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ACORN ENERGY, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion includes statements that are forward-looking in nature. Whether such statements ultimately prove to be accurate depends upon a variety of factors that may affect our business and operations. Certain of these factors are discussed in this report, in our Annual Report on Form 10-K for the year ended December 31, 2012 and below under "Risk Factors." FINANCIAL RESULTS BY COMPANY The following table shows, for the periods indicated, the financial results (dollar amounts in thousands) attributable to each of our consolidated companies. The financial results of OmniMetrix are included in our consolidated financial statements effective February 15, 2012. Accordingly, there are only partial comparative results reported for these activities for the nine month period ended September 30, 2012. 23-------------------------------------------------------------------------------- Table of Contents Nine months ended September 30, 2013 DSIT OmniMetrix GridSense USSI Acorn Total Revenues $ 9,631 $ 1,609 $ 3,543 $ 1,148 $ - $ 15,931 Cost of Sales 6,009 735 2,045 2,686 - 11,475 Gross profit 3,622 874 1,498 (1,538 ) - 4,456 Gross profit margin 38 % 54 % 42 % (134 )% 28 % R& D expenses, net of credits 1,146 499 1,787 2,904 6,336 Selling, general and administrative expenses 2,503 3,668 2,707 2,378 3,965 15,221 Impairment of intangibles - 6,731 - - - 6,731 Restructuring and related charges - 772 594 - - 1,366 Operating loss $ (27 ) $ (10,796 ) $ (3,590 ) $ (6,820 ) $ (3,965 ) $ (25,198 ) Nine months ended September 30, 2012 DSIT OmniMetrix GridSense USSI Acorn Total Revenues $ 10,034 $ 388 $ 2,884 $ 1,317 $ - $ 14,623 Cost of Sales 6,401 316 1,643 2,089 - 10,449 Gross profit 3,633 72 1,241 (772 ) - 4,174 Gross profit margin 36 % 19 % 43 % (59 )% 29 % R& D expenses, net of credits 789 208 1,114 2,660 - 4,771 Selling, general and administrative expenses 2,224 1,533 3,509 2,598 4,027 13,891 Operating income (loss) $ 620 $ (1,669 ) $ (3,382 ) $ (6,030 ) $ (4,027 ) $ (14,488 ) Three months ended September 30, 2013 DSIT OmniMetrix GridSense USSI Acorn Total Revenues $ 2,852 $ 548 $ 1,069 $ 513 $ - $ 4,982 Cost of Sales 1,826 275 621 1,201 - 3,923 Gross profit 1,026 273 448 (688 ) - 1,059 Gross profit margin 36 % 50 % 42 % (134 )% 21 % R& D expenses, net of credits 423 231 361 1,204 - 2,219 Selling, general and administrative expenses 856 1,301 860 768 1,210 4,995 Impairment of intangibles - 5,615 - - - 5,615 Restructuring and related charges - 772 - - - 772 Operating loss $ (253 ) $ (7,646 ) $ (773 ) $ (2,660 ) $ (1,210 ) $ (12,542 ) Three months ended September 30, 2012 DSIT OmniMetrix GridSense USSI Acorn Total Revenues $ 3,271 $ 231 $ 977 $ 234 $ - $ 4,713 Cost of Sales 2,141 130 553 401 - 3,225 Gross profit 1,130 101 424 (167 ) - 1,488 Gross profit margin 35 % 44 % 43 % (71 )% 32 % R& D expenses, net of credits 333 137 427 857 - 1,754 Selling, general and administrative expenses 750 699 1,320 1,205 1,298 5,272 Operating income (loss) $ 47 $ (735 ) $ (1,323 ) $ (2,229 ) $ (1,298 ) $ (5,538 ) 24-------------------------------------------------------------------------------- Table of Contents BACKLOG As of September 30, 2013, our backlog of work to be completed was as follows (amounts in millions of U.S. dollars): DSIT Solutions $ 4.1 GridSense 0.9 OmniMetrix 1.8 USSI 0.4 Total $ 7.2 RECENT DEVELOPMENTS Acorn Capital Raise On October, 17, 2013, Acorn closed on a public offering of 3,508,771 shares of its common stock at $2.85 per share for gross proceeds to Acorn of $10.0 million. Acorn received net proceeds of approximately $9.1 million after deducting discounts and commissions to the underwriters and estimated offering expenses. In connection with the Underwriting Agreement, Acorn also issued a warrant to the underwriters to acquire 228,070 shares of common stock at $3.14 per share which shall be exercisable for five years. This was followed by a second closing on October 23, 2013, whereby Acorn closed on a sale of 526,316 shares of its common stock following the full exercise of the over-allotment option granted to the underwriters at $2.85 per share for gross proceeds to Acorn of $1.5 million and issued a warrant to the underwriters to acquire 34,211 shares of common stock at $3.14 per share which shall be exercisable for five years . Acorn received net proceeds of $1.4 million from the over-allotment option exercise or a total of $10.5 million from both closings after deducting discounts and commissions to the underwriters and estimated offering expenses. Corporate Update Acorn committed as part of the offering described above to reduce its corporate overhead expenditures and has since implemented cost saving measures which will result in an estimated 35% reduction in 2014 over anticipated 2013 headquarters-related cash expenditures. These savings are primarily comprised of headcount and salary reductions, decreases in Director fees and reduced investor relations expenses. On November 11, 2013, Acorn's President and CEO, John