Stock Compensation Plans and Other Compensation Arrangements

12 Months Ended

Dec. 31, 2011

STOCK COMPENSATION PLANS AND OTHER COMPENSATION ARRANGEMENTS [Abstract]

17. STOCK COMPENSATION PLANS AND OTHER COMPENSATION ARRANGEMENTS

17. STOCK COMPENSATION PLANS AND OTHER COMPENSATION ARRANGEMENTS

Stock Compensation Plans

At December 31, 2011, Northrop Grumman had stock-based compensation awards outstanding under the following plans: the 2001 Long-Term Incentive Stock Plan (2001 Plan) and the 2011 Long-Term Incentive Stock Plan (2011 Plan), both applicable to employees, and the 1993 Stock Plan for Non-Employee Directors (1993 SPND) and 1995 Stock Plan for Non-Employee Directors (1995 SPND) as amended. In addition, as a result of prior acquisitions there are other stock-based compensation awards outstanding. All of these plans were approved by the company’s shareholders. The company has historically issued new shares to satisfy award grants.

Employee Plans – On May 18, 2011, the shareholders of the company approved the company’s new 2011 Plan, which replaced the expired 2001 Plan. The 2011 Plan permit grants to key employees of three general types of stock incentive awards: stock options, stock appreciation rights (SARs), and stock awards. Each stock option grant is made with an exercise price either at the closing price of the stock on the date of grant (market options) or at a premium over the closing price of the stock on the date of grant (premium options). Outstanding stock options granted prior to 2008 generally vest in 25 percent increments over four years from the grant date, and grants outstanding expire ten years after the grant date. Stock options granted after January 1, 2008 vest in 33 percent increments over three years from the grant date and grants outstanding expire seven years after the grant date. No SARs have been granted under either the plans. Stock awards, in the form of restricted performance stock rights and restricted stock rights, are granted to key employees without payment to the company. The 2011 Plan also provides equity-based award grants to non-employee directors.

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. The 2011 Plan authorized 39.1 million new shares plus 6.9 million shares from the 2001 LTISP that were previously authorized and available to be issued at the date the 2001 Plan expired. Under the terms of the 2011 Plan, 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.

Recipients of restricted performance stock rights earn shares of stock, based on financial metrics determined by the board of directors in accordance with the plan. For grants prior to 2010, if the objectives have not been met at the end of the applicable performance period, up to 100 percent of the original grant for members of the Corporate Policy Council (consisting of the CEO and certain other leadership positions) and up to 70 percent of the original grant for all other recipients will be forfeited. In 2010 and 2011, all recipients could forfeit up to 100 percent of the original grant, and all recipients could earn up to 200 percent of the original grant. Restricted performance stock rights and restricted stock rights issued under either plan generally vest after three or four years. Termination of employment can result in forfeiture of some or all of the benefits extended. 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.

As of December 31, 2011, 46 million shares are available for grant under the 2011 Plan.

Non-Employee Plans – Under the 1993 SPND, at least half of the retainer fee earned by each director must be deferred into a stock unit account (Automatic Stock Units). Effective January 1, 2010, the amended SPND provides that the Automatic Stock Units be awarded at the conclusion of board service or as specified by the director. If a director has less than 5 years of service, the stock units are awarded at the conclusion of board service. In addition, directors may defer payment of all or part of the remaining retainer fee and other annual committee fees, which are placed in a stock unit account (Elective Stock Units). The Elective Stock Units are awarded at the conclusion of board service or as specified by the director, regardless of years of service. Directors are credited with dividend equivalents in connection with the stock units until the shares are awarded. The 1995 SPND provided for annual stock option grants, and effective June 1, 2005, no new grants have been issued from this plan. Each grant of stock options under the 1995 SPND was made at the closing market price on the date of the grant, was immediately exercisable, and expires ten years after the grant date. The 1995 SPND was amended in May 2007 to permit payment of the stock unit portion of the retainer fee described above. The director plans reached their existing share limits during second quarter of 2011. Since all directors are eligible to receive awards under the 2011 LTISP, shares from this plan are available for future director awards following the same share counting limits as described for the employee plans.

Shipbuilding Spin-off Adjustments – As a result of the spin-off of Shipbuilding described in Note 6, 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 remaining stock options and stock awards was 1.0938. 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 stock-based compensation for the years ended December 31, 2011, 2010, and 2009, was $139 million, $134 million, and $101 million, respectively, of which $14 million, $27 million, and $20 million related to stock options and $125 million, $107 million, and $81 million, related to stock awards, respectively. Tax benefits recognized in the consolidated statements of operations for stock-based compensation during the years ended December 31, 2011, 2010, and 2009, were $55 million, $53 million, and $40 million, respectively. In addition, the company realized tax benefits of $18 million from the exercise of stock options and $37 million from the issuance of stock awards in 2011. As a result of the spin-off of HII described in Note 6, of the total stock-based compensation for the years ended December 31, 2011, 2010, and 2009, amounts recorded in discontinued operations are $3 million, $16 million, and $11 million, respectively.

