Webzen 20-F 2008
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file number: 000-50476
(Exact name of Registrant as specified in our charter)
(Translation of Registrant’s name into English)
The Republic of Korea
(Jurisdiction of incorporation or organization)
Daelim Acrotel Building, 8th Floor,
467-6 Dogok-dong, Kangnam-ku,
Seoul, Korea 135-971
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
* Not for trading, but only in connection with the registration of American Depositary Shares.
Securities registered or to be registered pursuant to Section 12(g) of the Act:
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
(Title of Class)
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.
As of December 31, 2007, 12,492,689 Shares and 9,415,170 ADSs are outstanding.
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
o Large accelerated filer x Accelerated filer o Non-accelerated filer
Indicate by check mark which financial statement item the Registrant has elected to follow.
Item 17 o Item 18 x
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes x No
PRESENTATION OF FINANCIAL INFORMATION
Unless the context otherwise requires, references in this annual report to:
The consolidated financial statements of Webzen have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). Unless otherwise stated or the context otherwise requires, all amounts in such financial statements are expressed in Won.
For your convenience, this annual report contains translations of certain Won amounts into U.S. dollars at the noon buying rate of the Federal Reserve Bank of New York for Won in effect on December 31, 2007 which was 935.8 to US$1.00.
This annual report contains statements that constitute “forward-looking statements” within the meaning of Section 21(E) of the Securities Exchange Act of 1934. When included in this annual report, the words, “will,” “should,” “expects,” “intends,” “anticipates,” “estimates” and similar expressions, among others, identify forward-looking statements. Such statements, which include, but are not limited to, statements contained in “Item 3. Key Information — 3.D. Risk Factors,” “Item 5. Operating and Financial Review and Prospects” and “Item 11. Quantitative and Qualitative Disclosure about Market Risk,” inherently are subject to a variety of risks and uncertainties that could cause actual results to differ materially from those set forth in such statements. These forward-looking statements are made only as of the date of this annual report. We expressly disclaim any obligation or undertaking to release any update or revision to any forward-looking statement contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based.
3.A. Selected Financial Data
The following selected consolidated financial information has been derived from our consolidated financial statements as of each of the dates and for each of the periods indicated below. This information should be read in conjunction with and is qualified in its entirety by reference to our consolidated financial statements, including the notes thereto, included in this annual report. Our consolidated financial statements are prepared in accordance with U.S. GAAP.
Fluctuations in the exchange rate between Won and U.S. dollars will affect the U.S. dollar equivalent of the Won price of our common shares on The Korea Exchange, Inc. (“KRX”) KOSDAQ Market (“KOSDAQ”) and, as a result, will likely affect the market price of our ADSs. These fluctuations will also affect the U.S. dollar conversion by the depositary of cash dividends paid in Won and the Won proceeds received by the depositary from any sale of our common shares represented by our ADSs.
In certain parts of this annual report, we have translated Won amounts into U.S. dollars for the convenience of investors. Unless otherwise stated, the rate we used for the translation was W935.8 to US$1.00, which was the noon buying rate announced by the Federal Reserve Bank of New York on December 31, 2007. The translation is not a representation that the Won or U.S. dollar amounts referred to herein could have been or could be converted into U.S. dollars or Won, as the case may be, at any particular rate, or at all. The table below sets forth, for the periods indicated, information concerning the noon buying rate for Won, expressed in Won per one U.S. dollar.
3.B. Capitalization and Indebtedness
3.C. Reasons for the Offer and Use of Proceeds
3.D. Risk Factors
Risks Related to the Company
Risks Related to Our Business
Our business is intensely “hit” driven. If we fail to deliver “hit” products or if consumers prefer our competitors’ products over our own, our operating results could suffer.
While many new online game products are regularly introduced, only a relatively small number of “hit” titles account for a significant portion of the total net revenue in our industry. We commenced commercial service of Soul of the Ultimate Nation (SUN) in Korea in the fourth quarter of 2006, in Taiwan and China in the second quarter of 2007 and in Japan in the second quarter of 2008. The performance in Korea, however, has not met our initial expectations. We have also tested other games such as Huxley and Parfait Station. We are unable to predict if our new games and services will be successful. In addition, even if any of our games are initially well-received, the introduction of more popular games by our competitors may significantly shorten the life-cycle of our game, which could cause our revenue to fall below our expectations. If our competitors develop more successful products, offer competitive products at lower prices, or if we do not continue to develop consistently high-quality and well-received products, our revenue, margins, and profitability will decline.
Additionally, our business is subject to risks that are generally associated with the entertainment industry, many of which are beyond our control. These risks could negatively impact our operating results and include: the popularity, price and timing of our games and the platforms on which they are played; economic conditions that adversely affect discretionary consumer spending; changes in consumer demographics; the availability and popularity of other forms of entertainment; and critical reviews and public tastes and preferences, which may change rapidly and are difficult to predict.
If we do not meet our product development schedules, our operating results will be adversely affected.
We have new games and services that we plan to launch from the third quarter of 2008. Huxley is scheduled for commercial launch in September 2008, and T-Project is planned to have an open beta testing in 2010. Our ability to meet product development schedules is affected by a number of factors, including the creative processes involved, the coordination of development teams required by the increasing complexity of our products and the need to fine-tune our products prior to their release. We have in the past experienced development delays of our products. Failure to meet anticipated production or commercialization schedules may cause a shortfall in our revenue, adversely affect our profitability and cause our operating results to be materially different from expectations. In addition, the perceived or actual delay of our launch schedules has in the past and will likely in the future have a negative affect on the price of our common shares and ADSs.
We currently depend on two games, MU and Soul of the Ultimate Nation (SUN), for substantially all of our revenue.
Substantially all of our revenues and profits are currently derived from two online games, MU and Soul of the Ultimate Nation (SUN). Revenue generated from MU decreased in 2007 and may decrease in the future as the game has reached its declining stage and as users may switch to newly introduced games or other massively-multiplayer online games (“MMOGs”) or discontinue playing MMOGs. We have commenced commercial service of Soul of the Ultimate Nation (SUN) in Korea in the fourth quarter of 2006, in Taiwan and China in the second quarter of 2007 and in Japan in the second quarter of 2008, but the game is still in its initial stages contributing less to our revenue than MU. We expect that the revenue generated by Soul of the Ultimate Nation (SUN) will grow as we upgrade the game and commercially launch it in other markets. However, if revenue derived from Soul of the Ultimate Nation
(SUN) does not increase at the pace we expect, or at all, and MU revenue continues to decline, our future results of operations and the prices of our common shares and ADSs will be negatively affected.
Increased competition in the online game industry may adversely affect our business.
Competition in our industry is intense and we expect new competitors to continue to emerge. There are over 100 companies in Korea alone that are dedicated to developing and/or operating online games. Our competitors in the MMOG industry vary in size from small companies to very large companies with dominant market shares such as Blizzard and NCsoft. Chinese game developers have also developed and successfully launched new games, many of which are tailored to the needs and tastes of Chinese game players. We also compete with online casual game and game portal companies such as NHN, Neowiz, Nexon and CJ Internet. In addition, we may face stronger competition from console game companies, such as Sony, Microsoft and Nintendo, many of which have expanded their game services and offerings to enable console games to be played over the Internet. Many of our competitors have significantly greater financial, marketing and game development resources than we have. As a result, we may not be able to devote resources to design and develop new games, undertake extensive marketing campaigns, adopt aggressive pricing policies, pay high compensation to game developers or compensate independent game developers to the same degree as some of our competitors. In markets outside Korea, we may not be able to provide games that are as customized to the tastes and preferences of local customers. We believe the decline in the number of MU subscribers in major overseas market such as China is attributable to the success of new games introduced by our competitors. In addition, increased competition in the online game industry may also reduce the number or growth rate of our subscribers, the average number of hours played by our subscribers, our license fee revenue or our subscription fees. All of these competitive factors may adversely affect our cash flows, operating margins and profitability.
We have identified certain deficiencies with respect to our internal control over financial reporting and, if we fail to remedy these deficiencies, investor confidence and the market price of our ADSs may be adversely affected.
We have been and are continuing to evaluate our internal control systems to allow our management to report on, and our auditors to attest to, our internal control over financial reporting. As of December 31, 2007, we identified deficiencies in our internal control over financial reporting. If we cannot remedy these deficiencies or if subsequent assessments of our internal control over financial reporting otherwise identify material weaknesses that must be disclosed in future annual reports on Form 20-F, we may receive an attestation with an adverse opinion from our independent auditors as to the adequacy of our internal control over financial reporting. Such an opinion could reduce confidence in our financial statements and negatively affect the price of our securities.
Rapid technological change may limit our ability to recover game development costs and adversely affect our future revenues and profitability.
The online game industry is subject to rapid technological change. We need to anticipate the emergence of new technologies and games, assess their market acceptance, and make substantial game development and related investments. In addition, new technologies in online game programming or new platforms such as the game consoles introduced to the market could render MU, Soul of the Ultimate Nation (SUN) or other online games that we expect to develop in the future less attractive to our subscribers, thereby limiting our ability to recover development costs and potentially adversely affecting our future revenues and profitability.
We have recently experienced departures of a key executive officer and key game development personnel. If we fail to attract highly skilled online game developers who can assume the tasks of those that have departed, our future game release schedule could be further delayed and our business could be materially and adversely affected.
Our success depends to a large extent upon the services of a limited number of executive officers and other key employees in our online game development department. The unanticipated loss of the services of several of our key employees, including Ki Yong Cho, our co-founder and former executive officer, and key game developers, may have a material and adverse effect upon the development schedule of the games that these employees were in charge of. The number of our employees in game development, web development and system engineering decreased from 548 as of December 31, 2006 to 319 as of December 31, 2007. We are in the process of seeking skilled online game developers who can assume the tasks of those who have departed. However, as competition for such personnel is
intense and as we continue to experience employee departures at a rate greater than that historically experienced, we may not be able to find the qualified replacement personnel that we are seeking or may need to offer higher compensation and other benefits. Even if such key personnel can be recruited, the time it takes for them to integrate into our current operations may challenge our ability to meet our development schedules, which could materially and adversely affect our results of operations and have a negative effect on the price of our common shares and ADSs.
Undetected programming errors or flaws in our games could harm our reputation or decrease market acceptance of our games, which would materially and adversely affect our results of operations.
Our games may contain errors or flaws that become apparent only after their release, particularly as we seek to develop and launch new games under tight time constraints. We believe that if our customers have negative experiences with our games, they may be less inclined to commence, continue or resume subscriptions with us or recommend our games to other potential customers. Undetected programming errors and game defects can harm our reputation, cause our customers to terminate subscriptions with us, divert our resources and delay market acceptance of our games, any of which could materially and adversely affect our results of operations and have a negative effect on the price of our common shares and ADSs.
Unexpected network interruptions caused by system failures or any personal information leak may lead to subscriber and revenue reductions and harm our reputation.
