Amid recent shifts in the AI narrative and weakening conviction in the supply chain, as the first major AI buyer to report earnings, $Alphabet(GOOGL.US) results—specifically Capex, Cloud backlog, and cash flow—are critical for the entire industry. Here are the key takeaways:

1. Capex surged to $44.9bn, doubling YoY. Management raised the full-year guidance from $18-19bn to $19.5-20.5bn, a net increase of $10bn. They also expect Capex to increase significantly in 2027. This aligns with buy-side expectations of a $5-10bn hike this year due to rising memory prices, with 2025 projections reaching $30-40bn.

2. Google Cloud grew 82%, slightly beating buy-side estimates of 75-80%. Note that this includes TPU hardware sales, though specific details were not disclosed. Remaining Performance Obligations (Backlog) reached $51.4bn, with over half expected to be recognized within 24 months, meeting the $50bn investor threshold.

3. Core Advertising slightly beat expectations. Search ads grew 17%, maintaining anticipated strength, while YouTube ads grew 12%, showing a slight QoQ recovery. Nielsen data shows YouTube’s viewership share is steadily rising, likely bolstered by increasing contributions from Shorts ads.

4. Group OP slightly missed. Due to massive investment expansion, Free Cash Flow (FCF) turned negative (-$5.8bn). EPS grew 294%, but this was primarily driven by valuation gains from investments in SpaceX and Anthropic, making it a distorted metric for Google’s core fundamentals.

5. Key Metrics vs. Estimates

Dolphin Research View

Overall, GOOGL’s results follow a script that favors the AI supply chain. Management remains highly aggressive on AI spending due to robust demand. This satisfies the market’s high Capex expectations, allowing supply chain investors to breathe a sigh of relief for now.

However, aggressive spending will accelerate the deterioration of short-term fundamentals, specifically margins and cash flow. This comes at a time of weak conviction, marked by Gemini’s rocky iterations and the departure of key talent. While Cloud performance was stellar, as long as the core Gemini model remains underwhelming, investors will likely scrutinize the negative cash flow issues.

Conversely, if Gemini 3.5 Pro or 4.0 performs well, investor sentiment toward high AI spending could flip 180 degrees. This would revive the full-stack AI narrative. We also recommend monitoring management’s comments on recent talent departures to determine if organizational issues pose long-term risks.

Despite these concerns, we maintain faith in Google’s systemic R&D strength and the trend of narrowing gaps in LLM competition. As valuations and high expectations are digested during this period of weak conviction and margin pressure, we may see the contrarian opportunities we have been waiting for.

Detailed Earnings Analysis

I. Business Overview

Alphabet has a complex structure. For those unfamiliar with the parent company of Google, please refer to the business architecture below.

The long-term logic of Google’s fundamentals:

a. Advertising remains the primary revenue and profit driver. While Search faces long-term threats from feed-based ads, the high-growth YouTube is stepping up to fill the gap.b. Cloud, which includes TPU hardware sales, has become the primary growth engine and the most direct manifestation of AI benefits.

II. Advertising: Strong Search, Recovering YouTube

Q2 ad revenue reached $81.6bn (+14% YoY). Search ads grew 17%, staying resilient, while YouTube ads grew 12%, accelerating from the previous quarter. The overall ad industry performed well in Q2, driven by macro resilience and the fading impact of April’s geopolitical tensions. Major events like the World Cup and the return of North American budgets from e-commerce giants like Temu and Shein also boosted demand.

AI-driven product innovations are helping major platforms capture incremental budgets. A William Blair survey suggests Google is benefiting from higher conversion rates and better targeting via AI search tools. While AI Overviews might reduce individual link clicks, the improved experience has helped recall users and increased engagement. Consequently, advertisers are increasing budgets to test AI Overview conversion effects.

YouTube continues to lead on TV screens but still faces the challenge of balancing paid subscriptions with ad-supported viewing. We attribute the Q2 recovery in YouTube ads partly to the World Cup, while the long-term growth opportunity remains centered on Shorts.

III. Cloud: Accelerating Revenue and Backlog Expansion

Cloud is the backbone of Google’s AI revaluation. From a forward-looking perspective, the market is laser-focused on backlog growth. Q2 Cloud performance was impressive, slightly exceeding optimistic buy-side expectations. A key sentiment indicator, Backlog, reached $51.4bn, a net increase of ~$5bn QoQ (implying $10bn in new contracts).

In the short term, mass shipments of TPU v7 in H2 and 8i/8t next year are expected to support high revenue growth. However, Gemini’s iteration speed clearly lags. Small updates in H1 have shown limited competitiveness compared to top-tier models from peers.

The recently launched Gemini 3.6 Flash focuses on token output optimization, making speed its core selling point. However, it lacks an edge in terms of intelligence or cost-per-task efficiency. While Anthropic, OpenAI, and Chinese players like Zhipu and Kimi have made waves, Gemini remained relatively quiet in H1.

Reports suggest Gemini is tightening compute for Meta. We suspect internal development was constrained by prioritizing compute for external customers, to the point where Google reportedly leased xAI compute at a premium. Frequent talent turnover within the team may also be hindering R&D progress.

AI demand remains explosive. The company disclosed that Gemini now processes 22bn tokens per minute, up 42% QoQ. Gemini’s MAU reached 950mn, with a net addition of 50mn this quarter.

IV. Other Businesses: Mediocre Growth

This segment includes YouTube subscriptions, Google Play, Google One, and hardware like Pixel and Nest. Q2 revenue for this segment was $12.9bn (+15% YoY), slightly missing estimates. Growth was primarily driven by YouTube TV subscriptions.

Nielsen data suggests that YouTube CTV and Google One subscription growth were the main contributors to this segment’s performance.

V. Impact of High Investment on Margins and Cash Flow

Core OP was $40.8bn with a 34% OPM, missing buy-side expectations. While investors may have extrapolated last quarter’s gains, we previously noted those were due to a mismatch in investment and depreciation. We are now seeing the cumulative pressure of recent high Capex on depreciation costs.

We estimate that depreciation will drag OPM by 500bps over the next five years. This will require aggressive cost-cutting in other areas, such as OpEx, to compensate. Consequently, OPM moderated to 34% this quarter.

By segment, Google Services saw a seasonal dip, while Cloud OPM improved to 36%, beating market expectations. Capex directly impacts short-term cash flow. Management raised the 2024 Capex target by $10bn and signaled significant increases for 2027.

Google’s $80bn financing plan has seen $49.6bn executed, with the remaining $40bn expected from Q3. Even with $250bn in projected OCF next year and $240bn in current cash, the total liquidity of $540bn can support the aggressive $350bn Capex estimate for 2027. However, managing this cash exposure is tight, and we cannot rule out additional financing beyond current plans.

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Past Dolphin Research on Google

Earnings Season

Apr 30, 2026 Earnings Call Notes: Under an ROIC framework, continuing to invest in AI to maintain industry leadership

Apr 30, 2026 Earnings Take: AI Google: no ghost stories, only a bumper harvest

Feb 5, 2026 Earnings Call Notes: Compute supply (energy, land, supply chain) expected to remain constrained throughout the year

Feb 5, 2026 Earnings Take: Google: big brother goes wild, doubling down on AI

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