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MGT > SEC Filings for MGT > Form 10-K on 29-Mar-2013All Recent SEC Filings

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Form 10-K for MGT CAPITAL INVESTMENTS INC


29-Mar-2013

Annual Report


Item 7. Management's discussion and analysis of financial condition and results
of operations

Executive summary

MGT Capital Investments, Inc. ("MGT", "the Company", "the Group", "we", "us") is a Delaware corporation, incorporated in 2000. The Company was originally incorporated in Utah in 1977. As of December 31, 2012, MGT is comprised of, the parent company, majority-owned subsidiary MGT Gaming, Inc. ("MGT Gaming") and wholly-owned subsidiary, Medicsight, Inc. ("Medicsight"). Our Corporate office is located at 500 Mamaroneck Avenue, Suite 204, Harrison, NY 10528. Our telephone number is (914) 630-7431.

The Company closed the following non-essential subsidiaries during the twelve months ended December 31, 2012, as part of its expense reduction plan:
Medicsight Nominees Limited, Medicsight UK Limited, Medicsight FZE, Medicendo Limited, MedicCO2LON Limited, Medicsight KK, Medicsight PTY, Medicsight Ltd, MGT Investments (Gibraltar) Limited, MGT Capital Investments Limited and its wholly-owned subsidiary MGT Capital Investments (UK) Limited.

In order to reduce the burden of further administrative costs on the Company, we filed an application to the Registrar of Companies under s1003 of the Companies Act 2006 for Medicsight Ltd's dissolution. As a part of the dissolution of this non-essential subsidiary, Medicsight Ltd assigned its intellectual property to Medicsight, Inc. and its ownership in Medicsight, Inc. to MGT. Medicsight Ltd was closed as of December 31, 2012.

The Company has incurred significant operating losses since inception and continues to generate losses from operations. As a result, the Company has generated negative cash flows from operations and has an accumulated deficit of $288,447 at December 31, 2012. The Company is operating in a developing industry based on new technology and its primary source of funds to date has been through the issuance of securities. While the Company is optimistic and believes appropriate actions are being taken, there can be no assurance that the products or patent monetization strategy will be successful. Furthermore, it is contemplated that any acquisitions may require the Company to raise capital; such capital may not be available on terms acceptable to the Company, if at all.

At December 31, 2012, MGT's cash, cash equivalents and restricted cash were $5,482, including $49 held in MGT Gaming.

Management believes that the current level of working capital will be sufficient to allow the Company to maintain its operations into April 2014.

MGT and its subsidiaries are engaged in the business of monetizing intellectual property.

MGT Gaming owns U. S. Patent No. 7,892,088 ("the '088 Patent") entitled "Gaming Device Having a Second Separate Bonusing Event." The '088 Patent describes a gaming system in which a second game played on an interactive sign is triggered once specific events occur in a first game. As part of a business strategy to enforce its ownership rights, on November 2, 2012, MGT Gaming filed a lawsuit alleging patent infringement against multiple companies believed to be violating the '088 Patent. The lawsuit was filed in the United States District Court for the Southern District of Mississippi (Jackson Division) and names as defendants Caesars Entertainment (NASDAQ GS: CZR), MGM Resorts International, Inc. (NYSE:
MGM), WMS Gaming, Inc. - a subsidiary of WMS Industries, Inc. (NYSE: WMS), Penn National Gaming, Inc. (NASDAQ GS: PENN), and Aruze Gaming America, Inc. The lawsuit alleges that the defendants either manufacture, sell or lease gaming systems that infringe on MGT Gaming's patent rights, or operate casinos that offer gaming systems in violation of MGT Gaming's patent rights. An amended version of the complaint was filed on December 17, 2012. The allegedly infringing products manufactured, distributed, used, sold and/or offered for sale by defendants include at least those identified under the trade names:
"Pirate Battle," "Battleship," and one or more of "Clue," "Monopoly," "Amazon Fishing Competition," "Massive Fishing Competition," "Big Game Competition," "Jackpot Battle Royal" and "Paradise Fishing." On January 3, 2013, WMS (joined by CZR and MGM) moved to sever the litigation against each defendant, to transfer the action against WMS to the Northern District of Illinois and to dismiss the case. On January 7, 2013, defendants Aruze and PENN filed motion to dismiss. On January 24, 2013, defendants Aruze and PENN filed a motion to transfer venue to Nevada and Pennsylvania, respectively. Responsive and reply briefs have been filed and these motions are now fully briefed. As of March 25, 2013, the court has not made any decisions on these motions. In addition, on March 21, 2013, Aruze filed a separate action in Nevada seeking a declaratory judgment that it does not infringe the '088 patent and/or that the '088 patent is invalid or unenforceable. MGT Gaming's response to the action is due on April 11, 2013.

