UPDATE 3-Tellabs profit falls less than expected, shares up

* Q1 EPS, revenue exceed Wall Street expectations

* Sees Q2 rev flat to up by a high-single-digit from Q1

* Shares rise 7 percent (Updates with share move, analyst and executive comments)

By Ritsuko Ando

NEW YORK, April 28 (Reuters) - Network equipment maker Tellabs Inc (TLAB.O) posted a smaller-than-expected drop in quarterly earnings due to cost cuts, helping the shares rise 7 percent.

The supplier of network gear to major operators, such as AT&T Inc (T.N) and Verizon Communications Inc (VZ.N), reported a 22 percent decline in first-quarter revenue to $361.7 million as phone companies cut back on capital spending.

But analysts were impressed by the rise in Tellabs' gross profit margin to 44.2 percent from 38.3 percent a year earlier.

"There was a little bit of margin upside. And even without good sales improvement, there were good earnings," said Morgan Keegan & Co analyst Simon Leopold.

First-quarter profit excluding special charges but including stock-based compensation came to 5 cents per share, higher than the average analyst forecast of 3 cents, according to Reuters Estimates.

Tellabs, which competes with Alcatel-Lucent (ALUA.PA), forecast second-quarter revenue to be sequentially "flat to up by a high-single-digit percentage", mostly in line with analysts' estimates.

Total operating expenses fell to 151.0 million from 164.5 million. Net profit fell to $6.5 million, or 2 cents per share, from $16.6 million, or 4 cent per share, a year earlier.

Investors have viewed Tellabs as a relatively safe bet in the economic downturn, particularly due to its strong cash position. It ended the quarter with $1.18 billion in cash, cash equivalents and marketable securities.

Morgan Keegan's Leopold said the strong balance sheet meant mergers and acquisitions would be a key focus for investors ahead. He and other analysts have said Tellabs may look to acquire small companies with optical transport and ethernet technology.

"I think having a phenomenal balance sheet with $1.2 billion in cash, and no debt, provides options. But it also provides risks because we don't know what they're going to do with it," he said.

Tellabs said it was examining potential acquisitions, but had nothing imminent planned.

Shares of Tellabs rose 31 cents to $5.30 by late morning trading on the Nasdaq. They have risen around 30 percent since the start of the year. (Reporting by Ritsuko Ando; Editing by Derek Caney)