Business Context and Reporting Period
Company: GRAVITY Co., Ltd.
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2008
Business Overview: Gravity is a leading developer and publisher of online games, primarily based in Korea. Its principal product is Ragnarok Online, which accounted for 73.3% of total revenues in 2008. The company operates through direct subsidiaries in key markets (Korea, US, Russia, France) and relies on overseas licensees for distribution in other regions, most notably Japan (GungHo Online Entertainment, Inc.).
Key Financial Metrics (Year Ended Dec 31, 2008)
| Metric | Amount (Won Millions) | Amount (US$ Thousands) |
|---|---|---|
| Total Revenues | 53,170 | 41,637 |
| Cost of Revenues | 27,772 | 21,748 |
| Gross Profit | 25,398 | 19,889 |
| Operating Income (Loss) | (236) | (185) |
| Net Income (Loss) | (2,773) | (2,172) |
| Cash and Cash Equivalents | 53,168 | 41,635 |
| Total Assets | 95,935 | 75,125 |
| Total Liabilities | 19,327 | 15,134 |
| Shareholders' Equity | 76,471 | 59,884 |
Note: US$ amounts are translated at the rate of Won 1,277.00 to US$1.00 (April 30, 2009 rate).
Material Changes vs. Prior Period (2007)
- Revenue Growth: Total revenues increased 32.2% to Won 53.17 billion from Won 40.23 billion in 2007. This was driven by a 33.7% increase in subscription revenue and a 21.9% increase in royalties/license fees.
- Profitability Improvement: The company significantly reduced its operating loss from Won 22.66 billion in 2007 to Won 236 million in 2008. The net loss narrowed from Won 23.20 billion to Won 2.77 billion.
- Key Drivers:
- Currency Effects: Significant foreign currency gains (Won 3.24 billion) due to the depreciation of the Korean Won against the Japanese Yen (approx. 36% weakening).
- Micro-transactions: Increased revenue from the sale of virtual in-game items, particularly in Korea and the US.
- Expense Reduction: Operating expenses decreased 40.9% year-over-year, primarily due to the absence of a Won 8.62 billion impairment loss on investments (Perpetual Entertainment) recorded in 2007 and a 77.6% drop in advertising expenses.
- Equity Losses: Equity loss from joint ventures and partnerships increased to Won 5.12 billion (from Won 1.03 billion in 2007), primarily related to the "Online Game Revolution Fund No. 1."
Guidance, Outlook, Risks, and Unusual Items
Outlook and Guidance
Management expects to launch Ragnarok Online II in the first half of 2010, though delays have occurred. The company plans to diversify revenue through new titles like Ice Age Online and mobile games. Management believes current cash resources are sufficient to meet capital needs through at least the first quarter of 2010.
Material Risks
- Product Concentration: Heavy reliance on Ragnarok Online (73.3% of revenue), which is in the maturity phase of its lifecycle with declining user bases in some markets.
- Licensee Dependence: 73.7% of revenues come from overseas licensees. GungHo Online Entertainment (Japan) alone accounted for 50.2% of 2008 revenues and is the majority shareholder (59.3%).
- Internal Controls: The company identified a material weakness in internal controls over financial reporting regarding equity method investments, leading to a material audit adjustment. Management concluded controls were not effective as of Dec 31, 2008.
- Regulatory Environment: Risks related to changing laws in Korea, China, and other markets regarding internet cafes, content ratings, and anti-addiction systems.
- PFIC Status: The company believes it was a Passive Foreign Investment Company (PFIC) in 2008 due to the deterioration of its ADS trading price, which could result in adverse US tax consequences for investors.
Unusual Items
- Tax Rate Change: The company lost its designation as a small-and medium-sized venture company in 2008, resulting in a corporate income tax rate increase from 13.75% to 27.5%.
- Legal Proceedings: The company is a defendant in two lawsuits (YNK Korea and Softstar Entertainment) with potential damages of approximately Won 1.34 billion and an undetermined amount, respectively.
Investor Verification Checklist
- Internal Control Remediation: Verify the specific steps taken to remediate the material weakness in equity method investment accounting and the status of the audit committee's oversight.
- Ragnarok Online II Launch: Confirm the current development status and realistic launch timeline for Ragnarok Online II, given the history of delays.
- GungHo Relationship: Assess the risks associated with GungHo's dual role as the majority shareholder (59.3%) and the primary licensee (50.2% of revenue), including potential conflicts of interest.
- PFIC Implications: Consult tax advisors regarding the tax consequences of the company's PFIC status for 2008 and potential status in 2009.
- Equity Method Investments: Review the financial health of the "Online Game Revolution Fund No. 1" and the magnitude of future equity losses expected.
- Legal Exposure: Monitor the status of the pending lawsuits with YNK Korea and Softstar Entertainment.