Medicsight, a medical technology company with patent ownership, as well as operations in imaging software and hardware devices, and consulting services. The company's computer-aided detection software ColonCAD™ assists radiologists with detection of colorectal polyps, and has received regulatory approvals including CE Mark and U. S. Federal Drug Administration ("FDA") clearance. The Company also has developed an automated CO2 insufflation device called MedicCO2LON, which it commercializes through a global distributor. In addition, the company provides consulting and communication services.

On March 21, 2012, MGT affected a reverse split, immediately followed by a forward split of our Common stock. At our March 20, 2012, Special Meeting of Stockholders, the Company's stockholders approved the proposal to amend the Company's Certificate of Incorporation to effect a Reverse/Forward Split of the Company's Common stock, $0.001 par value per share at an exchange ratio of 1-for-500 shares of the Company's outstanding Common stock, immediately followed by a forward split of the Company's outstanding Common stock, at an exchange ratio of 15-for-1 shares of the Company's outstanding Common stock. The amendment did not change the par value per share or the number of authorized shares of Common stock. As a result of the Reverse Split, stockholders holding fewer than 500 shares of Common stock, at the time of the reversal, received a cash payment instead of fractional shares and no longer had an interest in the Company. All share and per share amounts have been retrospectively adjusted for all periods presented to give effect to the Reverse/Forward Split.

On March 26, 2012, at Medicsight Ltd's General Meeting, stockholders approved a resolution to effect a Reverse Split of the Company's existing ordinary shares of £0.05 par value per share into 1 new ordinary share of £16,250 par value per share and for MGT to acquire all New Ordinary Shares representing the fractions of shares left over following the Reverse Split. The exchange ratio for the Reverse Split was 1 for 325,000. As a result of the Reverse Split, stockholders holding fewer than 325,000 shares were cancelled and not entitled to a cash payment for fractional shares. As of March 31, 2012, MGT held 318 shares (66.5%) of the 478 issued share capital of Medicsight Ltd.

Subsequent to March 26, 2012, and through December 31, 2012, MGT acquired an additional 160 shares of Medicsight Ltd's ordinary shares, 67 ordinary shares were acquired for cash consideration of $51 and 93 ordinary shares were acquired in exchange for 93,000 shares of the Company's Common stock with a fair value of $418. On December 6, 2012 at Medicsight Ltd's General Meeting, the stockholders approved a resolution to effect a Reverse Split of Medicsight Ltd's remaining shares at an exchange rate of 1 for 25. As a result, stockholders holding fewer than 25 shares at the time of the reversal received a cash payment of $16, in lieu of fractional shares and no longer had an interest in Medicsight Ltd. As a result of the purchase of additional shares and the reverse split, as of December 6, 2012, MGT held 100% of the issued share capital of Medicsight Ltd.

As of December 31, 2012, the Company paid $33 and accrued $18 related to acquisition of shares subsequent to March 26, 2012.

On May 11, 2012, the Company entered into a Contribution and Sale Agreement (the "Sale Agreement") with J&S Gaming, Inc. ("J&S"), and MGT Gaming, Inc. ("MGT Gaming") for the acquisition of U.S. Patent #7,892,088, entitled "Gaming Device Having a Second Separate Bonusing Event" ("the '088 Patent"). The '088 Patent acquired was recorded at its estimated fair value of $1,819 at the date of closing. Pursuant to the Sale Agreement, (i) J&S sold certain patents to MGT Gaming in exchange for 1,000 shares (constituting 100% ownership) of MGT Gaming Common stock, par value $0.001; (ii) the Company purchased from J&S 550 MGT Gaming Shares constituting 55% ownership in exchange for $200 cash and a four
(4) year warrant to purchase 350,000 shares of the Company's Common stock at an exercise price of $4.00 per share, subject to certain anti-dilution provisions (the "Warrants"); (iii) the Company and J&S agreed to grant rights of first refusal, "tag-along" and "drag-along" rights to one another with respect to their respective MGT Gaming Shares. As a result of an anti-dilution provision in the warrants, with respect to future stock or option grants to officers of the Company, the Company anticipated issuing 50,000 additional Warrants to J&S over the next 12 months from the date of acquisition. These additional warrants were included in the calculation of purchase price for the intellectual property acquisition. The fair value of the 400,000 warrants was determined to be $800 as of June 1, 2012, the warrant issuance date. The warrants were fair-valued as of the issuance date of June 1, 2012, at $800 based upon the following Black-Scholes pricing model ("BSM") assumptions; risk free rate 0.80%; expected term four (4) years; annual volatility 75.0%; exercise price $4.00; as the underlying shares had not yet been registered at the issuance date, the market price at June 1, 2012, was discounted by approximately 11% for options pricing purposes. In connection to the grant of restricted shares to officers of the Company, on November 19, 2012, the Company issued 3,029 additional warrants to J&S related to the anti-dilution provision in the Common stock Warrant agreement. The additional warrants were fair-valued on the grant date of the restricted shares, based upon the following Black-Scholes pricing model assumptions; risk free rate 0.80%; expected term four (4) years; annual volatility 75.0%; exercise price $4.00. The Company recognized $8 warrant expense for the year ended December 31, 2012, related to the issuance of these additional warrants.