A. Moore, voluntarily agreed to reduce his base salary by 25% effective with the October 16, 2013 payroll period from $425,000 per annum to $318,750 per annum. Effective November 1, 2013, Acorn's Executive Vice President, Richard S. Rimer, agreed to reduce his consulting fees by 20% from $30,720 per month to $24,576 and to end the consulting agreement whereby he serves as Acorn's EVP effective December 31, 2013 in exchange for a lump sum payment of $73,728, which represents 80% of the amounts that otherwise would be payable upon termination of the agreement as of such date. Mr. Rimer tendered his resignation from our Board and each of our subsidiary boards on November 11, 2013. Our CFO, Michael H. Barth, has also agreed to a $10,000 reduction in the portion of his salary payable by Acorn commencing January 1, 2014. Our outside Directors have also agreed to reduce their annual retainer (the "Retainer") for 2014 by 25%, which equates to $10,000 per annum per Director. Our Chairman has likewise reduced his annual chairman stipend of $100,000 (which amount consists of $60,000, plus $10,000 with regard to each subsidiary board on which he serves) by 25% for 2014, or an aggregate of up to $25,000, as he is currently serving on all four companies' boards of directors or managers. Under our existing Board compensation policy, each Director, in his or her discretion, may elect by written notice delivered on or before the first day of each calendar year (the "Election") whether to receive, in lieu of some or all of his or her Retainer and other fees (i.e., Chairman compensation and committee fees), options to purchase that number of Shares as shall have a value (determined as of the first day of the calendar year for which such Election is made (the "Election Year") in accordance with the methodology then used by the Company to determine stock compensation for purposes of its audited financial statements) as is equal to the applicable Retainer and fees and with an exercise price equal to the fair market value of our Common Stock at the close of business on the trading day preceding the first day of the applicable Election Year. Once made, the Election shall be irrevocable for such Election Year 25-------------------------------------------------------------------------------- Table of Contents and the options subject to the Election shall vest one-fourth upon the first day of the Election Year and one-fourth as of the first day of each of the second through fourth calendar quarters thereafter during the remainder of the Election Year. OVERVIEW AND TREND INFORMATION Acorn Energy, Inc. ("Acorn" or "the Company") is a holding company focused on technology driven solutions for energy infrastructure asset management. Each of our four businesses is focused on helping its customers achieve greater productivity, reliability, security and efficiency. Through our majority or wholly-owned operating subsidiaries, we provide the following services and products: · Oil and Gas Sensor Systems (formerly known as Energy and Security Sensor Systems). These products and services are provided by our US Seismic Systems, Inc. subsidiary ("USSI") which develops and produces "state of the art" fiber optic sensing systems for the energy, commercial security and defense markets. · Energy & Security Sonar Solutions. We provide sonar and acoustic related solutions for energy, defense and commercial markets with a focus on underwater site security for strategic energy installations and other advanced acoustic systems and real-time embedded hardware and software development and production through our DSIT Solutions Ltd. ("DSIT") subsidiary. · Smart Grid Distribution Automation. These products and services are provided by our GridSenseTM subsidiaries (GridSense Inc. in the United States and GridSense Pty Ltd. and CHK GridSense Pty Ltd. in Australia - collectively "GridSense") which develop, market and sell remote monitoring and control systems to electric utilities and industrial facilities worldwide. · Power Generation (PG) Monitoring. These products and services are provided by our OmniMetrixTM, LLC ("OmniMetrix") subsidiary, acquired in February 2012. OmniMetrix's PG products and services deliver critical, real-time machine information to customers and provide remote diagnostics that give users real-time visibility of their equipment. During 2013, each of the four abovementioned activities represented a reportable segment. In addition, our "Other" segment represents IT and consulting activities at our DSIT subsidiary as well as Cathodic Protection activities in our OmniMetrix subsidiary. As OmniMetrix's activities were acquired in February 2012, there are only partial comparative results reported for these activities for the nine month period ended September 30, 2012. The following analysis should be read together with the segment information provided in Note 10 to the interim unaudited condensed consolidated financial statements included in this quarterly report. USSI USSI's primary focus is on developing and producing "state of the art" fiber optic sensing