Google (GOOGL.US) Q2 cloud revenue surges by 82%, but capital expenditure set to soar to $205 billion; first-ever negative cash flow scares the market

According to Zhitong Finance APP, after the US stock market closed on July 22, Alphabet (GOOGL.US), the parent company of Google, released its Q2 2026 financial report. Despite the cloud computing business achieving its strongest growth ever, the company's stock price fell nearly 5% in after-hours trading due to the significant upward revision of its full-year 2026 capital expenditure guidance to as high as $205 billion, the first-ever single-quarter negative free cash flow, and ongoing delays of the flagship AI model Gemini 3.5 Pro.

The financial report showed that in the second quarter, Alphabet achieved consolidated revenue of $119.8 billion, up 24% year-on-year, beating market expectations of $116.9 billion. Total sales excluding partner revenue sharing were $103.6 billion, also higher than analysts' expectations of $101.07 billion.

However, profitability diverged. Driven by a sharp rise in the valuation of its investment portfolio (including holdings in Anthropic, SpaceX (SPCX.US), etc.), investment income for the quarter increased by nearly $100 billion, boosting GAAP net profit and resulting in diluted earnings per share of $9.11, far exceeding Wall Street expectations. But excluding investment income and other non-recurring items, adjusted earnings per share were $2.85, slightly below the market consensus of $2.89. This “mismatch” in earnings performance, coupled with rapidly soaring capital expenditures, made investors uneasy.

Record-High Capital Expenditure Increases Again, Free Cash Flow Turns Negative

The most concerning issue for the market was the unexpected increase in capital expenditure guidance. CFO Anat Ashkenazi announced in a call with analysts that the company expects full-year 2026 capital expenditures to reach $195 billion to $205 billion, a significant increase from the $180 billion to $190 billion guidance given last quarter and far exceeding Wall Street's earlier forecast of around $186 billion. She also reiterated that capital expenditures in 2027 will see a “significant” further increase.

In fact, Ashkenazi had warned as early as April this year that 2027 spending would increase “significantly” over the current year, and the market had begun aggressively pricing this in—according to FactSet data, analysts' consensus forecast for 2027 capital expenditures has already reached about $257 billion, and in last weekend's report, Evercore analysts even projected $262 billion, jokingly asking whether the number might head towards “$300 billion? $350 billion?” while expressing concern that actual spending may exceed their forecast.

These enormous expenditures directly eroded cash flow. Although the company achieved $39.1 billion in operating cash flow during the quarter, free cash flow was negative $5.9 billion—Alphabet's first-ever quarter of negative free cash flow.

Thomas Monteiro, Senior Analyst at Investing.com, commented: “After a quarter of negative cash flow, Alphabet again raised capital expenditure, which has unsettled the market. The most reliable cash generator is now spending more than it earns. As long as revenue accelerates, investors may tolerate it, but capital now has a real cost, and the margin for error shrinks each quarter.”

Ashkenazi explained that the company has significantly expanded its AI infrastructure capacity over the past three years, but “market demand still exceeds our input,” and some capacity is coming online faster than expected, which is also one reason for raising the expenditure plan. In the second quarter alone, Alphabet’s capital expenditures reached $44.92 billion, slightly exceeding the $44.15 billion expected by the market, with the “vast majority” invested in AI technology infrastructure. Within technology infrastructure, about 60% went to servers and 40% to data centers and network equipment.

Given ongoing capacity constraints, Ashkenazi also announced a new strategy: “We plan to expand third-party cloud capacity usage in Q3 as a transitional measure while we increase internal capacity.” This strategy builds upon Alphabet’s existing GPU leasing agreement with SpaceX; currently, the company pays SpaceX $920 million per month for renting NVIDIA (NVDA.US) GPUs to run AI models.

CEO Sundar Pichai added that the company is working to support several hyperscale cloud customers through this period of exploding demand. “The incremental opportunities they bring translate into very high short-term costs in just a few months, but over the lifecycle of the transaction, as more of our capacity comes online, the ROI will be very considerable.” However, Ashkenazi also acknowledged that using external capacity “will put some pressure on profit margins in the short term.”

Cloud Computing: Revenue Soars 82%, Backlog Surpasses $500 Billion

Nevertheless, the negative impact of the spending guidance overshadowed what was otherwise a solid second-quarter result.

The cloud division was the biggest highlight of this quarter’s earnings. Google Cloud achieved revenue of $24.8 billion, surging 82% year-on-year and far surpassing analysts’ expectations of around $22.46 billion. Cloud operating profit reached $8.8 billion, more than double the same period last year, with the operating profit margin jumping from 20.7% to 35.6%.

Pichai pointed out that the cloud business’s strong performance “benefited from robust demand for AI infrastructure and AI solutions.” GCP’s core services, AI solutions, and AI infrastructure are all important growth engines. Notably, this quarter Alphabet confirmed for the first time the recognition of revenues from direct delivery of TPU systems to customer data centers, though most of the related income will not be booked until next year.