For purposes of determining expected volatility, since the Company does not have representative historical data to determine volatility based upon its own information, the Company used significant judgment to identify a peer group and determine the appropriate weighting in order to estimate the volatility rate for use in the BSM. The risk-free rate for the period coincides with the expected life of the warrants and is based on the U.S. Treasury Department yield curve in effect at the time of closing.

On May 24, 2012, the Company entered into a securities purchase agreement (the "SPA") with Hudson Bay Fund Ltd. (the "Investor"). The SPA provided for the purchase of an 18 month promissory note (the "Senior Secured Convertible Note" or the "Note") convertible into up to 1,166,667 shares of Company Common stock at a conversion price of $3.00 per share and a warrant (the "Hudson Bay Warrant" or the "HB Warrant") to purchase up to 875,000 shares of Common stock at an exercise price of $3.00 per share for proceeds of $3,500 (the "Hudson Bay Transaction"). The HB Warrant is exercisable at the option of the holder at a $3.00 per share exercise price and the Company can require exercise if the Weighted Average Price of the Company's Common stock equals or exceeds 250% of the exercise price for no less than twenty (20) Trading Days during any thirty
(30) consecutive Trading Day period occurring following the issuance date, as such terms are defined in the HB Warrant. The HB Warrant exercise price is subject to adjustment in the case of combination or subdivision of stock or in the event of the granting of any stock appreciation rights, phantom stock rights or other rights with equity features. The Note allows for payment of Common stock in lieu of cash interest payments due pursuant to the Note. In connection with the Hudson Bay Transaction, MGT issued 75,000 shares of Common stock to Chardan Capital Markets, LLC ("Chardan") and certain affiliates of Chardan in consideration of investment banking services rendered. Stockholder approval was obtained for the issuance of 75,000 shares of Common stock to Chardan.

On October 9, 2012, the Company executed two identical exchange agreements (collectively, the "Agreements") settling the outstanding Note for a cash payment of $3.5 million and 100,000 shares of the Company's Common stock valued at $415, using the opening price of the Company's Common stock on October 9, 2012. The net carrying amount of the Note on the date of extinguishment was $2,698 which was comprised of the amount due at maturity of $3,500 less unamortized debt discount of $802 related to the amount allocated to the warrants and the beneficial conversion feature at issuance. The total reacquisition price of $3,915 was allocated first to the repurchased beneficial conversion feature by recording a reduction of additional paid-in capital of $1,341 measured as the intrinsic value of that conversion feature at the extinguishment date with the residual amount of the reacquisition price of $2,574 allocated to the Note. The difference between the reacquisition price allocated to the Note and the net carrying amount of the Note resulted in a gain of $124 which when netted with the write off of unamortized deferred financing costs of $462 and legal cost of $17, at extinguishment resulted in a total loss on extinguishment of $355. Extinguishment of debt, gains and losses, including fees, incurred in connection with the early extinguishment of debt are charged to current earnings as reductions in non-operating expenses.

On November 2, 2012, the Company closed two separate financing agreements with various institutional investors providing an aggregate of $5.9 million of capital. The capital raise was comprised of the sale of 1,380,362 Convertible Preferred Series A Stock ("Preferred Stock") (including 2,760,724 warrants to purchase MGT Common stock), resulting in gross proceeds of $4.5 million, plus a separate sale of 453,000 shares of MGT Common stock at $3.01 per share for gross proceed of $1.4 million. On October 26, 2012, this transaction was approved by the Exchange. The Preferred Stock is convertible into the Company's Common stock at a fixed price of $3.26 per share and carries a 6% dividend. In February and March 2013, 241,748 and 30,000 shares of the Company's Preferred Convertible Series A Stock were converted into 241,748 and 30,000 shares, of the Company's common stock, respectively. The Warrants have a five-year life and are exercisable at $3.85 per MGT share; the Company issued a total of 2,760,724 warrants. The Common stock was sold at $3.01 per share with a total of 453,000 shares sold, under its S-3 Registration Statement (Registrant No. 333-182298), which was declared effective on September 25, 2012.

