Business Context and Reporting Period
Company: GRAVITY Co., Ltd.
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2010
Business Overview: Gravity is a leading developer and publisher of online games, primarily based in Korea. The company's revenue is heavily dependent on its flagship title, Ragnarok Online, which accounted for approximately 71.8% of total revenues in 2010. The company operates through a mix of direct publishing in key markets (Korea, US, Canada, Europe) and licensing agreements with overseas operators, most notably GungHo Online Entertainment, Inc. in Japan.
Key Financial Metrics (Year Ended Dec 31, 2010)
| Metric | Amount (Won) | Amount (US$) |
|---|---|---|
| Total Revenues | 52,362 million | 47,722 thousand |
| Gross Profit | 31,489 million | 28,699 thousand |
| Operating Income | 5,940 million | 5,414 thousand |
| Net Income (Parent Company) | 3,730 million | 3,398 thousand |
| Cash and Cash Equivalents | 44,122 million | 40,211 thousand |
| Total Assets | 125,490 million | 114,368 thousand |
| Total Liabilities | 27,078 million | 24,678 thousand |
| Long-term Debt | None | None |
Margins (2010):
- Gross Profit Margin: 60.1%
- Operating Profit Margin: 11.3%
- Net Profit Margin: 7.1%
Material Changes vs. Prior Period (2009)
- Revenue Decline: Total revenues decreased by 8.8% to Won 52.36 billion. This was primarily driven by a 21.8% drop in subscription revenue (due to market maturity of Ragnarok Online in Korea and the US/Canada) and a 5.6% decrease in royalties and license fees (impacted by the strengthening of the Korean Won against the Japanese Yen).
- Profitability Compression: Net income attributable to the parent company fell 46.1% to Won 3.73 billion. Operating income decreased 45.3% to Won 5.94 billion.
- Expense Increases: Research and development expenses surged 158.6% to Won 4.65 billion, driven by the development of Ragnarok Online II, social network games, and the acquisition of Gravity Games (formerly Barunson Interactive). Advertising expenses also increased 63.0%.
- Acquisition: In October 2010, the company acquired a 50.83% stake in Barunson Interactive (renamed Gravity Games) for Won 11.69 billion, adding the game Dragonica to its portfolio.
- One-time Items: The company recorded no settlement costs for litigation in 2010, compared to Won 1.65 billion in 2009.
Guidance, Outlook, Risks, and Contingencies
Outlook and Strategy:
- The company expects to launch Ragnarok Online II in the fourth quarter of 2011, though delays have occurred previously.
- Management plans to diversify revenue streams through new MMORPGs, mobile games, and social network games to reduce reliance on Ragnarok Online.
- Cash resources are deemed sufficient to meet capital needs through at least the first quarter of 2012.
Key Risks:
- Product Concentration: Over 70% of revenue is derived from Ragnarok Online, which is in the maturity/decline phase of its lifecycle.
- Licensee Dependence: 55.5% of 2010 revenue came from GungHo Online Entertainment, Inc. (Japan), which is also the company's majority shareholder (59.3%).
- Regulatory Environment: Operations are subject to strict regulations in Korea, China, and other markets regarding content, gambling, and minor protection.
- Internal Controls: The company previously identified material weaknesses in internal controls over financial reporting, though management concluded these were remediated as of December 31, 2010.
- PFIC Status: The company may be classified as a Passive Foreign Investment Company (PFIC) for U.S. tax purposes, which could result in adverse tax consequences for U.S. investors.
Contingencies:
- Legal Proceedings: The company is defending against lawsuits filed by a former executive regarding employment termination and unauthorized fund withdrawal. No material adverse effect is currently anticipated.
- Tax Matters: A tax examination for fiscal years 2006–2009 resulted in recognized expenses for penalties and withholding taxes related to transfer pricing adjustments.
Important Facts for Investor Verification
- Revenue Concentration: Verify the continued performance of Ragnarok Online and the success of new titles like Ragnarok Online II and Dragonica in offsetting the decline of the flagship product.
- Major Shareholder Influence: Assess the potential conflicts of interest given that GungHo Online Entertainment, Inc. owns 59.3% of the company and accounts for over half of its revenue.
- Development Timelines: Monitor the launch schedule for Ragnarok Online II, which has faced significant delays and license agreement amendments in the past.
- Currency Exposure: Evaluate the impact of foreign exchange fluctuations, as 81.4% of revenues are denominated in foreign currencies while costs are primarily in Korean Won.
- Internal Controls: Confirm the effectiveness of remediated internal controls over financial reporting to ensure accurate future disclosures.