Any failure to maintain the satisfactory performance, reliability, security and availability of our network infrastructure may cause significant harm to our reputation and our ability to attract and maintain subscribers. Any server interruptions, breakdowns or system failures, including failures attributable to sustained power shutdowns, efforts to gain unauthorized access to our systems, loss or corruption of data or malfunctions of software or hardware, or other events outside our control that could result in a sustained shutdown of all or a material portion of our services could adversely impact our ability to service our subscribers. Our network systems are also vulnerable to damage from fire, flood, power loss, telecommunications failures, hackings and similar events.
In addition, subscriber personal information leaks or any security breach may adversely affect our business. For example, there were recent incidents of private information leaks in Korea that raised serious concerns among internet and online service users. Internet Auction Co., the South Korean unit of U.S. online auction house eBay Inc., recently announced that its website had been hacked in February 2008, leading to the theft of 10.8 million users’ confidential information. Certain users of Auction service are gathering members to launch a class-action lawsuit against Auction. LG Telecom Co., the country's third largest mobile carrier, was also found to have been attacked by a hacker who managed to access the private information of its subscribers. Any failure to maintain reliable network infrastructure or proper security measures can harm our reputation and our business, expose us to litigation risks and have a negative effect on the price of our common shares and ADS.
We may not be able to adequately protect our intellectual property rights, which could decrease our competitiveness.
We regard our proprietary software, domain names, trade names, trademarks and similar intellectual properties as critical to our success. We rely on a combination of copyrights, service marks and patents to protect our intellectual property rights. Policing unauthorized use of proprietary technology is difficult and expensive. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our technology. We cannot be certain of our ability to prevent misappropriations of our technology in Korea, China and other countries where intellectual property protection laws may not be as robust as in the United States. From time to time, we may have to resort to litigation to enforce our intellectual property rights, which could result in substantial costs and diversion of our resources.
We believe that we may have been a passive foreign investment company (“PFIC”) for 2007, which has certain adverse U.S. federal income tax consequences to holders of common shares and ADSs.
In general, we will be considered a PFIC for U.S. federal income tax purposes for any taxable year in which (i) 75% or more of our gross income consists of passive income or (ii) 50% or more of the average quarterly value of our assets consist of assets that produce, or are held for the production of, passive income. Based on the price of our common shares and ADSs during our 2007 taxable year and the amount of passive assets, including cash and cash
equivalents, held by us throughout that year, we believe we may have been a PFIC for our 2007 taxable year. Further, there is a significant risk that we will be a PFIC for our 2008 taxable year, and we may be a PFIC for future taxable years.
If we are a PFIC for any year that you hold common shares or ADSs, certain adverse U.S. federal income tax consequences could apply to you, including recharacterization of gains realized on the disposition of, and certain dividends received on, the common shares or ADSs as ordinary income earned pro rata over your holding period for such common shares or ADSs, taxed at the maximum rates applicable during the years in which such income is treated as earned, and subject to interest charges for a deemed deferral benefit. You should consult your own tax adviser with respect to our potential PFIC status and the consequences to you. See “Item 10. Additional Information – 10.E. Taxation – U.S. Federal Income Tax Considerations – Passive Foreign Investment Company Considerations.”
Our online games may be subject to government restrictions or ratings systems, which could delay or prohibit the release of new games or reduce the existing and potential range of our customer base.
Legislation is periodically introduced in Korea by government agencies to establish a system for protecting consumers from the influence of graphic violence and sexually explicit material contained in various types of games. Korean law also requires online game companies to obtain ratings classifications and implement procedures to restrict the distribution of online games to certain age groups. See “Item 4. Information on the Company — 4.B. Business Overview — Laws and Regulations.” Similar mandatory ratings systems and other regulations affecting the content and distribution of our games have also been adopted in China and other markets. In the future we may be required to modify our game content or features or alter our marketing strategies to comply with new government regulations or new ratings assigned to our current or future games, which could delay or prohibit the release of new games or upgrades and reduce the existing and potential range of our customer base. Moreover, uncertainties regarding government restrictions or ratings systems applicable to our business could give rise to market confusion, thereby adversely affecting our business or the prevailing price of our common shares or ADSs.
Risks Specific to Our Overseas Operations
Foreign operations are subject to different business, political and economic risks.
For the year ended December 31, 2007, our license and royalty revenues from operations outside of Korea, including China, Taiwan, Thailand, Japan, the Philippines, Vietnam and the U.S. comprised 21.4% of our total net revenues. Foreign operations are subject to inherent risks, including disputes with our licensees or joint venture partners, uncertain legal environments, different consumer preferences, unexpected regulatory requirements, tariffs and other barriers, difficulties in training and retraining staff and managing foreign operations, difficulties in obtaining or renewing required licenses and obtaining administrative approvals and difficulties in collecting foreign receivables. We will also be exposed to risks of foreign exchange fluctuations as we record our license and joint venture income in Won in our financial statements.
Risks Related to The Republic of Korea
Increased tension with North Korea could adversely affect us.
Relations between Korea and North Korea have been tense over most of Korea’s modern history. The level of tension between Korea and North Korea has fluctuated and may increase or change abruptly as a result of current and future events, including ongoing contacts at the highest levels of the governments of Korea and North Korea. The level of tension between Korea and North Korea, as well as between North Korea and the United States, has increased as a result of the missile testing conducted in the East Sea, as well as recent public announcements that nuclear tests had been conducted in North Korea. On October 9, 2006, North Korea announced that it had successfully conducted a nuclear test, which increased tensions in the region and raised strong objections from Korea, the United States, Japan, China and other nations worldwide. In response, the United Nations Security Council passed a resolution which prohibits any United Nations member state from conducting transactions with North Korea in connection with any large-scale arms and material or technology related to missile development or weapons of mass destruction, and providing luxury goods to North Korea. The resolution also imposes an asset freeze and an international travel ban on persons associated with North Korea’s weapons programs and calls upon all United Nations member states to take cooperative actions, including inspections of cargo to or from North Korea.
North Korea agreed in late October 2006 to return to the six-party talks to hold further discussions on its nuclear programme and other related topics. In February 2007, Korea, China, Japan, Russia, the United States and North Korea reached agreement during six-party talks in Beijing for South Korea to provide up to 1 million tons of heavy fuel oil and other economic support to North Korea in exchange for North Korea’s agreement to shut down its nuclear facilities in Yongbyun and allow the International Atomic Energy Agency (“IAEA”) inspectors to be admitted for conducting the necessary monitoring. North Korea also agreed not to produce any plutonium for use in producing nuclear weapons. In addition, the United States and Korea have recently begun to restructure and reorganize the nature of their military alliance in Korea. In October 2004, the United States and Korea agreed to a three-phase withdrawal of approximately one-third of the 37,500 U.S. troops then stationed in Korea by the end of 2008. By the end of 2006, 10,000 U.S. troops had departed Korea, with an additional 2,500 U.S. troops to be withdrawn by the end of 2008. Further, in February 2007, the United States and Korea agreed to dissolve their joint command structure by 2012, which would allow Korea to assume the command of its own armed forces in the event of war on the Korean peninsula.
Escalated tensions between the Korea and North Korea due to any reason, including if high-level contacts break down or military hostilities increase, could have a material adverse effect on the credit rating of Korea, our operations and the price of our common shares and ADSs.
If economic conditions in Korea deteriorate, our current business and future growth could be materially and adversely affected.
We are incorporated in Korea and a substantial portion of our operations and assets are located in Korea. As a result, we are subject to political, economic, legal and regulatory risks specific to Korea. The economic indicators in the past few years have shown mixed signs of recovery and uncertainty, and future recovery and growth of the economy is subject to many factors beyond our control. Any future deterioration of the Korean and global economy could adversely affect our business, financial condition and results of operations.
Developments that could hurt Korea’s economy in the future include:
Securities class action litigation may be brought against us in Korea following periods of volatility in the market price of our securities.
The Securities-Related Class Action Act of Korea, which became effective on January 1, 2005, permits class action suits to be instituted by one or more representative plaintiffs on behalf of 50 or more persons who collectively hold 0.01% or more of the shares of the company and who claim to have been damaged in a capital markets transaction involving securities issued by a company listed on the KRX Stock Market or KOSDAQ. Applicable causes of action with respect to such suits include, among others, claims for damages caused by misleading information contained in a securities registration statement, the filing of a misleading business report, insider trading or market manipulation and claims instituted against auditors for damages caused by accounting irregularities. In cases of false and inaccurate statements provided in registration statements, prospectuses, business reports and accounting irregularities of companies whose total assets are less than W2.0 trillion on a non-consolidated basis as at the end of the fiscal year immediately preceding January 1, 2005 (such as us), the new law started to apply from January 1, 2007. Following periods of significant volatility in the market price of a company’s securities, it is possible that securities class action litigation can be brought against that company under the new law. If similar litigation were instituted against us, it could result in substantial costs and divert management’s attention and resources from our core business.
Risks Related to Our ADSs
KOSDAQ volatility may adversely affect the price of our common shares and the ADSs.
Certain shares listed on the KOSDAQ have recently experienced significant price and volume fluctuations, sometimes without regard to the underlying fundamentals of such shares. Historically, the KOSDAQ itself has had substantially less trading volume than the KRX Stock Market. As a result, our common shares may be less liquid and the prevailing price of the common shares may be more volatile in the future than other shares listed on the KOSDAQ or shares listed on the KRX Stock Market. The volatility and limited liquidity of our common shares on the KOSDAQ may adversely affect the market price of the ADSs.
Any dividends paid on our common shares will be in Won and fluctuations in the exchange rate between the Won and the U.S. dollar may affect the amount received by you.
When we declare cash dividends, the dividends will be paid to the depositary for the ADSs in Won and then converted by the depositary into U.S. dollars pursuant to the deposit agreement. Fluctuations in the exchange rate between the Won and the U.S. dollar will affect, among other things, the U.S. dollar amounts you will receive from the depositary as dividends.
Your ability to deposit common shares into the depositary facility may be limited.
Neither common shares acquired in the open market nor common shares withdrawn from the ADS depositary facility may be deposited or redeposited, as the case may be, under the deposit agreement governing the ADSs without our consent. It is our policy to consent to any deposit unless such deposit is prohibited by Korean law, violates our Articles of Incorporation or the total number of our common shares on deposit with the depositary does not exceed 3,900,000. No assurance can be given that deposits or redeposits of our common shares will always be permitted. If an investor’s ability to deposit common shares is limited, the prevailing market price of our ADSs may differ from the prevailing market price of the equivalent number of our common shares traded on the KOSDAQ.
You may not be able to exercise preemptive rights.
The Korean Commercial Code and our Articles of Incorporation require us, with certain exceptions, to offer shareholders the right to subscribe for new common shares in proportion to their existing ownership percentages whenever new common shares are issued. Under the deposit agreement governing the ADSs, if we offer rights to subscribe for additional common shares, the depositary under the deposit agreement, after consultation with us, may make such rights available to you or dispose of such rights on your behalf and make the net proceeds available to you or, if the depositary is unable to take such actions, it may allow the rights to lapse with no consideration to be received by you. The depositary is required to make available any rights to subscribe for any securities only when a registration statement under the United States Securities Act of 1933, as amended (“Securities Act”), is in effect with respect to the securities or if the offering of the securities is exempt from the registration requirements under the Securities Act. We are under no obligation to file a registration statement under the Securities Act to enable you
to exercise preemptive rights for our common shares underlying the ADSs, and we cannot assure you that any registration statement will be filed or that an exemption from the registration requirement under the Securities Act will be available. Accordingly, you may not be entitled to exercise preemptive rights and may thereby suffer dilution of your interests in us.