The Company is analyzing potential acquisition opportunities, as well as various intellectual property assets. There can be no assurance that any future acquisitions will occur at all, or that any such acquisitions will be accretive to earnings, book value and other financial metrics, or that any such acquisitions will generate positive returns for Company shareholders. Furthermore, it is contemplated that any acquisitions may require the Company to raise additional capital; such capital may not be available on terms acceptable to the Company, if at all.

Patent enforcement

On November 2, 2012, MGT Gaming filed a lawsuit alleging patent infringement against multiple companies believed to be violating the '088 Patent. The lawsuit was filed in the United States District Court for the Southern District of Mississippi (Jackson Division) and names as defendants Caesars Entertainment (NASDAQ GS: CZR), MGM Resorts International, Inc. (NYSE: MGM), WMS Gaming, Inc.
- a subsidiary of WMS Industries, Inc. (NYSE: WMS), Penn National Gaming, Inc. (NASDAQ GS: PENN), and Aruze Gaming America, Inc. The lawsuit alleges that the defendants either manufacture, sell or lease gaming systems that infringe on MGT Gaming's patent rights, or operate casinos that offer gaming systems in violation of MGT Gaming's patent rights. An amended version of the complaint was filed on December 17, 2012. The allegedly infringing products manufactured, distributed, used, sold and/or offered for sale by defendants include at least those identified under the trade names: "Pirate Battle," "Battleship," and one or more of "Clue," "Monopoly," "Amazon Fishing Competition," "Massive Fishing Competition," "Big Game Competition," "Jackpot Battle Royal" and "Paradise Fishing." On January 3, 2013, WMS (joined by CZR and MGM) moved to sever the litigation against each defendant, to transfer the action against WMS to the Northern District of Illinois and to dismiss the case. On January 7, 2013, defendants Aruze and PENN filed motion to dismiss. On January 24, 2013, defendants Aruze and PENN filed a motion to transfer venue to Nevada and Pennsylvania, respectively. Responsive and reply briefs have been filed and these motions are now fully briefed. As of March 25, 2013, the court has not made any decisions on these motions. In addition, on March 21, 2013, Aruze filed a separate action in Nevada seeking a declaratory judgment that it does not infringe the '088 patent and/or that the '088 patent is invalid or unenforceable. MGT Gaming's response to the action is due on April 11, 2013.

MGT Gaming is seeking preliminary and permanent injunctions against all defendants enjoining them from any continued acts of patent infringement, as well as to recover damages adequate to compensate for the infringement in an amount to be proven at trial, and to recover, in any event, a reasonable royalty from each defendant for its infringement, trebled, plus interest and costs as fixed by the court.

MGT Gaming has entered into a contingent fee arrangement with Nixon & Vanderhye P.C. ("the law firm") to represent MGT Gaming as plaintiff in the lawsuit. MGT Gaming will pay out-of-pocket expenses (as that term is defined in the retainer agreement) until such time, if ever, as the lawsuit produces revenue. At that time, the law firm is entitled to a percentage of such revenue, after out-of-pocket expenses are deducted. This contingent fee arrangement reduces the potential value of any legal settlements or judgments, but also reduces the possibility of unpredictable and uncontrollable legal expenses.

Critical accounting policies and estimates

Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The notes to the consolidated financial statements contained in this Annual Report describe our significant accounting policies used in the preparation of the consolidated financial statements. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. We continually evaluate our critical accounting policies and estimates.

We believe the critical accounting policies listed below reflect significant judgments, estimates and assumptions used in the preparation of our consolidated financial statements.

Principles of consolidation

The consolidated financial statements include the accounts of our Company plus majority-owned subsidiary, MGT Gaming and wholly-owned subsidiary, Medicsight. All intercompany transactions and balances have been eliminated. Prior to the change in functional currency, all foreign currency translation gains and losses arising on consolidation were recorded in stockholders' equity as a component of accumulated other comprehensive income / (loss). Non-controlling interest represents the minority equity investment in any of the MGT subsidiaries, plus the minorities' share of the net operating result and other components of equity relating to the non-controlling interest.

Use of estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amount of assets and liabilities and disclosure of contingent liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Cash, cash equivalents and restricted cash

The Company considers investments with original maturities of three months or less to be cash equivalents. Restricted cash primarily represents cash not available for immediate and general use by the Company.

