Business Context and Reporting Period
Company: GRAVITY Co., Ltd.
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2007
Business Overview: GRAVITY is a leading developer and publisher of online games, primarily based in Korea. Its principal product is Ragnarok Online, a massively multiplayer online role-playing game (MMORPG) distributed in Korea and 23 other countries. The company generates revenue through subscription fees, royalties, and license fees from overseas operators, as well as mobile games and character merchandising.
Key Financial Metrics (Year Ended Dec 31, 2007)
| Metric | Amount (Won Millions) | Amount (US$ Thousands) |
|---|---|---|
| Total Revenues | 40,229 | 42,989 |
| Cost of Revenues | 19,479 | 20,815 |
| Gross Profit | 20,750 | 22,174 |
| Operating Loss | (22,660) | (24,214) |
| Net Loss | (23,201) | (24,792) |
| Cash and Cash Equivalents | 53,588 | 57,264 |
| Total Assets | 96,927 | 103,577 |
| Total Liabilities | 21,383 | 22,850 |
| Shareholders' Equity | 75,476 | 80,654 |
Key Margins:
- Gross Profit Margin: 51.6%
- Operating Profit Margin: (56.3%)
- Net Profit Margin: (57.7%)
Material Changes vs. Prior Period (2006)
- Revenue Decline: Total revenues decreased by 1.8% to Won 40.2 billion. This was driven by a 5.5% drop in royalties and license fees (primarily from Ragnarok Online due to market maturity and competition) and a 20.0% drop in character merchandising revenue. These declines were partially offset by an 11.7% increase in subscription revenue (due to new game launches) and a 5.8% increase in mobile game revenue.
- Widening Losses: The net loss increased to Won 23.2 billion from Won 22.3 billion in 2006. The operating loss widened significantly to Won 22.7 billion from Won 12.2 billion.
- Impairment Charges: The company recorded a significant impairment loss of Won 8.6 billion on its investment in Perpetual Entertainment, Inc., which went into liquidation in October 2007.
- Expense Fluctuations: Selling, general, and administrative (SG&A) expenses increased by 5.4% due to higher advertising costs for new game launches and the Gravity Festival. Conversely, litigation charges and proceeds from a former chairman (related to fraud) were zero in 2007, compared to significant charges and proceeds in 2006.
Guidance, Outlook, Risks, and Unusual Items
Outlook and Strategy
The company's future success depends heavily on the commercial success of new titles, particularly Ragnarok Online II, which was in open beta testing with an expected launch in the fourth quarter of 2008. The company is also diversifying into casual games and mobile platforms to reduce reliance on its flagship MMORPG.
Material Risks
- Product Concentration: Ragnarok Online accounted for 77.3% of total revenues in 2007. The game is reaching maturity in principal markets, leading to declining user bases and revenues.
- Licensing Dependence: 72.4% of revenues came from overseas licensees. The company is heavily dependent on GungHo Online Entertainment, Inc. (Japan), which contributed 44.1% of total revenues.
- Internal Control Weakness: Management identified a material weakness in internal controls over financial reporting related to a lack of monitoring over outsourced IT functions. Consequently, disclosure controls and procedures were deemed ineffective as of December 31, 2007.
- Corporate Governance: In April 2008, GungHo Online Entertainment, Inc. acquired majority ownership (approx. 52.4%, rising to 59.3% by June 2008), creating potential conflicts of interest as GungHo is both the largest shareholder and the primary licensee in Japan.
- Regulatory Environment: Operations are subject to varying and evolving regulations in key markets like Korea, China, and Taiwan, including restrictions on internet cafes and content ratings.
Unusual Items
In 2006, the company recorded a one-time gain of Won 4.9 billion from proceeds recovered from a former chairman due to fraud. This item was not present in 2007. Additionally, the company benefited from a reduced corporate income tax rate of 13.75% in 2007 due to its designation as a venture company, a benefit not expected to continue in 2008.
Investor Verification Checklist
- Product Pipeline: Verify the actual launch date and market reception of Ragnarok Online II and other new titles (e.g., Requiem, Emil Chronicle Online) to assess revenue diversification.
- Internal Controls: Review subsequent filings to confirm the remediation of the material weakness regarding outsourced IT functions and the effectiveness of disclosure controls.
- Shareholder Structure: Monitor the relationship and potential conflicts of interest between GRAVITY and its new majority shareholder, GungHo Online Entertainment, Inc.
- Licensee Performance: Track the financial health and performance of key overseas licensees, particularly GungHo (Japan) and Soft-World (Taiwan), given the high revenue concentration.
- Tax Status: Confirm the impact of the expiration of the 13.75% reduced tax rate in 2008 on future net income.