Make no mistake, that surge has been massive. Says AT&T (T): “Since 2008 AT&T’s network in the San Francisco area has experienced a 3G data traffic increase of 2,000 percent.”

Wow. No wonder my calls kept dropping at that last Apple (AAPL) event in San Francisco (yes, an iPhone 3G repeatedly dropping calls at Apple’s Sept. invitation-only music gathering). In any event, the upgrade, which includes the bolstering of backbone infrastructure, should result in better coverage, 3G performance and in-building penetration.

“More than ever before, customers look to wireless communications to stay in touch with family, friends and business colleagues,” said Terry Stenzel, AT&T vice president and general manager for Northern California/Reno. “The additional spectrum helps to enhance the 3G network so that our customers have the best experience when they make a call, check an e-mail, download a video or song, access applications or surf the Internet on their AT&T device.”

“Now we aren’t typically the carrier that comes out and announces what we are going to be selling 12 months from now. Other carriers do that, and the media loves to speculate on what we are bringing to market. But what I will tell you is that over the next six months or so you will see devices like the Palm Pre and the cousin on our network from Palm.”

– Verizon Wireless President and CEO Lowell McAdam

For Palm, 2010 will be a year of channel expansion, with its new webOS handsets coming to more carriers. Top among them, Verizon (VZ), which has been rumored to be getting a device “like the Palm Pre” since Palm (PALM) launched it. In a research note to investors today, Kaufman Bros. analyst Shaw Wu says a Palm smartphone on Verizon is pretty much inevitable.

“Based on our checks with industry and supply chain sources, we have fairly high conviction in Verizon carrying Palm’s webOS-based smart phones sometime in 2010 (potentially as early as 1H),” Wu writes.

“The reason,” Wu explains, “is three-fold: 1) despite heavy promotion and favorable reviews, sales of Android 2.0 smart phones (MOT Droid and HTC Droid Eris) have been somewhat disappointing and below expectations; 2) strong indications point to Palm’s launch exclusive with Sprint ending in 2009; and 3) our checks show high interest in webOS from Verizon including public comments by CEO Lowell McAdam.”

Interesting, especially the comment about Droid sales. If Wu is right, the device may not prove as daunting a competitive challenge as you would think.

“It’s too early to declare game over,” Wu says. “Talking with investors, most have written off Palm as a legitimate competitor and assumed Android will be the platform of choice at Verizon and other carriers. We believe Palm still has sizable advantages with its multitouch capability and vertical integration.”

Once again, AT&T (T) argues that coverage maps featured in Verizon’s (VZ) ad are misleading and falsely suggest that AT&T offers no coverage in areas where it actually does service.

“Contrary to the image presented in the Verizon ads, our wireless network is pervasive,” said an AT&T spokesman. “It covers over 300 million people, or 97 percent of the U.S. population. Our fastest, or 3G, network covers approximately 233 million people, or 75 percent of the U.S. population….[Verizon's] use of white space is misleading.”

While AT&T is deadly serious about this accusation, the fact that it must make it by referencing creatures like the Abominable Snow Monster and a pink spotted elephant makes it, well, hysterical.

“The ‘Island of Misfit Toys’ television advertisement is a parody of the ‘Rudolph the Red Nose Reindeer’ television special that depicts an island to which Rudolph travels after escaping an attack from the Abominable Snow Monster,” AT&T argues in its complaint. “The advertisement begins with outdated, discarded toys expressing surprise at the arrival of an Apple iPhone. The red Charlie-in-the-Box says ‘Hey! Check out the new guy!’ The spotted elephant, in a surprised manner, asks the iPhone ‘What are you doing here? You can download apps and browse the web!’ and a Dolly for Sue asserts that ‘Yeah. People will love you [the iPhone].’”

The complaint continues: “In response, a blue AT&T coverage map depicting large swaths of ‘white’ or ‘blank’ space across the United States appears above the iPhone. All the toys exclaim ‘Oh . . .’ in dismay, while the iPhone wilts and its screen turns dark. The toy airplane then assures the iPhone that ‘you’re going to fit right in here!’”