Inventory

We account for inventory at the lower of cost (first-in, first-out) or market. Cost is determined to be purchased cost for the finished MedicCO2LON product from the third party supplier. We perform full physical inventory counts to maintain controls and obtain accurate data. The MedicCO2LON product is either
(i) sold to our exclusive distributor or (ii) placed in an external third party secure warehouse facility and remains our property. Once the units are shipped to the distributor it is deemed that the ownership is transferred to the distributor and the goods are delivered. Reserves for slow-moving and obsolete inventories are provided based on historical experience and product demand. Management evaluates the adequacy of these reserves periodically based on forecasted sales and market trends.

Property and equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line method on the various asset classes over their estimated useful lives, which range from two to five years.

Deferred financing costs

In conjunction with the issuance of Senior Secured Convertible Notes on June 1, 2012, the Company incurred certain financing costs, including the issuance of Common stock. The Company accounts for deferred financing costs in accordance with Accounting Standards ("ASC") 470-10 "Debt". Deferred financing costs are amortized through periodic charges to other non-operating expenses over the term of the related financial instrument using the effective interest method.

Intangible assets

Estimates of future cash flows and timing of events for evaluating long-lived assets for impairment are based upon management's judgement and whenever events or changes in circumstances indicate that their carrying value may not be recoverable in accordance with ASC Topic 360-10-35, "Impairment or Disposal of Long-Lived Assets". If any of our intangible or long-lived assets are considered to be impaired, the amount of impairment to be recognized is the excess of the carrying amount of the assets over its fair value. Applicable long-lived assets are amortized or depreciated over the shorter of their estimated useful lives, the estimated period that the assets will generate revenue, or the statutory or contractual term in the case of patents. Estimates of useful lives and periods of expected revenue generation are reviewed periodically for appropriateness and are based upon management's judgment.

Convertible instruments

The Company evaluates and accounts for conversion options embedded in convertible instruments in accordance with ASC 815 "Derivatives and Hedging Activities" and ASC 470 "Debt". Applicable GAAP requires companies to bifurcate conversion options from their host instruments and account for them as freestanding derivative financial instruments according to certain criteria. The criteria includes circumstances in which (a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured at fair value under otherwise applicable generally accepted accounting principles with changes in fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument would be considered a derivative instrument. An exception to this rule, when the host instrument is deemed to be conventional as that term is described under applicable GAAP.

Beneficial conversion features

From time to time, the Company may issue convertible instruments that may have conversion prices that create an embedded beneficial conversion feature. A beneficial conversion feature exists on the date a convertible note is issued when the fair value of the underlying common stock to which the note is convertible into is in excess of the remaining unallocated proceeds of the note after first considering the allocation of a portion of the note proceeds to the fair value of any detachable equity instruments, if any related equity instruments were granted with the debt. The intrinsic value of the beneficial conversion feature is recorded as a discount with a corresponding amount to additional paid-in-capital. A discount to the convertible instrument is accreted to expense over the life of the instrument using the effective interest method.

Revenue recognition

The Company recognizes revenue when it is realized or realizable and earned. We consider revenue realized or realizable and earned when there is persuasive evidence of an arrangement and that the product has been shipped or the services have been provided to the customer, the sales price is fixed or determinable and collectability is probable.

Software - License fee revenue is derived from the licensing of computer software. Maintenance revenue is derived from software maintenance. Our software licenses are generally sold as part of an arrangement that includes maintenance and support.

The Company licenses software and sells maintenance contracts through visualization solution partners and original equipment manufacturers. The Company receives regular sales reporting detailing the number of licenses sold by original equipment manufacturers, value-added resellers and independent distributors (collectively, "Resellers") to end users. The Company generally offers terms that require payment 30 - 45 days from invoicing. Provided the Reseller: (i) assumes all risk of the purchase, (ii) has the ability and obligation to pay regardless of receiving payment from the end user, and (iii) all other revenue recognition criteria are met, license revenue from Resellers is recognized upon shipment of its product to vendors ("sell-in basis").

Revenue from license fees is recognized when notification of shipment to the end user has occurred, there are no significant Company obligations with regard to implementation and the Company's services are not considered essential to the functionality of other elements of the arrangement.

Maintenance - Revenue from maintenance and support arrangements is deferred and recognized ratably over the term of the maintenance and support arrangements.

Multiple-element arrangements - the Company enters into arrangements with resellers that include a combination of software products, maintenance and support. For such arrangements, the Company recognizes revenue using the Multiple-Deliverable Revenue Arrangements. The Company allocates the total . . .

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