You will not have the same voting rights as a holder of common shares.
You may exercise voting rights with respect to the common shares underlying your ADRs. You may instruct the depositary as to how to exercise the voting rights for the common shares which underlie your ADSs if the depositary asks you to provide it with voting instructions. After receiving voting materials from us, the depositary will notify the ADR holders of any shareholder meeting or solicitation of consents or proxies. This notice will describe how you may instruct the depositary to exercise the voting rights for the common shares that underlie your ADSs, subject to Korean law and the provisions of our Articles of Incorporation. For instructions to be valid, the depositary must receive them on or before the date specified. The depositary will endeavor, insofar as practicable and subject to Korean law and the provisions of our Articles of Incorporation, to vote or to have its agents vote the common shares or other deposited securities represented by your ADSs as you instruct. The depositary will not itself exercise any voting discretion. ADSs for which no voting instructions have been received will not be voted. You may only exercise the voting rights in blocks of 10 ADSs. Neither the depositary nor its agents are responsible for any failure to carry out any voting instructions (if acting in good faith), for the manner in which any vote is cast or for the effect of any vote. There is no guarantee that you will receive voting materials in time to instruct the depositary to vote and it is possible that you, or persons who hold their ADSs through brokers, dealers or other third parties, will not have the opportunity to exercise a right to vote.
You may not be able to exercise dissent and appraisal rights.
In some limited circumstances, including the transfer of the whole or any significant part of our business, our acquisition of a part of the business of any other company having a material effect on our business, and our merger or consolidation with another company, dissenting shareholders have the right to require us to purchase their shares under Korean law. See “Item 10. Additional Information — 10.B. Articles of Incorporation — Rights of Dissenting Shareholders.” However, if you hold our ADSs, you will not be able to exercise such dissent and appraisal rights unless you have withdrawn the underlying common shares and become a direct shareholder prior to the record date for the shareholders’ meeting at which the relevant transaction is to be approved.
You may be subject to Korean withholding taxes.
Under Korean tax law, if you are a U.S. investor, you may be subject to Korean withholding taxes on capital gains and dividends on the ADSs unless an exemption or a reduction under the income tax treaty between the United States and Korea is available. Under the United States-Korea tax treaty, capital gains realized by holders that are residents of the United States eligible for treaty benefits will not be subject to Korean taxation upon the disposition of the ADSs, with certain exceptions. See “Item 10. Additional Information — 10.E. Taxation — Korean Taxation” for a more detailed discussion of the effects of Korean tax laws on the holders of ADSs, including the possible imposition of a Korean securities transaction tax.
You may have difficulty enforcing any judgment obtained outside Korea against us or our Directors and officers.
We are organized under the laws of Korea, and all of our Directors and officers reside in Korea. All or a significant portion of our assets and the assets of such persons are located outside of the United States. As a result, it may not be possible for you to effect service of process within the United States upon these persons or to enforce against them or us court judgments obtained in the United States that are predicated upon the civil liability provisions of the federal securities laws of the United States or of the securities laws of any state of the United States. We have, however, appointed an agent in New York to receive service of process in any proceedings in the State of New York relating to our common shares or ADSs. Notwithstanding the foregoing, it may be difficult to enforce in Korea civil liabilities predicated on the federal securities laws of the United States or the securities laws of any state of the United States.
4.A. History and Development of the Company
We were incorporated as a company with limited liability under Korean law on April 28, 2000. Our legal and commercial name is “주식회사웹젠” (pronounced “Chushikhoesa Webzen”) in Korean, and “Webzen Inc.” in English. Our registered office is located at Daelim Acrotel Building, 8th Floor, 467-6 Dogok-dong, Kangnam-ku, Seoul, Korea 135-971. Our telephone number is (822) 3498-1600. We maintain a website at http://www.webzen.com. The information on our website is not incorporated by reference into this annual report. Our agent for U.S. federal securities law purposes is National Registered Agents, Inc., located at 875 Avenue of the Americas, Suite 501, New York, New York, 10001.
We are a leading developer and distributor of online games in Korea. Some of the important events in the development of our business since the beginning of 2006 are set forth below:
Our key strategic objective is to maintain our position as a leading developer of online games in Korea and to emerge as a leading developer and publisher of online games in other markets. We are currently developing several games to diversify our game portfolio and to target various segments in the market. By developing different game genres within the MMOG space, such as FPS, we will seek to diversify and increase our subscriber base. In addition to our internally developed games, we are also publishing third-party games. We believe that our proven operational experience, established distribution platform and existing subscriber base make us an attractive partner for other online game companies interested in licensing their games to us for distribution in our markets. In line with this objective, we regularly review proposed online games, acquisitions, and investments to supplement and broaden our own game development activities.
4.B. Business Overview
We are a leading developer and distributor of online games. Our game Soul of the Ultimate Nation (SUN) is a new three-dimensional MMOG provided in Korea, Taiwan, China and Japan. MU is a MMOG initially launched in 2001 and currently provided in Korea, China, Japan, Taiwan, Thailand, the Philippines, Vietnam, and the U.S. We are also planning to release new online games beginning in the third quarter of 2008.
We commercially launched our new game Soul of the Ultimate Nation (SUN) in Korea in November 2006, in Taiwan in April 2007, in China in May 2007 and in Japan in April 2008.
We have new games and services that we plan to launch. Huxley is scheduled for commercial launch in September 2008, and T-Project is planned to have an open beta testing in 2010.
Soul of the Ultimate Nation (SUN) is a massively-multiplayer online role-playing game in which the players experience an epic medieval tale in a world of emperors, armies, magicians and monsters set to an original soundtrack by Howard Shore, an Academy Award winner and composer of the theatrical score for the “Lord of the Rings” films. Soul of the Ultimate Nation (SUN) features a state-of-the-art game graphics environment, taking advantage of normal map rendering and various graphical effects, offering players rich and realistic graphics with high polygon counts. Our programmers have developed game engines that enable fluid movement and console-level control of the game characters. Soul of the Ultimate Nation (SUN) can be accessed from any location with a high-bandwidth Internet connection. Registered subscribers may enter our network with a password and a user ID, after downloading our game client software. Players choose a character from five distinct character classes with different fighting skills and magical powers and control the development of that character by allocating points and carrying out tasks to meet the prerequisites for learning certain skills. Players can individually play the game, but they can also form a group using various communication methods to wage a large-scale battle, known as siege warfare.
We commenced the commercial service of Soul of the Ultimate Nation (SUN) in Korea in November 2006, in Taiwan in April 2007, in China in May 2007 and in Japan in April 2008.
In the markets in which we currently provide commercial service of Soul of Ultimate Nation (SUN), we provide the basic service of the game for free. End-users pay us when they buy at our in-game item shops various items for their characters, such as armor, weapons and potions, and the right at our in-game item shops to change the world or stage at our in-game item shops in which the end-user plays. This new revenue generating business model is referred to in the online game industry as “microtransaction.”
MU is an MMOG which was initially launched in 2001. MU players select a specific character with which they develop experience and enhanced game capabilities that can be carried over into sequential gaming sessions. Players are able to communicate with each other during the game through instant messaging and may coordinate their activities with other players to form groups, thereby coordinating their game skills to achieve collective objectives.
Our MU users pay hourly charges based upon the hour they use our service or, alternatively, pay a flat fee – usually a fixed amount per month – for a longer period of time. In 2007, we introduced microtransaction sales for MU service in Japan, Taiwan and China, and the end-users in those markets pay us when they buy at our in-game item shops various items for their characters, such as armor, weapons and potions and the right to change the world or stage in which the end-user plays.
Products under Development
Huxley is a massively-multiplayer online first person shooting game developed for both PCs and the Xbox 360. Users will be able to play a “Doom”-style first person shooting game with up to 5,000 other players simultaneously and battle against opposing races. Huxley has finished its first, second and third closed beta testing in Korea in September 2007, December 2007 and March 2008, respectively, and is set for commercial launch in September 2008.
T-Project is being developed by Red 5 and is planned to have an open beta testing in 2010. For T-Project, we signed a worldwide publishing rights contract with the developing company. The contract is for five years after the
game is commercialized, and we have agreed to pay royalties for the exclusive world-wide distribution rights to this games.
During 2007 and early 2008, our management reassessed our financial position, business prospects and product lineup and made a strategic decision to focus on the development of a smaller number of products and manage our company in a more cost-efficient manner. As a result, we concentrated our development resources on Soul of the Ultimate Nation (SUN), which was being commercially launched in several overseas markets, and Huxley and decided to put on hold the development of Kingdom of Warriors (Il Ki Dang Chun) and Parfait Station until the development of the first two games was completed. In addition, we terminated the publishing rights contract for the online game All Points Bulletin (“APB”) with Real Time Worlds, Ltd. (“RTW”). RTW agreed to reimburse part of the development cost we have invested by paying us certain fixed amounts and a percentage of the net receipt it will collect after the commercial launch of APB.
In 2001 and 2002, substantially all of our revenue was generated from online game subscriptions in Korea. In 2003, approximately 85.5% of our revenue was generated from online game subscriptions in Korea and approximately 14.5% of our revenue was generated from the payment of royalties and license fees by our overseas licensee. In 2004, 2005 and 2006, approximately 84.9%, 84.8% and 88.3% of our revenue was generated from online game subscriptions in Korea, Taiwan and China, and approximately 15.1%, 15.2% and 11.7% of our revenue was generated from royalties and license fees paid by our licensees in the overseas markets, respectively. In 2007, approximately 67.5%, 6.6% and 4.5% of our revenue was generated from online game subscriptions and microtransaction sales in Korea, Taiwan and China, respectively, and approximately 11.4%, 6.9%, 1.4%, 1.0% and 0.7% of our revenue were generated from royalties and fees paid by our licensees in China, Japan, the U.S., Vietnam and the Philippines, respectively.
Korea. We commenced commercial service of MU in Korea in November 2001. We divide our MU online game subscribers in Korea into individual PC account subscribers and Internet cafe subscribers. Individual PC account subscribers are individuals who log on to our game servers either from home or at work, whereas Internet cafe subscribers are commercial businesses with multiple PCs that provide Internet and online game access to their customers for hourly fees. After the introduction of the game, the number of individual PC account subscribers grew until the first quarter of 2004. Since then, the number of individual PC account subscribers has declined, and we recorded 38,461 individual account subscribers at the end of first quarter of 2008 compared to 49,838 at the end of the first quarter of 2007.
The following table sets forth information on MU users and accounts in Korea since 2006.
