Business Context and Reporting Period
Company: GRAVITY Co., Ltd.
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2005
Business Overview: GRAVITY is a leading developer and distributor of online games, primarily based in Korea. The company's revenue is heavily dependent on its flagship title, Ragnarok Online, which accounted for approximately 88.3% of total revenues in 2005. The company operates through direct management in Korea and the U.S./Canada, and through licensing agreements with overseas operators in markets including Japan, Taiwan, and Thailand.
Key Financial Metrics (Year Ended Dec 31, 2005)
| Metric | 2005 (Won Millions) | 2005 (US$ Thousands) |
|---|---|---|
| Total Revenues | 53,384 | 52,856 |
| Cost of Revenues | 16,038 | 15,879 |
| Gross Profit | 37,346 | 36,977 |
| Operating Income (Loss) | (2,668) | (2,641) |
| Net Income (Loss) | (3,030) | (3,000) |
| Cash and Cash Equivalents | 25,874 | 25,618 |
| Total Assets | 144,857 | 143,423 |
| Total Liabilities | 24,073 | 23,835 |
| Shareholders' Equity | 120,762 | 119,566 |
Margins: Gross profit margin decreased to 70.0% (from 84.3% in 2004). Operating margin turned negative at -5.0%. Net profit margin was -5.7%.
Material Changes vs. Prior Period
- Revenue Decline: Total revenues decreased by 17.1% to Won 53.38 billion. This was driven by a 30.8% drop in subscription revenue and a 17.1% drop in royalties and license fees, attributed to the relative maturity of Ragnarok Online and increased competition.
- Profitability Reversal: The company shifted from a net income of Won 28.06 billion in 2004 to a net loss of Won 3.03 billion in 2005.
- Expense Surge: Operating expenses increased by 155.0% to Won 40.01 billion.
- Selling, General & Administrative (SG&A): Increased 125.4% primarily due to Won 9.57 billion in fees and expenses related to the investigation and restatement of financial statements regarding accounting irregularities by the former Chairman.
- Research & Development (R&D): Increased 354.4% due to costs associated with developing new titles (Requiem and Ragnarok Online II) and publishing rights for STYLIA and Time N Tales.
- Interest Expense Reduction: Interest expense decreased 54.4% due to the expiration of the distribution agreement with YNK Korea in July 2005.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary and Outlook
Management expects to continue deriving a substantial portion of revenues from Ragnarok Online but is actively diversifying. Key strategic initiatives include:
- New Game Launches: Planned open beta testing for Ragnarok Online II by the end of 2006 and Requiem in the first half of 2007.
- Acquisitions and Investments: Completed acquisition of a controlling interest in NEOCYON, Inc. (mobile solutions) and TriggerSoft Corporation (developer of R.O.S.E. Online). Entered into an agreement to invest US$9 million in Perpetual Entertainment, Inc.
- International Expansion: Conducting beta testing in Russia, Vietnam, Spain, and Latin American countries.
Material Risks and Contingencies
- Internal Control Weaknesses: The company identified material weaknesses in internal controls over financial reporting, including a lack of effective control environment that allowed the former Chairman to embezzle funds and manipulate financial records. This necessitated the restatement of financial statements for 2002, 2003, and 2004.
- Legal Proceedings: The company is subject to a consolidated class action lawsuit in the U.S. District Court for the Southern District of New York regarding alleged misstatements in the IPO prospectus. Additionally, minority shareholders have formed a committee to review management decisions and pursue legal action if necessary.
- Product Concentration: Heavy reliance on Ragnarok Online (88.3% of 2005 revenue) and specific licensees (GungHo in Japan and Soft-World in Taiwan accounted for over 50% of total revenue combined).
- Regulatory Environment: Operations are subject to evolving regulations in key markets (Korea, China, Taiwan, Thailand) regarding content, user protection, and internet cafe operations.
Key Facts for Investor Verification
- Restatement Impact: Verify the extent of the financial restatements for 2002-2004 and the specific adjustments made to the 2005 financials regarding the former Chairman's misconduct.
- Internal Control Remediation: Assess the progress of the new ERP system implementation and the effectiveness of the new Audit Committee and Chief Compliance Officer in addressing identified control weaknesses.
- Licensee Performance: Monitor the performance and financial stability of key licensees (GungHo, Soft-World) given the high concentration of revenue risk.
- New Game Viability: Track the user acquisition and monetization metrics for R.O.S.E. Online and the development timeline for Ragnarok Online II to ensure successful diversification away from the aging flagship title.
- Legal Exposure: Review the status of the securities class action lawsuit and potential settlement costs or regulatory fines.