AT&T Inc reported a higher-than-expected quarterly profit on Tuesday as iPhone sales declined, reducing the amount of cash it had to pay Apple Inc and boosting its margins.

Shares of AT&T rose 3 percent after the report, while Apple shares were down 1.5 percent. AT&T and rivals such as Verizon Wireless are reducing smartphone sales by tightening their upgrade policies since they were weighed down by hefty subsidies for iPhone in fourth quarter, when the latest model hit stores.

While fewer iPhone sales meant weaker subscriber growth, it did help the company's wireless profit.

Piper Jaffray analyst Christopher Larsen said AT&T's wireless service margin of 41.6 percent had beaten his expectation for 39.7 percent and was a major driver for AT&T. The margin, based on earnings before interest, tax, depreciation and amortization, was 28.7 percent in the fourth quarter and 39 percent in the year-earlier quarter.

One of the big things is they didn't have such a big iPhone refresh, said Larsen, who added that AT&T results were pretty good across the entire company.

The more often AT&T customers upgrade to a new iPhone, the more it hurts AT&T margins, because an existing customer does not necessarily increase his or her spending, while a new customer will automatically boost revenue.

AT&T said it had activated 4.3 million iPhones in the quarter, down from 7.6 million in the fourth quarter. In comparison, larger rival Verizon Wireless sold 3.2 million iPhones in the latest quarter.

GOOD FOR AT&T, BAD FOR APPLE

The percentage of AT&T subscribers upgrading their handsets fell to 7 percent in the quarter from 12 percent the fourth quarter and 8.9 percent in the first quarter the year before.

Pacific Crest analyst Steve Clement said the carrier policy change was bad news for handset makers including Apple. And the risk of customers leaving because of the new policy appears to be mitigated by the fact that rival Verizon Wireless and Sprint Nextel also allow less frequent upgrades, Clement said.

It will be interesting to see how folks react around the next iPhone refresh, Clement said, but added: When it's a quasi coordinated move it definitely helps. It decreases the competitive risk.

AT&T's net income rose to $3.58 billion, or 60 cents per share, from $3.4 billion, or 57 cents per share, a year earlier. Analysts on average had expected 57 cents per share, according to Thomson Reuters I/B/E/S.

Consolidated revenue rose nearly 2 percent to $31.8 billion from $31.25 billion.

The No. 2 U.S. mobile provider added 187,000 subscribers in the quarter, which was roughly in line with expectations for 193,000 from six analysts surveyed by Reuters. This was much fewer than Verizon Wireless, which reported 501,000 net additions last week.

AT&T shares rose $1.04 or 3 percent to $31.65 in morning trade on the New York Stock Exchange. Apple shares fell $8.33 or 1.5 percent to $563.36 on Nasdaq.

(Reporting by Sinead Carew in New York and Sayantani Ghosh in Bangalore; Editing by Dave Zimmerman, Lisa Von Ahn and Alden Bentley)

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