Alphabet Inc. (GOOGL) Earnings

Management highlights

### AI Product and Model Development - Launched new Gemini 3.6 Flash and 3.5 Flashlight models, which hit a high-demand sweet spot of strong performance at low cost; also launched Gemini 3.5 Flash Cyber for cybersecurity vulnerability detection and remediation, paired with the core vendor agent. Gemini 4, the next-generation frontier base model, is currently in pretraining with encouraging early progress. - More than 9 million developers build monthly with Gemini models via Alphabet's APIs, with model API token volume growing from 16 billion tokens per minute last quarter to 22 billion tokens per minute this quarter. Open-weight Gemini models for edge devices have been downloaded over 900 million times total, with the latest GM4 models downloaded over 300 million times since April 2026. - The Antigravity agentic development platform has 2.4 million weekly active users, and has accelerated internal development timelines by up to 8x for product teams. The Gemini app hit 950 million monthly active users, with daily active users tripling year-over-year. ### Core Consumer Products - **Search**: Combined AI Overview and AI mode into a single seamless experience, which surpassed 1 billion monthly active users after global expansion. AI features drive incremental search queries and send billions of weekly clicks to third-party websites. Search usage hit an all-time high during the 2026 FIFA World Cup, and cost per AI mode response has fallen to its lowest level since launch despite added capabilities. - **YouTube**: 1.7 billion global unique viewers watched World Cup-related content, making it the most viewed World Cup in YouTube history. The Ask YouTube conversational AI feature, which lets users query video content, had 140 million monthly engaged users in June 2026. YouTube's subscription business (Premium/Music) is growing faster than YouTube advertising, particularly on connected TV. ### Google Cloud and Enterprise AI - Gemini Enterprise is now used by nearly 90% of the Fortune 100, with strong demand for enterprise AI agent development, process automation, cybersecurity, and analytics. The Gemini Enterprise agent development kit reached nearly 70 million total downloads. 90% of the Fortune 100 are Google Cloud security users, with nearly 90% of those using AI-powered security features, which saw a 45% quarter-over-quarter increase in protected AI workloads. - Alphabet offers a full-stack AI infrastructure portfolio, including third-party NVIDIA accelerators and custom TPUs/CPUs: the Virgo network for large-scale unified AI supercomputing, native multi-framework software support, and the agent-optimized Axion CPU which delivers 30% better performance per dollar than peer offerings. New customer acquisition velocity more than doubled year-over-year, and Google Cloud Marketplace transactions grew over 7x year-over-year. ### Other Bets Progress - Waymo launched its sixth-generation Driver platform on new vehicles, which are now available to public riders with broader rollout planned. Wing drone delivery surpassed 1 million safe home deliveries, with growing partnerships with major retail and delivery brands. Isomorphic Labs raised over $2 billion to scale its AI drug discovery engine and advance its candidate pipeline. ### Advertising Innovation - Gemini has improved search ad quality: for shopping ads, Gemini drove a 20% improvement in relevance for long-tail queries. AI Max, the AI-powered advertiser campaign tool, is out of beta with 0.5 million active advertisers, delivering an average 15% higher conversion value at similar return on ad spend. Over half of global SMB advertisers use Alphabet's AI tools to create and optimize ad creative. - New ad formats are being tested in AI search mode, including contextual text ad matching, direct offers from travel partners, and clearly marked sponsored links in list responses. Alphabet launched the open-source Universal Commerce Protocol (UCP) for agentic commerce, and the Universal Card single-checkout system for cross-retail purchases.

Guidance

- **Q3 2026**: Alphabet expects a slight foreign exchange headwind to consolidated revenue, concentrated in Search and YouTube ads, compared to a 1 percentage point FX tailwind in Q2. The company will lap the acceleration in Search growth that began in Q3 2025. To meet unmet demand during the current capacity constrained environment, Alphabet will use third-party capacity as a short-term bridging solution while building internal capacity, which will create modest near-term cloud margin pressure. - **TPU revenue recognition**: Only a relatively small portion of revenue from existing signed TPU system sales agreements will be recognized in 2026, with ramping recognition starting in late 2026. The vast majority of TPU system revenue will be recognized in 2027. - **Full year 2026 CapEx**: Alphabet upwardly revised its full-year 2026 CapEx guidance range to $195 billion to $205 billion, up from the prior range of $180 billion to $190 billion. The increase is driven by accelerated capacity delivery to meet growing AI demand. CapEx is expected to increase significantly again in 2027, with further details to be provided later. - **2026 Expenses and cash flow**: Higher technical infrastructure investments will drive increased depreciation and data center operating costs. Alphabet will continue hiring in key AI and cloud roles, and increase marketing spend for new AI products. Free cash flow will remain under pressure due to heavy infrastructure investments to capitalize on the AI opportunity.