At December 31, 2011, there was $144 million of unrecognized compensation expense related to unvested awards granted under the company’s stock-based compensation plans, of which $14 million relates to stock options and $130 million relates to stock awards. These amounts are expected to be charged to expense over a weighted-average period of 1.4 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. 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 for the years ended December 31, 2011, 2010, and 2009, were as follows:

	2011			2010			2009
Dividend yield		2.8	%		2.9	%		3.6%
Volatility rate		25	%		25	%		25%
Risk-free interest rate		2.3	%		2.2	%		1.7%
Expected option life (years)		6			6			5-6

The company generally grants stock options exclusively to executives, and the expected term of six years is based on these employees’ exercise behavior. In 2009, the company granted options to non-executives and assigned an expected term of five years for valuing these options. The company believes that this stratification of expected terms best represents future expected exercise behavior between the two employee groups.

Using the Black-Scholes option pricing model, the weighted-average grant date fair value of stock options granted during the years ended December 31, 2011, 2010, and 2009, was $12, $11, and $7, per share, respectively.

Stock option activity for the year ended December 31, 2011, was as follows:

							Weighted-
				Weighted-			Average		Aggregate
	Shares			Average			Remaining		Intrinsic
	under Option			Exercise			Contractual		Value
	(in thousands)			Price			Term		($ in millions)
Outstanding at January 1, 2011		13,221			$	55		3.8 years		$	149
Granted		848				63
Exercised		(2,384	)			44
Canceled and forfeited		(91	)			55
Shipbuilding spin-off adjustments		150				59
Outstanding at December 31, 2011		11,744			$	53		3.4 years		$	93
Vested and expected to vest in the future at December 31, 2011		11,716			$	53		3.4 years		$	93
Exercisable at December 31, 2011		8,974			$	53		2.8 years		$	79

The total intrinsic value of options exercised during the years ended December 31, 2011, 2010, and 2009, was $46 million, $42 million, and $11 million, respectively. Intrinsic value is measured using the fair market value at the date of exercise (for options exercised) or at December 31, 2011 (for outstanding options), less 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 stock awards and performance stock awards is determined based on the closing market price of the company’s common stock on the grant date. The fair value of market-based stock awards is determined at the grant date using a Monte Carlo simulation model. For purposes of measuring compensation expense for performance awards, the number of shares ultimately expected to vest is estimated at each reporting date based on management’s expectations regarding the relevant performance criteria.

Stock award activity for the years ended December 31, 2011, 2010, and 2009, is presented in the table below. Vested awards include stock awards fully vested during the year and net adjustments to reflect the final performance measure for issued shares.

							Weighted-
				Weighted-			Average
	Stock			Average			Remaining
	Awards			Grant Date			Contractual
	(in thousands)			Fair Value			Term
Outstanding at January 1, 2009		3,276			$	75		1.4 years
Granted		2,356				45
Vested		(1,645	)			71
Forfeited		(329	)			66
Outstanding at December 31, 2009		3,658			$	58		1.6 years
Granted		2,317				60
Vested		(1,319	)			79
Forfeited		(356	)			56
Outstanding at December 31, 2010		4,300			$	53		1.5 years
Granted		1,748				63
Vested		(1,824	)			42
Forfeited		(350	)			50
Shipbuilding spin-off adjustments		(252	)			47
Outstanding at December 31, 2011		3,622			$	58		1.6 years

The company issued 1.4 million, 1.3 million, and 2.5 million shares to employees in settlement of prior year stock awards that were fully vested, which had total fair values at issuance of $87 million, $76 million, and $111 million and grant date fair values of $101 million, $91 million, and $161 million during the years ended December 31, 2011, 2010, and 2009, respectively. The differences between the fair values at issuance and the grant date fair values reflect the effects of the performance adjustments and changes in the fair market value of the company’s common stock.

In 2012, the company expects to issue to employees 2.8 million shares of common stock from the 2009 stock award grant that vested as of December 31, 2011, with a grant date fair value of $115 million. The ultimate amount of shares to be paid out is subject to approval by the Compensation Committee of the Board of Directors and may vary from this estimate.

Cash Performance Units

Cash performance units are cash units, which are paid in cash based on the achievement of long-term financial goals at the end of a three-year period. If objectives are not met at the end of the applicable performance period, the entire grant may be forfeited. However if objectives are exceeded, up to 200 percent of the original grant may ultimately be paid out. Each unit has an initial value equal to the company’s stock price on the date of grant. For purposes of measuring compensation expense, the amount ultimately expected to be paid out is estimated at each reporting date based on management’s expectations regarding the applicable performance criteria. At December 31, 2011, there was $133 million of unrecognized compensation expense related to cash performance units.