Finally, as AT&T describes it, “AT&T’s and Verizon’s coverage maps then appear and the announcer states, ‘with five times more 3G coverage than AT&T, Verizon Wireless is your destination for great gifts.’ The image of the sad and wilting iPhone on an island of misfit toys falsely communicates that the iPhone is a broken device because it cannot browse the web or download applications when outside of AT&T’s depicted coverage area. Further, the maps in the advertisement deceive consumers into believing that AT&T’s customers have no coverage whatsoever when they are outside of AT&T’s depicted coverage area and thus cannot use their wireless devices in many parts of the United States.”

Verizon’s attorneys are probably doubled over with laughter at this very moment.

Below, AT&T’s amended complaint in its entirety:

VerizonAmendComp _3_ –

With Clearwire struggling to build out a next-generation network that will go up against Verizon Wireless (VZ) and AT&T (T) for future mobile customers, Sprint has little choice but to throw more money at it. But it’s not alone in doing so. Fellow partners Comcast (CMSCA), Time Warner Cable (TWC), Intel (INTC), Eagle River Holdings and Bright House Networks are also making additional investments, though together they total only $500 million.

Oddly absent from this list is Google (GOOG), which participated in a May 2008 investment round that pumped $12 billion into Clearwire but has evidently decided to sit this one out. Said Google spokesman Andrew Pederson: “We have already made a significant financial investment, and at this point we think the best way we can continue to add value is through continued product and strategic cooperation.”

One wonders if the shared mission of which the two companies boasted when the deal was announced has somehow changed in the ensuing year.

“There will be no banner ads on the Google homepage or web search results pages. There will not be crazy, flashy, graphical doodads flying and popping up all over the Google site. Ever.”

– Google Vice President of Search Product and User Experience Marissa Mayer

“People wouldn’t like [ads on the homepage]. We prioritize the end user over the advertiser.”

– Google CEO Eric Schmidt, August 2009

Well, this is a first, I think: Google is promoting a consumer electronics device on its front page. Surf over to Google.com right now and you’ll find this pitch plugging Droid, Motorola’s (MOT) new Android smart phone: “The Droid is on sale now. Learn more.”

The text is simple and at just 42 characters, it jibes well with Google’s (GOOG) minimalist design ethic. Click on that “learn more” link and you’re taken to a mobile partners page that touts Droid’s Google-enabled search prowess. Only then are you presented with a big “Get the Verizon Droid Now” button that takes you to Verizon Wireless (VZ), where you can purchase the device.

So is it an ad? Google will almost certainly argue that it is not. But clearly, it commercializes the page. Droid is a consumer product sold by another company and Google is branding it on its most prominent page. Wonder how much that spot is worth.

Furthermore, it’s interesting to see Google leveraging search–a product in which it enjoys a de facto monopoly–to promote a second product that isn’t yet dominant (Android). More so, given this remark from CEO Eric Schmidt, made just yesterday:

“Hopefully, we won’t repeat the mistakes that Microsoft made 10 years ago that ultimately led to all these things that happened to them.”

I’ve asked Google for comment and will update this post if and when I receive a reply.

UPDATE Here’s Google’s comment on the Droid promotion via company spokesperson Gabriel Stricker:

We are currently running a homepage promotion for Droid. From time to time we include a link on the Google home page that points users to exciting and important information, whether it be relief opportunities in the wake of a tsunami or hurricane, awareness about an important cause, or information about a new product. The Droid is a hardware collaboration that we’ve been very active and involved with, so it makes sense that Google has an interest in getting the word out.

UPDATE Turns out this is not the first Google has promoted a handset on its homepage. Last October it plugged another Android device there, the T-Mobile G1.

“The cost of smart phones is considerably higher than feature phones for which the early termination fees were created years ago at $175,” said Verizon spokesman Jim Gerace. He added that the new $350 ETF declines by $10 per month through the life of the contract and customers can avoid it by buying their devices off contract and paying full retail price.

