Palantir: Deserving the Title of AI Application Leader, Guidance Flaws Are Not an Issue

Palantir released its Q2 2025 earnings after the market closed on August 5th, Eastern Time.

Overall, the Q2 performance remains impressive. Although the guidance implies that the peak is near and a slowdown is imminent, the overall operating condition is healthy, especially with most of the issues from Q1 being resolved.

Considering the current government's positive attitude towards AI and defense spending, as well as the still large TAM in the ToB space, it is not impossible for future performance to continue beating guidance.

Key information from the financial report:

1. Strong demand from U.S. enterprises: The ToB performance is the most critical factor and the main support for Palantir's valuation. Commercial revenue in Q2 accelerated significantly, especially with a 92% year-over-year surge in demand from U.S. local enterprises.

Meanwhile, the decline in international enterprise demand, which was under pressure in Q1, has moderated, and with new orders, it is expected to recover quickly.

2. Government growth remains robust: Government revenue in Q2 grew by 43% year-over-year, maintaining high prosperity. Although there was a slight deceleration quarter-over-quarter, government revenue does not follow a linear trend, so short-term fluctuations are normal. Given the current government's attitude towards AI and the emphasis on defense spending, future growth is essentially assured.

3. Healthy operating metrics: Looking at forward-looking operating metrics, they are generally in a healthy state of accelerated growth.

(1) Mid-to-long-term focus on TCV, RPO, and customer numbers: The total contract value (TCV) in Q2 saw a sudden year-over-year increase of 140%, driven not only by the consistent doubling growth in the U.S. but also by explosive growth in international regions due to several large orders from NATO, the UK Ministry of Defense, and Indonesian energy companies.

RPO, which indicates the amount of the remaining contract value that is already locked in (non-cancelable), also accelerated. As contract fulfillment progresses, it is expected to support future revenue growth.

The net increase in customer numbers was also impressive, with the majority of new customers coming from U.S. enterprises, but government departments and international enterprises also saw accelerated growth quarter-over-quarter.

(2) Short-term market focus on Billings and NDR changes: Billings in Q2 grew by 54% year-over-year, exceeding expectations. The overall contract liabilities (including customer deposits) saw a net increase of nearly 10 billion quarter-over-quarter, with a net expansion rate of 128% from existing customers, continuing to rise quarter-over-quarter, reflecting the trend of existing users upgrading their payments.

4. Growth Guidance 'Flaw' Is Not an Issue: Finally, let's look at the guidance. Palantir's high valuation is built upon expectations of high future growth. Therefore, a key factor in breaking valuation limits, in addition to whether current performance beats expectations, is the anticipation of signals indicating a slowdown in growth.

Given the Q2 performance, management consequently raised its guidance. However, this guidance implies a slight sequential slowdown in Q4 growth and signs of slowing profit improvement. This might be the main flaw that led to a muted market reaction. If future growth remains at 30% with no improvement in profit margins, or even under pressure, then the current 60x PS (price-to-sales) becomes even more glaring.

However, putting aside valuation fluctuations, Dolphin Research believes that the so-called flaw is not an issue. Software revenue recognition has short-term fluctuations, and the company's growth still depends on order status, especially the "locked-in" portion. Palantir's order book is in very good shape.

While converting new clients, existing clients are also upgrading their payments, indicating that Palantir's product competitiveness remains leading, and its core logic has not been weakened.

5. Key Performance Indicators Overview

Dolphin Research’s View

During a boom cycle, Palantir's fundamentals are unlikely to have major problems. This includes the implied slowdown signal in the latest guidance, which, given management's consistently cautious and non-aggressive guidance style, is not actually a cause for concern.

It's simply a matter of high valuation at a precarious peak. In Q1, due to lower-than-expected international revenue, the stock price plummeted by 12% after earnings. Although Dolphin Research believes Palantir carries a high valuation premium, we have no doubt about the current prosperity of Palantir's fundamentals.Therefore, at that time, we believed that despite being relatively overvalued, the valuation would not be shattered by the international revenue miss.

The core logic for our judgment was to examine operational indicators to determine that Palantir's product competitive advantage in its serviceable market had not changed. Therefore, looking back at the Q2 situation, indicators related to new/remaining contract value, new customer penetration, and existing customer stickiness all showed a healthy state of further quarter-over-quarter improvement. This indicates that Palantir remains at the forefront of a robust market where prosperity is not a concern.

However, regarding valuation, the current state of short-term overvaluation is not entirely detached from the fundamentals. Besides its scarcity (competitiveness), Dolphin Research believes that the key lies in the definition of Palantir's Total Addressable Market (TAM). Conservatives define Palantir's TAM as data and developer tools, a market of approximately $100 billion (Gartner).

At its current annual revenue level of $4-5 billion, Palantir already accounts for 5% of this market size. For the more segmented, high-ticket, customized data analysis demands within this market, its market share is already significant. However, optimists define Palantir's TAM as the broader software market, valued at $10,000 USD.

Therefore, the core lies in observing Palantir's expansion of its circle of competence, especially leveraging the opportunities presented by AI. At least in the short term, with its competitive advantage being absolutely leading, Dolphin Research tends to believe that Palantir has the ability to expand its business scope, but it won't happen overnight and requires ample patience.

For Palantir's target customers, which are traditional enterprises reliant on process management or data analysis (such as healthcare, finance, etc.), Palantir's AI+ solutions can provide relatively comprehensive functionalities and supporting professional services, simplifying deployment difficulty and accelerating clients' internal business efficiency improvements.

Below is a detailed analysis

1.Still in a Boom Cycle

In Q2, total revenue exceeded $1 billion, growing by 48% year-over-year, surpassing market expectations (~$940 million), with the growth rate continuing to accelerate quarter-over-quarter.

Palantir primarily provides customized software services to clients, so its revenue visibility is strong in the short term, and the company's guidance range is relatively narrow, implying high revenue certainty. However, exceeding the upper end of guidance for multiple consecutive quarters still demonstrates the strong demand from clients for AIP and Foundry.

1. Business Segment Breakdown

(1) Government Client Revenue: Both Domestic and International Accelerate.

In Q2, government client revenue grew by 49% year-over-year. The main driver of growth continued to be the US government; international government growth slowed slightly but remained high.

The US government signed two major new contracts this quarter: one is a $218 million order with the US Space Force to support multi-domain operational collaboration (Maven intelligent system contract); the other is a ten-year, $10 billion contract signed with the Army (integrating 75 existing fragmented contracts), deepening long-term cooperation.

The growth drivers for international government clients are likely still European countries such as Germany, the UK, France, and Sweden, with whom cooperation was successively signed in previous quarters, and who are themselves in a phase of expanding defense spending. Concurrently, this quarter also saw new contracts signed with NATO and the UK government (additional orders).

The main purpose of government procurement of Palantir's products is to improve data analysis decision-making and national defense combat capabilities. In recent years, with the maturation of AI technology, there has also emerged a demand for improving work efficiency. However, government projects often involve multiple functional requirements, including not only software capabilities but also hardware infrastructure. Such integrated demands typically lead to seeking a large-scale solution provider for long-term cooperation, which then handles internal solutions or subcontracts.

However, government requirements for software compliance are extremely stringent, and small and medium-sized software vendors bear high costs for review and compliance. Palantir also specifically proposed the FedStart program:

This program leverages Palantir's compliance licensing advantages, combined with Apollo cloud, to allow third-party applications to enter a government-compliant development and deployment environment, similar to deploying on AWS, to provide services. It aims to jointly provide a complete solution with other technology suppliers for the US government (departments such as defense, intelligence, and civil security), satisfying more government needs at scale in Palantir's areas of absolute technical advantage (such as cross-structured data analysis decision-making, process management, etc.).

This ecological cooperation model allows Palantir to move beyond the fluctuating impact of single-function products and become a platform that collects hosting and compliance service fees. On one hand, it indirectly expands its ecosystem's circle of competence (indirectly solidifying its own competitiveness), and on the other hand, it can achieve relatively smooth and stable revenue growth. Currently, more than thirty software vendors have joined the FedStart program.

(2) Commercial Market: International Market Recovery Imminent.

In Q2, commercial revenue grew by 47% year-over-year, accelerating once again. Specifically:

US domestic enterprise revenue was very impressive, with growth accelerating to 93%. Leading companies in industries such as healthcare, finance, and real estate have signed partnerships with Palantir, achieving significant internal business efficiency improvements. This quarter, a five-year, $100 million contract was signed with The Nuclear Company to jointly develop and deploy NOS, which is the first AI-driven real-time software system designed specifically for nuclear power construction.

International enterprises, which performed poorly last quarter (indicating weak demand in the European market), are still declining this quarter. However, based on the order situation, they are expected to recover growth soon. Specific details can be found in the conference call disclosures.

II. Contract Status: Accelerated Expansion.

For software companies, future growth is central to valuation. However, quarterly recognized revenue is a relatively lagging indicator. Therefore, we recommend focusing on the acquisition of new contracts, primarily indicated by contract status (RPO, TCV), current Billings, and an increase in customer numbers.

(1) Remaining Performance Obligations (RPO): Marginal Expansion in New Mid-to-Long-Term Contracts. In Q2, Palantir's remaining contract value was $2.42 billion, a quarter-over-quarter increase of $520 million, which was better than the previous quarter. Among these, long-term contracts saw a significant net increase.

(2) Current Cash Flow (Billings) & Deferred Revenue: Growth Recovery. In Q2, Billings reached $1.1 billion, a year-over-year increase of 54%. Total contract liabilities (including customer deposits) saw a net quarter-over-quarter increase, and the expansion rate of existing customer payments was 128%, continuing to improve quarter-over-quarter, reflecting strengthened customer stickiness and an upgrading payment trend.

(3) Total Contract Value (TCV): Seasonal Fluctuations, Continued Healthy Growth. In Q2, the newly recorded Total Contract Value was $2.27 billion, a sudden year-over-year surge of 140%, primarily driven by new international orders from NATO, the UK government, and others.

(4) Customer Growth: Driven Entirely by US Enterprises.

From the most intuitive metric, customer count, which is also a more mid-to-long-term indicator, Q2 saw a net increase of 80 customers quarter-over-quarter. Of these, 70 came from commercial clients, and 53 were from US enterprises.

III. Slowing Pace of Profitability Improvement.

In Q2, Palantir achieved GAAP operating profit of $270 million. Three operating expenses continued to maintain a year-over-year growth of around 20%, which was lower than the revenue growth, thus improving profit margins. Share-Based Compensation (SBC) growth was not high, but market capitalization increased significantly during the same period, suggesting that employee optimization might be occurring concurrently.

Finally, the adjusted operating profit margin was 48%, a continued improvement. Looking at the Q3 and full-year guidance, the Q3 operating profit margin is expected to decline quarter-over-quarter due to personnel additions. However, the guidance also indicated that profit margins would see some recovery in Q4.

However, Dolphin Research tends to believe that improving profit margins is not the primary goal at present; expanding TAM and market share are key to maintaining growth. Therefore, the market's tolerance for short-term profit fluctuations should be relatively high.

Palantir's cash flow is related to contract payments, so it experiences seasonal fluctuations. In Q2, there were many new contracts, naturally increasing incoming payments. Management's full-year cash flow guidance is $1.8-2 billion. Assuming cash flow still grows by 40% next year, then the current EV/FCF valuation of 125x implies too many positive expectations.