Drowning Conan Drags Funcom Down With Record Losses

After six weeks of waiting, we finally have our hands on Funcom's 2nd Quarter 2008 Financial Report, and the prognosis is decidedly negative.  Buzz from the mid-May launch of Age of Conan: Hyborian Adventures failed to overcome the disappointment as Funcom reported the worst quarterly losses in company history.



Operating Profit Continues Downward Trend

The graph above shows Funcom's quarterly reported EBIT, or "operating profit," over the past three and a half years (the bulk of the development time for Age of Conan).  For those unfamiliar with the term, a description of Earnings Before Interest And Tax is available on Investopedia.  Referencing financial reports from Q4-2005, Q4-2006, Q4-2007, and Q2-2008, one finds a pattern that has recently become much more alarming.

Negative profits can be absorbed from time to time, but the losses in this case have increased for seven straight quarters, from 353,000 USD in Q3-2006 to 5.73 million USD lost in Q2-2008.  With such a sustained dropoff, management's handle on the situation should fall under serious scrutiny.

Age of Conan Debuts With Huge Sales...

Media and gamers alike have been following the developing story of Age of Conan since its launch on May 20th (right in the middle of Q2). Funcom reported record sales numbers upon release, and expectations were high for the new mature-rated MMORPG, but software glitches and a perceived lack of game content has led to negative reviews and a rapidly dwindling playerbase.

A June 30, 2008 investor update reports the company can expect to receive roughly 20% of the 60 USD Age of Conan sale price from retail channels.  The Q2 report gives us concrete figures of approximately 800,000 units sold at retail, so at 12 USD per game we're looking at ~9.6 million USD in retail revenues from Age of Conan.

Unfortunately for Funcom, nearly half the customers who purchased the game failed to subscribe beyond the "free month" included with the box.  The official figure released in the financial report indicate that only 415,000 subscribers were active by June 30, 11 days after the free month expired.

... But the Losses Keep Piling Up

After suffering 14 consecutive quarters of negative profits during Age of Conan's development, we were under the impression that Funcom's future would be largely dictated by the success of this particular title.  Funcom says as much in the Risk Factors report included with the Q4 2007 financials:

"Funcom's future income is highly dependent on the success of the Age of Conan MMO ... [the game] is expected to contribute with significant revenues and earnings..."

"Furthermore, the game is intended to be one of the funding sources for the development of other titles ... lower cash inflows than expected could also have an indirect effect in terms of reduced revenues, earnings, and cash flows from other games and the future funding requirements of the Company."

Indeed, the Company has dug itself into quite a hole over the past few years while banking on Age of Conan's future success.  If we take a look at the cumulative losses in operating profit piled up since the beginning of 2005, we see that the damage has now topped 20.7 million USD:



The close of Q1-2008 in March saw Funcom nursing cumulative operating losses of almost 15 million USD over the previous three years, with the promise of salvation in Q2 with Age of Conan's launch.  It is now clear, however, that the game's release acted more like an anchor than a life raft, pulling profits down to a record low.

Return To Profitability Seems Unlikely

With the big launch having come and gone, the future appears dim for Funcom.  The in-game activity level and population counts on Age of Conan are widely reported to have fallen dramatically since launch, and the inference is that subscription numbers should roughly match this decline.  If the game could hang on to 800,000 subscribers (12 million USD per month), a recovery of the development losses would be within reach, but speculation within the community is that only a small fraction of those subscribers remain.  Indeed, the official confirmation that only 415,000 subscriptions remained active on June 30 signals a sharp downward trend.

Operational costs have ramped up since the launch, as increases in hardware, hosting demands, and support personnel cut directly into game revenues.  Can Funcom right the ship with other new products or major improvements to the Age of Conan game?  When four+ years of focused work and sustained losses culminate in a record-selling game launch that still fails to turn a profit, it doesn't seem likely.

In today's unforgiving MMO market, we can't know for sure if the fault lies with the management or the game itself, but we do know that Funcom needs to cut one or the other loose before the whole company is pulled under.

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Read more of our coverage on Age of Conan:

* Risky Business: Funcom's Fears Become Reality (August 3, 200
* Funcom Investors Jump Ship As Age of Conan Founders (July 15, 200
* Age of Conan Flatlining (July 2, 200