An interesting move for Verizon (VZ), which just last year agreed to pay $21 million to settle a class-action lawsuit filed by California consumers over the very early-termination fees it is now increasing. The plaintiffs in the suit alleged that Verizon’s ETFs were illegal under California law and that they were designed to unfairly lock consumers into long-term contracts and prevent them from switching carriers. When Verizon settled the suit, it denied any wrongdoing, insisting that early-termination fees are simply a means of recovering legitimate costs. And to some extent Verizon does have a point.

Full retail price for the Motorola’s (MOT) new Droid is $559.99. With a two-year contract, Verizon sells the handset for $199.99. Theoretically, that’s a $359.99 subsidy (I have no idea at what price Verizon purchases Droid from Motorola). So if Verizon allowed subscribers to break their contract after a month without paying an early-termination fee, the company would stand to lose money. And subscribers who did so could subsequently sell the device online and potentially make a profit, though a small one.

So it’s certainly understandable that Verizon and other carriers want to protect the subsidies they dole out for these new smart phones. And as noted earlier, Verizon’s new ETF drops by $10 each month a subscriber remains under contract. But at this rate, subscribers are still bound to pay a $110 termination fee in the 23rd month of a two-year contract. The contract is nearly over, the subscriber obligation to Verizon almost fulfilled, yet the company can still slap its customers with nearly a third of the full ETF if they break it at that time.

By month 23 of a two-year contract, does Verizon really stand to lose $110 if subscribers decide to switch carriers? Doesn’t seem likely if subscribers can walk away just a month later without consequence, taking their handsets with them.

Since Verizon is pro-rating the ETF, why isn’t it doing so in such a way that it zeroes out by the end of the contract?

And isn’t the fast pace of innovation in the smart-phone sector such that prices–for both component and device–are dropping so quickly that high ETFs aren’t really justified? Remember, you can get Apple’s (AAPL) iPhone for $99 today. When the iPhone debuted in 2007, it commanded a price of $499/$599, depending on model.

I’ve put those same questions to Verizon and will update here when I hear back. In the meantime, here’s what Consumers Union policy analyst Joel Kelsey has to say on the matter: “When people want to switch wireless services, the biggest cost they face is early termination fees. These fees are designed to lock people into long-term contracts and stop them from getting better deals. Early-termination fees make the marketplace less competitive. Verizon’s move is painful proof that it’s time for lawmakers to crack down on these fees.”

UPDATE: Verizon Wireless spokesperson Nancy Stark offers the following answers to the questions I posed above:

Your first question regarding the balance at month 23 or 24 assumes that, at that point, we have recovered all of our subsidy and up-front costs for every device. That simply is not so.

On your second question, while the pace of innovation plays a role in prices coming down somewhat, it also plays a role in driving up costs as more and more complexity that customers want is added to phones–from premium HTML browsers to high-resolution MP cameras with optical zoom; videoplayers; music players; dual processor chipsets; WiFi; very high display resolution, operating systems such as BlackBerry, Windows Mobile, Palm, Android–ALL with the added value (vs a desktop) of mobility, and ALL in one tiny device that ALSO allows you to talk to anyone from anywhere. phew! (by comparison, I recently paid $200 for a camera and all it can do is take pictures, and it has only middle of the road capabilities.)

But getting back to ETFs specifically. The most important point is that Verizon Wireless customers do not have to have an ETF at all if they do not want to. ETFs allow customers to have it either way: They can have no ETF and pay full retail for their device. OR, they can get a greatly discounted device by having an ETF.

According to News.com, 100 people or so lined up outside Verizon’s midtown Manhattan store last night prior to its midnight opening. And various reports posted to Twitter suggest there were queues at other outlets as well, though quite a bit shorter (see below; click to enlarge).

In any event, the fact that there are lines at all must be a welcome sight for Verizon (VZ), which has been looking for a strong rival to Apple’s (AAPL) iPhone, and for Motorola (MOT), which hopes Droid will revive its much-diminished post-Razr cellphone business. As one Verizon subscriber eager to trade up to Droid told me, “it’s the best smart phone not made by Apple.”

With endorsements like this, Motorola should be working a bit harder on branding the device as its own. Right now, the Droid marketing push from Verizon Wireless is so overwhelming that you’d think CEO Lowell McAdam designed it himself. Why aren’t we hearing from Motorola as well?

