Business context and reporting period
Gravity Co., Ltd. filed this Form 20-F on April 27, 2015, reporting audited U.S. GAAP results for the fiscal year ended December 31, 2014, with comparisons to 2013 and 2012. Although the request refers to 2014 Q4, this filing is annual and does not provide a clear standalone fourth-quarter income statement or cash-flow value.
Gravity develops, publishes and distributes online and mobile games. Its mature flagship, Ragnarok Online, remained its largest revenue source. GungHo Online Entertainment, the Japanese publisher of Ragnarok Online and the company’s majority shareholder, owned 59.3% of Gravity.
Key financial metrics
Unless otherwise noted, amounts are in millions of Korean won (W). Approximate U.S. dollar equivalents are provided in the filing at W1,090.89 per US$1.
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Revenue | W39,889 (US$36.6m) | W47,685 | Down 16.3% |
| Cost of revenue | W34,188 | W35,399 | Down 3.4% |
| Gross profit / margin | W5,701 / 14.3% | W12,286 / 25.8% | Profit down 53.6%; margin down 11.5 percentage points |
| Operating loss / margin | W11,829 / (29.7%) | W16,730 / (35.1%) | Loss narrowed 29.3% |
| Net loss attributable to parent / net margin | W20,907 / (52.4%) | W18,588 / (39.0%) | Loss widened 12.5% |
| Operating cash flow | W(6,147) | W(3,244) | Cash use increased |
| Cash and cash equivalents at year-end | W28,382 (US$26.0m) | W31,222 | Down W2,840 |
- Revenue mix: Online-game subscription revenue was W7,962, down 3.0%; royalties and license fees were W13,093, down 39.7%; mobile games and applications were W15,055, up 3.8%; character merchandising, animation and other revenue was W3,779, up 16.3%.
- Balance sheet and liquidity: Current assets were W50,692 and current liabilities W9,651 at year-end. Short-term financial instruments were W14,500, in addition to cash and cash equivalents. Total assets were W63,096; total liabilities W15,248; and total equity W47,848.
- Debt: The filing reports no long-term debt obligations. Contractual capital-lease obligations were W137, of which W121 was due within one year. Total disclosed contractual cash obligations were W4,266, including operating leases and purchase obligations.
Material changes versus prior periods
- Revenue declined for a second consecutive year, following a 17.5% decline in 2013. The 2014 decrease was driven chiefly by lower Ragnarok Online royalties and license fees, particularly in Japan and China, and weaker Ragnarok Online II subscriptions in the United States and Canada.
- Ragnarok Online generated W15,985, or 40.1% of 2014 revenue, compared with W21,531, or 45.2%, in 2013. GungHo represented 28.1% of 2014 revenue.
- Mobile revenue increased, but did not offset declining online-game licensing revenue. Online-game royalties and license fees fell to 32.7% of total revenue from 45.6% in 2013, while mobile revenue rose to 37.7% from 30.4%.
- Gross margin fell sharply as revenue contracted while cost of revenue remained comparatively high. Operating loss narrowed partly because operating expenses fell, including lower selling and administrative, R&D and impairment charges.
- Net loss attributable to the parent widened despite the smaller operating loss, primarily because income-tax expense rose to W10,147 from W5,108. Gravity recorded full valuation allowances against deferred tax assets, concluding they were not more likely than not to be realized.
- Cash used in operations rose to W6,147. Investing activities provided W3,483, mainly reflecting a decrease in short-term financial instruments; cash and cash equivalents still declined by W2,840 over the year.
Outlook, risks and unusual items
- Management said available cash and cash equivalents and expected operating cash flows should meet capital needs through at least the first quarter of 2016, while cautioning that changed conditions, investment or acquisitions could accelerate cash use. The filing gives no specific revenue or earnings guidance.
- Key business risks include dependence on Ragnarok Online and GungHo, declining popularity of mature games, unsuccessful new-game launches, intense competition, reliance on overseas licensees, foreign-exchange exposure and evolving gaming, privacy and consumer regulations. The company reported no outstanding currency-forward contracts at year-end.
- Ragnarok Online’s Japan license was scheduled to expire in September 2015; the Thailand license was due to expire in March 2015 and was under renewal discussion. The filing also describes several Ragnarok Online II license terminations in 2014. A January 2015 China license agreement for Ragnarok Online II included a US$1m minimum guarantee and a 25% royalty on gross revenue.
- Gravity stated it believed it was a passive foreign investment company (PFIC) in 2008–2014 and expected PFIC status in 2015, potentially exposing U.S. investors to adverse tax treatment.
- Gravity had not regained Nasdaq’s US$1 minimum bid-price compliance as of the filing. A change in the ADS-to-share ratio, effective May 11, 2015, was intended to operate as a 1-for-8 reverse split of ADSs; the company cautioned that compliance was not assured.
- Unusual items include the W10,147 income-tax expense associated largely with deferred-tax-asset valuation allowances; a W4,270 court-deposit refund in late 2014 that mitigated operating cash outflow; and a W981 revenue out-of-period adjustment in the 2013 statements relating to in-game items, which management said was not material.
- Management concluded internal control over financial reporting was effective at December 31, 2014. The 2013 and 2014 financial statements received unqualified audit opinions; the auditor did not provide an internal-control attestation.
Most important facts for investors to verify
- Whether the 2015 Nasdaq bid-price compliance objective was achieved following the ADS ratio change, and the resulting effect on trading liquidity.
- Subsequent trends in Ragnarok Online revenue, Japan user activity and the renewal or replacement of major overseas licenses, including Thailand and Japan.
- Whether mobile-game growth can offset continued weakness in licensing revenue, and whether new releases achieve commercial success.
- Actual cash burn, liquidity runway and the realization or expiration of deferred tax assets and tax credits.
- Related-party exposure to GungHo, which was both a major customer and controlling shareholder, and the implications of management and board ties to GungHo.
- Whether the 2013 in-game-item revenue adjustment or changes in revenue-recognition controls require further correction or disclosure.