Alphabet, Google’s parent company, reported second-quarter revenue of $119.8 billion, up 24% from the same period last year. The main driver was its cloud division, whose revenue jumped 82% to nearly $25 billion. But the same report also contained something that had never happened at Google before: the company spent more cash during the quarter than it generated. And that is exactly what Wall Street is now focusing on most.
Cloud is no longer a side project
Just over three years ago, Google Cloud was still losing money. But since turning profitable in early 2023, it has been accelerating at a breakneck pace. Revenue growth climbed over the past year from 28% to 48%, then to 63%, and now to 82%. And unusually, profitability increased along with the growth rate.
Cloud operating profit more than tripled year over year, from $2.8 billion to $8.8 billion. Its operating margin, meaning how much of every dollar in revenue remains after costs are paid, rose to nearly 36%. That is a combination rarely seen in the large technology sector. Usually, when a company grows this quickly, it pours huge amounts of money into acquiring customers and building capacity, causing its margins to fall. Google is doing the exact opposite.
Growth is being driven by demand for artificial intelligence computing infrastructure and ready-made AI solutions, Alphabet CEO Sundar Pichai said. Cloud accounted for nearly half of all new revenue compared with last year and almost two-thirds of the increase in operating profit. It is no longer the expensive appendage hanging off Google’s advertising machine.
Customers are spending more than they committed to
Google Cloud CEO Thomas Kurian added a revealing detail in an interview with CNBC. Existing customers are reportedly spending roughly 50% more than they originally committed to with the company. According to Kurian, this is due to the breadth of its offering and the strength of its sales team, and it is visible in both revenue and operating profit.
The division also made a dent in its enormous backlog of contracted but not yet invoiced orders. At the end of the quarter, it stood at $514 billion, up more than $50 billion from the previous quarter. But revenue grew even faster, so the ratio of this backlog to actual annual revenue fell from nearly six years to just over five. Kurian makes no secret of the fact that the race to meet demand will temporarily slow margin growth. The company will rent third-party capacity for a few quarters so it can serve interested customers, expecting the investment to pay off because those customers will then also spend on additional services.
Advertising still works, and AI is everywhere
With all the focus on cloud, it is easy to forget that advertising still generates the vast majority of Google’s money. Google Services, which includes Search, YouTube, subscriptions, and devices, brought in $94.5 billion and grew by 15%. Search alone added 17% to reach $63.3 billion, while YouTube advertising rose 13% to $11.1 billion.
Pichai emphasized that AI features in Search are increasing the number of queries. Gemini models now process 22 billion tokens per minute, and the Gemini app has 950 million monthly active users. The company also said that nearly 90% of Fortune 100 companies use its enterprise version of Gemini. In short, artificial intelligence is no longer a separate line item in the report; it permeates everything Google does.
Total operating profit rose 30% to $40.8 billion, while the operating margin increased by two percentage points to 34%. Net income then nearly quadrupled to $112.1 billion, though caution is warranted here. Most of that increase was caused by a one-time accounting gain of around $98 billion from revaluing stakes that Alphabet holds in other companies. It has little to do with ordinary operations.
And now for the downside
This is where we get to the reason the stock fell after the results were released. For the first time in more than two decades as a publicly traded company, Alphabet burned through more money than it generated. Free cash flow fell into negative territory at minus $5.9 billion.
Capital expenditures are to blame. They doubled year over year and reached $44.9 billion in a single quarter. The company is pouring the money into data centers and the chips that power artificial intelligence. The problem is that operating cash flow totaled $39.1 billion, but when you spend nearly $45 billion in three months, even that healthy amount of incoming cash is not enough.
Alphabet raised its estimate for this year’s capital expenditures to between $195 billion and $205 billion, after projecting $180 billion to $190 billion just last quarter. CFO Anat Ashkenazi told analysts that the increase was mainly due to the company accelerating capacity deliveries to meet growing demand. She also added a crucial sentence: we continue to operate in an environment where capacity is constrained. Ashkenazi also made it clear that as long as AI investment continues to grow at this pace, cash flow will remain under pressure.
Why the market got nervous
But even excellent numbers were not enough for investors. They were primarily watching one line item: spending. According to Reuters, the first cash burn in Alphabet’s history was a clear sign of how artificial intelligence is reshaping the entire big tech sector. Companies once valued for their fat margins and rivers of cash are now turning to debt and stock sales to cover their spending. Combined spending by major technology companies is expected to exceed $700 billion this year as their own cash flow ceases to be sufficient.
Alphabet has already borrowed to finance the construction of infrastructure, issuing more than $85 billion in bonds over the past year. Analysts expect Amazon to burn cash this year as well, while Meta’s cash flow is projected to fall by more than 95%. The ratio of spending to revenue, which shows how much of every dollar earned companies reinvest, is expected to roughly double across the industry.
Can artificial intelligence revenue grow faster than spending, depreciation, and operating costs? That is the question investors are now asking. Google has shown that its cloud business can grow and make money at the same time. The rest of big tech, which has yet to report its results, must now demonstrate the same. The next test will come next week, when Microsoft, Meta, and Amazon release their reports.
Sources: finance.yahoo.com, theinformation.com and s206.q4cdn.com