systems for the energy market. The primary product lines for which USSI is currently developing products include downhole fiber optic sensor systems for hydrofrac monitoring used in unconventional oil and gas exploration and recovery, and 4D seismic reservoir monitoring systems. We believe that the only way to improve understanding of the subsurface, is via seismic monitoring with sensors specifically designed to detect and locate microseismic events. While we previously believed based on discussions with leading industry participants, that they would monitor all their frac jobs if equipment cost can be reduced by 75% below the cost of monitoring with traditional geophones (a goal we believe is achievable by utilizing USSI fiber optic sensor systems), based on our current understanding of the marketplace and customer constraints, we anticipate that the rate of adoption may occur at a slower pace. We remain optimistic, however, that the market for advanced seismic monitoring will nevertheless be sizable based upon current pricing of $250,000 (for a 10-level system) to $1.0 million for a larger (40-level) monitoring system. USSI targets its products into the oilfield geophysics market and its potential customers are primarily the oilfield service companies. To date, we have not sold a product for commercial deployment, as all of our sales have been for trials or pilot projects. We are currently focused on completing what we believe are the final steps toward having a commercial product that we hope will lead to reference customers. As a result of several recent customer trials, USSI believes that its products may be of particular interest to those oilfield services companies supporting hydro-fracking in high temperature fields who further desire the ability to deploy and retract sensing devices rather than permanently embed them in their customers' wells. USSI's products are, however, designed for mid and low temperature deployments as well. 26-------------------------------------------------------------------------------- Table of Contents In connection with some of the trials referred to above, USSI has experienced various design and deployment challenges that have negatively impacted product performance. Although feedback from several customers indicates that the data from our sensors meets or exceeds our specifications, several customers have requested improvements regarding water blocking (primarily a solution to prevent a crack in the fiber optic cable from allowing water to penetrate the entire array), noise cancellation (a process to eliminate the impact of ambient noise on frac detection), improved clamping mechanisms to improve vector fidelity (the ability to identify the location of a fracture point with precision) and more reliable seals and connections between array segments . We believe that we have provided or are close to achieving solutions responsive to each of these concerns, but the time involved in resolving these technical issues has delayed our ability to ship product beyond what we had previously anticipated. In the interim, customers continue to rely on existing competing technology, primarily conventional retrievable downhole sensors. Where these systems are not capable of sustained performance (i.e., in high temperature, long-term deployments), well owners are simply foregoing monitoring. We ramped up USSI's manufacturing capabilities and head count in anticipation of order volumes we expected would occur during the second half of 2013. Those expectations have not been realized and we do not anticipate significant array sales for the balance of 2013 and early 2014; it therefore may be necessary to realign expenses at USSI with the scope of current and near-term revenues. We therefore plan to closely monitor expenses to ensure they remain in line with current and projected activities. We may also make strategic hires of additional personnel with experience in the oil and gas industry to assist with our penetration into this complex market. Our path toward full-scale production and, we believe, ultimate profitability, involves our successfully following four key steps: • Prove that our tool works. Customer feedback from the trials to date are telling us that our data is excellent and that we meet or exceed our own published specs, but we need to solve our deployment challenges in order to position ourselves to fulfill commercial-level sales; • Confirm through further testing that the data we collect has economic value to our target customers. We expect to do this by further field trials with producers and the oilfield services companies that support them and are in active discussions now for more of these projects; • Increase opportunities to attract early adopters of our technology by building, as capital permits, a "fleet" of rental arrays to reduce the economic hurdle to their evaluation of our products; and • Reach a level of industry adoption and sales where we can either operate USSI profitably on our own, attract a partner with the financial and other resources necessary to scale the business, or