Gravity Co Ltd Ads (NASDAQ:GRVY)

Recall that the GeoTeam® mentioned Gravity yesterday, coding the stock as a low tier special situation play.  While this is still the case there a few items that the GeoTeam® uncovered during further due diligence.

1. Originally we indicated that the 2009 first quarter was the company's first profit in some time.  In actuality, the company was able to achieve profits in 2008. ^a

• Using the 20F as our guide the company posted a loss of $0.08 per ADR share.  Reviewing the cash flow statement it appears that it contains some non-cash charges that should be added back in order to calculate a non-GAAP Earnings Per Share number. In doing this the GeoTeam® estimated a 2008 fully taxed  $0.04 non-GAAP EPS figure ( $1.1 million). This should also have translated into a non-GAAP profit for the fourth quarter.

• The company reported a profit in its 2008 third quarter.

2. Inconsistency between net income reported in its 2008 year end release and its 2008 year end SEC 20F Filing, page 74. (Likey due to a GAAP vs. non-GAAP issue, but we could not locate such a reference).

• 20F: "We recorded a net loss of Won 2,773 million (US$2,172,000) in 2008."

• Press Release (as reported in 6-K): "The Company recorded net income of KRW 921 million (US$730,000) for 2008."

3.  A Significant portion of the company's year end and quarterly net income includes interest income and foreign currency income.

4. Outstanding legal issues per the 2008 year end SEC 20F Filing, page 95.

• The filing states, "As of December 31, 2008, we are a defendant in two separate lawsuits claiming damages for breach of contract in which we have been a party. In May 2007, YNK Korea Inc., formerly known as Sunny YNK Inc., our former investor for Ragnarok Online, filed a lawsuit against us claiming that we failed to distribute the earnings from a certain amount of net sales due to the embezzlement of royalty revenue committed by our former chairman and from license fees from overseas licensees. The claim of the lawsuit amounts to approximately Won 1,344 million. In October 2006, Softstar Entertainment Inc., our former licensee in Taiwan, Hong Kong and Macao for R.O.S.E. Online, filed a lawsuit against us insisting that the game program for the open beta testing of the game in Taiwan which was provided by us was different from the program used for the closed beta testing and was materially deficient, thereby causing them to incur a loss in their business."

^a The GeoTeam® is still reviewing Gravity's 2008 quarterly financials statements in order to derive non-GAAP EPS  data.  Unfortunately, we were unable to locate quarterly cash flow statements which normally contains information to identify non-GAAP adjustments.  We will email the company on this point and provide more information if warranted.

Gravity shares are quietly rising today in a reaction to its first quarter financial results reported this morning. 

Net income came in at $4.1 million, reversing a prior year loss.  It also appears to be the company's first profit in some time.

The GeoTeam® is attempting to uncover further details on the Gravity story.  The company did not provide much information on its future outlook and impetus for growth.  Part of the improved net income results was due to less amortization expense related to a prior acquisition.  More puzzling is the fact the company did not provide EPS data in its press releases.  Using the 2008 year end outstanding share count of 6,948,900 (27.8 million ADR), the GeoTeam® calculated a first quarter fully tax adjusted EPS figure of $0.49 (0.12 ADR). Using 6,948,900 as the share count seems like a fair assumption due to verbiage in its SEC 20F Filing (Filed June 30, 2009, page 80)

"We believe that our available cash and cash equivalents and net cash provided by operating activities will be sufficient to meet our capital needs through at least the first quarter of 2010."

There are reasons to view this story with trepidation:

1. The company essentially has one product source:

 "Due to the highly dependent revenue structure on Ragnarok Online^TM , the Company is in need of diversified revenue structure, global market expansion and new business initiatives for sustainable revenue growth."

2. No business direction was provided in the company's press release.  Thus, we are not sure if this quarter's profitability can be sustained.

3. No earnings per share data was provided in the company's press release.

4. We were unable to locate an investor contact person in the United States.

5. Company derives a good deal of revenue from royalty and licensing activities. 

6. The GeoTeam® has not thoroughly dissected the company's financial statements.

7. The GeoTeam® is not absolutely confident that we used the correct share count to calculate an implied first quarter EPS figure. 

Nonetheless, at its current price, the GeoTeam® is coding Gravity as a low tier special situation play.  The key to the Gravity story will be its ability to diversify its product line and consistently generate profits.  The stock may still exhibit some short-term price momentum due to:

• The company attaining profitability. 
• Book value per ADR share as of the first quarter was $2.31.
• Cash per ADR share as of the first quarter was $1.63.
• Significant event- The company recently regained compliance with NASDAQ.

GeoTeam® urges investors to perform their own due diligence before making an investment decision.