IBM raised its full-year outlook and reported higher-than-expected quarterly profit on Thursday as its growing focus on higher-margin software and services businesses helped it cope with weak technology spending.

International Business Machines Corp still failed to satisfy investors, whose expectations had built up along with a 24 percent rise in the shares. A drop in service contract numbers, an indication of future business, also worried Wall Street.

I think people had expected a bigger upside, said Kim Caughey, an analyst with Fort Pitt Capital. If you are someone who follows technology closely, the third quarter isn't a strong quarter -- so that they beat at all, I'm happy.

Indeed, IBM reported third-quarter net profit rose to $3.2 billion, or $2.40 a share, from $2.8 billion, or $2.04 a share, a year earlier. Analysts on average expected a profit of $2.38 per share, according to Thomson Reuters I/B/E/S.

Revenue fell 7 percent from a year earlier to $23.6 billion, although it rose 1 percent from the previous quarter and was better than Wall Street's forecast of $23.4 billion.

IBM forecast a return to revenue growth in the fourth quarter.

We've been complaining about tech companies that beat their estimates based on cost-cutting, but haven't really been able to beat their topline number. It's good to see one that's finally done that, said Ted Parrish, co-portfolio manager at Henssler Equity Fund.

One concern among investors is that service contract signings fell 7 percent $11.8 billion. Such signings are an indicator of long-term sales.

Sometimes there are ups and downs, Frost & Sullivan analyst Ronald Gruia said, but added that the overall results were still positive. I think it's mostly 'sell on the news'-type stuff.

IBM has managed to escape the worst of the tech downturn of the past year by shifting more of its sales from servers to software and services in outsourcing, automation and technology support -- areas that have remained relatively strong as companies seek ways to cut costs.

We are optimistic about 2009 as we again raise our full-year expectations and we remain well ahead of pace for our 2010 roadmap of $10 to $11 per share, said Chief Executive Samuel Palmisano.

IBM shares, which had risen on hopes of a recovery in technology spending, fell 3.6 percent to $123.30 after closing at $127.98 on the New York Stock Exchange.

We expected them to exceed expectations on both numbers. I also think you can interpret that the dynamics within the technology category are vastly improving. I think IT spending appears to be on the mend, said Keith Wirtz, president and chief investment officer at Fifth Third Asset Management.

(Reporting by Ritsuko Ando; Editing by Gary Hill and Matthew Lewis)