July 17 (Bloomberg) -- Google Inc. fell as much as 12 percent in late trading after reporting earnings that missed analysts' estimates on a surge in spending on new projects and costs to defend YouTube in a copyright lawsuit.

The owner of the most popular Web-search engine dropped to $470.55, the lowest level in three months. Excluding costs such as stock-based compensation, profit amounted to $4.63 a share, trailing the $4.73 average of estimates compiled by Bloomberg.

Research spending climbed 65 percent, sparking investor ire because Google is boosting investments amid a slowing economy and concern that demand for Internet advertising may soften. The YouTube suit with Viacom Inc. adds to costs and the video site loses money. Today, Chief Executive Officer Eric Schmidt said for the first time Google faces ``a more challenging economic environment.''

``It's easy to portray this as a negative vote on the economic outlook,'' said Colin Gillis, an analyst at Canaccord Adams Inc. in New York. ``This is going to be an ugly tape tomorrow.''

Google, based in Mountain View, California, fell in after- hours trading after closing at $533.44 on the Nasdaq Stock Market. If the decline holds when the market opens tomorrow, that would be the largest drop since the 2004 initial public offering.

This is only the third time Google has missed projections in 16 quarters as a public company. Net income rose to $1.25 billion, or $3.92 a share, from $925 million, or $2.93, a year earlier, the company said today in a statement. Sales excluding revenue from partner sites climbed 43 percent to $3.9 billion. Google doesn't provide forecasts.

Clicks on advertisements climbed 19 percent, decelerating from growth of 47 percent in the year-earlier period.

Economic Challenges

``We are very well positioned in a slowdown,'' Schmidt, 53, said today on a conference call. ``Traffic and revenue have held up well despite uncertain economic conditions.''

While Schmidt didn't say Google was hurt by the economic slowdown, analysts including Stanford Group Co.'s Clayton Moran said this is the first time the company had acknowledged the challenging economy.

Economists on average estimate the U.S. economy expanded 1.2 percent last quarter, compared with 3.8 percent a year ago and 1 percent the previous quarter. First-time jobless claims rose last week to 366,000 as the U.S. housing market, tightening credit and slowing consumer spending weighed down growth.

Some analysts' forecasts for Google's profit didn't include an effect from the $3.24 billion purchase of DoubleClick Inc. in March, said Jeff Lindsay, an analyst at Sanford C. Bernstein & Co. in New York.

Interest Income

The acquisition reduced Google's cash, giving it less money to put into short-term investments to earn interest. Income from interest and other sources fell to $58 million from $167 million the previous quarter and $137 million a year ago.

The Viacom lawsuit helped boost Google's general and administrative expenses 49 percent to $475 million, Lindsay said. While Google declined to disclose how much it spent on legal expenses, the company acknowledged that legal costs rose and might be difficult to predict.

Legal costs come in bursts, Schmidt told analysts on the conference call. ``Welcome to the information economy.''

Google is working to reduce expenses, co-founder Sergey Brin said today in an interview. In addition to hiring fewer workers, the company is analyzing ways to cut back on contractors, he said.

``We have a much more sustainable level of hiring now,'' he said. ``There were a few things here and there that might have been somewhat unique to the quarter that might have added some costs to us.'' He declined to elaborate on why general and administrative costs rose.

Ad Spending

U.S. ad spending will grow 2 percent this year, down from an earlier forecast of 3.7 percent, New York-based researcher Magna Global said this month. Google, which got more than half its sales from the U.S. last year, is vying with Yahoo! Inc. and Microsoft Corp. for customers as advertisers look for the most effective way to spend shrinking budgets.

Google fielded about 62 percent of U.S. Web searches in May, about double the market share of Yahoo and Redmond, Washington- based Microsoft combined, according to ComScore Inc. To take advantage of Google's higher prices, Yahoo Chief Executive Officer Jerry Yang struck a deal to let Google sell some ads for his company's search engine, shunning offers from Microsoft to buy all or part of the Sunnyvale, California-based company.

The partnership, under review by the Justice Department and the subject of hearings this week by U.S. lawmakers, may increase prices for Yahoo's search ads by 22 percent, said Roger Barnette, president of SearchIgnite Inc., an Atlanta-based search marketing firm.

To contact the reporter on this story: Crayton Harrison in Dallas at tharrison5@bloomberg.net

Last Updated: July 17, 2008 20:25 EDT