover, the laws concerning intellectual property rights vary among countries and the protection provided to our intellectual property by these laws and foreign courts may not be the same as the remedies available under U.S. law.
If we are unable adequately to control or protect our intellectual property rights against claims by our customers or others, or otherwise procure necessary intellectual property, it could have an adverse effect on our financial position, results of operations and/or cash flows.
Unanticipated changes in our tax provisions or exposure to additional tax liabilities could affect our profitability and cash flow.
We are subject to income and other taxes in the U.S. and foreign jurisdictions. Changes in applicable U.S. or foreign tax laws and regulations, or their interpretation and application, including the possibility of retroactive effect, could affect our tax expense and profitability. For example, a change in the U.S. corporate tax rate would result in a remeasurement of our net deferred tax assets through the income tax provision because our deferred tax assets are measured at the current statutory tax rate. In addition, the final determination of any tax audits or related litigation could be materially different from our historical income tax provisions and accruals. Changes in our tax provision or an increase in our tax liabilities, whether due to changes in applicable law and regulations, the interpretation or application thereof, changes in the tax rate or a final determination of tax audits or litigation, could have an adverse effect on our financial position, results of operations and/or cash flows.
The spin-off of our former Shipbuilding business may expose us to claims, liabilities and reputational harm.
In connection with the spin-off transaction, we entered into a number of agreements with HII setting forth certain rights and obligations of the parties after the separation. For example, under the Separation and Distribution Agreement, from and after the spin-off transaction, each of HII and Northrop Grumman is generally responsible for the debts, liabilities and other obligations related to the business or businesses that it owns and operates following the consummation of the spin-off. It is possible that a court would disregard the allocation agreed to between us and HII, and require that we assume responsibility for certain obligations allocated to HII (for example, tax and/or environmental liabilities), particularly if HII were to refuse or were unable to pay or perform such obligations.
In addition, third parties could seek to hold us responsible for any of the liabilities or obligations for which HII has agreed to be responsible and/or to indemnify us, directly or indirectly. The indemnity related rights we have under our agreements with HII may not be sufficient to protect us against such liabilities. Even if we ultimately succeed in

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NORTHROP GRUMMAN CORPORATION


recovering from HII or the U.S. Government any amounts for which we are held liable, we may be required to record these losses ourselves until such time as the indemnity contribution is paid. In addition, certain indemnities that we may be required to provide HII are not subject to a cap, may be significant, and could negatively impact our business.
In connection with the spin-off transaction, we received a letter ruling from the IRS and an opinion of counsel confirming that we and our shareholders would not recognize any taxable income, gain or loss for U.S. federal income tax purposes as a result of the merger, the internal reorganization or the distribution, except that our shareholders who received cash in lieu of fractional shares would recognize gain or loss with respect to such cash. Nevertheless, if the merger, the internal reorganization or the distribution were ultimately determined to be taxable for U.S. federal income tax purposes, we and our shareholders could be subject to additional income tax liabilities.
The impact of these factors is difficult to predict, but one or more of them could cause reputational harm and could have an adverse effect on our financial position, results of operations and/or cash flows.
Item 1B. Unresolved Staff Comments
None.
FORWARD-LOOKING STATEMENTS AND PROJECTIONS
This Annual Report on Form 10-K and the information we are incorporating by reference contain statements, other than statements of historical fact, that constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “expect,” “intend,” “may,” “could,” “plan,” “project,” “forecast,” “believe,” “estimate,” “outlook,” “anticipate,” “trends,” “goals” and similar expressions generally identify these forward-looking statements. Forward-looking statements include, among other things, statements relating to our future financial condition, results of operations and cash flows. Forward-looking statements are based upon assumptions, expectations, plans and projections that we believe to be reasonable when made, but which may change over time. These statements are not guarantees of future performance and inherently involve a wide range of risks and uncertainties that are difficult to predict. Specific risks that could cause actual results to differ materially from those expressed or implied in these forward-looking statements include, but are not limited to, those identified under Risk Factors in Part I, Item 1A and other important factors disclosed in this report and from time to time in our other filings with the SEC.
You are urged to consider the limitations on, and risks associated with, forward-looking statements and not unduly rely on the accuracy of forward-looking statements. These forward-looking statements speak only as of the date this report is first filed or, in the case of any document incorporated by reference, the date of that document. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law.
Item 2. Properties
At December 31, 2015, we had approximately 34 million square feet of floor space at 467 separate locations, primarily in the U.S., for manufacturing, warehousing, research and testing, administration and various other uses. At December 31, 2015, we leased to third parties approximately 250,000 square feet of our owned and leased facilities, and had vacant floor space of approximately 1 million square feet.
At December 31, 2015, we had major operations at the following locations:
Aerospace Systems
Carson, El Segundo, Manhattan Beach, Mojave, Palmdale, Redondo Beach and San Diego, CA; Melbourne and St. Augustine, FL; Devens, MA; Moss Point, MS; and Bethpage, NY.
Electronic Systems
Azusa, Sunnyvale and Woodland Hills, CA; Apopka, FL; Rolling Meadows, IL; Annapolis, Elkridge, Halethorpe, Linthicum and Sykesville, MD; Williamsville, NY; Cincinnati, OH; Salt Lake City, UT; and Charlottesville, VA. Locations outside the U.S. include France, Germany and Italy.
Information Systems
Huntsville, AL; McClellan, Redondo Beach, San Diego and San Jose, CA; Aurora and Colorado Springs, CO; Annapolis Junction, MD; Bellevue, NE; Beavercreek, OH; and Chantilly, Chester, Fairfax, Herndon, McLean and Richmond, VA.

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NORTHROP GRUMMAN CORPORATION


                        

Technical Services
Sierra Vista, AZ; Warner Robins, GA; Lake Charles, LA; and Herndon, VA.
Corporate
Falls Church and Lebanon, VA and Irving, TX.
The following is a summary of our floor space at December 31, 2015:
Square feet (in thousands)
 
Owned
 
Leased
 
U.S. Government
Owned/Leased
 
Total
Aerospace Systems
 
6,591

 
5,961

 
1,930

 
14,482

Electronic Systems
 
8,172

 
2,316

 

 
10,488

Information Systems
 
658

 
5,646

 

 
6,304

Technical Services
 
142

 
1,823

 
1

 
1,966

Corporate
 
657

 
495

 

 
1,152

Total
 
16,220

 
16,241

 
1,931

 
34,392

We maintain our properties in good operating condition and believe that the productive capacity of our properties is adequate to meet current contractual requirements and those for the foreseeable future.
Item 3. Legal Proceedings
We have provided information about certain legal proceedings in which we are involved in Note 10 to the consolidated financial statements in Part II, Item 8.
We are a party to various investigations, lawsuits, claims and other legal proceedings, including government investigations and claims, that arise in the ordinary course of our business. These types of matters could result in fines; penalties; compensatory, treble or other damages; or non-monetary relief. Government regulations also provide that certain allegations against a contractor may lead to suspension or debarment from future government contracts or suspension of export privileges for the company or one or more of its components. Suspension or debarment could have a material adverse effect on the company because of our reliance on government contracts and authorizations. The nature of legal proceedings is such that we cannot assure the outcome of any particular matter. However, based on information available to us to date and other than as noted in Note 10 to the consolidated financial statements, we do not believe that the outcome of any matter currently pending against the company is likely to have a material adverse effect on the company's consolidated financial position as of December 31, 2015, its annual results of operations and/or cash flows. For further information on the risks we face from existing and future investigations, lawsuits, claims and other legal proceedings, please see Risk Factors in Part I, Item 1A.
Item 4. Mine Safety Disclosures
No information is required in response to this item.

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NORTHROP GRUMMAN CORPORATION


                        

PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
COMMON STOCK
We have 800,000,000 shares authorized at a $1 par value per share, of which 181,303,083 shares and 198,930,240 shares were outstanding as of December 31, 2015 and 2014, respectively.
PREFERRED STOCK
We have 10,000,000 shares authorized at a $1 par value per share, of which no shares were issued and outstanding as of December 31, 2015 and 2014.
MARKET INFORMATION
Our common stock is listed on the New York Stock Exchange and trades under the symbol NOC.
The following table sets forth, for the periods indicated, the intraday high and low prices of our common stock as reported in the consolidated reporting system for the New York Stock Exchange Composite Transactions.
 
