Stock Compensation Plans (Unaudited)

6 Months Ended

Jun. 30, 2011

STOCK COMPENSATION PLANS [Abstract]

13. STOCK COMPENSATION PLANS

13.   STOCK COMPENSATION PLANS

On May 18, 2011, the shareholders of the company approved the company’s 2011 Long Term Incentive Stock Plan (2011 Plan), which replaced the expired 2001 Long-Term Incentive Stock Plan (2001 Plan). At June 30, 2011, Northrop Grumman had stock-based compensation awards outstanding under the 2001 Plan, which is applicable to employees, as well as under the 1993 Stock Plan for Non-Employee Directors and 1995 Stock Plan for Non-Employee Directors, as amended (Directors Plans). At June 30, 2011, no stock-based compensation awards had yet been issued under the new 2011 Plan. Each of these plans was approved by the company’s shareholders. In addition, as a result of prior acquisitions there are other stock-based compensation awards outstanding. Share-based awards authorized under these employee plans include stock options, stock appreciation rights, stock bonuses, restricted stock, restricted stock units, performance shares and similar rights to purchase or acquire shares.

Under the 2011 Plan, the company is authorized to issue or transfer shares of common stock pursuant to any of the types of awards mentioned above. At June 30, 2011, the aggregate number of shares that may be issued or transferred pursuant to awards under the 2011 Plan is 45.6 million shares, including 6.5 million shares from the 2001 Plan that were previously authorized and available to be issued at the date the 2001 Plan expired. In addition, in the event that outstanding awards under the 2001 plan expire or terminate without being exercised or paid, as the case may be, such shares (the Forfeited Shares) will become available for award under the 2011 Plan. Shares issued under the 2011 Plan other than for stock options, stock appreciation rights and the Forfeited Shares will be counted against the 2011 Plan’s aggregate share limit as 4.5 shares for every one share actually issued in connection with the award; any shares issued for stock options, stock appreciation rights and the Forfeited Shares will be counted against the remaining shares on a one for one basis. The 2011 Plan will also continue to provide equity-based award grants to non-employee directors once the existing share limits of the Directors Plans have been reached.

Shipbuilding Spin-off Adjustments – As a result of the spin-off of Shipbuilding, effective March 31, 2011, all outstanding stock-based compensation awards related to HII employees and retirees were assumed by HII. Also effective with the spin-off, the share amounts for all remaining Northrop Grumman outstanding stock options and stock awards, and the strike price for stock options were adjusted to maintain the aggregate intrinsic value of the grants at the date of the spin-off pursuant to the terms of the company’s applicable stock-based compensation plans. Taking into account the change in the value of the company’s common stock as a result of the distribution of the HII shares to the company’s shareholders, the conversion ratio for the stock options and stock awards was 1.09. For stock options, the net effect of these adjustments resulted in an increase to the stock options outstanding due to the limited number of stock options applicable to and assumed by HII for Shipbuilding employees. For stock awards, the net effect was a decrease in stock awards outstanding as the number of shares assumed by HII for Shipbuilding employees exceeded the impact of the adjustment to the remaining Northrop Grumman employees. The Shipbuilding spin-off adjustments are reflected in the stock option and stock award tables below.

Compensation Expense

Total pre-tax stock-based compensation expense for the six months ended June 30, 2011, and 2010, was $64 million and $69 million, respectively, of which $7 million and $18 million related to stock options and $57 million and $51 million related to stock awards, respectively. Tax benefits recognized in the condensed consolidated statements of operations for stock-based compensation during the six months ended June 30, 2011, and 2010, were $26 million and $27 million, respectively. In addition, the company realized tax benefits of $15 million and $11 million from the exercise of stock options and $32 million and $34 million from the issuance of stock awards in the six months ended June 30, 2011, and 2010, respectively. As a result of the spin-off of HII described in Note 5, stock-based compensation for HII employees of $3 million and $7 million has been recorded in discontinued operations for the six months ended June 30, 2011 and 2010, respectively.

At June 30, 2011, there was $216 million of unrecognized compensation expense related to unvested awards granted under the company’s stock-based compensation plans, of which $20 million relate to stock options and $196 million relate to stock awards. These amounts are expected to be charged to expense over a weighted-average period of 1.5 years.

