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.

In a 13-page letter to the Federal Communications Commission Wednesday, the carrier again said that Google should play by the same rules as its telecom competitors. AT&T also took issue with the search giant’s claim that Google Voice restricts calls to certain rural areas to avoid the so-called traffic pumpers that route calls there to drive up charges.

“Contrary to the public pronouncements of Google and its allies, Google’s rural call blocking regime is not limited to Google simply blocking calls to ‘adult sex chat lines’ and ‘free’ conference calling services to avoid high access charges,” wrote AT&T’s senior vice president, Bob Quinn, in the letter to the FCC’s wireline bureau. “In fact, Google is blocking calls to, among others, an ambulance service, church, bank, law firm, automobile dealer, day spa, orchard, health clinic, tax preparation service, community center, eye doctor, tribal community college, school, residential consumers, a convent of Benedictine nuns, and the campaign office of a Member of the U.S. House of Representatives.”

My God. Google, the company whose business philosophy proudly proclaims “you can make money without doing evil,” blocking calls to small businesses? To Benedictine nuns? Don’t be evil?

Don’t be evil, my ass.

“We can now see the power of Internet-based applications providers to act as gatekeepers who can threaten the ‘free and open’ Internet,” Quinn continues. “Google’s double standard for ‘openness’–where Google does what it wants while other providers are subject to Commission regulations–is plainly inconsistent with the goal of preserving a ‘free and open’ Internet ecosystem.”

That established, Quinn goes in for the kill, arguing that the FCC should regulate the search giant not just on the wires, but on the Web as well.

“Google’s call blocking begs an even more important question that the Commission must consider as it evaluates whether to adopt rules regarding Internet openness,” he writes. “If the Commission is going to be a ’smart cop on the beat preserving a free and open Internet,’ then shouldn’t its ‘beat’ necessarily cover the entire Internet neighborhood, including Google? Indeed, if the Commission cannot stop Google from blocking disfavored telephone calls as Google contends, then how could the Commission ever stop Google from also blocking disfavored websites from appearing in the results of its search engine; or prohibit Google from blocking access to applications that compete with its own email, text messaging, cloud computing and other services; or otherwise prevent Google from abusing the gatekeeper control it wields over the Internet?”

An interesting question. And one for which Google (GOOG) is presumably already preparing a long-winded answer. This is far from over yet, and we’ll continue to go round and round until the FCC puts a stop to it.

Seems AT&T (T) feels that Google’s Google Voice Internet call-forwarding service violates federal rules designed to ensure that phone companies connect all calls. From the company’s letter:

Numerous press reports indicate that Google is systematically blocking telephone calls from consumers that use Google Voice to call telephone numbers in certain rural communities. By blocking these calls, Google is able to reduce its access expenses. Other providers, including those with which Google Voice competes, are banned from call blocking because in June 2007, the Wireline Competition Bureau emphatically declared that all carriers are prohibited from pursuing “self help actions such as call blocking.” The Bureau expressed concern that call blocking “may degrade the reliability of the nation’s telecommunications network.” Google Voice thus has claimed for itself a significant advantage over providers offering competing services. Google casually dismisses the Bureau’s Order, claiming that Google Voice “isn’t a traditional phone service and shouldn’t be regulated like other common carriers.” But in reality, “Google Voice” appears to be nothing more than a creatively packaged assortment of services that are already quite familiar to the Commission….

[The FCC] cannot, through inaction or otherwise, give Google a special privilege to play by its own rules while the rest of the industry, including those who compete with Google, must instead adhere to [FCC] regulations.

AT&T’s letter comes just days after FCC Chairman Julius Genachowski proposed six Net neutrality regulations that will apply to both wireline and wireless platforms. Interestingly, it also follows an FCC investigation into the rejection/delay of Google Voice for the iPhone.

UPDATE:

Google’s responded to AT&T’s letter in a post to the company blog, pointing out the differences between Google Voice and traditional phone service and questioning AT&T’s motives for appealing to the FCC.

“AT&T is trying to make this about Google’s support for an open Internet, but the comparison just doesn’t fly,” Richard Whitt, the company’s Washington telecom and media counsel, wrote. “The FCC’s open Internet principles apply only to the behavior of broadband carriers–not the creators of Web-based software applications. Even though the FCC does not have jurisdiction over how software applications function, AT&T apparently wants to use the regulatory process to undermine Web-based competition and innovation.”

For Sprint, which is suffering from declining revenue and a thinning subscriber base, the move is a quick-and-dirty way of cutting costs and freeing up resources to focus on innovation and remedying the real and perceived issues with its services.

“This is about improving our customer experience,” Steve Elfman, head of Sprint’s network operations, said during a conference call this morning. “While we get the benefit of Ericsson’s expertise…we can focus our attention on bringing great devices, great services, great applications to them….We’ll benefit from the current scale and efficiency and expertise of Ericsson, and this will keep improving over time.”

Verizon (VZ) reported net income of $3.21 billion. Adjusted for one-time items, the company earned 63 cents a share. Analysts had expected 59 cents a share. It added 1.3 million new wireless customers, that number bolstered by the purchase of Alltel, and ended the quarter with 86.6 million mobile subscribers. Verizon’s FiOS fiber network is also doing quite well. It added 299,000 new subscribers, pushing the total to 2.2 million. (Click on graph below to enlarge.)

Quite a performance given the current economic climate.

And what of those rumors of an iPhone deal with Apple (AAPL)? During a conference call to discuss earnings, Verizon COO Denny Strigl declined comment but didn’t rule such a deal out: “We’re always open to discussions with any supplier,” he said, adding, “We have no announcements to make relative to Apple today. Historically we haven’t been dependent on any one device. We’ve been well-positioned with high-value customers.”

Translation: Do we look like a company in need of a Jesus phone?

No. I guess not.

With 1.6 million iPhones sold in its first quarter and 40 percent of those activated during that time new to its network, AT&T (T) sure does, though. Zing….

I just the other day got, an Internet was sent by my staff at 10 o’clock in the morning on Friday and I just got it yesterday. Why?

“Because it got tangled up with all these things going on the Internet commercially.

“… the Internet is not something you just dump something on. It’s not a truck. It’s a series of tubes. And if you don’t understand those tubes can be filled, and if they are filled, when you put your message in, it gets in line and it’s going to be delayed by anyone that puts into that tube enormous amounts of material, enormous amounts of material.”

This year, it’s motorcycles and wirelines. From the Senate Commerce Committee hearing on number portability yesterday:

Stevens: Let me be just the devil’s advocate here. Could I just decide I want to keep my wireline and I want to add wireless to it? Can I have two providers on the same number?
Answer: … um, I don’t think that technology exists right now.
Stevens: If I had an IP phone, by definition, I’d have to leave the wire… wireline phone to use it?
Answer: I think that is the case with the technology today.
Stevens: Is it coming? Why shouldn’t I be able to say, just by a little switch on my phone at home that’s wired, I’m going off on the wireless now, I want to use this as I ride my motorcycle. … I’m bad. Pardon me.

See what I mean? Comedy gold. Give him a few props and he’d be giving Gallagher a run for his money …