 
2015
 
2014
January to March
 
$141.58 to $172.30
 
$109.17 to $125.37
April to June
 
152.44 to 166.55
 
116.11 to 126.00
July to September
 
152.31 to 176.83
 
118.23 to 134.24
October to December
 
168.26 to 193.99
 
118.24 to 153.19
HOLDERS
The approximate number of common stockholders was 25,444 as of January 28, 2016.
DIVIDENDS
Quarterly dividends per common share for the most recent two years are as follows:
 
 
2015
 
2014
January to March
 
$
0.70

 
$
0.61

April to June
 
  
0.80

 
  
0.70

July to September
 
  
0.80

 
  
0.70

October to December
 
  
0.80

 
  
0.70

Total
 
$
3.10

 
$
2.71


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NORTHROP GRUMMAN CORPORATION


                        

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
The table below summarizes our repurchases of common stock during the three months ended December 31, 2015:
Period
Total Number
of Shares
Purchased
 
Average 
Price
Paid per
Share(1)
 
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
 
Approximate Dollar
Value of Shares that
May Yet Be
Purchased under the
Plans or Programs
($ in millions)
October 3, 2015 - October 30, 2015
647,990

 
$
175.95

 
647,990

 
$
4,444

October 31, 2015 - November 27, 2015
420,316

 
185.48

 
420,316

 
4,366

November 28, 2015 - December 31, 2015
486,407

 
187.96

 
486,407

 
4,274

Total
1,554,713

 
$
182.28

 
1,554,713

 
$
4,274

(1) 
Includes commissions paid.
Share repurchases take place from time to time, subject to market conditions and management's discretion, in the open market or in privately negotiated transactions. The company retires its common stock upon repurchase and has not made any purchases of common stock other than in connection with these publicly announced repurchase programs in the periods presented.
See Note 2 to the consolidated financial statements in Part II, Item 8 for further information on our share repurchase programs.

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NORTHROP GRUMMAN CORPORATION


                        

STOCK PERFORMANCE GRAPH
Comparison of Cumulative Five Year Total Return
Among Northrop Grumman Corporation, the S&P 500 Index,
and the S&P Aerospace & Defense Index
(1)
Assumes $100 invested at the close of business on December 31, 2010, in Northrop Grumman Corporation common stock, Standard & Poor’s (S&P) 500 Index and the S&P Aerospace & Defense Index.
(2)
The cumulative total return assumes reinvestment of dividends. In March 2011, we completed the spin-off of Huntington Ingalls Industries, Inc. (HII). Our shareholders received one share of HII common stock for every six shares of our common stock held on the record date. The effect of the spin-off is reflected in the cumulative total return as a reinvested dividend.
(3)
The S&P Aerospace & Defense Index is comprised of The Boeing Company, General Dynamics Corporation, Honeywell International Inc., L-3 Communications, Lockheed Martin Corporation, Northrop Grumman Corporation, Precision Castparts Corporation, Raytheon Company, Rockwell Collins, Inc., Textron, Inc. and United Technologies Corporation.
(4)
The total return is weighted according to market capitalization of each company at the beginning of each year.
(5)
This graph is not deemed to be filed with the U.S. Securities and Exchange Commission (SEC) or subject to the liabilities of Section 18 of the Securities and Exchange Act of 1934 (the Exchange Act), and should not be deemed to be incorporated by reference into any of our prior or subsequent filings under the Securities Act of 1933 or the Exchange Act.
Item 6. Selected Financial Data
The data presented in the following table is derived from the audited consolidated financial statements and other information. 2011 data is adjusted to reflect the effects of discontinued operations.

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NORTHROP GRUMMAN CORPORATION


                        

SELECTED FINANCIAL DATA
 
 
Year Ended December 31
$ in millions, except per share amounts
 
2015
 
2014
 
2013
 
2012
 
2011
Sales
 
 
 
 
 
 
 
 
 
 
U.S. Government(1)
 
$
19,458

 
$
20,085

 
$
21,278

 
$
22,268

 
$
23,432

International(2)
 
3,339

 
3,045

 
2,493

 
2,085

 
2,076

Other Customers(3)
 
729

 
849

 
890

 
865

 
904

Total sales
 
23,526

 
23,979

 
24,661

 
25,218

 
26,412

Operating income
 
3,076

 
3,196

 
3,123

 
3,130

 
3,276

Earnings from continuing operations
 
1,990

 
2,069

 
1,952

 
1,978

 
2,086

Basic earnings per share, from continuing operations
 
$
10.51

 
$
9.91

 
$
8.50

 
$
7.96

 
$
7.54

Diluted earnings per share, from continuing operations
 
10.39

 
9.75

 
8.35

 
7.81

 
7.41

Cash dividends declared per common share
 
3.10

 
2.71

 
2.38

 
2.15

 
1.97

Year-End Financial Position
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
24,454

 
$
26,572

 
$
26,381

 
$
26,543

 
$
25,411

Notes payable to banks and long-term debt
 
6,526

 
5,928

 
5,930

 
3,935

 
3,948

Other long-term obligations(4)
 
7,059

 
7,520

 
4,018

 
7,043

 
5,005

Financial Metrics
 
 
 
 
 
 
 
 
 
 
Net cash provided by continuing operations
 
$
2,162

 
$
2,593

 
$
2,483

 
$
2,640

 
$
2,347

Free cash flow from continuing operations(5)
 
1,691

 
2,032

 
2,119

 
2,309

 
1,855

Other Information
 
 
 
 
 
 
 
 
 
 
Company-sponsored research and development expenses
 
$
712

 
$
569

 
$
507

 
$
520

 
$
543

Total backlog
 
35,923

 
38,199

 
37,033

 
40,809

 
39,515

Square footage at year-end (in thousands)
 
34,392

 
34,264

 
34,500

 
35,053

 
37,397

Number of employees at year-end
 
65,000

 
64,300

 
65,300

 
68,100

 
72,500

(1) 
Sales to the U.S. Government include sales from contracts for which Northrop Grumman is the prime contractor, as well as those for which the company is a subcontractor and the ultimate customer is the U.S. Government. Each of the company's segments derives substantial revenue from the U.S. Government.
(2) 
International sales include foreign military sales contracted through the U.S. Government, direct commercial sales with governments outside the U.S. and commercial sales outside the U.S.  
(3) 
Sales to Other Customers include sales to U.S. state and local governments and U.S. commercial customers.  
(4) 
Other long-term obligations include pension and other post-retirement benefit plan liabilities, deferred compensation, unrecognized tax benefits, environmental liabilities and other long-term obligations.
(5) 
Free cash flow from continuing operations is a non-GAAP financial measure and is calculated as cash provided by continuing operations less capital expenditures. See Liquidity and Capital Resources – Free Cash Flow in Part II, Item 7 for more information on this measure.

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NORTHROP GRUMMAN CORPORATION


                        

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
U.S. Political and Economic Environment
The U.S. Government continues to face substantial fiscal and economic challenges, which affect funding for its discretionary and non-discretionary budgets. Part I of the Budget Control Act of 2011 (Budget Control Act) provided for a reduction in planned defense budgets by at least $487 billion over a ten year period. Part II mandated substantial additional reductions, through a process known as “sequestration,” which took effect in March 2013.
In December 2013, Congress passed the National Defense Authorization Act (NDAA). Congress also passed, and the President signed into law, the Bipartisan Budget Act of 2013, which set discretionary spending levels for fiscal year (FY) 2014 and FY 2015. The legislation provided for additional budget funding of approximately $63 billion over FY 2014 and FY 2015. The additional funding alleviated some budget cuts that would otherwise have been instituted through sequestration in FY 2014 and FY 2015.
In December 2014, Congress passed and the President signed into law the Consolidated and Further Appropriations Act of 2015, providing for federal spending levels for FY 2015 consistent with the Bipartisan Budget Act of 2013.
On November 2, 2015, the President signed into law the Bipartisan Budget Act of 2015 (the Budget Act). The Budget Act raises the debt ceiling until March 2017 and raises the sequester caps imposed by the Budget Control Act by $80 billion, split equally between defense and non-defense spending, over the next two years ($50 billion in FY 2016 and $30 billion in FY 2017).
On December 18, 2015, Congress passed and the President signed the Consolidated Appropriations Act of 2016, which provides funding for the U.S. Government for FY 2016, providing $1.1 trillion in discretionary funding for federal agencies through September 2016. The FY 2016 DoD budget approved by Congress is approximately $581 billion (including $58 billion for Overseas Contingency Operations (OCO)), which represents an approximately four percent increase relative to the DoD funding for FY 2015.
The federal budget continues to be the subject of considerable debate, which could have a significant impact 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 in Part I, Item 1A.
Operating Performance Assessment and Reporting
We manage and assess our business based on our performance on contracts and programs (typically two or more closely-related contracts). We recognize sales from our portfolio of long-term contracts primarily using the cost-to-cost method of percentage of completion accounting, but in some cases we utilize the units-of-delivery method of percentage of completion accounting. As a result, sales tend to fluctuate in concert with costs incurred across our large portfolio of contracts. Due to Federal Acquisition Regulation (FAR) rules that govern our U.S Government business and related Cost Accounting Standards (CAS), most types of costs are allocable to U.S. Government contracts. As such, we do not focus on individual cost groupings (such as manufacturing, engineering and design labor costs, subcontractor costs, material costs, overhead costs and general and administrative costs), as much as we do on total contract cost, which is the key driver of our sales and operating income.
In evaluating our operating performance, we look primarily at changes in sales and operating income, including the effects of meaningful changes in operating income as a result of changes in contract estimates. Where applicable, significant fluctuations in operating performance attributable to individual contracts or programs, or changes in a specific cost element across multiple contracts, are described in our analysis. Based on this approach and the nature of our operations, the discussion below of results of operations first focuses on our four segments before distinguishing between products and services. Changes in sales are generally described in terms of volume, deliveries or other indicators of sales activity, and contract mix. For purposes of this discussion, volume generally refers to increases or decreases in sales or cost from production/service activity levels or delivery rates. Performance generally refers to changes in estimates-at-completion (EACs) for contract operating margin rates during the period (net EAC adjustments), as well as the continuing effect of prior net EAC adjustments.