We commenced commercial service of our new game Soul of the Ultimate Nation (SUN) in Korea in November 2006. We divide our Soul of the Ultimate Nation (SUN) online game subscribers into individual PC account subscribers and Internet cafe subscribers, but unlike MU, do not collect hourly or monthly subscription fees from them. Our Soul of the Ultimate Nation (SUN) users pay us when they buy – at our in-game item shops – various items for their characters, such as armor, weapons and potions, and the right to change the world or stage in which the end-user plays. The performance of Soul of the Ultimate Nation (SUN) in Korea has not met our initial expectations.
The following table sets forth information on Soul of the Ultimate Nation (SUN) users and accounts in Korea since the fourth quarter of 2006, when it was commercially launched:
Overseas markets>. In China, we license our game to GameNow or conduct our business through 9Webzen, Ltd. (“9Webzen”), a Hong Kong company which we established with GameNow. GameNow, a wholly-owned subsidiary of The9, is an operator of a leading Chinese-language game website called The9.com and holds a 30% interest in 9Webzen. GameNow is a licensee of our game Soul of the Ultimate Nation (SUN) and it offers and distributes the game in China. GameNow, through its website The9, launched open beta testing of the Chinese version of Soul of the Ultimate Nation (SUN) in April 2007 and launched commercial service in May 2007. Our Soul of the Ultimate Nation (SUN) users in China pay us when they buy at our in-game item shops various items for their characters, such as armors, weapons and potions, and the right to change the world or stage in which the end-user plays. MU has been distributed in China through 9Webzen since 2002. We have licensed our MU online game to 9Webzen, based on a five-year license agreement we entered into in September 2002. The license agreement was extended another two years in September 2007. The Chinese version of MU was commercialized in February 2003 after a five-month beta testing period. MU game users in China purchase online credits or prepaid cards to access the game. The operational results and financial position of 9Webzen have been consolidated with our financial statements since December 14, 2005, when we increased our interest in the company from 49% to 70%.
In Taiwan, Soul of the Ultimate Nation (SUN) was commercialized through our Taiwan subsidiary in April 2007 after a four-month beta testing period. Our Soul of the Ultimate Nation (SUN) users in Taiwan pay us when they buy at our in-game item shops various items for their characters, such as armors, weapons and potions, and the right to change the world or stage in which the end-user plays. We introduced MU in August 2002 through a license agreement with IGC, a content publishing company in Taiwan. In July 2004, our two-year agreement with IGC expired, and we decided to provide our online game services in Taiwan through a wholly-owned subsidiary, which we established in July 2004.
In 2007, we introduced microtransaction sales for MU service in Taiwan and China, and the end-users in those markets pay us for various items for their characters they buy at our in-game item shops, in addition to the subscription fee.
In Japan, we entered into a three-year term licensing agreement with Gameon Co., Ltd., or Gameon, for Soul of the Ultimate Nation (SUN) in October 2007. Soul of the Ultimate Nation (SUN) went through closed beta testing in February 2008 and open beta testing in March 2008 and was commercialized in April 2008. MU has been distributed in Japan by Gameon since February 2003. From Gameon, we received one-time licensing fees when we entered into the license agreements. Gameon receives microtransaction payments from MU and Soul of the Ultimate Nation (SUN) users in Japan, and we receive a certain percentage of the revenue generated in Japan as a royalty fee.
In other overseas markets, we licensed MU to game developers and operators such as New Era Online Co., Ltd. in Thailand (June 2003), Digital Media Exchange, Inc. in the Philippines (May 2004) and FPT Communications in Vietnam (May 2005). In each case, we agreed to receive a certain percentage of the revenue generated in each market as a royalty fee for licensing MU. The terms are usually two years and renewable. From New Era Online, we received a one-time licensing fee when we entered into the licensing agreement, and from Digital Media Exchange and FPT Communications, we received installation fees for setting up the game servers. In Thailand, the licensing agreement with New Era Online Co., Ltd. ended in June 2006, and we did not renew the contract.
In December 2005, we entered into a three-year licensing agreement with K2 for the licensing of a MU global server. The global server provides MU service in countries where we have no exclusive licensing agreements. We received an initial installation fee for setting up the game servers and have received a certain percentage of the revenue as a royalty fee. In January 2007, we extended the global server licensing agreement for two more years.
The following table presents the royalty revenue generated from MU distributors in overseas market since 2006:
The following table presents the royalty revenue generated from the Soul of the Ultimate Nation (SUN) distributors in overseas market since 2007:
Although we have only limited historical data, usage of our online games has typically increased around the New Year and other Korean holidays, in particular during winter and summer school holidays. See “Item 3. Key Information — 3.D. Risk Factors” for a description of other factors that affect the demand for our games.
We have engaged independent promotional agents to promote our online games to Internet cafes in Korea. We grant each promotional agent exclusive rights to promote our online games within a specified area and pay a monthly commission based on the revenue generated from Internet cafes in the allocated area. We also conduct a variety of marketing programs and online events to target potential subscribers accessing the Internet from home. Our main marketing efforts include:
In 2005 and 2006, we participated in the Electronic Entertainment Expo, or E3, held in Los Angeles. In 2007, however, we decided not to participate in E3 after reassessing the marketing impact and as part of our cost-cutting measures. Our advertising and promotion expenses were W8,176 million, W8,898 million, and W2,271 million in 2005, 2006 and 2007, respectively.
Our marketing activities in China are managed through The9 Computer, and marketing activities in Taiwan are conducted by Webzen Taiwan. Marketing activities in Japan, Thailand, the Philippines and Vietnam are primarily conducted by our licensees and consist of advertising on website portals and in online game magazines and conducting online promotional events.
In connection with deploying our games in Korea, we have designed and assembled a flexible and reliable game server and information systems network. Our distributors in China, Japan, the Philippines, Thailand, and Vietnam have separate game servers and information system networks modeled on our system architecture in Korea.
In order to provide MU online game service in foreign markets where we do not have a distributor, we established in September 2003 a “global server” network in our office in Korea. Through this server, users in countries in which we did not have a presence could download for free a reduced version of MU. On December 1, 2005, we licensed the operation of this global server to K2.
We believe that the principal competitive factors in the online game industry are the ability to consistently attract creative game developers and offer new online games, maintain a high quality network and implement innovative and effective sales and marketing campaigns.
Korea>. Our primary subscription-based online game competitors in the Korean market are NCsoft, Neowiz, Nexon, NHN, CJ Internet, YNK, Gravity, Hanbit Soft and Blizzard Entertainment. In 2007, there were several launches of online games including CJ Internet’s Oriental Fantasy, Neowiz’s FIFA Online 2 and Warload, MGame’s Punglim and Gravity’s Ragnarok 2 and Requiem. In 2008, the industry has launched or is expecting the launch of several additional online game titles in the Korean market, such as NCSoft’s Point Blank, Hanbitsoft’s Popoming, Neowiz’s Warload and Tenvi and Nexon’s Counter Strike Online and Elsword. The new releases of high-quality game will increase competition in our industry. Recently, there were two major M&A deals in the game industry in Korea. In March 2008, GungHo Online Entertainment, Inc. purchased 52.4% of Gravity Co., Ltd’s common shares, and, in May 2008, T3 Entertainment acquired 26.29% of Habit Soft Inc.’s shares as well as the management right of the company.
China>. Our primary online game competitors in China are The9, Ltd. (which distributes WoW), Shanda Networking (which distributes Actoz Soft’s “Legend of Mir” series), Netease (which distributes “Mong Hwan Seo Yu, Dae Hwa Seo Yu”), Zheng Tu (which distributes “Zheng Tu Online”).
Japan>. Our primary online game competitors in Japan are GungHo’s “Ragnarok,” NCsoft Japan’s “Lineage II,” Square Enix’s “Final Fantasy Online” , YNK Japan’s “ROHAN,” and Nexon Japan’s “Mabinogi.” To date, Japan’s game market still has been primarily driven by console games, although online games are gaining popularity among Japanese game users as broadband access becomes more widely available.
Other markets>. We consider our main competitors to be: Wowtaiwan’s WoW, Gamania’s “Lineage I” and Softworld’s “Ragnarok” in Taiwan; Asia Soft’s “Ragnarok” and NCTrue’s “Lineage” in Thailand; and Level Up’s “Ragnarok” and “RFOnline” and IPVG’s “RAN Online” in the Philippines.
In all of these markets, we also compete against PC-based game developers such as Electronic Arts, Take Two Interactive Software, Activision, THQ and Midway Games, Inc., which produce popular PC-packaged games, and against game console manufacturers such as Microsoft, which produces Xbox, Sony, which produces Playstation, and Nintendo, which produces Wii. Microsoft, Sony and Nintendo are providing Internet online game services with their new consoles, Xbox 360, Playstation 3 and Nintendo Wii, respectively. Xbox 360 was launched in November 2005, and Playstation 3 and Nintendo Wii were released in November 2006.
Members of our senior management team have been and continue to be instrumental in planning and developing core programming technology for our online games. We require all key personnel engaged in technological research and development capacities to sign agreements that substantiate our exclusive right to those works and to transfer any ownership claim that they may have in those works to us.
In Korea, we own two patents relating to data transmission over the Internet for online games, obtained program registration for our games MU, Soul of the Ultimate Nation (SUN) and Kingdom of Warriors (Il Ki Dang Chun) and own the service marks for MU, Soul of the Ultimate Nation (SUN), Kingdom of Warriors (Il Ki Dang Chun), Huxley and Parfait Station. In other countries, we registered some of our service marks and plan to apply for the
registration of our other intellectual properties. We will take legal action in any jurisdiction where we believe our intellectual property rights have been infringed.
We maintain medical and accident insurance for our employees to the extent required under Korean law, and we are insured against fire with respect to our facilities in Korea. In addition, we maintain directors’ and officers’ liability insurance policies covering potential liabilities of our Directors and officers.
Laws and Regulations
Korea.> The Korean game industry is subject to comprehensive regulation by the Ministry of Culture,Sports and Tourism (“MCST”), which is responsible for establishing policies for the industry under the Act on Promotion of Game Industry. As an online game company operating in Korea, we are also subject to:
Ratings regulation. Businesses manufacturing or importing games for the purpose of distributing or providing games in Korea must obtain game ratings in advance from the Game Rating Board. Online games are generally divided into four ratings categories: “suitable for users of all ages,” “suitable for users over 12 years of age,” “suitable for users over 15 years of age” and “suitable for users over 18 years of age.” Soul of the Ultimate Nation (SUN) has been rated “suitable for users over 18 years of age.” Our standard player-versus-player (“PVP”) version of the MU online game, which allows players to kill other players’ characters, has been rated “suitable for users over 18 years of age.” We also offer a non-player-versus-player (“non-PVP”) version of MU, which allows players to kill only non-player characters, which has been rated “suitable for users over 15 years of age” in Korea. Our Huxley online game has recently been rated “suitable for users over 15 years of age.”
Value-added communications business regulation. Under the Telecommunications Business Act we are classified as a value-added service provider and are required to make periodic reports to the MKE and report any transfer, takeover, suspension or closing of our business activities. The MKE may cancel our registration or order us to suspend our business for a period of up to one year if we fail to comply with its rules and regulations.