monetize our investment through a sale or other strategic event. In the first nine months of 2013, USSI reported revenues of $1.1 million, a decrease of $0.2 million (13%) compared to first nine months 2012 revenues of $1.3 million. Third quarter revenues of $513,000 reflect increases of $203,000 (65%) and $279,000 (119%) as compared to second quarter 2013 and third quarter 2012 revenues, respectively. The increased revenues for each period is due to the timing of the delivery of USSI's sensor systems. In the third quarter of 2013, revenue recorded was from the system delivered to the oil supermajor as part of their ongoing evaluation of USSI's sensor systems. In the first nine months of 2013, gross profit continued to be negative ($1.5 million) as it was in the first nine months of 2012 ($0.8 million). The negative gross profit is primarily due to large amounts of up front non-recurring engineering ("NRE") design costs that accompanied USSI's other proof of concept projects in 2012 and continue to do so in 2013. In addition, approximately $1.0 million of the negative gross profit was attributable to adjustments of sensor systems built-to-lease and inventory to net realizable values. USSI has increased its production staff and has developed proprietary automated manufacturing/assembly stations for its products. USSI has also implemented inventory control and tracking systems necessary to support larger scale production. These investments in equipment and systems are designed to make manufacturing more efficient and improving the production process is expected to ultimately result in fewer man-hours required for each product sold. However, such systems have either not yet been fully tested or are not yet fully operational. We expect that the impact of these improved production processes should produce improved gross margins when USSI begins to have commercial sales of its products. In the first nine months of 2013, USSI recorded approximately $2.9 million of R&D expense, slightly above the $2.7 million of R&D expense recorded in the first nine months of 2012. Third quarter R&D expense of $1.2 million reflects an increase of $0.4 million and $0.3 million compared to the $0.8 million and $0.9 million of R&D expense recorded in the second quarter of 2013 and the third quarter of 2012, respectively. The increased R&D expense was attributable to increased field tests and increased materials costs in the development of new interrogator prototypes as well as work on developing and improving new clamp designs and resolving noise reduction issues. While USSI continues to develop more efficient production versions of its 27-------------------------------------------------------------------------------- Table of Contents current products and addressees the technical issues encountered in customer field trials, USSI expects R&D expense to decline in the coming quarters as it works toward reducing its cash expenditures. In the first nine months of 2013, USSI recorded approximately $2.4 million of SG&A expense representing a decrease of approximately $0.2 million (8%) compared to the first nine months of 2012. The decrease from the first nine months of 2012 is due to a decrease in non-cash stock compensation expense recorded. Third quarter SG&A expense of approximately $0.8M was relatively unchanged from first and second quarter 2013 SG&A expense. USSI expects SG&A expense to decline in the coming quarters as it works toward reducing its cash expenditures. In July 2013, USSI signed an agreement to lease an additional 8,600 square feet of space contiguous to its facilities in Chatsworth, California. The additional space was expected to be used for production of anticipated commercial orders. If the pace of commercialization does not increase, we may explore opportunities to sublet this space. Whether and on what terms we may be able to do so cannot be determined at this time. During the third quarter of 2013, USSI delivered 20 levels of its previously announced $1.0 million project with SR2020. The 20-level array's cable was damaged in a test due to the bending radius of the array's cable being exceeded during the removal from the well. This issue is the type of early adoption risk that USSI intends to neutralize for its potential customers by affording them an option to initially lease, rather than purchase, its sensor arrays. In that regard, USSI and SR2020 have agreed to convert the prior $1.0 million of SR2020 purchase orders into a leasing arrangement. As at September 30, 2013, USSI's backlog of approximately $0.4 million relates to lease arrangements with SR2020 and another customer. USSI anticipates beginning recognition of revenue associated with these lease arrangements when the systems are delivered to the customers, one of which is scheduled for the fourth quarter of 2013 and another for the first quarter of 2014. We continue to anticipate significant growth in orders, particularly from new customers related to our 4D reservoir and shale gas monitoring systems following the demonstrations performed during 2013 (such as the