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NORTHROP GRUMMAN CORPORATION


                        

CONSOLIDATED OPERATING RESULTS
Selected financial highlights are presented in the table below:
 
Year Ended December 31
 
% Change in
$ in millions, except per share amounts
2015
 
2014
 
2013
 
2015

2014
Sales
$
23,526

 
$
23,979

 
$
24,661

 
(2
)%
 
(3
)%
Operating costs and expenses
20,450

 
20,783

 
21,538

 
(2
)%
 
(4
)%
Operating income
3,076

 
3,196

 
3,123

 
(4
)%
 
2
 %
Operating margin rate
13.1
%
 
13.3
%
 
12.7
%
 
 
 
 
Federal and foreign income tax expense
800

 
868

 
911

 
(8
)%
 
(5
)%
Effective income tax rate
28.7
%
 
29.6
%
 
31.8
%
 
 
 
 
Net earnings
1,990

 
2,069

 
1,952

 
(4
)%
 
6
 %
Diluted earnings per share
10.39

 
9.75

 
8.35

 
7
 %
 
17
 %
Net cash provided by operating activities
$
2,162

 
$
2,593

 
$
2,483

 
(17
)%
 
4
 %
Sales
2015 Sales decreased $453 million, or 2 percent, as compared with 2014, primarily due to lower sales on U.S. Government contracts at Aerospace Systems and Information Systems, partially offset by an increase in international sales at Aerospace Systems.
2014Sales decreased $682 million, or 3 percent, as compared with 2013, primarily due to lower sales on U.S. Government contracts, partially offset by an increase in international sales across the company.
See “Revenue Recognition” in Note 1 to the consolidated financial statements in Part II, Item 8 for further information on sales by customer category.
See Segment Operating Results below for further information by segment and the Product and Service Analysis section that follows Segment Operating Results for product and service detail.
Operating Costs and Expenses
Operating costs and expenses primarily comprise labor, material, subcontractor and overhead costs, and are generally allocated to contracts as incurred. In accordance with industry practice and the regulations that govern cost accounting requirements for government contracts, most general management and corporate expenses incurred at the segment and corporate locations are considered allowable and allocable costs. Allowable and allocable general and administrative costs, including independent research and development (IR&D) and certain bid and proposal costs, are allocated on a systematic basis to contracts in progress.
Operating costs and expenses comprise the following:
 
Year Ended December 31
 
% Change in
$ in millions
2015
 
2014
 
2013
 
2015
 
2014
Product costs
$
10,333

 
$
10,431

 
$
10,623

 
(1
)%
 
(2
)%
Service costs
7,551

 
7,947

 
8,659

 
(5
)%
 
(8
)%
General and administrative expenses
2,566

 
2,405

 
2,256

 
7
 %
 
7
 %
Operating costs and expenses
$
20,450

 
$
20,783

 
$
21,538

 
(2
)%
 
(4
)%
Operating costs and expenses as a % of sales
86.9
%
 
86.7
%
 
87.3
%
 
 
 
 
2015 Operating costs and expenses as a percentage of sales increased in 2015 as compared with 2014, which reduced our operating margin rate to 13.1 percent from 13.3 percent in the prior year period. The increase in operating costs and expenses as a percentage of sales was driven by $179 million of lower segment operating income, as described in the Segment Operating Results section below, and $21 million in higher unallocated corporate expenses, partially offset by a $79 million increase in our net FAS (GAAP Financial Accounting Standards)/CAS pension adjustment. For further information regarding net FAS/CAS pension adjustment and unallocated corporate expenses, see Note 3 to the consolidated financial statements in Part II, Item 8.
2014Operating costs and expenses as a percentage of sales declined in 2014 as compared with 2013, which increased our operating margin rate to 13.3 percent from 12.7 percent in the prior year period. The reduction in

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NORTHROP GRUMMAN CORPORATION


                        

operating costs and expenses as a percentage of sales was driven by a $101 million increase in our net FAS/CAS pension adjustment and $19 million of higher segment operating income, partially offset by $50 million in higher unallocated corporate expenses.
2015General and administrative expenses as a percentage of sales increased to 10.9 percent in 2015 from 10.0 percent in 2014, principally due to an increase in IR&D as we continue to invest in future business opportunities.
2014 General and administrative expenses as a percentage of sales increased to 10.0 percent in 2014 from 9.1 percent in 2013, principally due to an increase in IR&D as we continue to invest in future business opportunities.
For further information regarding product and service sales and costs, see the Product and Service Analysis section that follows Segment Operating Results.
Operating Income and Margin Rate
We define operating income as sales less operating costs and expenses, which includes general and administrative expenses. Operating margin rate is defined as operating income as a percentage of sales.
2015Operating income decreased $120 million, or 4 percent, as compared with 2014, and operating margin rate decreased to 13.1 percent from 13.3 percent in 2014, primarily due to the lower sales volume described above and the absence in 2015 of a $75 million benefit realized in 2014 in connection with agreements reached with the U.S. Government to settle certain claims relating to use of the company's intellectual property and a terminated program.
2014 – Operating income increased $73 million, or 2 percent, as compared with 2013, and operating margin rate increased to 13.3 percent from 12.7 percent in 2013, primarily due to a $101 million increase in our net FAS/CAS pension adjustment and higher operating income at Aerospace Systems due to the settlements described above, partially offset by higher unallocated corporate expenses and lower operating margin rates at Electronic Systems.
Federal and Foreign Income Taxes
2015 – Our effective tax rate for 2015 was 28.7 percent, as compared with 29.6 percent in 2014. This reduction was driven by a $76 million increase in research credits primarily resulting from additional credits claimed on our prior year tax returns, partially offset by a $51 million benefit recorded in 2014 for the partial resolution of the Internal Revenue Service (IRS) examination of our 2007-2009 tax returns.
2014 – Our effective tax rate for 2014 was 29.6 percent, as compared with 31.8 percent in 2013. The decline in the company's lower effective tax rate for 2014 reflects a $51 million benefit for the partial resolution of our 2007-2009 IRS examination.
Net Earnings
2015 – Net earnings for 2015 decreased $79 million, or 4 percent, as compared with 2014, primarily due to lower operating income and higher interest expense, partially offset by the lower effective tax rate described above.
2014 – Net earnings for 2014 increased $117 million, or 6 percent, as compared with 2013, primarily due to higher operating income and a lower effective tax rate, partially offset by higher interest expense.
Diluted Earnings Per Share
2015 – Diluted earnings per share for 2015 increased $0.64, or 7 percent, as compared with 2014. The increase is primarily due to a 10 percent reduction in weighted-average diluted shares outstanding resulting from shares repurchased in 2014 and 2015, partially offset by the 4 percent decline in net earnings discussed above.
2014 – Diluted earnings per share for 2014 increased $1.40, or 17 percent, as compared with 2013. The increase is primarily due to a 9 percent reduction in weighted-average diluted shares outstanding resulting from shares repurchased in 2013 and 2014 and the 6 percent increase in net earnings discussed above.
Net Cash Provided by Operating Activities
See “Operating Cash Flow” in the Liquidity and Capital Resources section below for further information on net cash provided by operating activities.
SEGMENT OPERATING RESULTS
Basis of Presentation
At December 31, 2015, the company was aligned in four segments: Aerospace Systems, Electronic Systems, Information Systems and Technical Services. For a more complete description of each segment’s products and services and for further information, see Business in Part I, Item 1.
This section discusses segment sales, operating income and operating margin rates. A reconciliation of segment sales to total sales is provided in Note 3 to the consolidated financial statements in Part II, Item 8. A reconciliation of

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NORTHROP GRUMMAN CORPORATION


                        

segment operating income to total operating income, as well as a discussion of the reconciling items, is provided in Note 3 to the consolidated financial statements in Part II, Item 8. For purposes of the discussion in this Segment Operating Results section, references to operating income and operating margin rate reflect segment operating income and segment operating margin rate.
Segment Operating Income and Margin Rate
Segment operating income, as reconciled in the Reconciliation of Segment Operating Income to Total Operating Income table below, is a non-GAAP measure and is used by management as an internal measure for financial performance of our operating segments. Segment operating income reflects total earnings from our four segments, including allocated pension expense recognized under CAS, and excludes unallocated corporate items, including FAS pension expense.
 
