Backlog

Total contractual backlog for Military Aircraft and Missile Systems was $21.1 billion at December 31, 2002, $17.6 billion at December 31, 2001 and $17.1 billion at December 31, 2000. Military Aircraft and Missiles Systems contractual backlog increased by 20% in 2002 compared to 2001. The increase in 2002 compared to 2001 is primarily attributed to the capture of several key international awards including the Korean F-15 Eagle contract and the Italian 767 Tanker contract. Backlog also increased due to rate increases on several domestic programs in low rate initial production including V-22 Osprey and the F/A-22 Raptor. The C-17 Globemaster program maintained consistent backlog as new orders replaced sales on the existing production contracts. The program is well positioned for continued sales well into this decade. The F/A-18E/F Super Hornet program backlog increased moderately as the customer continues to increase production rate. The JDAM program backlog also increased moderately with additional orders from both the Navy and Air Force. Aerospace Support orders continued to increase this past year.

Business Environment and Trends

Overview The U.S. Department of Defense (DoD), represents nearly 50% of the world’s defense budget, and remains the principal customer of the Military Aircraft and Missile Systems business unit. Several trends are emerging that are shaping customer behavior in this market. U.S. military force structure is shrinking, its platforms are aging, and the tempo of operations and engagements worldwide remains high. The United States’ current military activity demonstrates the value of systems solutions that allow all systems to communicate with each other, to operate over longer ranges, are unmanned and provide the advantages of precision, persistence and selective engagement. These factors are driving the U.S. DoD, along with militaries worldwide, to focus on ways to transform their forces and the way they operate.

Military Transformation The transformation in forces is evidenced by a trend toward smaller, but more capable and more technologically advanced force structures. The transformation in acquisition is evidenced by an increasing trend toward spiral development programs, cooperative international development programs and a demonstrated willingness to explore new forms of acquisition and ownership including the lease of military support aircraft.

Institutions and events continue to shape the defense industrial environment. From an institutional perspective, the establishment of the Homeland Defense and U.S. Northern Command are creating new organizations with responsibilities for national airspace control, coastal protection and civil support. The creation of the U.S. Strategic Command is consolidating responsibilities for global strike, integrated missile defense, information operations, command, control, communications and computers, and intelligence, surveillance and reconnaisance into a single organization. Events like Operation Enduring Freedom and the continuing war on global terrorism reaffirms the need for the rapid projection of decisive combat power around the world and emphasizes the need for new capabilities and solutions for the warfighter. Toward that end, the DoD is fully committed to a transformation that will achieve and maintain advantages through changes in operational concepts, organizational structure and technologies that significantly improve warfighting capabilities.

Competitive environment The global competitive environment continues to intensify, with increased focus on the U.S. defense market, the world’s largest and most attractive. Military Aircraft and Missile Systems faces strong competition in all market segments, primarily from Lockheed Martin, Raytheon, EADS and Northrop Grumman. The financial problems plaguing some domestic industry competitors appear to be resolved, enabling them to acquire new assets and compete more vigorously. EADS continues to strategically build a presence in the U.S. market through building its North American operations and by partnering with U.S. defense companies.

Continued industry consolidation and market concentration was marked by the acquisition of TRW by Northrop Grumman. Northrop’s position in the UAV, space, systems integration, and strike markets has been strengthened. However, all prime contractors continue to partner or serve as major suppliers to each other on various programs. At the lower tiers, consolidation persists and select companies have been positioning for larger roles, especially in the Aerospace Support market.

In addition to leveraging its internal resources and capabilities, the Company is creating a competitive advantage by developing global strategic relationships to provide superior value for its customers, both in the U.S. and abroad.

Summary Events like nuclear proliferation in North Korea, Operation Enduring Freedom and the continued war on terrorism, highlight the fact that our National Security goals are not rhetorical. There is an immediate and a durable need to maintain strong U.S. defense capabilities covering a very broad spectrum of threats and responses. Near-term DoD budgets have increased, and longer-range forecasts expect DoD budgets to grow faster than anticipated prior to September 11, 2001. However, with a softening global economy and anticipated federal budget tensions, allocations to DoD procurement are unlikely to increase significantly. This suggests that the DoD will continue to focus on affordability strategies emphasizing network- centric operations, long range strike, unmanned air combat and reconnaissance vehicles, precision guided weapons and continued privatization of logistics and support activities as a means to improve overall effectiveness while maintaining control over costs. The Company’s capabilities and programs are well suited to provide the military capabilities essential to meet the challenges facing our nation.