Updated from 5:42 p.m. EST

IBM

(IBM) - Get Report

boosted fourth-quarter profit and gross margins well above Wall Street's expectations, and told analysts to boost their 2006 earnings expectations.

But the strong dollar, sluggish software sales and light revenue in services contributed to a slightly disappointing top-line performance.

In recent after-hours trading, shares were up 30 cents to $83.30 on Instinet.

Service bookings declined from a year ago, but not by as much as some investors had feared, and likely will be viewed as a positive. Revenue for the services unit, however, was off 5% (1% excluding currency) to $12 billion.

Including a one-time tax charge, Big Blue posted a profit of $3.2 billion, or $2.01 a share. Without the charge, the company earned $2.11 a share, 17 cents better than analysts had forecast. The charges included $267 million relating to the companys reduction of employee pension benefits.

Total revenue was $24.4 billion, down 12% year over, but up 3% when currency fluctuations and results from IBM's now-divested PC business are included. Even so, the currency hit and the need to back out last year's PC revenue was well known and analysts likely included it in their estimates. Analysts polled by Thomson First Call were looking for revenue of $25.49 billion.

Bookings in the critical services business were $11.5 billion, down from $12.7 billion a year ago. Last month, some analysts believed the company would only book $10 billion in new business, but the quarter picked up steam at the very end. Gross margins for the services unit improved to 27.4% from 24.3% a year earlier.

Overall gross margins, now liberated from the money-losing PC business spun off last May, increased to 44.1% in the 2005 fourth quarter compared with 38.8% in the 2004 period.

"They got rid of a dud (PC) so that the profitability of the rest of IBM hardware can now shine. Hardware revenues without the PC business increased 6% or 9% in constant dollars," says longtime Big Blue watcher Bob Djurdjevic of Annex Research.

IBM does not give detailed guidance on its calls, but often will comment on some aspects of the First Call consensus. CFO Mark Loughridge suggested that analysts raise their EPS estimates for 2006 by 12 cents to $5.78.

Hours before it released the earnings news, IBM announced that it has signed a 10-year, $1.1 billion contract to provide

Gap

(GPS) - Get Report

, the specialty apparel retailer, with mainframe, server, network and helpdesk support services across its North American stores and corporate locations. Revenue from the deal was not included in December's results.

Loughridge noted that the deal will contribute just $20 million or $30 million in profit. The signings contribute much more to margins and revenue over the long term, he said during a call with analysts.

Loughridge said the company's short-term services business was not up to par, but said he expects that performance to improve later in the year.