Segment performance

Alphabet consolidated revenues reached $119.8 billion, up 24% year-over-year (23% in constant currency), with operating income of $40.8 billion and an operating margin of 34%. 1. **Google Services**: Revenues increased 15% year-over-year to $94.5 billion, contributing ~78.9% of total consolidated revenue. Operating income increased 20% to $39.5 billion, with an operating margin of 41.8%. Breakdown: - Google Search and other advertising: +17% YoY to $63.3 billion, contributing ~52.8% of total revenue; retail and finance were the largest growth drivers - YouTube advertising: +13% YoY to $11.1 billion, contributing ~9.3% of total revenue; driven by direct response and brand advertising, with particular strength in connected TV (living room) viewing - Network advertising: -1% YoY to $7.3 billion, contributing ~6.1% of total revenue - Subscription platforms and devices: +15% YoY to $12.9 billion, driven by growth in YouTube Music/Premium and Google One AI plans 2. **Google Cloud**: Revenues increased 82% YoY to $24.8 billion, contributing ~20.7% of total consolidated revenue. Operating income more than tripled YoY to $8.8 billion, with operating margin expanding from 20.7% in Q2 2025 to 35.6% in Q2 2026. Total cloud backlog grew by more than $50 billion sequentially to $514 billion, with ~50% expected to be recognized as revenue over the next 24 months. Growth was driven by GCP, AI solutions, AI infrastructure, and the first revenue recognition from TPU system sales to customer data centers. 3. **Other Bets**: Revenues were $382 million, contributing ~0.3% of total consolidated revenue. Operating loss was $1.8 billion, driven by continued investment in scaling Waymo and other early-stage initiatives. Alphabet-level shared operating loss was $5.8 billion, driven by shared AI R&D expenses.

Risks & headwinds

- Persistent industry-wide supply constraints for AI accelerator hardware have left demand outpacing Alphabet's available internal capacity, requiring short-term use of higher-cost third-party capacity that creates near-term margin pressure. - The generative AI model market is highly competitive, with frequent model releases from rival developers creating pressure to maintain pace of innovation and frontier performance, particularly in coding capabilities. - Heavy ongoing capital investment in AI infrastructure creates near-term free cash flow pressure, with returns dependent on sustained long-term demand growth for AI products and services. - Near-term margin headwinds are expected from the ongoing integration of the Wiz cybersecurity acquisition in 2026.

Analyst Q&A

• Q: How has Alphabet's view of the GenAI ROIC opportunity changed over the past year, and how does supply constraint change CapEx budgeting philosophy?

  A: Management stated GenAI remains in very early innings across consumer and enterprise markets, with the total opportunity larger than expected a year ago. Demand for AI native workloads is still in the early adoption phase, and the full-stack approach across consumer, enterprise, and developer segments creates attractive long-term returns. The company maintains a multi-year budgeting framework, and will continue to aggressively invest in capacity as long as attractive returns are available, even as demand continues to outpace existing supply.

• Q: Can Alphabet confirm Gemini can remain at the AI frontier, especially in coding, and what is the optimal capital structure strategy after recent fundraises?

  A: Management noted the Gemini Flash line is already a high-demand workhorse model with strong performance across use cases, with 10-point benchmark gains in the latest 3.6 Flash release including coding improvements. The ambitious Gemini 4 frontier model is in active training with strong early progress, and the company is confident it will remain competitive at the frontier. For capital structure, the company prioritizes cash from operations first for investments, then expands debt, and recently tapped equity markets to maintain a resilient, healthy balance sheet; no additional large equity raises are planned outside of a small ongoing at-the-market program to cover stock-based compensation taxes.

• Q: How does Alphabet balance internal and external demand for TPUs, what is the TPU revenue and margin outlook, and where are capacity constraints most severe?

  A: The top priority for TPU allocation is frontier AI model development, followed by serving first-party consumer products and core enterprise cloud solutions for Gemini Enterprise and Vertex AI. Most TPU system sale revenue is included in the $514 billion cloud backlog and will be recognized primarily in 2027. Third-party capacity is used as a short-term bridge for large existing cloud customers, with upfront near-term higher costs justified by long-term high-ROI multi-year customer relationships. Capacity allocation priorities remain focused on frontier development, core consumer products, and core enterprise cloud solutions, with no material changes to prioritization.

• Q: What are Alphabet's sustainable moats in the AI market, and what will drive faster YouTube revenue growth going forward?

  A: Management emphasized that most enterprise AI demand is for end-to-end integrated solutions, where models are just one component. Alphabet's full-stack advantage includes integrated data infrastructure, security, governance, orchestration of agentic workflows, and enterprise data confidentiality guarantees that create customer stickiness beyond model performance alone. For YouTube, growth will be driven by expanding connected TV/connected TV advertising, new creator exclusive shows, growth in direct response via Demand Gen and Shorts, new shoppable ad formats including one-click CTV purchases, and growth in affiliate shopping revenue. The rising engagement from AI features like Ask YouTube also creates additional monetization opportunities.