Even more encouraging for the bulls is the cloud backlog indicator, representing future revenue. By the end of the quarter, cloud backlog soared to $514 billion, an increase of over $50 billion from the previous quarter. The company expects more than 50% of this to be recognized as revenue in the next 24 months. Ashkenazi said this growth is driven by broad demand for enterprise-level AI products.

Pichai also disclosed that Gemini Enterprise has been adopted by nearly 90% of Fortune 100 companies; in the past year, nearly 500 cloud customers each processed over 1 trillion tokens, and more than 2,000 companies consumed upwards of 100 billion tokens. In security, 90% of Fortune 100 firms are Google Cloud Security users, nearly 90% of Wiz customers have enabled AI-powered security features, with AI workload protection up over 45% quarter-on-quarter.

Advertising & YouTube: World Cup Boost, AI Deep Integration

This quarter, Google Services contributed $95 billion in revenue, up 15% year-on-year, mainly driven by search. Search and other income exceeded $63 billion, with retail and financial sectors contributing the most. YouTube ad revenue was $11.1 billion, up 13%, thanks to direct response and brand advertising, and was significantly boosted by the 2026 FIFA World Cup. Pichai reported that over 1.7 billion unique viewers watched World Cup content on YouTube, with more than 550 million watching via TV, making this World Cup the most watched on YouTube ever.

In advertising technology, Chief Business Officer Philipp Schindler said the company is fully integrating Gemini into its ad infrastructure, improving query understanding, especially in long-tail searches that were previously hard to monetize. Shopping ad relevance improved by 20%. Additionally, the AI Max tool has completed testing and is being used by 500,000 advertisers; along with AI-driven ad series like Performance Max, advertisers saw average increases of 15% in search conversions or value at similar ad spend ROI.

AI Arms Race: Model Delays an Issue, Hopes Rest on Gemini 4

While the cloud business is booming, Google’s own large model R&D has faced headwinds. The flagship Gemini 3.5 Pro, originally set for a June release, has been delayed, and in the AI programming tools market Google has clearly lagged behind the continuous rollout of enterprise-level upgrades by Anthropic and OpenAI. The rise of Chinese open-source models has also intensified competition.

Analysts repeatedly asked about the competitiveness of Google's frontier models on the earnings call. Pichai admitted: “We’re still at the cutting edge in some fields, but we acknowledge there are areas needing improvement—programming and agent coding are good examples.” He quickly shifted focus to reveal that training has begun on the next-generation Gemini 4 model, with massive compute and energy invested, and that he’s “very confident about maintaining an edge in the coming generation.” The company also plans to accelerate its model release cycle, possibly moving towards monthly updates.

On the product side, newly released mainstream models like Gemini 3.6 Flash and 3.5 Flash-Lite drew attention. According to Pichai, more than 9 million developers now use Google models via APIs and for product development each month, with model APIs handling about 22 billion tokens per minute—a substantial increase from last quarter. Monthly active Gemini application users have reached 950 million, above expectations though slightly below the prior quarter’s peak, and daily active users have doubled year-on-year. Since its global expansion last year, AI Mode now has over 1 billion monthly active users and has been integrated with AI Overviews for a “seamless search experience.”

Other Businesses & Investment Portfolio: Waymo’s New Vehicle Debuts, Investment Value Surges

The “Other Bets” segment posted $382 million in revenue for the quarter, missing expectations. Still, some subsidiary projects stood out: Waymo opened its latest Oasis vehicle with sixth-generation Waymo Driver to the public; delivery drone company Wing completed over 1 million home deliveries and continued partnership expansion with Walmart (WMT.US), DoorDash (DASH.US), etc.; and AI drug R&D firm Isomorphic Labs raised more than $2 billion to support its drug design engine and candidate pipeline.

Moreover, Alphabet’s investment portfolio saw its valuation soar by nearly $100 billion this quarter, main driver of the surge in net profit and again demonstrating the company’s broad footprint in science and tech investment.

Despite the impressive cloud performance, surging capital spending and delays in model launches are still weighing on market sentiment. Alphabet’s share price fell more than 4% after hours. The stock is up close to 11% this year but has fallen about 9% since late April due to Gemini delays, departures of multiple executives, and regulatory pressures.

With Microsoft (MSFT.US) and Amazon (AMZN.US) due to report earnings next week, Alphabet—as the first tech giant to report—offers a preview of the “high investment for high growth but under pressure for profit quality” model, raising new questions about the sustainability of the current AI infrastructure investment boom.

Investing.com’s Monteiro noted that the growth in cloud backlog is at least a clear signal that “investment is turning into rapidly growing, profitable revenue—and once capacity is built, contracts can go live right away,” but warned that market patience for high cash burn is being tested: “Expectations that the company can remain self-sufficient from free cash flow forever may be starting to wobble.”