Year Ended December 31
 
% Change in
$ in millions
2015
 
2014
 
2013
 
2015
 
2014
Segment operating income
$
2,920

 
$
3,099

 
$
3,080

 
(6
)%
 
1
%
Segment operating margin rate
12.4
%
 
12.9
%
 
12.5
%
 
 
 
 
2015 - Segment operating income for 2015 decreased $179 million, or 6 percent, as compared with 2014 and segment operating margin rate decreased to 12.4 percent from 12.9 percent in 2014. The decrease in segment operating income was principally due to lower sales volume and the absence in 2015 of the $75 million in settlements described above and a benefit of approximately $45 million from lower 2014 CAS costs due to passage of the Highway and Transportation Funding Act of 2014 (HATFA). The absence in 2015 of the noted settlements and HATFA benefits was the primary driver of the lower 2015 operating margin rate.
2014 - Segment operating income for 2014 increased $19 million, or 1 percent, as compared with 2013 and segment operating margin rate increased to 12.9 percent from 12.5 percent in 2013. The increase in segment operating income and margin rate was principally due to the benefits recognized as a result of the settlements and the HATFA legislation described above. These increases more than offset the impact of lower sales volume.
Net EAC Adjustments - We record changes in estimated contract operating margin at completion (net EAC adjustments) using the cumulative catch-up method of accounting. In aggregate, net EAC adjustments can have a significant effect on reported sales and operating income and are presented in the table below:
 
Year Ended December 31
$ in millions
2015
 
2014
 
2013
Favorable EAC adjustments
$
924

 
$
922

 
$
1,044

Unfavorable EAC adjustments
(344
)
 
(258
)
 
(291
)
Net EAC adjustments
$
580

 
$
664

 
$
753

Net EAC adjustments by segment are presented in the table below:
 
Year Ended December 31
$ in millions
2015
 
2014
 
2013
Aerospace Systems
$
358

 
$
372

 
$
394

Electronic Systems
140

 
207

 
312

Information Systems
57

 
73

 
49

Technical Services
39

 
44

 
43

Eliminations
(14
)
 
(32
)
 
(45
)
Net EAC adjustments
$
580

 
$
664

 
$
753


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NORTHROP GRUMMAN CORPORATION


                        

Reconciliation of Segment Operating Income to Total Operating Income - The table below reconciles segment operating income to total operating income by including the impact of net FAS/CAS pension adjustments, as well as certain corporate-level expenses, which are not considered allowable or allocable under applicable CAS or FAR (unallocated corporate expenses). See Note 3 to the consolidated financial statements in Part II, Item 8 for further information on the net FAS/CAS pension adjustment and unallocated corporate expenses.
 
Year Ended December 31
 
% Change in
$ in millions
2015
 
2014
 
2013
 
2015
 
2014
Segment operating income
$
2,920

 
$
3,099

 
$
3,080

 
(6
)%
 
1
 %
     CAS pension expense
703

 
384

 
542

 
83
 %
 
(29
)%
     Less: FAS pension expense
(355
)
 
(115
)
 
(374
)
 
209
 %
 
(69
)%
Net FAS/CAS pension adjustment
348

 
269

 
168

 
29
 %
 
60
 %
Unallocated corporate expenses
(190
)
 
(169
)
 
(119
)
 
12
 %
 
42
 %
Other
(2
)
 
(3
)
 
(6
)
 
(33
)%
 
(50
)%
Total operating income
$
3,076

 
$
3,196

 
$
3,123

 
(4
)%
 
2
 %
Aerospace Systems
 
Year Ended December 31
 
% Change in
$ in millions
2015
 
2014
 
2013
 
2015
 
2014
Sales
$
10,004

 
$
9,997

 
$
10,014

 
 %
 
 %
Operating income
1,220

 
1,315

 
1,215

 
(7
)%
 
8
 %
Operating margin rate
12.2
%
 
13.2
%
 
12.1
%
 
 
 
 
2015 - Aerospace Systems sales for 2015 were comparable to the prior year. Sales in 2014 included the $75 million in settlements described above. Excluding the settlements, sales for 2015 increased $82 million, or 1 percent, as compared to 2014. The increase in unmanned systems (UMS) sales reflects higher volume on a number of programs, including Global Hawk. These increases were partially offset by lower volume on the Fire Scout and NATO Alliance Ground Surveillance (AGS) programs. Military aircraft systems (MAS) sales increased principally due to the transition to full rate production on the E-2D Advanced Hawkeye program, increased deliveries on the F-35 program and higher volume on the Joint Surveillance Target Attack Radar System (JSTARS) program. These increases were partially offset by lower volume on the F/A-18 program due to fewer deliveries as the program ramps down. Space sales include higher volume on restricted programs, partially offset by lower volume on the Advanced Extremely High Frequency (AEHF) program.
Operating income for 2015 decreased $95 million, or 7 percent, and operating margin rate decreased to 12.2 percent from 13.2 percent. Lower operating income and margin rate in 2015 were primarily due to the benefits recognized in 2014 associated with the settlements described above.
2014 - Aerospace Systems sales for 2014 were comparable to 2013, and include the impact of the settlements described in the Segment Operating Income and Margin Rate section above. Excluding the settlements, Aerospace Systems had lower sales on UMS, space and MAS programs. The decrease in UMS programs reflects declines of $136 million on Global Hawk due to lower production activity and $111 million on Fire Scout as a result of lower development activity. These declines were partially offset by $135 million of higher volume on the NATO AGS program. The decrease in space programs was mainly due to lower volume on the James Webb Space Telescope and AEHF programs. The decrease in MAS programs was primarily the result of lower volume on the JSTARS, F-35 and B-2 programs, partially offset by higher volume of $87 million on the E-2D Advanced Hawkeye program.
Operating income for 2014 increased $100 million, or 8 percent, and operating margin rate increased to 13.2 percent, from 12.1 percent. Higher operating income and margin rate in 2014 were primarily due to the settlements described above and improved performance.

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NORTHROP GRUMMAN CORPORATION


                        

Electronic Systems
 
Year Ended December 31
 
% Change in
$ in millions
2015
 
2014
 
2013
 
2015
 
2014
Sales
$
6,842

 
$
6,951

 
$
7,149

 
(2
)%
 
(3
)%
Operating income
1,068

 
1,148

 
1,226

 
(7
)%
 
(6
)%
Operating margin rate
15.6
%
 
16.5
%
 
17.1
%
 
 
 
 
2015 - Electronic Systems sales for 2015 decreased $109 million, or 2 percent, as compared with 2014. The decrease was primarily due to lower volume on Airborne Intelligence, Surveillance, and Reconnaissance & Targeting (AISR&T) Systems and Land & Self Protection Systems (L&SPS), partially offset by higher volume on Navigation & Maritime Systems (N&MS) programs. AISR&T sales decreased primarily due to lower volume on the LITENING program. The decline in L&SPS is due to in-theater force reductions and ramp-down on an international program, partially offset by increased deliveries on infrared countermeasures (IRCM) programs and ramp-up on the G/ATOR program. The increase in N&MS sales reflects higher volume from ramp-up activities on a number of marine and undersea systems programs.
Operating income for 2015 decreased $80 million, or 7 percent, and operating margin rate decreased to 15.6 percent from 16.5 percent. Operating income and margin rate for 2015 decreased primarily due to business mix changes, which resulted in lower volume for mature fixed price production programs and higher volume for cost-type development programs, and less favorable performance on AISR&T and L&SPS programs.
2014 - Electronic Systems sales for 2014 decreased $198 million, or 3 percent, as compared with 2013. Lower sales are principally due to lower volume for L&SPS programs, including lower deliveries of $174 million on IRCM and laser systems; lower volume for U.S. intelligence, surveillance, reconnaissance and targeting programs, including $93 million of lower deliveries on combat avionics; and $109 million of lower volume for N&MS programs. The declines were partially offset by higher sales of $178 million on international programs.
Operating income for 2014 decreased $78 million, or 6 percent, and operating margin rate decreased to 16.5 percent from 17.1 percent. Operating income and margin rate for 2014 declined primarily due to a reduction in net EAC adjustments, lower volume and the absence in 2014 of the benefit from the reversal of a $26 million non-programmatic risk reserve in 2013.
Information Systems
 
