Google's quarterly profit topped expectations, helped by cost controls, but Chief Executive Eric Schmidt said the economic environment remains tough with Internet users still searching but buying less.

Shares of the No. 1 U.S. Internet search company initially rose 5 percent on the stronger-than-expected results, but then erased gains to trade flat after hours.

We're still basically in uncharted territory, Schmidt said on a conference call. Google is absolutely feeling the impact. Users are still searching but they're buying less. Ultimately, what that really means is the ads are converting less.

Compared to other Internet and media companies that depend on advertising revenue, Google has been extremely resilient to the economic downturn, though its revenue growth has slowed sharply from the heady 50 percent rates it used to enjoy.

Google reported first-quarter revenue of $5.51 billion, up 6 percent from the year-ago quarter but down 3 percent from the 2008 fourth quarter -- its first ever sequential decline. The figure was in line with average Wall Street expectations.

In one sense, revenue was certainly not robust, but considering the environment people are obviously taking that as somewhat of a comfort that it wasn't any worse, said Martin Pyykkonen, senior analyst at Wunderlich Securities.

Tougher times but better discipline within the company on the cost management side (meant) that they were still able to come in and beat the bottom line pretty nicely by a few percentage points.

Net profit for the quarter ended March 31 was $1.42 billion, or $4.49 cents a share, up from $1.31 billion, or $4.12 a share, a year earlier.

Excluding special items, Google earned $5.16 a share, ahead of the average Wall Street forecast of $4.93 according to Reuters Estimates. The figure also beat the whisper number of $5 per share that some analysts and investors were expecting.

Google executives said lower labor costs, as the company reset performance based bonuses for the new year, kept expenses in line. And after several years in which Google expanded its workforce, the company's headcount declined slightly in the first quarter to 20,164 employees worldwide.

Google announced three rounds of layoffs in the first quarter, although the 200 sales and marketing job cuts announced in March were not reflected in the latest headcount.

Good quarter considering the environment, said Youssef Squali, managing director at Jefferies & Co. Cost containment, including capex, was pretty impressive, which is what's needed to make the stock work short-term.

ON YOUTUBE, TWITTER

Separately, Google's YouTube said it has signed a deal with Sony Corp <6758.T> to add the company's films and TV shows to the video-sharing site and that it was talking with other big studios.

Schmidt said Google did not have any intention of changing its conservative view toward cash management, in a sign that a major acquisition may not be on the near horizon.

However, Schmidt said Google would be happy to pursue an advertising partnership with companies like Twitter, the microblogging site that is often cited as a possible acquisition target for the Internet search giant.

Google also said it expected to continue to make significant capital expenditures, but did not provide financial forecasts, following its custom.

Shares of Google rose as high as $410 before falling back to $388.24, compared with their Nasdaq close of $388.74. The stock had risen about 30 percent in the past three months.

PAID CLICKS UP 17 PCT

Google said paid clicks, by Web surfers on its text-based search ads, rose 17 percent in the first quarter from a year earlier.

But the revenue that Google derives per click appears to have declined, as advertisers reduced the bids they make for keywords in Google's auction-based advertising system.

Consumers are clicking on more ads before they buy. And in response advertisers are only prepared to bid a lower amount for keywords, said Sanford Bernstein analyst Jeff Lindsay who estimated that Google's revenue per click declined 11 percent in the first quarter.

Still, Lindsay said the continued growth in paid clicks offset the lower revenue per click, as overall revenue increased during the quarter.

Google executives said the company continues to benefit from advertisers shifting marketing dollars online, where the return on investment is greater than for other forms of advertising.

As Google's growth rate slows amid the tough economic environment, CFO Patrick Pichette said seasonal fluctuations in business activity would become more apparent in the company's results.

Google said the second and third quarters are seasonally weak.

Google also said Omid Kordestani would step down as senior vice president of global sales and business development to become senior advisor to the office of the CEO. He will be replaced by Nikesh Arora, Google's president of international operations.

The change comes one month after Tim Armstrong, head of Americas operations, left Google to become CEO of Time Warner Inc's AOL unit.

(Additional reporting by Gina Keating, Sue Zeidler and Gabe Madway; Editing by Tiffany Wu and Richard Chang)

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