supermajor noted above) and prior years as well as follow-on projects from our current proof-of-concept projects. USSI will continue to require working capital support while it continues to transition from development to production and as it continues to work on refining its manufacturing capabilities. During 2013 (through October 31) we invested $6.6 million in USSI to support its working capital requirements. We expect that USSI's working capital requirements will ultimately lessen if and when it begins to have commercial scale orders. We cannot however, provide any assurance as to whether or when such orders will be received. Accordingly, USSI is proactively monitoring its operating expenses to ensure that they are in line with its current and expected near term activities and will make adjustments as necessary. We expect that we will be investing additional funds in USSI before year-end 2013 and into 2014, though the amounts to be invested will be dependent on USSI's needs at that time. During 2013, we grew our employee base from 47 full-time equivalent employees (inclusive of consultants) at the end of 2012 to 62 full-time equivalent employees (inclusive of consultants) as of September 30, 2013. This increase in staff in 2013 was due in part to anticipation of order volumes we expected would occur during the second half of 2013 which have not been realized. In the short-term, we do not anticipate make staffing changes as we work to solve our technical challenges and fulfill anticipated near-term orders for trial systems. If orders are not received as anticipated, we may need to consider adjusting staffing levels. USSI reached agreement with a bank for a $1 million line-of-credit in November 2012. Although the loan term has technically expired, USSI and the bank are currently discussing a new bank facility which we expect to reflect an increase in USSI's line-of-credit. Assuming the credit facility is renewed, we have no assurance that USSI's future capital needs will not exceed the amount of the credit line or that USSI will generate sufficient cash flow in the future to fund its operations in the absence of additional funding sources. USSI may need additional funds if revenues fail to meet projections or to fund a rapid expansion to meet product demand, respond to competitive pressures or acquire complementary products, businesses or technologies. Additional financing for USSI may be in the form of an expanded bank line, new investment by others, a loan or investment by Acorn, or a combination of the above. The availability and amount of any additional investment from us in USSI may be limited by the working capital needs of our corporate activities and other operating companies. DSIT Solutions DSIT revenues of $9.6 million in the first nine months of 2013 were slightly below ($0.4 million or 4%) revenues for the first nine months of 2012 while gross profit was unchanged and gross margin increased from 36% in 2012 to 38% in 2013. Operating income decreased, primarily as a result of increased research and development costs during the year combined with non-cash stock compensation costs recorded in 2013. DSIT's revenues of $2.9 million for the third quarter of 2013 represents a 28-------------------------------------------------------------------------------- Table of Contents decrease of approximately $0.4 million or 13% as compared to the third quarter of 2012. In addition, third quarter 2013 revenues reflected a decrease of $0.6 million or 18% compared to second quarter 2013 revenues of $3.5 million. Revenues in our Energy & Sonar Security Solutions segment decreased from $9.2 million for the first nine months of 2012 to $8.7 million for the first nine months of 2013. Revenues from DSIT's other IT and consulting activities which are included in Acorn's Other segment activities increased marginally in 2013 (an increase of $46,000 to $910,000). Third quarter 2013 Energy & Sonar Security Solutions revenues of $2.5 million were $0.5 million or 15% lower than third quarter 2012 revenues due to slowdown in revenue recognition in one of the company's major projects as it nears completion without a similar size project replacing it in the company's backlog. Third quarter 2013 revenues from DSIT's other IT and consulting activities were relatively unchanged from 2012 to 2013. Despite the decrease in revenues in 2013, DSIT's gross profit was virtually unchanged at $3.6 million for both the nine months ended September 30, 2012 and 2013. This was due to the increase in gross margin over the period. Gross margin increased from 36% in the first nine months of 2012 to 38% in the first nine months of 2013. The increase in the gross margin in the first nine months of 2013 was due to the mix of projects worked on during the period. Third quarter 2013 gross margin of 36% reflected an increase from 35% in the third quarter of 2012 and a decrease from 37% in the second quarter of 2013. The increase in the gross margin in the third quarter of 2013 compared to the third quarter of 2012 was also due to the mix of projects worked on during the