Year Ended December 31
 
% Change in
$ in millions
2015
 
2014
 
2013
 
2015
 
2014
Sales
$
5,894

 
$
6,222

 
$
6,596

 
(5
)%
 
(6
)%
Operating income
616

 
611

 
633

 
1
 %
 
(3
)%
Operating margin rate
10.5
%
 
9.8
%
 
9.6
%
 
 
 
 
2015 - Information Systems sales for 2015 decreased $328 million, or 5 percent, as compared with 2014. The decrease is primarily driven by lower volume on Command and Control (C2) and civil programs. The decrease in C2 is mainly driven by lower volume on the Consolidated Afloat Network and Enterprise Services program, the impact of in-theater force reductions, and completion of the Ground Combat Vehicle contract. The decrease in civil is primarily due to the restructuring of the Emergency Communications Transformation Program Stage II contract.
Operating income for 2015 increased $5 million, or 1 percent, and operating margin rate increased to 10.5 percent from 9.8 percent. The increase in operating income and margin rate reflects improved performance, partially offset by the decline in sales volume described above.
2014 - Information Systems sales for 2014 decreased $374 million, or 6 percent, as compared with 2013. Sales principally declined as a result of lower volume of $294 million on C2 programs and $62 million on communications programs due to in-theater force reductions, reduced funding levels and the wind-down of various programs.
Operating income for 2014 decreased $22 million, or 3 percent, and operating margin rate increased to 9.8 percent from 9.6 percent. The lower operating income is primarily a result of the lower sales described above. The higher operating margin rate reflects additional operating income resulting from improved performance.

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NORTHROP GRUMMAN CORPORATION


                        

Technical Services
 
Year Ended December 31
 
% Change in
$ in millions
2015
 
2014
 
2013
 
2015
 
2014
Sales
$
2,838

 
$
2,799

 
$
2,843

 
1
 %
 
(2
)%
Operating income
254

 
261

 
262

 
(3
)%
 
 %
Operating margin rate
8.9
%
 
9.3
%
 
9.2
%
 
 
 
 
2015 - Technical Services sales for 2015 increased $39 million, or 1 percent, as compared with 2014. The increase was principally due to higher volume on mission solutions and readiness (MS&R) programs, partially offset by lower volume on integrated logistics and modernization (IL&M) programs. The increase in MS&R was primarily due to higher volume on the Saudi Arabian Ministry of National Guard Training Support program (through our interest in a joint venture for which we consolidate the financial results). The decrease in IL&M was mainly due to ramp-down activities on the InterContinental Ballistic Missile (ICBM) program, partially offset by increased volume on the JSTARS and Hunter programs.
Operating income for 2015 decreased $7 million, or 3 percent, and operating margin rate decreased to 8.9 percent from 9.3 percent. The declines in both operating income and operating margin rate were principally due to lower income from an unconsolidated joint venture than in the prior year period.
2014 - Technical Services sales for 2014 decreased $44 million, or 2 percent, as compared with 2013. The decrease was primarily due to lower volume on the ICBM, Hunter and Combined Tactical Training Range programs, which were partially offset by growth in international sales, principally as a result of the acquisition of Qantas Defence Services Pty Limited (QDS) in the first quarter of 2014.
Operating income and margin rate for 2014 were comparable to 2013.
PRODUCT AND SERVICE ANALYSIS
The following table presents product and service sales and operating costs and expenses by segment:
 
 
Year Ended December 31
$ in millions
 
2015
 
2014
 
2013
Segment Information:
 
Sales
 
Operating Costs and Expenses
 
Sales
 
Operating Costs and Expenses
 
Sales
 
Operating Costs and Expenses
Aerospace Systems
 
 
 
 
 
 
 
 
 
 
 
 
Product
 
$
8,001

 
$
7,037

 
$
7,986

 
$
6,897

 
$
8,210

 
$
7,197

Service
 
2,003

 
1,747

 
2,011

 
1,785

 
1,804

 
1,602

Electronic Systems
 
 
 
 
 
 
 
 
 
 
 
 
Product
 
5,530

 
4,706

 
5,532

 
4,622

 
5,574

 
4,612

Service
 
1,312

 
1,068

 
1,419

 
1,181

 
1,575

 
1,311

Information Systems
 
 
 
 
 
 
 
 
 
 
 
 
Product
 
1,282

 
1,157

 
1,335

 
1,244

 
990

 
895

Service
 
4,612

 
4,121

 
4,887

 
4,367

 
5,606

 
5,068

Technical Services
 
 
 
 
 
 
 
 
 
 
 
 
Product
 
222

 
210

 
184

 
173

 
210

 
191

Service
 
2,616

 
2,374

 
2,615

 
2,365

 
2,633

 
2,390

Segment Totals
 
 
 
 
 
 
 
 
 
 
 
 
Total Product
 
$
15,035

 
 $
13,110

 
$
15,037

 
$
12,936

 
$
14,984

 
$
12,895

Total Service
 
10,543

 
9,310

 
10,932

 
9,698

 
11,618

 
10,371

Intersegment eliminations
 
(2,052
)
 
(1,814
)
 
(1,990
)
 
(1,754
)
 
(1,941
)
 
(1,685
)
Total Segment(1)
 
$
23,526

 
$
20,606

 
$
23,979

 
$
20,880

 
$
24,661

 
$
21,581

(1) 
The reconciliation of segment operating income to total operating income, as well as a discussion of the reconciling items, is included in the Segment Operating Results section above.

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NORTHROP GRUMMAN CORPORATION


                        

Product Sales and Product Costs
2015 - Product sales for 2015 were comparable with 2014. Sales in 2014 included the $75 million in settlements at Aerospace Systems as described above and sales in 2015 reflect lower product sales at Information Systems and higher product sales at Technical Services. The decrease at Information Systems was primarily due to lower product sales on certain cyber programs, partially offset by higher F-35 volume. The increase at Technical Services was primarily due to higher volume on intercompany restricted work.
Product costs for 2015 increased $174 million, or 1 percent, as compared to 2014. The increase was primarily due to higher product costs at Aerospace Systems and Electronic Systems due to lower performance and changes in business mix. These increases were partially offset by a reduction in product costs at Information Systems due to lower sales and improved performance.
2014 - Product sales for 2014 were slightly higher than 2013, primarily due to higher product sales at Information Systems, offset by lower product sales at Aerospace Systems. The increase at Information Systems was primarily due to higher product sales on certain restricted and C2 programs. The decrease at Aerospace Systems was primarily driven by lower product volume in unmanned and space programs, partially offset by the settlements described in the Segment Operating Results section above.
Product costs for 2014 were slightly higher than 2013, primarily due to higher product costs at Information Systems, offset by lower product costs at Aerospace Systems, consistent with the changes in product sales described above.
Service Sales and Service Costs
2015 - Service sales for 2015 decreased $389 million, or 4 percent, as compared with 2014. The decrease was primarily due to lower service sales at Information Systems and Electronic Systems. The decrease at Information Systems was primarily due to lower volume on C2 and civil programs, including the impact of in-theater force reductions. The decrease at Electronic Systems was primarily due to lower service sales on certain tactical sensor and other programs.
Service costs for 2015 decreased $388 million, or 4 percent, as compared with 2014, consistent with the change in service sales described above.
2014 - Service sales for 2014 decreased $686 million, or 6 percent, as compared with 2013. The decrease was primarily driven by lower service sales at Information Systems, principally from reduced volume on restricted work and the impacts of in-theater force reductions as described in the Segment Operating Results section above.
Service costs for 2014 decreased $673 million, or 6 percent, as compared with 2013, consistent with the change in service sales described above.
BACKLOG
Total backlog includes both funded backlog (firm orders for which funding is authorized and appropriated) and unfunded backlog. 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. For multi-year service contracts with non-U.S. Government customers having no stated contract values, backlog includes only the amounts committed by the customer. Backlog is converted into sales as costs are incurred or deliveries are made.
Backlog consisted of the following at December 31, 2015 and 2014:
 
 
2015
 
2014
 
 
$ in millions
 
Funded
 
Unfunded
 
Total
Backlog
 
Total
Backlog
 
% Change in 2015
Aerospace Systems
 
$
8,218

 
$
9,381

 
$
17,599

 
$
20,063

 
(12
)%
Electronic Systems
 
7,323

 
2,342

 
9,665

 
9,715

 
(1
)%
Information Systems
 
2,857

 
3,115

 
5,972

 
6,115

 
(2
)%
Technical Services
 
2,355

 
332

 
2,687

 
2,306

 
17
 %
Total backlog
 
$
20,753

 
$
15,170

 
$
35,923

 
$
38,199

 
(6
)%
The percentage of total backlog from the U.S. Government, International, and Other Customers at December 31, 2015 totaled 81 percent, 16 percent, and 3 percent, respectively.

