AT&T Inc. (T) reported a 26% increase in second-quarter earnings due to an investment gain, lower costs and fewer customer defections, but the rate of growth in new contract customers slowed despite the benefits of the new Apple Inc. (AAPL) iPhone.

National wireless carriers have increasingly found it difficult to maintain momentum in signing up customers to long-term contracts, with many consumers opting to move to prepaid alternatives. AT&T's so-called postpaid net subscriber growth, which saw a dramatic decline from a year ago, continued to lag in the second quarter, underscoring the difficulties of the wireless industry's most lucrative source of income.

AT&T said it added 496,000 postpaid subscribers, or a little more than a third of the number of customers it signed up a year ago.

"Overall, the underlying metrics were not so great," said Walter Piecyk, an analyst at BTIG, adding that the tone remains positive.

The iPhone continued to be the single-largest driver of AT&T's growth. The carrier activated 3.2 million iPhones in the period, with fewer of those activations coming from new customers than in the past.

The company turned to the burgeoning prepaid market and the business of providing cellular services to nontraditional devices such as electronic readers and dog collars for growth. In total, it added 1.6 million wireless connections in the period.

AT&T reported a profit of $4.02 billion, or 68 cents a share, up from $3.2 billion, or 54 cents, a year earlier. The most-recent quarter included a 7-cent investment gain from a stock deal involving Telmex Internacional S.A.B. de C.V. (TII). Revenue rose 0.6% to $30.81 billion.

Analysts polled by Thomson Reuters had most recently forecast earnings of 57 cents on $30.9 billion in revenue. A company spokesperson said analysts' comparisons wouldn't factor in that the company excluded the revenue from its Sterling Commerce business-to-business holding, which it is divesting, from the results.

AT&T was able to post impressive margin growth through its stronger mix of high-quality subscribers and fewer defections. The growth comes despite the recently released iPhone 4 weighing heavily on AT&T's profitability. The telecommunications giant has to pay a lofty subsidy for each iPhone, increasing the costs for adding customers. Having launched with a week left in the quarter, customers with the new device contributed little to revenue.

During the quarter, AT&T changed its data service plans and placed limits on how much a customer could browse the Internet, stream music or videos and send and receive email on their smartphones. In exchange, it cut the price of each plan in an effort to attract new customers.

"Early results of tiered-data pricing are positive; in line with expectations," AT&T said in its quarterly presentation.

While growth may have slowed, customers stuck to AT&T. Its rate of turnover fell to 1.29% from 1.48% a year ago, with postpaid defections falling to 1.01%.

Prepaid results were also helped by sales of cellular-connected iPads, which access data services through a prepaid model. The company added 300,000 prepaid customers, compared with a decline of 412,000 from a year ago.

On the wireline side, the company continued to lose customers. In the crucial high-speed Internet business, the company added 255,000 U-Verse Internet customers, but lost 92,000 total broadband customers, implying a loss of 347,000 traditional DSL customers.

AT&T also added 209,000 U-Verse TV subscribers to reach 2.5 million total customers of its Internet-based TV service.

The company generated $5.4 billion in revenue from residential customers, flat with year-earlier results.

The company said it is seeing further signs of stabilization in the business markets, but revenue of $9.6 billion still marked a 4.7% decline from a year ago. The company is heavily dependent on businesses hiring new workers and has suffered from high unemployment.

AT&T changed its tone for its expectations for the year. Rather than stable-to-improved per-share earnings, it now expects strong earnings growth, along with improved margins and free cash flow above 2008 levels.

AT&T shares rose 3% to $28.42 in recent trading.

-By Roger Cheng, Dow Jones Newswires; 212-416-2153; roger.cheng@dowjones.com
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