“Droid is potentially a game changer for Motorola,” iSuppli analyst Tina Teng said in a recent research note. “Motorola now is no longer just emphasizing slick form factors, such as it did with its RAZR handset. The company now has focused on the hottest segment of the global mobile handset market–providing compelling smartphone products that are usable and expandable through third-party applications.”

That being the case, Motorola might want to do a bit more to get its name out there.

Reporting a wider third-quarter loss than expected this morning, Sprint (S) said it lost 545,000 wireless customers and 801,000 more in the crucial postpaid category. That’s well below what analysts had feared, but brutal nonetheless. Even more so considering that AT&T (T) and Verizon Wireless (VZ) added two million and 1.2 million total customers respectively during their latest quarters.

As I said earlier this year, Sprint is hemorrhaging subscribers like Dan Ackroyd’s exsanguinating Julia Child. And it continues to do so. The company’s churn rate, or the measure of subscribers dropping service, was 2.17 percent, up from 2.05 percent in the second quarter. Alarming, to say the least, though as the charts below (click to enlarge) indicate, the bleeding is slowing a bit.

And what of Sprint’s financial performance for the quarter? Well, put it this way: The company lost nearly half a billion dollars. For the three months ending Sept. 30, Sprint lost $478 million, or 17 cents a share. This compares with a loss of $326 million, or 11 cents a share, during the same period in 2008.

Analysts had been expecting a loss of 21 cents a share for the quarter. Revenue was $8.04 billion, down nine percent from $8.82 billion last year and below consensus estimates of $8.09 billion for the quarter.

In other words, another tough quarter for Sprint. Said Bernstein analyst Craig Moffett: “The results illustrate the enormous challenge facing Sprint. Many of the cost cuts have already been taken. Their best exclusive handset has been deployed. And still, the rock rolls downhill.”

Not the prettiest of quarters, but that penny-a-share profit beat the consensus estimates of analysts, who had expected the company to simply break even.

“We delivered on our commitment to improve the financial performance of Mobile Devices and to commercially launch two smartphones in time for the fourth-quarter holiday season,” Sanjay Jha, co-CEO of Motorola and CEO of Mobile Devices, said in a statement.

“The introductions of our new products powered by Android,” Jha continued, “are important milestones as we begin to address the mobilization of the Internet and the growing demand for modern smartphones. Next year, we will continue to expand our smartphone portfolio and deliver improved financial results.”

Glad those layoffs are paying off for someone.

Which is not to say that Motorola’s suffering is over. Sales at the company’s struggling wireless division dropped a precipitous 46 percent to $1.7 billion. Its estimated global market share is now 4.7 percent, compared with 8.4 percent it claimed in 2008. An ugly decline indeed.

That said, with some strong new Android handsets in the pipeline, things are beginning to look up for Motorola (MOT). At $8.44, company shares are trading up six percent this morning.

Analysts polled by Thomson Reuters had been expecting earnings of 59 cents on revenue of $27.17 billion at Verizon (VZ). Excluding one-time costs, the company reported a profit of 60 cents a share on revenue of $27.3 billion. That’s a 10 percent decline year-over-year, but still better than expected. (See chart below; click to enlarge.)

Wireless subscription gains, though they trailed AT&T’s (T) iPhone-bolstered numbers, were impressive nonetheless. Verizon added 1.2 million wireless customers during the quarter, raising its total count to 89 million. That’s not the two million AT&T added, but it certainly demonstrates that the absence of the Apple (AAPL) iPhone from Verizon’s handset lineup isn’t holding the carrier back all that much.

Verizon also added 198,000 net new customers for FiOS Internet and 191,000 for FiOS TV service.

“Verizon continues to generate strong cash flow, which we have used in building the foundation for sustainable, long-term shareowner value,” Verizon CEO Ivan Seidenberg said in a statement. “Even through the worst of the recession, we have continued to raise our dividend and to add new customers, expand markets and grow revenues based on the power and innovation of Verizon’s wireless, broadband and global networks.”

Evidently, McCain views such rules, which would require Internet service providers to treat all Web traffic equally, as “onerous federal regulation” at best and, at worst, another one of those “government takeovers.”