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NORTHROP GRUMMAN CORPORATION


                        

New Awards
2015 - The estimated value of contract awards recorded during 2015 was $21.3 billion. Significant new awards during 2015 include $1.8 billion for the F-35 program, $1.1 billion for the E-2D Advanced Hawkeye program, $947 million for the Saudi Arabian Ministry of National Guard Training Support program (through our interest in a joint venture for which we consolidate the financial results), $597 million for the B-2 program and $504 million for the F/A-18 program.
On October 27, 2015, the U.S. Air Force announced it was awarding us a contract for Engineering and
Manufacturing Development and early production for the Long Range Strike Bomber (LRS-B). In November 2015, the unsuccessful offeror filed a protest asking the U.S. Government Accountability Office (GAO) to review the decision to award the company the LRS-B contract, triggering an automatic stay of performance of the contract. As a result, the LRS-B award is not included in 2015 new awards or backlog.
2014 - The estimated value of contract awards recorded during 2014 was $25.0 billion. Significant new awards during 2014 include $4.1 billion for the E-2D Advanced Hawkeye program, $1.4 billion for the Global Hawk program, $1.3 billion for the F-35 program, $727 million for the B-2 program, and $560 million for the Virginia Class Submarine program.
LIQUIDITY AND CAPITAL RESOURCES
We endeavor to ensure the most efficient conversion of operating income into cash for deployment in our business and to maximize shareholder value. In addition to our cash position, we use various financial measures to assist in capital deployment decision-making, including cash provided by operating activities, free cash flow, and net debt-to-equity and net debt-to-capital ratios. We believe these measures are useful to investors in assessing our financial performance and condition.
Cash balances and cash generated from operating activities, supplemented by borrowings under credit facilities and/or in the capital markets, if needed, are expected to be sufficient to fund our operations for at least the next 12 months.
Operating Cash Flow
The table below summarizes the key components of cash flow provided by operating activities:
 
 
Year Ended December 31
$ in millions
 
2015
 
2014
 
2013
Net earnings
 
$
1,990

 
$
2,069

 
$
1,952

Non-cash items(1)
 
1,035

 
731

 
724

Changes in assets and liabilities:
 
 
 
 
 
 
Trade working capital
 
(564
)
 
(121
)
 
54

Retiree benefits
 
(263
)
 
(17
)
 
(281
)
Other, net
 
(36
)
 
(69
)
 
34

Net cash provided by operating activities
 
$
2,162

 
$
2,593

 
$
2,483

(1) 
Includes depreciation and amortization, stock based compensation expense (including related excess tax benefits) and deferred income taxes
2015 – Net cash provided by operating activities for 2015 decreased by $431 million, or 17 percent, as compared with 2014, principally due to changes in trade working capital and a $500 million voluntary pre-tax pension contribution made in March 2015, partially offset by lower net tax payments.
2014 – Net cash provided by operating activities for 2014 increased by $110 million, or 4 percent, as compared with 2013, principally due to a $500 million voluntary pre-tax pension contribution made in April 2013, partially offset by changes in trade working capital during 2014.
As of December 31, 2015, the amount of cash, cash equivalents and marketable securities held outside of the U.S. by foreign subsidiaries was $551 million. We intend to permanently reinvest these balances and expect future U.S. cash generation will be sufficient to meet future U.S. cash needs. Capital expenditure commitments were $393 million at December 31, 2015, and are expected to be paid with cash on hand.

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NORTHROP GRUMMAN CORPORATION


                        

Free Cash Flow
We define free cash flow as cash provided by operating activities less capital expenditures. We believe free cash flow is a useful measure for investors to consider as it represents cash flow the company has available after capital spending to invest for future growth, strengthen the balance sheet and/or return to shareholders through dividends and share repurchases. Free cash flow is a key factor in our planning for and consideration of strategic acquisitions, payment of dividends and stock repurchases.
Free cash flow is not a measure of financial performance under GAAP, and may not be defined and calculated by other companies in the same manner. This measure should not be considered in isolation, as a measure of residual cash flow available for discretionary purposes, or as an alternative to operating results presented in accordance with GAAP as indicators of performance.
The table below reconciles cash provided by operating activities to free cash flow:
 
 
Year Ended December 31
 
% Change in
$ in millions
 
2015
 
2014
 
2013
 
2015
 
2014
Net cash provided by operating activities
 
$
2,162

 
$
2,593

 
$
2,483

 
(17
)%
 
4
 %
Less: Capital expenditures
 
(471
)
 
(561
)
 
(364
)
 
(16
)%
 
54
 %
Free cash flow
 
$
1,691

 
$
2,032

 
$
2,119

 
(17
)%
 
(4
)%
2015 Free cash flow for 2015 decreased $341 million, or 17 percent, as compared with 2014. The decrease was principally driven by the lower net cash provided by operating activities described above, partially offset by a reduction in capital expenditures.
2014 Free cash flow for 2014 decreased $87 million, or 4 percent, as compared with 2013. The decrease was principally driven by higher capital expenditures associated with our Aerospace Systems' Centers of Excellence, partially offset by an increase in net cash provided by operating activities, as described above.
Investing Cash Flow
2015 - Cash used in investing activities for 2015 decreased $214 million, or 33 percent, as compared with 2014. The decrease was principally due to lower capital expenditures and the 2014 acquisition of QDS.
2014 - Cash used in investing activities for 2014 increased $299 million, or 86 percent, as compared with 2013. The increase was principally due to higher capital expenditures associated with our Aerospace Systems’ Centers of Excellence, as well as the acquisition of QDS.
Financing Cash Flow
2015 - Net cash used in financing activities during 2015 was comparable with the prior year period and reflects an increase in share repurchases and dividends offset by $600 million of net proceeds from our issuance of unsecured senior notes in 2015.
2014 - Cash used in financing activities for 2014 increased $2.4 billion, or 281 percent, as compared with 2013. The increase was primarily due to the absence in 2014 of $2.8 billion of net proceeds from our issuance of unsecured senior notes, of which $850 million was used for the redemption of existing debt in 2013, as well as increased share repurchases in 2014.
Credit Facility and Unsecured Senior Notes - See Note 9 to the consolidated financial statements in Part II, Item 8 for further information on our credit facility and unsecured senior notes.
Financial Arrangements - See Note 11 to the consolidated financial statements in Part II, Item 8 for further information on our use of standby letters of credit and guarantees.

