Lockheed Martin (NYSE:LMT) will announce its third quarter earnings Wednesday, October 24. The company posted impressive numbers in the first half of 2012 with revenues of $23.2 billion, up 4.7% y-o-y, and operating profit at $2.2 billion, up 19.1% y-o-y.  The growth was driven by increased F-35 production activity under the Low-Rate Initial Production (LRIP) contracts, higher aircraft and commercial satellite deliveries and increased production volume on the Orion program.
The company has sustained production activity under the F-35 LRIP contracts in the third quarter. However, the winding down of the F-22 program and non-replacement of several government IT projects, because of the constrained fiscal environment will likely impact its Q3 earnings.
We currently have a stock price estimate of $97.32 for the company, approximately 5% above its current market price.
F-35 production orders to continue to drive growth
The final three LRIP lot 2 aircraft were delivered to the U.S. government in the second quarter. Lockheed has so far received production orders for 93 F-35 aircraft, of which 14 were delivered by the end of Q2.  We anticipate deliveries against these remaining orders to drive earnings growth for the third quarter and beyond.
Growth offset by winding up of F-22 and other programs
However, growth will be offset by the winding down of F-22 program. Final deliveries under this program were completed in the second quarter. A total of 187 F-22 aircraft were built for the U.S. Air Force. This fifth-generation fighter jet with stealth capabilities is touted as the most advanced fighter jet ever built. However, production under the program was halted due to high unit cost for the F-22 and delays in Russian and Chinese fifth-generation fighter jet programs.
In addition, a number of other programs, particularly in the information systems division of the company, has been completed. Non-replacement of these programs due to fiscal constraints will impact Lockheed’s earnings in the third quarter. The programs include ODIN (Outsourcing Desktop Initiative for NASA), the U.K. Census and JTRS (Joint Tactical Radio System). In the first half of 2012, revenues from the information systems division declined 3.5% y-o-y to $4.4 billion. 
Defense spending cuts to impact earnings over the long term
Lockheed faces a serious challenge to its long-term growth from the U.S. defense spending cuts. The enactment of the Budget Control Act of 2011 reduces defense spending by $487 billion over a 10-year period starting from the government fiscal year (GFY) 2012.  Lockheed Martin, which receives more than 80% of its revenues from the U.S. government, will be impacted significantly from the proposed cuts. The extent of the impact will depend on the extent of budget cuts. However, the company anticipates across-the-board cuts to reduce U.S. defense spending by $52 billion in the GFY 2013.
Share repurchase and high dividend yield to help address shareholder concerns
In anticipation of the cuts, the company has taken certain steps to address shareholder concerns. First, it approved a share repurchase program, and second, it increased its dividend payout.
Lockheed is authorization to repurchase its common stock worth up to $6.5 billion. By the end of Q2, it had repurchased stock worth $3.6 billion under the program.  Such a program helps prevent a large decline in stock price in the wake of a decline in revenues stemming from budgetary cuts. Also, the company recently announced its fourth quarter dividend of $1.15 per share, resulting in a high dividend yield of 4.88%.  Such shareholder focused strategies help address their concerns, which stem from the challenge posed by defense spending cuts to the company’s growth.
On the whole, Lockheed faces a tough third quarter as several U.S. government programs that were completed have not been replaced, which will likely impact its earnings. In addition, the defense spending cuts pose a challenge to its long-term growth.Notes: