Unexpected surprise, I can feel the butterflies in my stomach again.

On the afternoon of August 31st, Beijing time, Xindong Company (2400.HK) released its 2022 interim financial report. Despite the difficult environment in the first half of the year, the company exceeded market expectations by relying on the outstanding performance of some games launched overseas and the gradual recognition and marketing of TapTap by major players in the gaming industry.

The key points of the interim report for the second quarter are as follows:

(1) Total revenue for the first half of the year was RMB 1.594 billion, a year-on-year increase of 15.6%, exceeding the conservative market expectation of RMB 1.4 billion (yoy+2%). The performance of games and information services was better than expected.

(2) Game revenue was RMB 1.12 billion, a year-on-year increase of 8%. Although the revenue of old games such as "Ragnarok Online" and "Immortal Odyssey" continued to decline, and the industry is relatively sluggish, the incremental overseas service of "Sausage Party" and "Flash Party" launched in Japan and China respectively in February and April in the second quarter is clearly better than eating from old games compared to the same period last year.

In terms of Dolphin Analyst's future prospects, in the second half of the year, domestic game launches through agency cooperation may still be the main focus. Dolphin Analyst is more concerned about the self-developed games, which may adopt the rhythm of overseas launches before domestic launches, primarily due to the uncertainties of domestic version issuance time. However, even if it is only an incremental increase from overseas, it is still better than the situation last year. Therefore, we expect game growth to continue to rebound in the second half of the year.

(3) Information service revenue mainly based on TapTap monetization continues to maintain strong growth. The overall income was RMB 468 million, a year-on-year increase of nearly 40%. The monthly active users increased by 46% year-on-year, reaching 41.73 million, and it is estimated that the launch of cloud playing games drove a lot of activity. At the same time, TapTap is gradually gaining recognition from major players in the domestic gaming industry. Although there were not many new games in the industry in the first half of the year, major players' budgets have also shifted to old games. TapTap is estimated to have benefited from this.

(4) After releasing revenue, gross profit margin improved on a month-on-month basis. The comprehensive gross profit margin for the first half of the year was 49%, returning to the level of the first half of last year, and improved significantly on a month-on-month basis. The gross profit margins of games and TapTap have also improved significantly. The high-gross-profit TapTap business has increased its contribution to total revenue and brought about a structural improvement in overall gross profit margin.

Looking back at previous years, both gaming gross profit margin and TapTap gross profit margin have yet to return to historical normal levels. However, in terms of gaming business, some companies are transitioning from agency cooperation to more self-development and sole representation, as reflected in the gradual decline in revenue recognized on a net basis. Therefore, gross profit margin is probably difficult to return to the high point of previous years.

However, TapTap's gross profit margin of 70% currently has a lot of room for improvement, and there is still a mismatch between input and output. For example, overseas TapTap is still in the investment period and has not yet entered commercialization. Investment in TDS, TapTap Cloud Play, and TapTap Accelerator has not yet brought income release. (5) In the second quarter, management expenses decreased year-on-year (-6.4%). In addition to layoffs, there was a one-time impact of rent reduction for the Shanghai office due to the epidemic. Although R&D expenses are still increasing (+14%), they include compensation for layoffs. From the perspective of R&D personnel size, it has decreased by nearly 250 people compared to the end of last year.

Looking ahead, Dolphin Analyst believes that expenses may be mainly optimized through "layoffs + new game promotion" in the second half of the year, and the reduction effect of overall expenses may disappear or even expand next year due to the increase in sales expenses.

(6) Finally, the operating loss in the second quarter slightly exceeded 400 million, although it is still increasing compared to the first half of last year, there has been improvement compared to the previous quarter. Going forward, we expect the revenue to continue to be released as the product cycle approaches and the gross profit margin to continue to improve with the increase in advertising revenue ratio and overall expense stability, thus showing a trend of continuous profit recovery.

(7) As of the end of June, the company's cash + investment totaled 3.79 billion yuan, and the operating cash outflow in the first half of the year was 180 million yuan. Short-term debt is not high, and there is mainly a convertible bond of nearly 1.8 billion yuan in the long term. With the growth of future revenue and the reduction of losses, there is not much short-term and medium-term pressure on cash flow.

Dolphin Analyst's Viewpoint:

Last time, Dolphin Analyst said that registering for a license is an emergency medicine for Heartbeat, and since the license restarted in early April, although Heartbeat's self-developed games only obtained one license, the active industry supply side can help promote growth for TapTap.

In the case of a bad environment, TapTap can still achieve high growth. Dolphin Analyst believes that essentially, it is more game manufacturers' recognition of the TapTap platform, especially those of medium and large enterprises. In the first half of the year, there were few new games. The overall market buyout scale mainly relied on medium and large manufacturers to continuously promote their old games, and TapTap could benefit from this, proving that its platform attractiveness is gradually recognized by investors.

