Palantir Q2 2023 ER Digest
1.0 The ER is All About AIP
AIP (Artificial Intelligence Platform) seems to be growing fast and promises to enable customers to achieve much higher levels of operating leverage.
From the Q2 conference call I continue to get the sense that organizations across all sorts of industries are finding value in Palantir´s offerings. The results of the commercial and government businesses are a mixed bag, with nothing overly exciting or concerning.
Healthcare and transportation grew 93% and 129% year-over-year, respectively. - Ryan Taylor, Chief Legal Officer during Q2 conference call.
Financially speaking, nothing much has changed with respect to the last quarter. On a positive note, the company is continuing to see higher operating margins and expects to remain profitable for the foreseeable future.
Further, as some of you may remember, the focus of my Palantir deep dive was on the company reducing time-to-value, so as to eventually productize its offerings and evolve into a platform. This quarter, there was no mention of this aspect of the business, with management instead embarking on repeated pseudo-philosophical soliloquies.
I’ve been using contribution margin to measure time-to-value. Recently, it’s been distorted by the spike in entry-level clients. I still believe, however, that the metric will prevail if Palantir is to succeed.
Broadly speaking, the current numbers fall short of management´s pollyannaish philosophizing, but I do share the sense that Palantir (and the world) is nearing an inflection point. For 20 years Palantir has been laying the plumbing, and now, LLMs (large language models) are accelerating how Palantir enables their customers’ workforce productivity.
LLMs are for Palantir what the mouse was for PC companies in the 1980s.
AIP has been live for only 10 weeks and according to management:
It is now being used by more than 100 organizations and 5,000 monthly users.
It is growing 50% MoM.
I believe that as this feature scales through Palantir´s customer base, the value of the offerings will increase at a marginal cost. It will enable customers to do way more with the product than it was previously possible.
2.0 Distribution Issues
Management made no mention of how or if they are improving distribution, technically speaking.
I would have liked to hear management touch on any distribution advances the company may have made over the past quarter, particularly in terms of the facility with which they deploy software. Customer count is growing well, with US commercial customer count up 35% YoY for example. Yet distribution still needs improvement, per the look of it.
*Note: management seems to tweak these graphs quarterly and they ultimately conceal not so great news. This is a big red flag.
As I outlined in my UIPath deep dive last month, Palantir´s plan to become a platform may in the abstract be disrupted by companies with less proficient solutions, but with a far superior distribution capacity. In more concrete terms, UIPath is a very serious contender.
Palantir´s software is highly impactful, but costly to deploy in an organization and currently, only really adequate for very large organizations. UIPath offers much less valuable forms of automation, but its distribution advantage affords it a platform from which it can iterate its way to automating workflows of higher value.
In my deep dive of UIPath, I found that they indeed have an excellent track record of gradually automating more important functions with organizations: they have that iterative nature that underpins so many world class companies. As they now move towards semantic automation, they are effectively on a collision course with Palantir.
Unless Palantir meaningfully ramps up its distribution efforts (which I have no insight on in this quarter), by the time it wants to move onto the SMB space it may find its potential customers are already tied up in an automation platform that they really like, per UIPath´s net retention rates.
In previous calls management did place significant emphasis on this topic, but LLMs are now all but drowning them out.
Palantir is right to channel resources towards the LLM revolution, but they should also focus on core metrics that will drive the business forward over the long term–and they should also keep investors informed on a quarterly basis.
The company is in good financial health and I celebrate that management is taking steps to protect shareholder returns.
Palantir still has an excellent balance sheet, with $3.1B in cash and no debt.
Positive cash flow has been a big contributor to a healthy balance sheet. During Q2, Palantir generated $96 million in adjusted free cash flow, representing a margin of 18% and $90 million in cash from operations, representing a margin of 17%. In aggregate, the company has generated $285M in adjusted free cash flow over H1 FY2023.
In Q2, the board approved a stock buyback program for up to $1B. This does not mean that they are forced to buy stock at the current levels, however. To get where they are, management has had to perform for two decades at the highest level and thus, I trust them to allocate capital well. Naturally, time will tell if they can allocate that capital well.
In the meantime, SBC (stock based compensation) continues to normalize, trending down steadily since the spike in FY2021. In conjunction with the stock buyback program, this should help protect shareholder returns going forward–to the extent that the $1B isn’t needed to solve distribution issues, for instance.
Until next time!
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