AT&T reported better-than-expected first quarter earnings on Tuesday, powered mainly by a strong customer retention rate and a decline in iPhone sales.

Ironically, a dip in iPhone activations actually yields a short-term boost in profit margins, as carriers are forced to pay Apple a large upfront sum for the handset and then make the money back over the duration of a two-year contract. Like rival Verizon, AT&T saw its margins shrink in Q4 of 2011 when it activated a record 7.6 million iPhones.

Selling only 4.3 million iPhones in the first quarter of 2012, AT&T saw its net income increase to $3.58 billion, or 60 cents per share – up from $3.4 billion, or 57 cents per share, a year earlier. Analysts polled by Bloomberg and Thomson Reuters expected earnings to fall in line with last year's totals.

AT&T's most impressive metric may be its average revenue per contract customer (ARPU), which increased 1.7 percent from a year earlier to $64.46. Similar to its competitors, AT&T has added service fees and additional upgrade costs to slow ARPU declines that have occurred over the last two years.

"Rising ARPU means the carriers are able to increase data pricing, which is good for the industry," Walter Piecyk, an analyst at BTIG, told Bloomberg.

AT&T added 726,000 customers in the first quarter, 25 percent of whom were more highly sought-after contract subscribers. In contrast, 68 percent of Verizon's 734,000 customer additions in Q1 were contract subscribers.

The Dallas-based carrier is trying to keep pace with Verizon's 4G LTE deployments, which have helped entice a number of new non-iPhone contract subscribers to call Verizon their carrier. Verizon claims its 4G footprint to be six times the size of its closest U.S. competitor.

AT&T's consolidated revenue increased nearly 2 percent to $31.8 billion. The carrier also lowered its churn rate from 1.2 percent to 1.1 percent in the first three months of the year. AT&T shares are up more than 3 percent on the day.