I'd say the water was working it's
way out thru the dipstick tube and
it just rusted the stick.

Sounds as reasonable as anything.  Does fairly fresh ATF not mix easily with water?

ATF is a very high detergent fluid it probably
took care of the contamination already,
but it won't hurt to change the fluid.

I ran about 5 new quarts through (maybe 6) and the stuff coming out towards the end looked pretty good.

I installed a drain plug last time I took
the pan off, I like it better than ATF in
my armpits  

Ya know, I installed one of them last year too and I still managed to get a mouthfull of ATF today    I just have the bolt on type right now.  I'd like to get it welded then I wouldn't have to worry about using two wrenches to free the drain bolt.  I had one welded on another vehicle and it worked great.

Make sure to mark the flange on the
front diff, that way when you put it
back on you don't get a high speed
vibration


Yup.  A little green spray paint does a good job of marking the orientation.

Wild