“The [Obama] administration can’t resist imposing regulations on the Internet–particularly since Google Inc. and other Internet content providers were promised the imposition of such regulations as these companies seek to control what consumers see and don’t see on the Internet–despite the fact that these regulations will only serve to hurt consumers,” McCain wrote in an op ed in the Washington Times.

“The wireless industry exploded over the past 20 years, in part due to limited government regulation. Wireless carriers invested $100 billion in infrastructure and development over the past three years, which has led to faster networks, more competitors in the marketplace and lower prices in the United States compared to any other country….Regulation kills innovation. Let’s not kill the Internet.”

McCain, it should be noted, received some $894,379 in contributions from AT&T (T), Verizon (VZ), Comcast (CMCSA) and other telecom industry interests over his career–all of them opposed to the Net neutrality regulations the FCC hopes to implement.

Pretty damn badly.

Posting third-quarter earnings that topped Wall Street expectations this morning, AT&T (T) said it activated a record 3.2 million iPhones during the period (not surprising given Apple’s blowout quarter).

Of those, 40 percent were for customers new to the carrier. That’s quite a bit more than Wall Street expected, and this surge did much to balance continued weakness in AT&T’s wireline business (click on slide below to enlarge). In fact, if that 40 percent metric is accurate, then Apple’s (AAPL) iPhone single-handedly generated an astonishing 92 percent of AT&T’s post-paid subscriber growth.

“We delivered a terrific wireless quarter, IP data growth was strong and execution across the business continues to be solid,” AT&T CEO Randall Stephenson said in an earnings release, and indeed, that would seem to be the case.

Wireless data-services revenue spiked 34 percent. And revenue from the wireless segment overall increased 8.2 percent as profit grew 41 percent. Wireless turnover rate fell to a record low of 1.4 percent.

Meanwhile, wireline revenue fell 7.1 percent, profit 30 percent.

So in the end, AT&T posted earnings of $3.2 billion, or 54 cents a share, down from $3.23 billion, or 55 cents a share, a year earlier. Revenue slipped 1.6 percent to $30.86 billion. Analysts polled by Thomson Reuters expected per-share earnings of 50 cents on revenue of $30.88 billion.

At $26.86, shares of AT&T are up about 3.5 percent in early morning trading.

Now, that figure includes sales made abroad, so we don’t yet know how many were sold by AT&T (T), but it’s clear that the number was substantial. In its third quarter last year, AT&T activated 2.4 million iPhones and 40 percent of those were for subscribers who switched from other carriers. So the fact that Apple (AAPL) sold as many iPhones as it did in the company’s most recent quarter, bodes well for the carrier.

As Craig Moffett over at Bernstein Research notes, “It is entirely conceivable that AT&T’s iPhone alone will account for more than 100 percent of the entire industry’s post-paid subscriber growth in the third quarter.”

But therein lies the rub. For while sales of Apple’s handset remain strong, the heavy subsidies it requires have pushed AT&T’s wireless margins down. And the heavy data traffic associated with the handset have led to widespread complaints about AT&T’s network, forcing infrastructure upgrades. Worse, AT&T’s dependence on iPhone exclusivity at a time when Apple is clearly transitioning away from such a model leaves it quite vulnerable.

“While the strong sales of the iPhone are positive for AT&T in the near term, they increase the company’s reliance on a product for which we do not believe it will be able to maintain exclusivity,” Pali Research analyst Walter Piecyk wrote in a note to clients Tuesday. “We believe more than one third of AT&T’s post paid customer base is tied to an iPhone user and that mix is likely to rise significantly over the next few quarters.”

But not this quarter. This quarter, AT&T is expected to add 1.5 million to 1.7 million net wireless customers, driven by demand for the iPhone 3GS, which was released early on in the quarter. And while another drop in wireline customers is likely to weigh on results, it will be tempered once again by the iPhone. AT&T is expected to earn 50 cents a share, compared to 55 cents in the year-earlier third quarter, according to analysts polled by Thomson Reuters, who see revenue falling to $30.9 billion from $31.3 billion.