respective periods. The decrease in the gross margin in the third quarter of 2013 as compared to the second quarter of 2013 was due to increased projected installation costs for one of the company's AquaShieldTM Diver Detection Sonar projects. During the first nine months of 2013, DSIT recorded approximately $1.1 million of Research and Development (R&D) expense, an increase of approximately $0.4 million compared to the first nine months of 2012. DSIT's increased R&D expense is related to work on the joint development (with USSI) of the PAUSS next generation integrated passive/active threat detection system for underwater site protection. Due to USSI's increased focus on its oil and gas activities, we foresee some slowdown in the development of the PAUSS in the near future. In 2013, R&D expense is net of approximately $0.2 million of participation from the Israel-U.S. Binational Industrial Research and Development ("BIRD") Foundation in the project. DSIT had been negotiating with USSI an agreement whereby DSIT would receive from USSI an exclusive world-wide license to use USSI technology to provide systems, devices, installations and methods for monitoring ground sites, facilities, locations and perimeters against land-based security threats for government and non-government customers for defense, security or military and safety applications. Negotiations on the agreement have stalled due to the abovementioned increased focus by USSI on its oil and gas activities. DSIT is continuing to expend resources to expand DSIT's portfolio of products to include land-based security fiber-optic solutions. During the first nine months of 2013, DSIT recorded approximately $2.5 million of selling, general and administrative (SG&A) expense with quarter expense ranging from $811,000 to $856,000 during each of the first three quarters of 2013. The 2013 SG&A expense is approximately $0.3 million above the SG&A recorded in the first nine months of 2012. The increase compared to the first nine months of 2012 is attributable to increased salary costs and increased marketing expenses as well as non-cash stock compensation expense recorded in the third quarter associated with the modification of certain options at DSIT (see below). The $0.9 million of SG&A in the third quarter of 2013 is $0.1 million above third quarter 2012 SG&A due to the abovementioned non-cash stock compensation expense incurred in the third quarter of 2013. At December 31, 2012, DSIT had a project backlog of approximately $9.6 million. During the first nine months of 2013, we received new orders totaling approximately $3.3 million and at the end of September 2013 had a backlog of approximately $4.1 million. DSIT's growth and profitability for the balance of 2013 and into 2014 is dependent upon pending orders for sonar systems. DSIT is currently awaiting receipt of a multi-million dollar project, which is expected to be received shortly. However, we have no assurance that we will win the project or that if we do win the project, that we will be able to perform enough work to be able to recognize significant amounts of revenue over the balance of 2013. While DSIT has a significant pipeline, most of its major projects come after a lengthy sales cycle over which it has little control. Should this project not be received or its receipt significantly delayed, DSIT's revenues and profitability will likely decrease. In July 2013, DSIT's renewed its lease for its operating facilities in the Tel Aviv, Israel metropolitan area which had expired in August 2012. The current lease expires in June 2016 and has an annual rent of approximately $285,000. DSIT has an option to renew the lease for an additional three year period with an increase of 6% in the annual rent. Effective July 1, 2013, Acorn entered into a Stock Purchase Agreement with DSIT pursuant to which Acorn converted a prior loan of approximately $800,000 into additional ordinary (common) shares of DSIT. Acorn also converted $2.8 million in 29-------------------------------------------------------------------------------- Table of Contents advances and loans into DSIT's Participating Preferred Stock (the "DSIT Preferred Stock"). At the closing, Acorn purchased an additional $800,000 of DSIT Preferred Stock and committed to purchasing an additional $1.4 million of DSIT Preferred Stock. In September 2013, Acorn informed DSIT that it would suspend payment of funds it committed to invest in DSIT over the remainder of 2013 and in 2014. The Stock Purchase Agreement with DSIT will need to be amended to reflect this decision. We are currently unable to predict the terms of the amendment at this time. In July 2013, DSIT amended the vesting terms of previously granted option agreements under the DSIT 2006 Key Employee Share Option Plan (the "Plan") such that those options become vested and exercisable upon the occurrence of any one of the following: i) The date of consummation of an IPO (as defined in the Plan); or ii) The date of consummation of a Corporate Transaction (as defined in the Plan).; or iii) The date of termination or