Protection of interests of online game users under 20 years of age. Pursuant to Korea’s civil law, contracts entered into with persons under 20 years of age without parental consent may be invalidated. Under the Telecommunication Framework Act, telecommunication service providers are also required to take certain steps to protect the rights of telecommunication service users. As a result, telecommunication service contracts and online game user agreements are required to set forth specific procedures for rescinding service contracts, which may be entered into by persons under 20 years of age without parental consent. Also, under the Promotion of Information and Communications Network Utilization and Information Protection Act, the operator of a website should monitor and delete any content harmful to minors.
Protection of consumer information for electronic settlement services. Under the Act on Consumer Protection for Transactions on Electronic Commerce, we are required to take measures to maintain the security of consumer information related to our electronic settlement services. We are also required to notify consumers when electronic payments are made and to indemnify consumers for damages resulting from the misappropriation of consumer information by third parties.
We believe that we have instituted appropriate safety measures to protect against data misappropriation. To date, we have not experienced material disputes or claims in this area.
Protection of personal information for users of information and communications services. Under the Act on Promotion of Information and Communications Network Utilization and Information Protection, we are permitted to gather personal information relating to our subscribers within the scope of their consents. We are, however, generally prohibited from utilizing personal information or providing it to third parties beyond the purposes disclosed in our subscriber agreements. Disclosure of personal information without consent from a subscriber is permitted if:
We are required to indemnify users for damages occurring as a result of our violation of the foregoing restrictions, unless we can prove an absence of willful misconduct or negligence on our part. We believe that we have instituted appropriate measures and are in compliance with all material restrictions regarding internal mishandling of personal information.
Taxation. For the years through 2007, we were entitled to a fifty-percent reduced tax rate by virtue of the Special Tax Treatment Control Law. Under the same law, we may claim a tax credit that can be carried forward for five years. However, the reduced tax rate and tax credit cannot be claimed in the same year. In 2004, we realized a net profit and elected to be taxed by the reduced tax rate. In 2006 and 2007, however, we realized net losses and, accordingly, chose the standard statutory tax rate of 27.5% to claim for tax credit. Our deferred income taxes as of December 31, 2007 were calculated based on the assumption that the statutory tax rate of 27.5% would apply to our operational results in 2008 and thereafter.
China>. The online games industry in China operates under a legal regime that consists of the State Council, which is the highest authority of the executive branch of the PRC central government, and the various ministries and agencies under its leadership. These ministries and agencies include the Ministry of Information Industry; the Ministry of Culture; the State Press and Publications Administration; the State Copyright Bureau; the Ministry of Public Security; and the Bureau of State Secrecy. The State Council and these ministries and agencies have issued a series of rules that regulate a number of different substantive areas of our business, including, among others, foreign ownership restrictions, Internet content provider licenses and regulation of Internet content. See “Item 3. Key Information — 3.D. Risk Factors — Risks Specific to Our Operations in China.”
As of December 31, 2007, we had three significant wholly-owned subsidiaries: Webzen Taiwan, Webzen China and Webzen America. We also own 55.4% of the common shares of Flux, Inc., a privately held wireless game developer, and 70% of 9Webzen, a joint venture with GameNow.
4.D. Property, Plant and Equipment
Because our main business is to provide online game services to our clients, we do not own any factories or facilities that manufacture products. There are no factories currently under construction, and we have no plans to build any factories in the future.
Korea>. Our principal executive and administrative offices are located at the Daelim Acrotel Building, 467-6, Dogok-dong, Kangnam-ku, Seoul, Korea 135-971. We currently own 26,582 square feet and lease 105,341 square feet. The latest of our leases expires in December 2009.
China.> The offices of 9Webzen (Shanghai) and Webzen China are located at 15th floor, Double Dove Tower, No. 438, Pu Dian Road, Shanghai, China 200122. 9Webzen (Shanghai) and Webzen China occupy 23,304 square feet of office space.
Taiwan.> The offices of Webzen Taiwan are located at 7F-3, No.176, Jian 1st Rd., Jhonghe City, Taipei County, Taiwan 23553, Republic of China.
United States>. The offices of Webzen America are located at 6601 Center Drive West, 7th Floor, Los Angeles, CA 90045.
We believe that our existing facilities are adequate for our current requirements and that additional space can be obtained on commercially reasonable terms to meet our future requirements.
There are no unresolved outstanding comments.
5.A. Operating Results
The following discussion and analysis provides information that management believes to be relevant to understanding our consolidated financial condition and results of operations. This discussion should be read in conjunction with the consolidated financial statements of Webzen, including the notes thereto included in this Annual Report. See “Item 18. Financial Statements.”
We are a developer and distributor of online games. Our total net revenues, which include online game subscription, microtransaction sales, royalties and license fees, were W24,058 million and W29,097 million in 2006 and 2007, respectively. Substantially all of our revenue come from our two online games, MU and Soul of the Ultimate Nation (SUN). With MU approaching the end of its life cycle in most of its markets and with intensifying competition due to the introduction of new games by competitors, we expect a decline in revenues generated from MU going forward. Unless we start generating significant revenues from Soul of the Ultimate Nation (SUN), or from other new games expected to be launched in 2008, we expect to incur losses in 2008.
In our overseas market, where we have licensed MU and/or Soul of the Ultimate Nation (SUN) to licensees, we recorded royalties from China, Japan, the U.S., Vietnam and the Philippines in the amounts of W3,287 million (US$3.5 million), W2,003 million (US$2.1 million), W417 million (US$0.4 million), W279 million (US$0.3 million) and W199 million (US$0.2 million), respectively, in 2007.
Our cost of revenues increased in 2007 to W17,505 million from W15,722 million in 2006, as costs related to Soul of the Ultimate Nation (SUN) were recognized as cost of revenue for the full year in 2007 after the commercial launch of the game in Korea in November 2006. Our operating expenses, which includes selling, general and administrative expenses and research and development expenses, significantly decreased in 2007 to W46,012 million from W56,761 million in 2006 as we implemented a series of cost-cutting measures. Our net loss decreased in 2007 to W25,594 million from W47,065 million in 2006.
Critical Accounting Policies
Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, contingent assets and liabilities, and revenue and expenses during the reporting period. The policies discussed below are considered by management to be critical not only because they are important to the portrayal of our financial condition and results of operations but also
because application and interpretation of these policies requires both judgment and estimates of matters that are inherently uncertain. As a result, actual results may differ materially from our estimates.
We derive and expect to continue to generate most of our revenues from online game subscription fees paid by our MU subscribers, royalties and license fees paid by our licensees and sales of game items to Soul of the Ultimate Nation (SUN) subscribers. We recognize revenue in accordance with accounting principles generally accepted in the United States, as set forth in the American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 97-2, Software Revenue Recognition, and AICPA SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition with respect to Certain Transactions, Staff Accounting Bulletin No. 104, Revenue Recognition and other related pronouncements. Our current revenues can be classified into the following categories:
Online subscription fees.> Subscription fees are fees we directly collect from client terminal level end-users. Our revenues from our operations in Korea consist mostly of prepaid subscription fees paid by individual PC accounts and Internet cafe subscribers, accounting for W14,774 million and W4,824 million, respectively, in 2007. Online subscription fees earned by our consolidated subsidiaries, which recorded W1,299 million from 9Webzen and W1,932 million from Webzen Taiwan in 2007, are also included in this item.
Microtransaction sales>. Microtransaction sales are fees we collect from in-game item sales for the online game Soul of the Ultimate Nation (SUN), which was commercialized in Korea in the fourth quarter of 2006, in Taiwan and China in the second quarter of 2007 and in Japan in the second quarter of 2008. The microtransaction sales model is also utilized in the MU online game in Japan, China and Taiwan. Under this model, players purchase points for in-game premium features. Microtransaction sales are typically paid by credit card or charged to the users’ mobile phone bills. These payments are deferred when received and the relevant revenues are recognized over the life of the premium features or as the premium features are consumed.
One-time license fee.> In certain cases, we receive a one-time license fee from licensees after we enter into a licensing agreement. License fees are deferred and recognized as revenue over the licensing period. When we receive a one-time license fee, we generally provide our licensees with minimal post-contract customer support on our software products, consisting of access to a support hotline and occasional unspecified upgrades or game enhancements, which typically occur within one year of the beginning of the licensing agreements. The estimated costs of providing such support are insignificant and sufficient vendor-specific evidence does not exist to allocate the revenue from software and related integration projects to the separate elements of such projects. As a result, all of our licensing revenue is recognized ratably over the life of the agreement.
Installation fee.> In connection with certain overseas licensing agreements, we receive a one-time installation fee in lieu of a licensing fee as we install game servers and information systems networks for our licensees. The system and network we use for our licensees are modeled after our system in Korea. As there are no sufficient vendor-specific information to allocate the revenue between installation service and other services, we recognize installation fees as revenue ratable over the life of the agreements.
Royalty revenues.> We receive royalty revenues from our licensees based on agreed percentage of the licensees’ revenue. Royalty revenues are recognized on a monthly basis after the licensees confirm their revenues based on the actual number of hours of services sold during the prior month. Royalty revenues generated from our consolidated subsidiaries, such as 9Webzen or Webzen Taiwan, are eliminated during the consolidation process and are not included in this item. Royalty revenues from foreign licensees accounted for 17.4% of our total net revenues in 2007. The following table sets forth our royalty revenues from each of our overseas licensees for the periods indicated.
Allowances for doubtful accounts
We maintain allowances for doubtful accounts receivable for estimated losses that result from the inability of our customers to make required payments. We base our allowances on the likelihood of recoverability of accounts receivable which is based on past experience and current collection trends. Allowances for accounts receivable generally arise when individual PC account subscribers who elect to make their payments through their fixed-line or mobile phone service provider fail to make such payments. We record allowances for doubtful accounts based on the historical payment patterns of our overall subscribers and increase our allowances as the length of time after which such receivables become past due increases.
Capitalized software development costs
We account for capitalized software development costs in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed. Software development costs incurred prior to the establishment of technological feasibility are expensed when incurred and treated as research and development expenses. Once a software product, such as an online game, has reached technological feasibility, then all subsequent software development costs for that product are capitalized until that product is released for sale. Technological feasibility is evaluated on a product-by-product basis but typically occurs once the online game has a proven ability to operate on a massively-multiplayer level. After an online game is released, the capitalized product development costs are amortized based on the expected life of the game. This amortized expense is recorded as a component of cost of revenues. We evaluate the recoverability of capitalized software development costs on a product-by-product basis. Capitalized costs for those products that are cancelled are expensed in the period of cancellation. In addition, a charge to cost of revenues is recorded when management’s forecast for a particular game indicates that unamortized capitalized costs exceed the net realizable value of that asset.
We account for income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes. Under SFAS No. 109, income taxes are accounted for under the asset and liability method. Management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and the extent to which deferred tax assets can be recognized. Deferred taxes are determined based upon differences between the financial reporting and tax bases of assets and liabilities and carryforwards at currently applicable statutory tax rates for the years in which the differences are expected to be reversed and carryforwards are expected to be realized.