The game business has always been viewed as a cash flow source that supports the expansion of TapTap. Under the uncertain pace of domestic registration, going overseas first is a chess move that domestic game manufacturers will choose. However, whether overseas users would accept it is a test of the manufacturers' own development and local operating capabilities. Whether it is the unexpectedly successful T3 or Sausage Party, they have proved that Heartbeat has a certain ability.

Looking forward to the second half of this year and next year, Heartbeat's product cycle is gradually approaching, although it may be affected by R&D progress, the worst stage has passed.

We will later publish the "Heartbeat Performance Conference Summary" in the investment research group. We recommend that interested users add the WeChat account "dolphinR123" to join the Dolphin investment research circle and discuss global asset investment viewpoints together! Detailed analysis of this season's financial report

1. TapTap: Expansion of the ecosystem, increased attractiveness of vertical platforms

In the first half of this year, the average monthly active users of TapTap in China reached 41.73 million, an increase of more than 7 million compared to the second half of last year. The main driving force behind this growth is the improved user stickiness resulting from TapTap's own video, cloud gaming, and other features, as well as the "TapTap Creator Program" launched in March and the company's "Flash Party" released in April, which may have contributed to user activity on the platform.

In terms of the frequency of downloads by individual users on TapTap in the first half of the year, although there were not many new games in the industry as a whole during this period (the restoration of the game license in April, but the number of licenses issued in the first batch was not large, and some games were not well prepared for launch in the short term), the average number of downloads per user on TapTap still increased slightly compared to the previous period.

Overseas TapTap has experienced a certain decline in popularity, as there have not been any new popular games released abroad this year, unlike last year, when games like "Genshin Impact" helped to drive traffic. In the first half of this year, the average monthly active users totaled 8.97 million, a decrease compared to the same period last year. As has been the case, for a gaming platform focused on a specific category, there is not much core traffic. In order to promote activity, TapTap needs to have high-quality exclusive or self-developed games to drive traffic.

As overseas TapTap is not yet commercialized, information services revenue primarily comes from game promotion revenue on the domestic TapTap platform, as well as a small proportion of cloud gaming subscription revenue. In the first half of this year, revenue from this advertising was CNY 0.468 billion, a year-on-year increase of 39%.

The advertising revenue of the platform is closely related to its activity level. The increase in TapTap's monthly active users in the first half of this year has had a significant impact on the growth of advertising revenue. However, the Dolphin Analyst believes that fundamentally speaking, TapTap has continued to gain more recognition from game developers, even though it is vertical platform with limited traffic. Therefore, despite the relatively small number of new games released in the first half of the year, TapTap has been able to leverage its high-growth advantages to overcome the industry headwinds and secure some budgets that big studios spend on promoting older games.

2. Gaming: High uncertainty in game license issuance, focus on overseas expansion in the short term Although the domestic version number resumed issuance in April, the pace and quantity of issuance are much less than usual. At present, most of Dolphin's core self-developed products have not yet obtained a version number, and the coping strategy is to go overseas first and then talk about the turnover.

In the first half of the year, "T3 Arena" and "Flash Party" were successfully launched overseas and performed well. At the same time, compared with last year, this year also saw incremental revenue from the overseas service of "Sausage Party". Therefore, the game's revenue reached 1.13 billion yuan, an 8% year-on-year increase, while the core investment bank was conservative and expected to remain flat or decline year-on-year.

Breaking down to the user and single user payment situation, it is mainly driven by higher payment rates, and the contribution of "Sausage Party" is probably indispensable. Following the victory of its first battle in Southeast Asia last year, "Sausage Party" went live in Japan, Hong Kong, Macao, and Taiwan in the second quarter of this year, and the preference of overseas users for shooting games gave this game, which has been in operation for 4 years, a new lease of life. At the same time, the payment rate of "Sausage Party" itself is relatively high, which has driven the overall number of Dolphin users.

Dolphin currently operates 20 online games and 22 paid games, with a large number but uneven commercial capabilities. Among the top five games in terms of contribution to turnover, in addition to "Sausage Party" recently continuously setting new records overseas, the other four games have been in operation for more than 3 years. If no major changes are made, they are basically in the latter half of their life cycle.

The two self-developed new games launched this year, "Flash Party" and "T3", the former belongs to the type of elite small amount, with good word of mouth but low commercial space, at least difficult to support the backbone of Dolphin's game revenue. The latter is a competitive shooting game. Like the successful type of "Sausage Party", it can provide "T3" with more operational experience, and we expect its commercial prospects to be higher than those of "Flash Party".

