By Sinead Carew
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But AT&T expects subscriber service revenue to recover this quarter due to strong sales of smartphones such as the iPhone, which boosts data service revenue.
Customers held back on purchases of new smartphones in the third quarter, in favor of the new iPhone 4S, which was introduced on earlier this month.
AT&T faces a difficult balance between profit margins and revenue. While iPhone sales boost AT&T's subscriber numbers and revenue, they also eat into its profits as the company heavily subsidizes it to get customers to commit to contracts.
Since the iPhone 4S didn't launch until after the quarter was over, this reduced third-quarter subsidies while it boosted AT&T's profit margins for the quarter.
AT&T executives promised a "significant" increase in smartphone sales boosting fourth quarter revenue growth, albeit at the expense of profit margins.
Chief Financial Officer John Stephens declined to discuss how far he expects margins to fall this quarter.
He was more focused on AT&T's sequential increase in quarterly revenue from business customers of its wireline service for the first time in three years. Stephens said he was "very optimistic" this trend would continue. That segment represents 29 percent of the company's overall revenue.
"The fact we grew sequential revenue in wireline business this quarter. That is important," he told Reuters. "The fact I sold a few less handsets in Q3 ... that's no big deal because I'm going to sell those handsets in the fourth quarter."
But Stephens conceded that the economy is a challenge.
"Bad debts are at a very low rate but the economy is still very difficult," he said citing weak housing starts as well as employment numbers. "We've got to get people jobs."
Mizuho analyst Michael Nelson said that AT&T's results -- the first of its peers to be published this quarter -- will likely be followed by similar wireless trends at rivals such as Verizon Wireless and Sprint Nextel <S.N>.
AT&T said activated 1 million customers of the latest Apple phone, the iPhone 4S, as of Tuesday. Orders for the device started on October 7, after the end of the third quarter.
This marked the most successful iPhone launch yet, according to AT&T, which has been heavily dependent on iPhone sales for customer additions since 2007. For more than 3 years AT&T had exclusive rights to sell iPhones, but it now shares the market with Verizon Wireless and Sprint.
AT&T added 319,000 subscribers in the quarter, compared with the median expectation for 311,000 from nine analysts contacted by Reuters.
The company is preparing a court battle to fight for regulatory approval to buy T-Mobile USA, a unit of Deutsche Telekom <DTEGn.DE>. Executives did not provide an update except to say that the company still hopes it can win approval.
It reported a drop in operating revenue to $31.48 billion from $31.58 billion in the year-ago quarter, and was shy of analyst expectations for revenue of $31.60 billion, according to Thomson Reuters I/B/E/S.
AT&T's profit of $3.6 billion, or 61 cents per share that was in line with Wall Street expectations. It compared with a profit of $12.32 billion or $2.07 per share in the same quarter the year before, when it had a big gain from an asset sale.
AT&T shares were down 22 cents at $28.87 in early afternoon trade on the New York Stock Exchange.
(Reporting by Sinead Carew; editing by Gerald E. McCormick and Derek Caney)