UPDATE 3-Rockwell Collins profit drops on weak defense sales

* Earnings of $1.32/share before items beat $1.12 estimate

* Says wins commercial contract but cannot reveal customer

* Warns again on job cuts if US defense budget slashed

* Shares up 1.6 percent in afternoon

(Adds company comments, updates stock price)

Oct 26 (Reuters) - Rockwell Collins Inc reported lower quarterly earnings on Friday as weaker government sales overshadowed stronger commercial revenue, and said it could cut 5 percent of its workforce as its defense operations face U.S. budget challenges.

The supplier of avionics and other electronic systems for planes said it could trim 1,000 jobs in the coming year, with 350 jobs hinging on mandatory cuts to defense spending set to take effect next year should U.S. lawmakers fail to avert them.

Those job reductions, initially disclosed in September, would be on top of 250 positions eliminated since Aug. 1. Rockwell Collins has 20,000 employees.

Companies with defense exposure are bracing for sustained pressure on military budgets. Under a process called sequestration, $500 billion in additional defense budget cuts could begin in January. That would likely reduce Rockwell's government systems revenue by 5 percent, or $120 million.

Rockwell has also merged facilities, exited slower-growing defense businesses and looked to sell more commercial technologies to military customers amid the cloudy defense outlook.

``You can't continue to carry excessive costs if your revenues are declining,'' Chairman and Chief Executive Clay Jones said in an interview.

The company said its commercial business was poised to expand over the next year and longer-term, buoyed by rising plane production at Boeing Co and Airbus. On Friday, Jones said the company has been chosen to supply a new commercial program to a customer it could not yet disclose.

Excluding charges for restructuring and asset impairment, profit topped estimates. Net income in the fourth quarter ended on Sept. 30 was $152 million, or $1.06 a share, down 13 percent from $175 million, or $1.13 a share, a year earlier.

Adjusted for items, the profit was $1.32 a share. Analysts on average expected $1.12, according to Thomson Reuters I/B/E/S.

Sales fell 2 percent to $1.27 billion. Commercial system sales rose 9 percent, aided by higher production at plane makers, but government system sales declined 10 percent.

Rockwell Collins has reduced its business in some defense segments as the United States moved to curb spending. Business aviation has been a challenge for Rockwell this year as Hawker Beechcraft, a major customer, filed for Chapter 11 bankruptcy protection in May.

The company stood by a prior forecast calling for a profit of $4.30 to $4.50 a share from continuing operations for the fiscal year that ends in September. For fiscal 2012, earnings came to $4.15.

Shares of Rockwell Collins were up 1.6 percent at $54.14 on Friday afternoon.

(Reporting by Karen Jacobs in Atlanta; editing by Gerald E. McCormick, Bernadette Baum, Lisa Von Ahn and Matthew Lewis)