resignation of Optionee's employment with DSIT, for any reason excluding termination for cause, provided that on the date of termination the Optionee was employed by DSIT for a continuous period of at least 25 years. As a result of the modification of the options, DSIT recorded stock compensation expense of $159,000 ($115,000 in SG&A) during the third quarter of 2013. GridSense In the first nine months of 2013, GridSense reported revenues of $3.5 million, an increase of $0.7 million (23%) compared to first nine month 2012 revenues of $2.9 million. Third quarter 2013 revenues of $1.1 million were slightly (9%) above third quarter 2012 revenues of $1.0 million. Third quarter 2013 revenues represents an increase of $0.1 million (15%) compared to second quarter 2013 revenues of $0.9 million. The increase in 2013 revenues was attributable to increased revenues from GridSense's U.S. operations which saw its revenues increase from $1.5 million in 2012 to $2.6 million in 2013. Revenues from GridSense's Australian operations decreased in the first nine months of 2013 compared to the same period in 2012 by $0.4 million. The increased revenue in the United States was attributable to an order GridSense was awarded in late 2012 for 800 Transformer IQ® units from a California based investor owned utility. This order was partially fulfilled in 2012 with the balance being completed in the first quarter of 2013. In addition, in June 2013, GridSense secured an order from a major national utility based on a partnership with a regional smart grid company. The order, valued in excess of $1.0 million, was partially delivered in the third quarter of 2013 with the balance to be delivered in the fourth quarter of 2013. The increased revenue in the third quarter of 2013 as compared to the third quarter of 2012 was attributable to the partial fulfillment of this order. GridSense anticipates fulfilling the balance of this order during the fourth quarter of 2013. The decrease in Australian revenues in 2013 is primarily attributable to changes in sales personnel, a short-term diversion in certain personnel's focus related the restructuring and unexpected delays in outbound shipments of PowerMonic units. While GridSense sees some improvement in the overall business environment in the utility industry and expects utility spending to increase in future quarters, the timing of such spending on products such as those that GridSense provides cannot be predicted with certainty due to the sales cycle of electric utilities which is typically long and requires much technical and application support. To address these long sales cycles, GridSense has expanded its customer pilot programs from just a handful in 2011 to over 50 ongoing pilots around the globe. GridSense has not, however, generally been able to leverage market exposure into high volume sales. We believe this is due to the fact that until recently, GridSense's focus had been on increasing the number of pilots which, though having potential for sizeable orders, required considerable engineering resources and customization effort. Furthermore, pilot programs (consisting of deployment of one or more products on a test basis) generally last between three and eighteen months. GridSense's new management has realigned sales and engineering efforts and is focusing on fewer and more standardized opportunities with the most perceived likelihood for successful deployment and commercial-scale orders. Specifically, we plan to focus our continued sales efforts in 2013 and into 2014 only on those products that have already shown the most traction in the marketplace such as the Transformer IQ®, the Line IQ® and GridInSiteTM and to work towards a goal of being cash flow neutral by year-end. GridSense's gross profit in the first nine months of 2013 increased by approximately $0.3 million or 21% compared to first nine months 2012 gross profit and increased by approximately $59,000 compared to second quarter 2013. The increase in gross profit was attributable to the abovementioned increase in revenues. Gross margins decreased slightly from 43% in 2012 to 42% in 2013. Gross margin was unchanged from the second quarter of 2013 to the third quarter of 2013. We expect gross margins 30-------------------------------------------------------------------------------- Table of Contents to continue at current or higher levels as we continue to work towards managing inventory more efficiently, improving forecasting for purchasing and procurement, and reducing production cycle times. In the first nine months of 2013, GridSense recorded $1.8 million of R&D expense as compared to $1.1 million in the same period of 2012. The increased R&D expense is due to the growth in GridSense's engineering team in 2012 in order to accelerate the development of some key products that GridSense believes will lead to the generation of new revenues. Third quarter R&D expense was $0.4 million following $0.7 million in the second quarter of 2013. The decrease in the third quarter is due to the downsizing of GridSense's Australian operations and reduced engineering