A valuation allowance is provided on deferred tax assets to the extent that it is more likely than not that such deferred tax assets will not be realized. The total income tax provision includes current tax expenses under applicable tax regulations and the change in the balance of deferred tax assets and liabilities.
Deferred income tax assets are recognized only to the extent that realization of the related tax benefit is more likely than not to occur. Realization of the future tax benefits related to the deferred tax assets is dependent on many factors, including our ability to generate taxable income within the period during which the temporary differences reverse, the outlook for the Korean economic environment, and the overall future industry outlook.
As of December 31, 2006, we recognized a valuation allowance for all of the deferred tax assets, as we determined that we would not be able to realize these assets based on our historical and projected net and taxable income. All deferred tax assets are recognized. We then assess if the realization of the related tax benefit is more likely than not to occur.
For the years through 2006, we were entitled to a fifty-percent reduced tax rate by virtue of the Special Tax Treatment Control Law. Under the same law, we may claim a tax credit that can be carried forward for five years. However, the reduced tax rate and tax credit cannot be claimed in the same year. In 2004, we realized a net profit and elected to be taxed by the reduced tax rate. In 2005, 2006 and 2007, however, we realized net losses and, accordingly, chose the standard statutory tax rate of 27.5% to claim the higher tax credit. Our deferred income taxes as of December 31, 2007 were calculated based on the assumption that the statutory tax rate of 27.5% would apply to our operational results in 2008 and thereafter.
In addition, beginning January 1, 2007, we account for uncertainties related to income taxes in compliance with FIN No 48, Accounting for Uncertainty in Income Taxes – an interpretation of SFAS No. 109. Under FIN No. 48, we evaluate our tax positions taken or expected to be taken in a tax return for recognition and measurement on our financial statements. Only those tax positions that meet the more likely than not threshold are recognized on the financial statements at the largest amount of benefit that is a greater than 50 percent likely of ultimately being realized.
On December 14, 2005, we acquired 21% of the common stock of 9Webzen from GameNow for US$2.75 million in cash, increasing our stake from 49.0% to 70.0%. The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141, Business Combination. We are required to allocate the purchase price of acquired companies to tangible and intangible assets acquired and liabilities assumed, based on their estimated fair values. In connection with the 9Webzen acquisition, we engaged an independent third-party appraisal firm to assist us in determining the fair values of assets acquired and liabilities assumed. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets.
The excess purchase price over those fair values is recorded as goodwill. In accordance with SFAS No. 142 Goodwill and other Intangible Assets, goodwill is not amortized but is reviewed annually and the value is adjusted downward whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. As of December 31, 2006, we recognized a goodwill impairment loss of W388 million since the carrying amount of the reporting unit goodwill exceeded the implied fair value of that goodwill. The fair value of that reporting unit was estimated using the expected present value of future cash flows.
Recent Accounting Pronouncements
In February 2007, the FASB issued SFAS No. 159 The Fair Value Option for Financial Assets and Financial Liabilities, which provides companies with an option to report selected financial assets and liabilities at fair value in an attempt to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. This Statement is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. We are currently evaluating the impact that the adoption may have on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141R Business Combinations. This standard establishes principles and requirements for how the acquirer recognizes and measures the acquired identifiable assets, assumed liabilities, noncontrolling interest in the acquiree, and acquired goodwill or gain from a bargain purchase. SFAS No. 141R also determines what information the acquirer must disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after January 1, 2009. We are assessing the potential impact of this standard on our financial condition and results of operations.
In December 2007, the FASB issued SFAS No. 160 Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51. This standard establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS No. 160 is effective for us as of January 1, 2009 with early adoption prohibited. SFAS No. 160 shall be applied prospectively as of the beginning of the fiscal year in which this standard is initially applied. The presentation and disclosure requirements of this standard shall be applied retrospectively for all periods presented and will impact how we present and disclose noncontrolling interests and income from noncontrolling interests in our financial statements.
In March 2008, the FASB issued SFAS No. 161 Disclosures about Derivative Instruments and Hedging Activities (“FAS 161”). The new standard is intended to help investors better understand how derivative instruments and hedging activities affect an entity’s financial position, financial performance and cash flows through enhanced disclosure requirements. The enhanced disclosures include, for example:
FAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. We are currently in the process of evaluating the impact of adopting this standard.
Results of Operations
2007 compared to 2006
The following table summarizes our results of operations for the periods indicated.
The following table summarizes our results of operations as a percentage of our total net revenues for the periods indicated.
Revenues. Our net revenues for 2007 increased 20.9% from W24,058 million in 2006 to W29,097 million in 2007 due to:
Cost of revenues. Our cost of revenues for 2007 increased 11.3% from W15,722 million in 2006 to W17,505 million in 2007, primarily due to:
As a percentage of total revenues, however, cost of revenues decreased from 65.4% in 2006 to 60.2% in 2007.
Selling, general and administrative expenses. Selling, general and administrative expenses consist of sales commissions paid to independent promotional agents that target our Internet cafe subscribers in Korea, commissions
paid to settlement providers, administrative expenses and related personnel expenses of executive and administrative staff, and marketing and promotional expenses and related personnel expenses. Selling, general and administrative expenses decreased 30.1% from W32,699 million in 2006 to W22,848 million in 2007 and, as a percentage of net revenues, decreased from 135.9% to 78.5% in 2007, primarily due to:
Research and development expenses. Research and development costs incurred prior to the establishment of technological feasibility are included in this item. Research and development costs in 2007 decreased 3.7% from W24,062 in 2006 to W23,164 million in 2007. Of this amount, W5,960 million was attributable to the wages and salaries paid in 2007 to personnel in research and development departments, W8,188 million was attributable to advance royalties paid to Red5 Studios for the development of T-project, and W5,706 million was attributable to advance royalties paid to RTW for the development of APB. We expect the level of research and development expenses to decrease in 2008, as we expect to implement tight cost controls and make effective use of our development resources.
Interest income. Our interest income is mainly generated from cash equivalents and short-term financial instruments. Interest income decreased 12.2% from W3,991 million in 2006 to W3,503 million in 2007, mainly due to a decrease of cash and cash equivalents. During the same period, the balance of our cash and cash equivalents decreased from W78,138 million as of December 31, 2006 to W66,857 million as of December 31, 2007.
Foreign currency gains and losses. We realized net foreign currency losses of W501 million in 2006 and a net foreign currency gain of W92 million in 2007.
Gain on disposal of property and equipment. Gain on disposal of property and equipment increased significantly from W115 million in 2006 to W3,931 million in 2007, mainly due to the sale of office space at the Daelim Acrotel Building in Dogok-dong, Seoul, for which we realized a gain of W3,892 million.
Gain on disposal of available-for-sale securities. Gain on disposal of available-for-sale securities increased mainly due to sale of common shares of GameOn Co., Ltd. In 2007, we sold 1,560 shares out of 2,560 shares and recognized gain on disposal of available-for-sales securities of W2,320 million.
Income taxes. Income tax expenses decreased 49.5% from W5,102 million in 2006 to W2,579 million in 2007. The income tax expenses in 2007 were attributable to an increase in the valuation allowance recorded in 2007, due to a decrease in the deferred tax liabilities recorded in equity in 2006 related to available for sale securities. In 2006, the valuation allowance recorded was equal to the net deferred tax asset balance at December 31, 2006. For description of income tax expenses in 2006, see “— 2006 compared to 2005.”
Net income. As a result of the factors discussed above, our net loss decreased from W47,065 million in 2006 to W25,594 million in 2007.
2006 compared to 2005
The following table summarizes our results of operations for the periods indicated.
The following table summarizes our results of operations as a percentage of our total net revenues for the periods indicated.
Revenues. Our net revenues for 2006 decreased 24.0% from W31,646 million in 2005 to W24,058 million in 2006, reflecting a decline in the number of MU subscribers in most of our major markets. This decline is primarily attributable to the success of new games introduced by our competitors, which has caused a significant number of our MU subscribers to switch to such games, and to our inability to timely introduce new games to capture new subscribers. Our MU pricing plan in Korea has not changed since our initial commercialization of the game.
Cost of revenues. Our cost of revenues for 2006 increased 22.7% from W12,815 million in 2005 to W15,722 million in 2006, and as a percentage of total revenues increased from 40.5% in 2005 to 65.4% in 2006 primarily due to:
Selling, general and administrative expenses. Selling, general and administrative expenses consist of sales commissions paid to independent promotional agents that target our Internet cafe subscribers in Korea, commissions paid to settlement providers, administrative expenses and related personnel expenses of executive and administrative staff, and marketing and promotional expenses and related personnel expenses. Selling, general and administrative expenses increased 22.2% from W26,763 million in 2005 to W32,699 million in 2006 and, as a percentage of net revenues, increased from 84.6% to 135.9%, primarily due to:
These increases were partly offset by the decrease in sales commission that declined from W1,339 million in 2005 to W809 million in 2006 and by a slight decrease in consulting and other fees from W3,536 million in 2005 to W3,154 million in 2006.
Research and development expenses. Research and development costs incurred prior to the establishment of technological feasibility are included in this item. Research and development costs in 2006 increased 18.6% from W20,282 million in 2005 to W24,062 in 2006, as we increased our spending for the development of the games. Of this amount, W8,194 million was attributable to the wages and salaries paid in 2006 to personnel in research and development departments, W6,793 million was attributable to advance royalties paid to Red5 Studios for the development of T-project, W4,363 million was attributable to advance royalties paid to RTW for the development of APB and W2,368 million was attributable to services outsourced to third-party developers. We expect the level of research and development expenses in 2007 to be similar to 2006, as we expect to implement tight cost controls and make effective use of our development resources.
Interest income. Our interest income is mainly generated from cash equivalents and short-term financial instruments. Interest income decreased 15.9% from W4,747 million in 2005 to W3,991 million in 2006, mainly due to a decrease of cash and cash equivalents. During the same period, the balance of our cash and cash equivalents decreased from W121,739 million as of December 31, 2005 to W78,138 million as of December 31, 2006, respectively.
Foreign currency gains and losses. Net foreign currency losses increased 32.9% from W377 million in 2005 to W501 million in 2006, primarily due to an appreciation of the Korean Won against the U.S. dollar during this period.
Gain on disposal of available-for-sale securities. Gain on disposal of available-for-sale securities increased mainly due to sale of common shares of GameOn Co., Ltd. As GameOn Co., Ltd. listed its common shares on the Tokyo Stock Exchange in 2006, we reclassified those securities to available-for-sale securities from other non current assets. In 2006, we sold 640 shares out of 3,200 shares and recognized gain on disposal of available-for-sales securities of W2,237 million.
Income taxes. In 2005, an income tax benefit of W5,507 million was recognized. In 2006, W5,102 million was recorded for income tax expenses mainly due to an increase of valuation allowance relating to operating loss carry-
forwards and research and development expenses. Valuation allowance increased by W16,548 million from W1,621 million as of December 31, 2005 to W18,169 million as of December 31, 2006, as we determined that we would not be able to realize our deferred tax assets based on our projected taxable income.