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NORTHROP GRUMMAN CORPORATION


                        

Other Sources of Capital - We believe we can obtain additional capital, if necessary for long-term liquidity, from such sources as the public or private capital markets, the sale of assets, sale and leaseback of operating assets, and leasing rather than purchasing new assets. We have an effective shelf registration statement on file with the SEC, which allows us to access capital in a timely manner.
Share Repurchases - In October 2015, the company completed its previously announced goal of repurchasing 60 million shares of common stock by the end of 2015. See Note 2 of the consolidated financial statements in Part II, Item 8 for further information on our share repurchase programs.
Contractual Obligations
The following table presents our contractual obligations as of December 31, 2015, and the estimated timing of future cash payments:
$ in millions
 
Total
 
2016
 
2017- 2018
 
2019- 2020
 
2021 and beyond
Long-term debt
 
$
6,523

 
$
110

 
$
1,056

 
$
535

 
$
4,822

Interest payments on long-term debt
 
4,114

 
298

 
573

 
503

 
2,740

Operating leases
 
839

 
251

 
336

 
160

 
92

Purchase obligations(1)
 
8,318

 
4,495

 
2,231

 
1,507

 
85

Other long-term liabilities(2)
 
1,044

 
269

 
327

 
143

 
305

Total contractual obligations
 
$
20,838

 
$
5,423

 
$
4,523

 
$
2,848

 
$
8,044

 
(1) 
A “purchase obligation” is defined as an agreement to purchase goods or services that is enforceable and legally binding on us and that specifies all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum, or variable price provisions; and the approximate timing of the transaction. These amounts are primarily comprised of open purchase order commitments to suppliers and subcontractors pertaining to funded contracts.
(2) 
Other long-term liabilities, including their current portions, primarily consist of total accrued environmental reserves, deferred compensation and other miscellaneous liabilities, of which $113 million is related to environmental reserves recorded in other current liabilities. It excludes obligations for uncertain tax positions of $246 million, as the timing of such payments, if any, cannot be reasonably estimated.
The table above excludes estimated minimum funding requirements for retirement and other post-retirement benefit plans, as set forth by the Employee Retirement Income Security Act, as amended (ERISA). For further information about future minimum contributions for these plans, see Note 12 to the consolidated financial statements in Part II, Item 8. Further details regarding long-term debt and operating leases can be found in Notes 9 and 11, respectively, to the consolidated financial statements in Part II, Item 8.
CRITICAL ACCOUNTING POLICIES, ESTIMATES, AND JUDGMENTS
Our consolidated financial statements are based on the application of U.S. GAAP, which require us to make estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements and the accompanying notes. We employ judgment in making our estimates in consideration of historical experience, currently available information and various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from our estimates and assumptions, and any such differences could be material to our consolidated financial statements. We believe the following accounting policies are critical to the understanding of our consolidated financial statements and require the use of significant management judgment in their application. For a summary of our significant accounting policies, see Note 1 to the consolidated financial statements in Part II, Item 8.
Revenue Recognition
Due to the long-term nature of our contracts, we generally recognize revenue using the percentage-of-completion method of accounting as work on our contracts progresses, which requires us to make reasonably dependable estimates for the design, manufacture and delivery of our products and services. In accounting for these contracts, we utilize either the cost-to-cost or the units-of-delivery method of percentage-of-completion accounting, with cost-to-cost being the predominant method.
Sales may include estimated amounts not contractually agreed to by the customer, including cost or performance incentives (such as award and incentive fees), un-priced change orders, claims and requests for equitable adjustment. Amounts pertaining to cost and/or performance incentives are included in estimated contract sales when they are reasonably estimable.

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NORTHROP GRUMMAN CORPORATION


                        

Our cost estimation process is based on the professional knowledge of our engineering, program management and financial professionals, and draws on their significant experience and judgment. We prepare EACs for our contracts and calculate an estimated contract operating margin based on estimated contract sales and cost. Since contract costs are typically incurred over a period of several years, estimation of these costs requires the use of judgment. Factors considered in estimating the cost of the work to be completed include 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 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. Changes in estimates of contract sales and cost are frequent. 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. 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 risks affecting contract costs, performance issues with our subcontractors or suppliers, changes in indirect cost allocations, such as overhead and general and administrative expenses, and changes in estimated award and incentive fees. EACs are also adjusted to reflect estimated risks related to contract performance. These risks typically include technical, schedule and performance risk based on our evaluation of the contract effort. Similarly, the changes in estimates may include identified opportunities for operating margin improvement.
For the impacts of changes in estimates on our consolidated statement of earnings and comprehensive income (loss), see the Consolidating Operating Results section above and Note 1 to the consolidated financial statements in Part II, Item 8.
Retirement Benefits
Overview – The determination of projected benefit obligations and the fair value of plan assets for our pension and other post-retirement plans requires the use of several actuarial assumptions. We perform an annual review of these assumptions in consultation with our outside actuaries. As we determine changes in the assumptions are warranted, or as a result of plan amendments, future pension and other post-retirement benefit expense and our projected benefit obligation could increase or decrease. The principal 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 mortality rate of those covered by our pension and other post-retirement benefit plans.
Discount Rate – The discount rate represents the interest rate that is used to determine the present value of future cash flows currently expected to be required to settle our pension and other post-retirement benefit obligations. The discount rate is generally based on the yield of high-quality corporate fixed-income investments. At the end of each year, we determine the discount rate using a portfolio of bonds matching the notional cash outflows related to projected benefit payments for each significant benefit plan. Taking into consideration the factors noted above, our weighted-average composite pension discount rate was 4.53 percent at December 31, 2015, and 4.12 percent at December 31, 2014.
The effects of a hypothetical change in the discount rate may be nonlinear and asymmetrical for future years as the discount rate changes and the accounting corridor is applied. The accounting corridor is a defined range within which amortization of net gains and losses is not required and is equal to 10 percent of the greater of plan assets or benefit obligations. Holding all other assumptions constant, an increase or decrease of 25 basis points in the December 31, 2015 discount rate assumption would have the following estimated effects on 2015 pension and other post-retirement benefit obligations and 2016 expected pension and other post-retirement expense:
$ increase/(decrease) in millions
25 Basis Point Decrease in Rate
 
25 Basis Point Increase in Rate
Pension expense
$
97

 
$
(93
)
Other post-retirement benefit expense
1

 
(1
)
Pension obligation
982

 
(931
)
Other post-retirement benefit obligation
58

 
(56
)

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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. Interest is credited monthly using the 30-Year Treasury bond rate. The interest crediting rate is part of the cash balance formula and independent of actual pension investment earnings. The cash balance crediting rate tends to move in concert with the discount rate but has an offsetting effect on pension benefit obligations and pension expense in comparison to the discount rate. Although current 30-Year Treasury bond rates are near historically low levels, we expect such bond rates to rise in the future. The cash balance crediting rate assumption has been set to its current level of 3.0 percent as of December 31, 2015, growing to 3.75 percent by 2021. Holding all other assumptions constant, an increase or decrease of 25 basis points in the December 31, 2015 cash balance crediting rate assumption would have the following estimated effects on 2015 pension benefit obligations and 2016 expected pension expense:
$ increase/(decrease) in millions
25 Basis Point Decrease in Rate
 
25 Basis Point Increase in Rate
Pension expense
$
(25
)
 
$
27

Pension obligation
(122
)
 
128

Expected Long-Term Rate of Return on Plan Assets – The expected long-term rate of return on plan assets represents the average rate of earnings expected on funds invested. Through consultation with our investment management team and outside investment advisers, management develops expected long-term returns for each of the plans’ strategic asset classes. In addition to our historical investment performance, we consider several factors, including current market data such as yields/price-earnings ratios, historical market returns over long periods and periodic surveys of investment managers’ expectations. Using policy target allocation percentages and the asset class expected returns, we calculate a weighted-average expected return.
The assumptions used for pension benefits are consistent with those used for other post-retirement benefits. The long-term rate of return on plan assets used for medical and life benefits is reduced to allow for the impact of tax on expected returns as the earnings of certain Voluntary Employee Beneficiary Association (VEBA) trusts are taxable, unlike the pension trust.
For 2015 and 2014, we assumed an expected long-term rate of return on pension plan assets of 8.0 percent and assumed an expected long-term rate of return on other post-retirement benefit plan assets of 7.58 percent and 7.45 percent, respectively. For 2016, we have assumed an expected long-term rate of return on plan assets of 8.0 percent on pension plans and 7.70 percent on other post-retirement benefit plans. Holding all other assumptions constant, an increase or decrease of 25 basis points in the December 31, 2015 expected long-term rate of return on plan asset assumption would have the following estimated effects on 2016 pension and other post-retirement benefit expense:
$ increase/(decrease) in millions
25 Basis Point Decrease
 
25 Basis Point Increase
Pension expense
$
58

 
$
(58
)
Other post-retirement benefit expense
3

 
(3
)
Estimated Fair Market Value of Plan Assets – For certain plan assets where the fair market value is not readily determinable, such as real estate, private equity and hedge funds, estimates of fair value are determined using the best information available. Estimated fair values on these plan assets are based on redemption values and net asset values, as well as valuation methodologies that include third party appraisals, comparable transactions, discounted cash flow valuation models and public market data.
Mortality Rate – Mortality assumptions are used to estimate life expectancies of plan participants. In October 2014, the Society of Actuaries issued updated mortality tables and a mortality improvement scale, which reflect longer life expectancies than previously projected. In October 2015, the SOA issued an updated mortality improvement scale which further refined the previous scale based on additional data and which generally contained lower mortality improvement projections. In consideration of this information, we studied our historical mortality experience and developed an expectation for continued future mortality improvements. Based on this data, we updated the mortality assumptions used in calculating our pension and post-retirement benefit obligations recognized at December 31, 2015, and the amounts estimated for our 2016 pension and post-retirement benefit expense.

