Business Context and Reporting Period
Company: GRAVITY Co., Ltd.
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2011
Accounting Basis: U.S. GAAP
Business Overview: Gravity is a leading developer and publisher of online games, primarily based in Korea. Its principal product is the MMORPG Ragnarok Online, which has been commercially offered since 2002. The company generates revenue through subscription fees, royalties, license fees, mobile games, and character merchandising. It operates directly in Korea and the U.S./Canada, while relying on overseas licensees for distribution in other major markets, most notably Japan.
Key Financial Metrics (Year Ended Dec 31, 2011)
| Metric | 2011 (Won) | 2011 (US$) | 2010 (Won) | Change |
|---|---|---|---|---|
| Total Revenues | 57,477 million | 49,613 thousand | 52,362 million | +9.8% |
| Cost of Revenues | 24,243 million | 20,926 thousand | 20,873 million | +16.1% |
| Gross Profit | 33,234 million | 28,687 thousand | 31,489 million | +5.5% |
| Gross Margin | 57.8% | 57.8% | 60.1% | -2.3 pts |
| Operating Income | 3,161 million | 2,729 thousand | 5,940 million | -46.8% |
| Operating Margin | 5.5% | 5.5% | 11.3% | -5.8 pts |
| Net Income (Parent) | 14,928 million | 12,886 thousand | 3,730 million | +300.2% |
| Cash & Equivalents | 42,430 million | 36,625 thousand | 44,122 million | -3.8% |
| Total Assets | 132,878 million | 114,699 thousand | 125,490 million | +5.9% |
| Total Liabilities | 22,219 million | 19,179 thousand | 27,078 million | -18.0% |
Note: US$ amounts are converted at the rate of Won 1,158.50 to US$1.00 (Dec 30, 2011).
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 9.8% to Won 57.477 billion. This was driven by a 16.6% increase in subscription revenue (due to the shift to free-to-play/micro-transaction models in Korea and the U.S.) and a 10.6% increase in royalties/license fees (driven by the acquisition of Gravity Games, developer of Dragonica, and the launch of H.A.V.E. Online in Japan).
- Operating Income Decline: Despite revenue growth, operating income fell 46.8% to Won 3.161 billion. This was primarily due to a significant increase in impairment losses on intangible assets (Won 3.697 billion vs. Won 475 million in 2010) related to Eternal Destiny and Dragonica, as well as higher selling, general, and administrative expenses (up 11.4%) due to professional fees and advertising.
- Net Income Surge: Net income attributable to the parent company jumped 300.2% to Won 14.928 billion. This dramatic increase was largely due to a reversal of income tax expenses into a tax benefit of Won 7.962 billion, resulting from the partial release of deferred tax assets for the parent company.
- Impairment Charges: The company recognized Won 2.384 billion in impairment losses for Dragonica product technology and Won 514 million for goodwill related to Gravity Games due to declines in fair value.
Guidance, Outlook, Risks, and Unusual Items
- Product Lifecycle Risk: Ragnarok Online accounts for 66.0% of total revenue but is in a mature stage with declining user bases in key markets. The company is heavily dependent on the success of Ragnarok Online II (launched March 2012) to drive future growth.
- Concentration Risk: The company relies heavily on overseas licensees, particularly GungHo Online Entertainment, Inc. (Japan), which generated 49.8% of total revenue in 2011. GungHo is also the majority shareholder (59.3%) and controls the Board of Directors.
- Regulatory Environment: Operations are subject to strict regulations in Korea, China, Taiwan, and Thailand regarding content ratings, minor protection, and internet cafe operations. Changes in these laws could restrict user access or increase compliance costs.
- Unusual Items:
- Tax Benefit: A one-time tax benefit of Won 7.962 billion significantly boosted net income, masking the decline in operating profitability.
- Impairments: Significant non-cash charges for intangible assets and goodwill reduced operating income.
- Legal Proceedings: The company settled a class action lawsuit regarding its 2005 IPO for US$5 million in 2007. Other litigation regarding former executives and licensees was ongoing or settled during the period.
- Outlook: Management expects continued revenue growth from new game launches (Ragnarok Online II, East Road) and mobile games, but faces risks from user migration to new titles without net user base growth and intense competition.
Key Facts for Investor Verification
- Revenue Concentration: Verify the sustainability of revenue from Ragnarok Online (66% of total) and the specific performance of the Japan market (51.3% of total revenue), given the reliance on a single licensee (GungHo).
- Impairment Sensitivity: Assess the assumptions used for the fair value of Dragonica and Gravity Games goodwill, as further impairments could materially impact future earnings.
- Tax Normalization: Analyze future earnings potential excluding the one-time tax benefit of Won 7.962 billion, which was the primary driver of the 300% net income increase.
- Succession of Ragnarok Online II: Monitor the commercial performance and user retention of Ragnarok Online II post-launch to determine if it can offset the natural decline of the original title.
- Related Party Transactions: Review the terms of agreements with GungHo and other related parties (subsidiaries like Gravity Interactive and NeoCyon) to ensure arm's length pricing and fair value.