Equity in loss of related equity investment, net of taxes. In 2005, we incurred a loss of W664 million in equity in earnings of related equity investments, net of tax, which reflected the loss of 9Webzen, our only equity-method investee in 2005. In 2006, however, we did not recognize any loss in equity in earnings of related equity investments, net of tax, as 9Webzen was re-characterized as a consolidated subsidiary.
Net income. As a result of the factors discussed above, our net loss increased to W47,065 million in 2006 from W18,804 million in 2005.
Impact of inflation
In view of our operating history, we believe that inflation in Korea and our other principal markets has not had a material impact on our results of operations. Inflation in Korea was 2.7% in 2005, 2.2% in 2006 and 2.5% in 2007.
Impact of Foreign Currency Fluctuations
See “Item 11. Quantitative and Qualitative Disclosures about Market Risk — Foreign currency risk.”
Government, Economic, Fiscal, Monetary or Political Factors
See “Item 3. Key Information — 3.D. Risk Factors — Risks Related to The Republic of Korea,” “Item 4. Information on the Company — 4.B. Business Overview — Laws and Regulations” and “Item 10. Additional Information — 10.E. Taxation.”
5.B. Liquidity and Capital Resources
In 2007, our primary sources of liquidity were existing cash on hand and cash generated from investing and financing activities. We used W22,026 million in operating activities in 2007, as our net loss amounted to W25,594 million during that period.
Net cash provided by investing activities in 2007 was W4,995 million, primarily due to the proceeds from disposal of available-for-sale securities amounting to W17,651 million and the proceeds from disposal of property, equipment and intangible assets amounting to W7,625 million (W7,465 million of which was attributable to the sales of office space at the Daelim Acrotel Building in Dogok-dong, Seoul), partially offset by W11,656 million used in the acquisition of available-for-sale securities and an increase of W5,105 million in short-term financial instruments and restricted cash.
Our cash investment policy emphasizes liquidity and the preservation of principal over other portfolio considerations. We satisfy a portion of our liquidity requirements by investing excess cash in short-term financial instruments, which primarily consist of time deposits with a maturity of one year or less, and demand deposits, money market demand deposits, and money market funds with a rolling maturity of 90 days or less. In addition, to avoid being an investment company under the Investment Company Act of 1940 (Investment Company Act), we hold a substantial portion of our net cash provided by operating activities in lower-yielding bank deposits and money market instruments, which due to their liquidity and certain other characteristics are not considered to be investment securities under the Investment Company Act.
Net cash provided by financing activities was W5,756 million for 2007, primarily due to the proceeds of the sales of treasury stock worth W14,166 million to Woori Investment Security Co., Ltd., partially offset by W9,443 million used for share purchase of 755,616 common shares in the market.
Capital resources.> As of December 31, 2007, our primary source of liquidity was W66,857 million (US$71.4 million) of cash and cash equivalents and W8,047 million (US$8.6 million) of unrestricted short-term financial instruments. We believe that our available cash, cash equivalents and short-term financial instruments will be sufficient to meet our capital needs for at least the next 12 months. However, we cannot assure you that our business or operations will not change in a manner that would consume available capital resources more rapidly than anticipated. As of December 31, 2007, Webzen Taiwan has a L/C credit line up to $660,000 from a local bank in Taiwan.
We expect to have capital expenditure requirements for the ongoing expansion into other markets, including hardware expenditures for the continuous expansion and upgrading of our existing server equipment, for which we expect to make approximately W4.2 billion in capital expenditures in 2008. The amount and timing of any investments have not yet been determined and will depend on our ability to identify suitable acquisition targets.
5.C. Research and Development, Patents and Licenses
During 2005 and 2006, we expected that the online game industry would continue its pattern of developing increasingly sophisticated games and offering improved graphics resolution, sound quality and other improvements to the gaming experience. In order to remain competitive, we expanded our game development and operation teams and invested in other outside game development opportunities. For example, in January 2006, we entered into a worldwide publishing rights contract for the online PC game T-project with Red5 Studios, Inc., a company based in the U.S. The contracts were for five years after the games are commercialized, and we agreed to fund part of the development costs and pay royalties for the exclusive world-wide distribution rights to the games.
During 2007 and early 2008, our management reassessed our financial position, business prospects and product lineup and made a strategic decision to focus on the development of a smaller number of products and manage our company in a more cost-efficient manner. As a result, we concentrated our development resources on Soul of the Ultimate Nation (SUN), which was being commercially launched in several overseas markets, and Huxley and decided to put on hold the development of Kingdom of Warriors (Il Ki Dang Chun) and Parfait Station until the development of the first two games were completed. In addition, we terminated the publishing rights contract for the online game APB with RTW.
5.D. Trend Information
See “—5.A. Operating Results—Overview.”
5.E. Off-balance Sheet Arrangements
We have provided guarantees of W1,704 million as of December 31, 2007 to lending institutions for certain loans extended to our employees for their purchase of our common shares. The guarantees are secured by a cash deposit with the lending institution.
We opened a stand-by letter of credit account at Hana Bank until February 28, 2009 for our business in Taiwan. In turn, Hana Bank provided a guarantee of up to $660,000 for Webzen Taiwan for its borrowings from a local bank in Taiwan.
We pledged W1,100 million in a restricted account as of December 31, 2007 to guarantee Webzen China’s payment of its short-term borrowings from Korea Exchange Bank Shanghai Branch.
We do not have any outstanding hedging contracts. See “Item 11. Quantitative and Qualitative Disclosures about Market Risk — Foreign currency risk.”
5.F. Contractual Obligations
The tables below set forth the maturities of contractual cash obligations as of December 31, 2007.
6.A. Directors and Senior Management
The following table sets forth the names, ages and positions at our company and other positions held by our Directors and officers as of May 31, 2008:
Nam-Ju Kim> is a founder of Webzen and has served as a Director since April 2000 and as the Representative Director, President and Chief Executive Officer since September 2002. From 1995 to 2000, he freelanced as a game developer. Mr. Kim graduated from Seoul Yerim Art High School.
Kil-Saup Song> is a founder of Webzen and has served as a Director since April 2000 and as a part-time Technology Advisor since May 2007. From April 2000 to May 2007, he served as the Chief Technology Officer of our company. He has been a registered director of 9Webzen, our Hong Kong joint venture, since January 2003. He served as a game developer for Pantech Co., Ltd., a wireless telecommunication company, from 1998 to 2000. Mr. Song graduated from Euijungboo Technology High School.
Hyung-Cheol Kim >is the newly elected Director and Chief Financial Officer serving since March 2008. From 2004 to 2007, he served as head of the business planning team at Daum Communication Co., Ltd. From 2001 to 2004, he worked at Saebit Accounting Firm as a manager. Mr. Kim received a bachelor’s degree in business administration from Korea University in 1996.
Yong-Seo Choi> is the newly elected Director and Chief Operating Officer serving March 2008. From 2006 to 2007, he served as a senior manager at Samil PWC. From 2005 to 2006, he worked at Visphor as a software architect. From 1999 to 2004, he served as a senior consultant for Microsoft Korea. Mr. Choi received a bachelor’s degree in industrial engineering from the Busan University and a master’s degree from The Graduate School of Information System, Sogang University.
Seong-Hoon Joo> has served as a Director since March 2008. He has worked as an in-house legal counsel at Woori Investment Security Co., Ltd. since 2007. From 2005 to 2007, he worked at KCL law firm as a lawyer. He completed Judicial training from the Judicial Research Training Institute on 2005. Mr. Joo received a bachelor’s degree in law from the Hanyang University.
Young-Bong Yoon> has served as an Outside Director and a member of the Audit Committee since March 2008. He has been working as a certified public accountant at Samduk Accounting Corporation since 2007. From 2001 to 2007, he worked at Woori Accounting Firm as a CPA. From 1999 to 2001, he worked at LG Investment & Security Co., Ltd. at its corporate finance department. Mr. Yoon received a bachelor’s degree in economics from Sungkyunkwan University in 1994.
Beom-Soo Seo> has served as an Outside Director and a member of the Audit Committee since March 2008. He is an attorney-at-law and has worked at Najeunhapdong Law Office since 2006. From 2005 to 2006, he worked at Onnuri law firm. He completed judicial training at the Judicial Research Training Institute on 2005. Mr. Seo received a bachelor’s degree in law from Korea University.
Young-Hwan Choi> was newly elected as a Outside Director and a member of the Audit Committee since March 2008. He served as a business consultant at Monitor Group. Mr. Kim received a bachelor’s degree in business administration from Yonsei University.
We have not extended any loans or credit to any of our Directors or executive officers, and we have not provided guarantees for borrowings by any of these persons. For the year ended December 31, 2007, the aggregate amount of compensation paid by us to all Directors and executive officers was W1.1 billion. We have not granted any stock options to any of our Directors and executive officers during this period. At our general meeting of shareholders, held on March 28, 2008, our shareholders approved an aggregate amount of up to W0.8 billion as compensation for our executive officers for the year 2008.
Under the Korean Labor Standard Act, we are required to pay a severance amount to eligible employees, including Directors and officers, who voluntarily or involuntarily terminate their employment with us, including through retirement. The severance amount for an officer or Director equals the monthly salary at the time of his or her departure, multiplied by the number of continuous years of service, and further multiplied by a discretionary number set forth in our Severance Payment Regulation, which depending on the position of the officer or Director ranges from two to four.
We maintain a Directors’ and officers’ liability insurance policy covering potential liabilities of our Directors and officers.
6.C. Board Practices
Board of Directors
Our board of Directors has the ultimate responsibility for the administration of our affairs. Our Articles of Incorporation, as currently in effect, provide for a board of Directors comprised of not less than three Directors. The Directors are elected at a general meeting of shareholders by a majority vote of the shareholders present or represented, so long as the affirmative votes also represent not less than 25% of all issued and outstanding shares with voting rights. For the purpose of electing a statutory auditor or auditors, a shareholder holding more than 3% of the issued and outstanding shares with voting rights may not exercise voting rights with respect to such shares in excess of 3%.
The term of office for our Directors is three years but is extendible to the close of the ordinary general meeting of shareholders convened in the last fiscal year of each term. The terms of Nam Ju Kim and Kil Saup Song expire on March 27, 2009. The term of office for our newly elected Directors is two or three years but is extendible to the close of the ordinary general meeting of shareholders convened in the last fiscal year of each term. The terms of Hyung-Cheol Kim, Yong Seo Choi and Seong Hoon Joo expire on March 27, 2011, and those of Young-Bong Yoon, Beom-Soo Seo and Young-Hwan Choi expire on March 27, 2010.
However, Directors may serve any number of consecutive terms and may be removed from office at any time by a resolution adopted at a general meeting of shareholders. None of our Directors is party to a service contract with our company that provides for benefits upon termination of employment.