In the TapTap game conference in July this year, Dolphin also released updates on 27 game projects, including new games and old game updates. Among them, there were a total of 9 self-developed games, which increased by four new projects, including "Isa Reboot Day", "Go Muffin", "Starfire Editor", and "The Angry Raccoon", compared with the previous disclosure. At the same time, considering the input-output ratio, four projects, including "Star Narrative", were cut.

However, from the perspective of version numbers and its own R&D progress, the short-term self-developed reserves can only rely on going overseas to achieve revenue. On the other hand, the worst phase has passed.

3. Gross profit margin has improved as expected, with room for further improvement

In the 2021 annual report commentary at the beginning of the year, Dolphin Analyst was not particularly worried about the deterioration of gross profit margin at the time. This was mainly due to the misalignment period of input and output, and with the increase in the proportion of self-developed games, gross profit margin would improve.

This financial report shows that not only has the gross profit margin of the gaming business been optimized and returned to the level of the first half of last year, but the TapTap business has also achieved high growth due to little impact from the domestic commercialization realization. Gross profit margin has also increased significantly.

If we compare with the normal level of previous years, there is still room for further improvement in the gross profit margin of both businesses. However, compared to the gaming business that is increasingly focused on self-development and exclusive games, the revenue recognized by the total amount method will continue to maintain a high proportion, so the overall gross profit margin may be difficult to return to its historical high.

However, TapTap's business is expected to continue to see improvement and growth as the misalignment period of input and output comes to an end. However, for the commercial prospects of overseas TapTap, it not only requires high operational capabilities, but also needs a big hit like "Free Fire" like Garena. Although "Sausage Party" is popular, there is still a gap compared to "Free Fire". Therefore, Dolphin Analyst currently does not have very high expectations for overseas TapTap realization. Our expectation for the improvement of TapTap's gross profit margin is still based on the gradual improvement of the domestic environment with the opening of game approvals.

4. The effect of layoffs will gradually be reflected in expenses

After a talent war that lasted less than two years, Heartbeat couldn't sustain the layoffs due to the cooling down of the industry under regulatory impact. Especially for the R&D personnel who were recruited at a high premium, nearly 250 people were less in the first half of this year than at the end of last year. The effect of the layoffs has not yet been fully reflected, mainly due to compensation expenses during the period. It will be more apparent in the second half of the year.

On the expense management side, in addition to optimization brought by layoffs, Longbridge employees worked from home for 2-3 months due to the Shanghai epidemic in the first half of the year, enjoying rent reductions from some of the office buildings, which resulted in a 6% YoY decline in management costs.

The sales expenses of gaming companies generally change with the rhythm of new product launches. In the first half of the year, three Longbridge games were launched in different regions, so necessary promotional spending was inevitable. However, as the subsequent Longbridge product cycle approaches, sales expenses may continue to be high. But if the game performs well, the rate will decrease, and the overall efficiency of the business will still be reflected.

Dolphin Investment Research "Heartbeat" Historical Articles:

Earnings Report Season

March 30, 2022 Earnings Call: "Longbridge: Hope to achieve profit and loss balance by going overseas without domestic certification (Earnings Call Summary)"

March 30, 2022 financial report review: "Longbridge: After the Abyss or the Abyss, can going overseas 'save the day'?"

August 27, 2021 Earnings Call: "Longbridge Earnings Call Summary: Management's plans for the short and long term are clear"

August 26, 2021 financial report review: "Longbridge Financial Report: The market is 'anxious', Longbridge is 'calm'"

March 26, 2021 Earnings Call: "[Longbridge Company 2020 Performance Conference Call Summary] The transformation of the gaming industry is not done overnight, and the growth of Longbridge is no exception](https://longbridgeapp.com/topics/720960?invite-code=032064)"

March 26, 2021 financial report review: "Longbridge Investment Essentials: Patience, Patience, Patience Again"

March 1, 2021 Earnings Preview Analysis: "Dolphin Investment Research | After a Profit Plunge, Longbridge "Squats Deep"? Perhaps Just a "Fake Fall""

Depth

On February 1, 2021, "Stranger Things Behind the Heart": Is it Possible to Take Action after Being Moved? was released.

On December 29, 2021, Dolphin Investment Research|Heavy Research: How Far Away is TapTap from the Chinese version of Steam?

On December 16, 2021, Dolphin Research on Investment | "Strange Phenomena" behind Heart Movement: Why is the Market Moved?

On December 15, 2021, Dolphin Investment Research | "Strange Phenomena" Behind the Heart Movement: The Great Changes in the Gaming Industry!

Hot Topics

On July 27, 2021, "How to View Heart Movement After the Big Drop?"

On June 2, 2021, Review of Download Status of TapTap's "Mole Manor"

Risk disclosure and statement of this article: Dolphin Investment Research Disclaimer and General Disclosure