Stock Options

The fair value of each of the company’s stock option awards is estimated on the date of grant using a Black-Scholes option pricing model that uses the assumptions noted in the table below. The dividend yield represents the current annual dividend yield at the time stock options are awarded. Expected volatility is based on an average of (1) historical volatility of the company’s stock and (2) implied volatility from traded options on the company’s stock. The risk-free rate for periods within the contractual life of the stock option award is based on the yield curve of a zero-coupon U.S. Treasury bond on the date the award is granted with a maturity equal to the expected term of the award. The company uses historical data to estimate future forfeitures. The expected term of awards granted is derived from historical experience under the company’s stock-based compensation plans and represents the period of time that awards granted are expected to be outstanding. The fair value of the company’s stock option awards is expensed on a straight-line basis over the vesting period of the options, which is generally three to four years.

The significant weighted-average assumptions relating to the valuation of the company’s stock options granted during the six months ended June 30, 2011, and 2010, were as follows:

	2011			2010
Dividend yield		2.7	%		2.9	%
Volatility rate		25	%		25	%
Risk-free interest rate		2.4	%		2.3	%
Expected option life (years)		6			6

The company grants stock options primarily to executives, and the expected term of six years is based on these employees’ exercise behavior. In 2009, the company granted stock options to non-executives and assigned an expected term of five years for valuing these stock options. The company believes that this stratification of expected terms best represents future expected exercise behavior between the two employee groups. The shorter expected life of non-executive employee stock options had an insignificant effect on the weighted average expected option life for the six months ended June 30, 2011, and 2010.

Using the Black-Scholes option pricing model, the weighted-average grant date fair value of stock options granted during the six months ended June 30, 2011, and 2010, was $14 and $11 per share, respectively.

Stock option activity for the six months ended June 30, 2011, was as follows:

	Shares			Weighted-		Weighted-Average		Aggregate
	under Option			Average		Remaining		Intrinsic Value
	(in thousands)			Exercise Price		Contractual Term		($ in millions)
Outstanding at January 1, 2011		13,221		$	55		3.8 years	$	149
Granted		805			63
Exercised		(1,988	)		45
Canceled and forfeited		(43	)		49
Shipbuilding spin-off adjustments		150			59
Outstanding at June 30, 2011		12,145		$	53		3.7 years	$	220
Vested and expected to vest in the future at June 30, 2011		12,025		$	53		3.7 years	$	218
Exercisable at June 30, 2011		9,337		$	52		3.1 years	$	176

The total intrinsic value of stock options exercised during the six months ended June 30, 2011, and 2010, was $38 million and $28 million, respectively. Intrinsic value is measured as the excess of the fair market value at the date of exercise (for stock options exercised) or at June 30, 2011 (for outstanding options), over the applicable exercise price.

Stock Awards

Compensation expense for stock awards is measured at the grant date based on fair value and recognized over the vesting period, generally three years. The fair value of performance-based stock awards is determined based on the closing market price of the company’s common stock on the grant date. For purposes of measuring compensation expense for performance-based stock awards, the amount of shares ultimately expected to vest is estimated at each reporting date based on management’s expectations regarding the relevant performance criteria. The fair value of market-based stock awards is determined at the grant date using a Monte Carlo simulation model.

Stock award activity for the six months ended June 30, 2011, was as follows:

	Stock			Weighted-Average		Weighted-Average
	Awards			Grant Date		Remaining
	(in thousands)			Fair Value		Contractual Term
Outstanding at January 1, 2011		4,300		$	53		1.5 years
Granted		1,617			63
Vested		(54	)		65
Forfeited		(220	)		49
ShipBuilding spin-off adjustments		(252	)		47
Outstanding at June 30, 2011		5,391		$	53		1.5 years

There were 2.2 million stock awards granted in the six months ended June 30, 2010, with a weighted-average grant date fair value of $60 per share. During the six months ended June 30, 2011 and 2010, the company issued 1.4 million and 1.3 million shares, respectively, to employees in settlement of prior year stock awards that became fully vested, which had total fair values at issuance of $87 million and $76 million, respectively, and grant date fair values of $101 million and $91 million, respectively. The differences between the fair values at issuance and the grant date fair values reflect the effects of performance adjustments (described above) and changes in the fair market value of the company’s common stock.