The board of Directors elects representative Directors from its members. Under the Korean Commercial Code and our Articles of Incorporation, any Directors with a special interest in an agenda of a board meeting may not exercise his voting rights at that board meeting.
Our ADSs are listed for quotation on the Nasdaq Market and we currently are subject to the Nasdaq listing requirements applicable to listed foreign companies. Under the Nasdaq listing requirements, Marketplace Rule 4350(c), a majority of the board of Directors should be comprised of independent directors. The independence standards under the Nasdaq rules exclude, among others, any person who is a current or former employee of a company (for the current year or the past three years) or of any of its affiliates, as well as any immediate family member of an executive officer of a listed company or of any of its affiliates. The Korea Securities and Exchange Act and regulations thereunder require companies listed on the KOSDAQ or KRX Stock Market to have at least one fourth of its board of Directors comprised of outside directors. Under Korean law, a director or officer of the company, any person who served as a director or an officer of the company during the past two years, certain family members of a director of the company or certain other affiliates of the company, do not qualify as an outside director. We elected three independent Outside Directors in March 2008 to comply with Korean law, but we do not satisfy the majority independent board requirement under Marketplace Rule 4350(c)(1).
The Sarbanes-Oxley Act of 2002 directs the Securities and Exchange Commission (“SEC”) to require U.S. national securities exchanges and national securities associations, such as the Nasdaq Global Market, to adopt rules prohibiting the listing of any security of an issuer that is not in compliance with the relevant audit committee requirements set forth in the Sarbanes-Oxley Act. The SEC adopted final rules relating to the audit committee requirements on April 9, 2003, and approved related proposed changes to the Nasdaq corporate governance rules on November 4, 2003. Marketplace Rule 4350(d), which sets forth the requirements for listing company’s audit committees, requires that at least three independent directors who are able to read and understand fundamental financial statements serve on the committee.
Under the Korean Commercial Code, a company may elect between appointing a statutory internal auditor or establishing an audit committee.
To comply with the Sarbanes-Oxley Act and the SEC rules and regulations as well as the Nasdaq listing requirements regarding the audit committee, our board of Directors established an audit committee by amending our Articles of Incorporation at the general meeting of shareholders held in March 2004. Our Audit Committee is currently comprised of the following three independent Directors: Young-Bong Yoon, Beom-Soo Seo and Young-Hwan Choi. All of our independent Directors are financially literate and our board of Directors designated Young-Bong Yoon as an audit committee financial expert. The Audit Committee is responsible for examining internal transactions and potential conflicts of interest and reviewing company accounting and other relevant matters. Under the Korean Commercial Code, the Audit Committee has the right to request the board of Directors to convene a shareholders’ meeting by providing a document that sets forth the agenda and reasons.
Difference between Nasdaq requirements and home country practices
In general, corporate governance principles for Korean companies are set forth in the Korean Commercial Code and the Korean Securities and Exchange Act and, to the extent they are listed on KOSDAQ, the listing rules of KOSDAQ. Corporate governance principles under provisions of Korean law may differ in significant ways from corporate governance standards for U.S. Nasdaq-listed companies. Under the latest amendment to the NASD Marketplace Rule 4350(a)(1), foreign private issuers are permitted to follow certain home country corporate governance practices in lieu of the requirements of Rule 4350. Under the amendment, foreign private issuers must disclose alternative home country practices they follow. The following are the requirements of Rule 4350 we do not follow and the descriptions of home country practices.
Under Rule 4350(b)(1)(A), issuers are required to distribute to shareholders copies of annual reports containing audited financial statements prior to the companies’ annual meetings and to file with Nasdaq at the time they are distributed to shareholders. We do not distribute our annual report to our shareholders. Instead, we make our annual report and audited non-consolidated financial statements available for inspection at our principal office and at all of our branch offices at least one week before the annual general meeting of shareholders. We also file our annual report on the Data Analysis Retrieval and Transfer System, or DART, an electronic disclosure system operated by Financial Supervisory Service (“FSS”), in accordance with the rules under the Korean Securities and Exchange Act.
Under Rule 4350(c)(2), issuers are required to have regularly scheduled meetings (executive sessions) at which only independent directors are present. We do not hold executive sessions of independent Directors, as such meetings are not required under Korean law. However, our three independent Directors serve on our Audit Committee and meet regularly.
Rule 4350(c)(3) requires that compensation of the chief executive officer and other executive officers must be determined, or recommended to the board, either by a majority of the independent directors or an independent compensation committee. We currently follow the home country practice, which allows the board of Directors to determine executive officers’ compensations.
Under Rule 4350(c)(4), director nominees must either be selected, or recommended for the board’s selection, either by a majority of the independent directors or an independent nominations committee. The Korean Commercial Code grants the power of nomination to the board of Directors, and we conduct our nomination process accordingly.
We, as a foreign issuer, have been granted an exemption by Nasdaq from the requirement that the minimum quorum for a shareholder meeting is 33-1/3% of the outstanding common shares as required by Nasdaq Rule 4350(f), on the basis that such requirement was inconsistent with our home country practice. Pursuant to our Articles of Incorporation, our shareholders may adopt resolutions at a general meeting by an affirmative majority vote of the voting shares present or represented at the meeting, where the affirmative votes also represent at least one-fourth of our total voting shares then issued and outstanding. Our quorum requirements comply with the requirements of the Korean Commercial Code and are consistent with that of other companies with common shares listed on KOSDAQ.
Rule 4350(g) requires issuers to solicit proxies and provide proxy statements for all meetings of shareholders and provide them to Nasdaq. Nasdaq is of the view that the proxy statements required under Rule 4350(g) should contain the information required by Section 14 of the United States Securities Exchange Act of 1934 (the “Exchange Act”) and rules thereunder. The Korean Securities and Exchange Act requires persons soliciting proxies to provide proxy materials, with information set forth in the rules, to shareholders prior to or at the same time as the solicitation and to file the proxy materials with the FSS before they are sent to the shareholders. However, the information required under the Korean rules is much less extensive than that required under the Exchange Act rules. We do provide to shareholders proxy statements prior to shareholder meetings, but the content of the materials is made in accordance with the Korean Securities rules.
Under Rule 4350(h), issuers should conduct a review of all related party transactions on an ongoing basis and all such transactions should be approved by the audit committee. Korean law does not have a comparable requirement, and our board of Directors reviews and approves related party transactions. Under the Korean Commercial Code and our Articles of Incorporation, however, any Director with a special interest in an agenda item of a board meeting may not exercise his voting rights at that board meeting.
Rule 4350(i) requires issuers to obtain shareholder approval prior to the issuance of certain securities, including when an issuance will result in a change of control, or in connection with the acquisition of the stock or assets of another corporation. We do not obtain shareholder approval for all of the cases provided in Rule 4350(i). However, under the Korean Commercial Code and our Articles of Incorporation, we do require approval by the holders of at least two-thirds of the voting shares present or represented at a meeting, where the affirmative votes also represent at least one-third of our total voting shares then outstanding, when we acquire all of the business of any other company or a part of the business of any other company that has a material effect on our business, issue new shares at a price below par value, transfer all or any significant part of our business, or effect a capital reduction.
As of December 31, 2007, we had 672 full-time employees. The following tables set forth the number of permanent employees at Webzen and its subsidiaries, for the dates indicated:
None of our employees is represented by a labor union or covered by a collective bargaining agreement. We consider our relations with our employees to be good.
As of December 31, 2007, our wholly-owned subsidiaries, Webzen Taiwan, Webzen China, and Webzen America, had 56, 72 and 4 full-time employees, respectively.
As of December 31, 2007, 9Webzen and its subsidiary employed 65 employees in China, none of whom is represented by a labor union or covered by a collective bargaining agreement.
Under the Korean Labor Standard Act, employees with more than one year of service are entitled to receive a lump sum payment upon voluntary or involuntary termination of their employment. The amount of the benefit equals the employee’s monthly salary, calculated by averaging the employee’s daily salary for the three months prior to the date of the employee’s departure, multiplied by the number of continuous years of employment.
Pursuant to the Korean National Pension Law, we are required to prepay 4.5% of each employee’s annual wages as part of our accrued severance payments to the National Pension Corporation. Our employees are also required to pay 4.5% of their annual wages to the National Pension Corporation. Our employees are entitled to receive an annuity in the event they lose, in whole or in part, their wage earning capability.
Hana Bank and Korea Exchange Bank extended loans to members of our employee stock ownership association. As of December 31, 2007, we have pledged short-term financial instruments in the amount of W1,704 million to guarantee these bank loans. On the same date, we also had outstanding housing and other loans to our employees in the aggregate amount of W1,291 million. We have not experienced any defaults under these loans to our employees. We provide these loans as a benefit to our employees and not as a requirement under Korean law. Our executive officers and Directors are not eligible for these loans.
6.E. Share Ownership
Some of our Directors and officers own our common shares. See “Item 7. Major Shareholders and Related Party Transactions—7.A. Major Shareholders.”
Stock Option Plan
Pursuant to our Articles of Incorporation and the Korean Securities and Exchange Act, stock options may be granted by either a special resolution of our shareholders or a resolution of our board of Directors, with the aggregate number of shares issuable in each case not to exceed 15% and 3%, respectively, of the total number of our then issued and outstanding common shares. Stock options may be granted to our executive officers and employees who have contributed or are qualified to contribute to our establishment, management and technical innovation. No stock options may be granted to any executive officer or employee who owns, or upon exercise of an option to purchase our common shares would own, directly or indirectly, 10% or more of our outstanding common shares.
According to our Articles of Incorporation, we may grant stock options that are exercisable to purchase our common shares and preferred shares. Such stock options can vest after two years from the stock option grant date
and can be exercisable up to seven years (four years for options granted in 2007) from the date of the grant. The stock option may be cancelled by a resolution of our board of Directors:
On January 20, 2005, we granted stock options to our employees to purchase an aggregate of 118,800 common shares. All of the options granted on this date can be exercised between January 20, 2008 through January 19, 2010, at a purchase price of W24,100 per share. On April 14, 2005, we granted stock options to our employees to purchase an aggregate of 24,500 common shares. All of the options granted on this date can be exercised between April 14, 2008 through April 13, 2010 at a purchase price of W24,100 per share. On April 12, 2006, we granted stock options to our employees to purchase an aggregate of 41,000 common shares. All of the options granted on this date can be exercised between April 12, 2008 through April 11, 2010 at a purchase price of W24,100 per share. Options for 18,000 shares of the total 41,000 shares were granted to two executive officers. On July 18, 2007, we granted stock options to our employees to purchase an aggregate of 114,000 common shares. All of the options granted on this date can be exercised between July 12, 2009 through July 11, 2011 at a purchase price of W16,000 per share. On October 12, 2007, we granted stock options to our employees to purchase an aggregate of 77,000 common shares. All of the options granted on this date can be exercised between October 12, 2009 through October 11, 2011 at a purchase price of W14,000 per share.
As of April 25, 2008, options to purchase an aggregate of 242,300 common shares were outstanding, and 109,700 of the 242,300 outstanding options were granted to our Directors or executive officers.
Employee Stock Ownership Association