Business Context and Reporting Period
Company: GRAVITY Co., Ltd.
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2012
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 55.9% of total revenues in 2012. The company operates through direct publishing in Korea, the U.S., and Canada, and via licensees in other major markets, most notably Japan (GungHo Online Entertainment, Inc.).
Key Financial Metrics (Year Ended Dec 31, 2012)
| Metric | Value (Won) | Value (US$) |
|---|---|---|
| Total Revenues | 57,781 million | 54,343 thousand |
| Cost of Revenues | 34,906 million | 32,830 thousand |
| Gross Profit | 22,875 million | 21,513 thousand |
| Gross Profit Margin | 39.6% | 39.6% |
| Operating Income (Loss) | (18,494) million | (17,395) thousand |
| Operating Margin | (32.0%) | (32.0%) |
| Net Income (Loss) | (20,540) million | (19,318) thousand |
| Net Income (Loss) Attributable to Parent | (12,224) million | (11,497) thousand |
| Cash and Cash Equivalents (End of Period) | 36,455 million | 34,287 thousand |
| Total Assets | 110,555 million | 103,979 thousand |
| Total Liabilities | 20,477 million | 19,259 thousand |
Material Changes vs. Prior Period (2011)
- Revenue: Total revenue increased slightly by 0.5% to Won 57.78 billion. This was driven by a 260.8% increase in character merchandising/animation revenue (due to Ragnarok Odyssey) and a 22.9% increase in mobile game revenue. These gains were offset by a 9.1% decline in royalties/license fees and a 12.2% decline in subscription revenue, primarily due to the maturity of Ragnarok Online in key markets.
- Profitability: The company swung from a net income of Won 14.9 billion in 2011 to a net loss of Won 20.5 billion in 2012. Gross profit margin contracted significantly from 57.8% to 39.6% due to increased amortization of intangible assets and higher commissions.
- Impairment Charges: A primary driver of the operating loss was a Won 14.6 billion impairment loss on intangible assets and goodwill. This included significant write-downs for the game East Road (Won 8.5 billion), Dragonica (Won 2.2 billion), and goodwill related to Gravity Games (Won 3.6 billion).
- Operating Expenses: R&D expenses increased by 69.7% to Won 7.0 billion, largely due to mobile game development. SG&A expenses decreased by 10.8% due to reduced salaries and professional fees, partially offset by a 46.9% increase in advertising expenses.
Guidance, Outlook, Risks, and Unusual Items
- Outlook: Management expects future growth to depend on the successful launch of new titles, specifically Ragnarok Online II (commercially launched in Korea in March 2012, with global rollout planned for 2013) and mobile games. The company anticipates continued revenue decline from the mature Ragnarok Online franchise.
- Liquidity: As of December 31, 2012, the company held Won 36.5 billion in cash and cash equivalents. Management believes this, combined with operating cash flows, is sufficient to meet capital needs through at least the first quarter of 2014.
- Key Risks:
- Product Concentration: Heavy reliance on Ragnarok Online (55.9% of revenue) and its aging lifecycle.
- Licensee Dependence: 54.3% of revenue comes from overseas licensees. GungHo Online Entertainment (Japan) alone accounted for 51.0% of total revenue in 2012 and is also the majority shareholder (59.3%).
- Regulatory Environment: Strict regulations in Korea regarding internet cafes, minor protection, and speculative games, as well as complex regulatory regimes in China and Taiwan.
- Asset Impairment: Significant risk of future impairment charges if new game launches fail to meet revenue expectations.
- Unusual Items: The 2012 results were significantly impacted by non-cash impairment charges totaling Won 14.6 billion. Additionally, the company recorded a gain on the disposal of equity method investments (Won 528 million) and a gain on loss of control in a subsidiary (Won 548 million) in 2011, which were not present in 2012.
Important Facts for Investor Verification
- Major Shareholder Influence: Verify the extent of GungHo Online Entertainment's control (59.3% ownership) and potential conflicts of interest, given that GungHo is also the primary licensee in Japan and accounts for over half of Gravity's revenue.
- Ragnarok Online II Performance: Monitor the commercial performance and user migration rates of Ragnarok Online II to determine if it can offset the declining revenue of the original Ragnarok Online.
- Impairment Sensitivity: Review the assumptions used in the fair value calculations for goodwill and intangible assets, as small changes in revenue forecasts or discount rates could trigger further significant impairment charges.
- Licensee Compliance: Assess the risk of revenue leakage or non-compliance by overseas licensees, particularly in markets with complex regulatory environments like China and Taiwan.
- Cash Flow Sustainability: Confirm that the company's cash reserves are sufficient to fund ongoing R&D and marketing for new titles without requiring dilutive equity financing, given the current operating losses.