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NORTHROP GRUMMAN CORPORATION


                        

For further information regarding our pension and post-retirement benefits, see Risk Factors in Part I, Item 1A and Note 12 to the consolidated financial statements in Part II, Item 8.
Litigation, Commitments and Contingencies
We are subject to a range of claims, investigations, lawsuits, overhead cost claims, environmental matters, income tax matters and administrative proceedings that arise in the ordinary course of business. Estimating liabilities and costs associated with these matters requires judgment based upon the professional knowledge and experience of management and counsel. 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 likely to occur; they do not necessarily reflect what management believes should occur. The ultimate resolution of any such exposure to us may vary materially from earlier estimates as further facts and circumstances develop or become known to us.
Environmental Matters - We are subject to environmental laws and regulations in the jurisdictions in which we do or have done business. Factors that could result in changes to the assessment of probability, range of estimated costs and environmental accruals include: modification of planned remedial actions, changes in the estimated time required to conduct remedial actions, discovery of more or less extensive (or different) contamination than anticipated, information regarding the potential causes of contamination, results of efforts to involve other responsible parties, financial capabilities of other responsible parties, changes in laws and regulations or contractual obligations affecting remediation requirements or other obligations, and improvements in remediation technology.
For further information on litigation, commitments and contingencies, see Risk Factors in Part I, Item 1A, and Note 1, Note 10 and Note 11 to the consolidated financial statements in Part II, Item 8.
Goodwill
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. Such fair value assessments require judgments and estimates that can be affected by contract performance and other factors over time, which may cause final amounts to differ materially from original estimates. Adjustments to the fair value of purchased assets and liabilities after the initial measurement period are recognized in net earnings.
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, 2015 and 2014, respectively, indicated that the estimated fair value of each reporting unit substantially exceeded its respective carrying value. There were no impairment charges recorded in the years ended December 31, 2015, 2014 and 2013.
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 during an interim period. 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.
When testing goodwill for impairment, we compare the fair values of each of our reporting units to their respective carrying values. To determine the fair value of our reporting units, we primarily use the income approach based on the cash flows that the reporting unit expects to generate in the future, consistent with our operating plans. This income valuation method requires management to project sales, operating expenses, working capital, capital spending and cash flows for the reporting units over a multi-year period, as well as to determine the weighted-average cost of capital (WACC) used as a discount rate and terminal value assumptions. The WACC takes into account the relative weights of each component of our consolidated capital structure (equity and debt) and represents the expected cost of new capital adjusted as appropriate to consider lower risk profiles associated with longer-term contracts and barriers to market entry. 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.
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, differences in assumptions may have a material effect on the results of our impairment analysis.

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NORTHROP GRUMMAN CORPORATION


                        

OTHER MATTERS
Off-Balance Sheet Arrangements
As of December 31, 2015, we had no significant off-balance sheet arrangements other than operating leases. For a description of our operating leases, see Note 11 to the consolidated financial statements in Part II, Item 8.

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NORTHROP GRUMMAN CORPORATION


                        

Item 7A. Quantitative and Qualitative Disclosures about Market Risk
EQUITY RISK
We are exposed to market risk with respect to our portfolio of trading and available-for-sale marketable securities with a fair value of $310 million at December 31, 2015. These securities are exposed to market volatilities, changes in price and interest rates.
INTEREST RATE RISK
We are exposed to interest rate risk on variable-rate short-term credit facilities for which there were no borrowings outstanding at December 31, 2015. At December 31, 2015, we have $6.5 billion of long-term debt, primarily consisting of fixed-rate debt, with a fair value of approximately $6.9 billion. The terms of our fixed-rate debt obligations do not generally allow investors to demand payment of these obligations prior to maturity. Therefore, we do not have significant exposure to interest rate risk for our fixed-rate debt; however, we do have exposure to fair value risk if we repurchase or exchange long-term debt prior to maturity.
FOREIGN CURRENCY RISK
We are exposed to foreign currency risk with respect to our international operations. We enter into foreign currency forward contracts to manage a portion of the exchange rate risk related to receipts from customers and payments to suppliers denominated in foreign currencies. We do not hold or issue derivative financial instruments for trading purposes. At December 31, 2015, foreign currency forward contracts with a notional amount of $141 million were outstanding. At December 31, 2015, a 10 percent unfavorable foreign exchange rate movement would not have a material impact on our consolidated financial position, annual results of operations and/or cash flows.
INFLATION RISK
We have generally been able to anticipate increases in costs when pricing our contracts. Bids for longer-term firm fixed-price contracts typically include assumptions for labor and other cost escalations in amounts that historically have been sufficient to cover cost increases over the period of performance.


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Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Northrop Grumman Corporation
Falls Church, Virginia
We have audited the accompanying consolidated statements of financial position of Northrop Grumman Corporation and subsidiaries (the “Company”) as of December 31, 2015 and 2014, and the related consolidated statements of earnings and comprehensive income (loss), changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Northrop Grumman Corporation and subsidiaries at December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2015, based on the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 1, 2016 expressed an unqualified opinion on the Company’s internal control over financial reporting.

/s/
Deloitte & Touche LLP
 
McLean, Virginia
 
February 1, 2016


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NORTHROP GRUMMAN CORPORATION


                        

CONSOLIDATED STATEMENTS OF EARNINGS AND COMPREHENSIVE INCOME (LOSS)
 
 
 
Year Ended December 31
$ in millions, except per share amounts
 
2015
 
2014
 
2013
Sales
 
 
 
 
 
 
Product
 
$
13,966

 
$
14,015

 
$
14,033

Service
 
9,560

 
9,964

 
10,628

Total sales
 
23,526

 
23,979

 
24,661

Operating costs and expenses
 
 
 
 
 
 
Product
 
10,333

 
10,431

 
10,623

Service
 
7,551

 
7,947

 
8,659

General and administrative expenses
 
2,566

 
2,405

 
2,256

Operating income
 
3,076

 
3,196

 
3,123

Other (expense) income
 
 
 
 
 
 
Interest expense
 
(301
)
 
(282
)
 
(257
)
Other, net
 
15

 
23

 
(3
)
Earnings before income taxes
 
2,790

 
2,937

 
2,863

Federal and foreign income tax expense
 
800

 
868

 
911

Net earnings
 
$
1,990

 
$
2,069

 
$
1,952

 
 
 
 
 
 
 
Basic earnings per share
 
$
10.51

 
$
9.91

 
$
8.50

Weighted-average common shares outstanding, in millions
 
189.4

 
208.8

 
229.6

Diluted earnings per share
 
$
10.39

 
$
9.75

 
$
8.35

Weighted-average diluted shares outstanding, in millions
 
191.6

 
212.1

 
233.9

 
 
 
 
 
 
 
Net earnings (from above)
 
$
1,990

 
$
2,069

 
$
1,952

Other comprehensive income (loss)
 
 
 
 
 
 
Change in unamortized benefit plan costs, net of tax (expense) benefit of ($45) in 2015, $1,423 in 2014 and ($1,177) in 2013
 
75

 
(2,316
)
 
1,790

Change in cumulative translation adjustment
 
(41
)
 
(59
)
 
14

Other, net
 
2

 
3

 
(1
)
Other comprehensive income (loss), net of tax
 
36

 
(2,372
)
 
1,803

Comprehensive income (loss)
 
$
2,026

 
$
(303
)
 
$
3,755

The accompanying notes are an integral part of these consolidated financial statements.


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NORTHROP GRUMMAN CORPORATION


                        

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION 
 
 
December 31
$ in millions
 
2015
 
2014
Assets
 
 
 
 
Cash and cash equivalents
 
$
2,319

 
$
3,863

Accounts receivable, net
 
2,841

 
2,806

Inventoried costs, net
 
807

 
742

Prepaid expenses and other current assets
 
367

 
369

Total current assets
 
6,334

 
7,780

Property, plant and equipment, net of accumulated depreciation of $4,849 in 2015 and $4,611 in 2014
 
3,064

 
2,991

Goodwill
 
12,460

 
12,466

Deferred tax assets
 
1,409

 
2,026

Other non-current assets
 
1,187

 
1,309

Total assets
 
$
24,454

 
$
26,572

 
 
 
 
 
Liabilities
 
 
 
 
Trade accounts payable
 
$
1,282

 
$
1,305

Accrued employee compensation