staff in the U.S., GridSense expects that R&D expense going forward will stabilize at or about their current levels going forward. During the first nine months of 2013, GridSense recorded approximately $2.7 million of SG&A expense representing a decrease of approximately $0.8 million (23%) compared to the first nine months of 2012 SG&A expense. The decreased SG&A costs is due to headcount reduction due to role consolidation and cost cutting measures that were commenced in late 2012 and continued into 2013.Third quarter 2013 SG&A expense of $0.9 million reflects an increase of $0.1 million compared to second quarter 2013 SG&A expense reflecting increased sales commissions associated with our order from a major national utility based on a partnership with a regional smart grid company. We expect that SG&A costs will stabilize at or about their current levels going forward. Acorn continues to provide funds for GridSense's working capital needs. In the period from January 1 to July 31, 2013, Acorn provided GridSense with $1.5 million for its working capital needs plus an additional $480,000 to help fund the costs of the restructuring noted above. If GridSense is able to meet its sales goals for the second half of 2013, we believe that no additional funding would be required. However, from time to time, GridSense may need working capital support due to the timing of its cash receipts from customers and payments to suppliers. During the third quarter of 2013, we also lent GridSense $750,000 to support the order it received from a major national utility based on a partnership with a regional smart grid company. We anticipate making an additional short-term loan of approximately $300,000 to GridSense this week to offset a delay in the expected payment of a customer receivable. We believe the risk of default by the customer is low. We anticipate that all loan amounts would be repaid, subject to bank approval and assuming it is able to access funds under its bank credit line as discussed below, by year end. These loans are unsecured and subordinated to the bank providing a credit facility to GridSense. In August 2012, GridSense signed a Loan and Security Agreement with a bank to provide it with up to a $1.0 million revolving line of credit (subject to a calculated borrowing base). The outstanding balance as of September 30, 2013 was $100,000. The line-of-credit is subject to certain financial and other covenants. GridSense was in compliance with its financial covenants at September 30, 2013. The line-of-credit expired on November 1, 2013. The bank has extended the expiration date of the line-of-credit for a period of three months. GridSense is continuing to negotiate with the bank regarding the terms of a longer extension and potential increase of the line-of-credit based on Acorn guaranteeing GridSense's obligations to the bank . Such guarantee would require the approval of the Acorn's Board of Directors and we cannot determine whether and on what terms such extension may be available or if such terms would be acceptable to GridSense and Acorn. On October 31, 2013, GridSense had cash on hand of approximately $0.1 million and was utilizing approximately $0.2 million of its line of credit. We have no assurance that GridSense will increase its sales or reduce its need for additional financing to support its working capital needs. Additional working capital support may be in the form of an additional or expanded bank line, new investment by others, additional loans by Acorn, or a combination of the above. There is no assurance that GridSense will be able to obtain an additional or expanded line-of-credit or other support in sufficient amounts, in a timely manner or on acceptable terms. The availability and amount of any additional loans from us in GridSense may be limited by the working capital needs of our corporate activities and other operating companies. OmniMetrix In accordance with applicable accounting standards, we began consolidating the results of OmniMetrix beginning February 15, 2012, the date we acquired OmniMetrix. Accordingly, there are only partial comparative results reported for OmniMetrix for the nine month period ended September 30, 2012. In the first nine months of 2013, OmniMetrix recorded revenues of $1.6 million ($1.2 million in its Power Generation Monitoring ("PG") segment and $0.4 million in its Cathodic Protection ("CP") segment) as compared to $0.4 million recorded in the first nine months of 2012 following our acquisition. The increase in revenues is driven by the increase in the number of units being monitored. Third quarter 2013 revenues of $0.5 million were flat compared to second and first quarter 2013 revenues of $0.5 million each. 31-------------------------------------------------------------------------------- Table of Contents Following our acquisition of OmniMetrix, we invested heavily in developing its infrastructure and growing its staff (from 12 at acquisition to a peak of 36 in July 2013) in order to accommodate expected growth and expand our market presence. During the first half of 2013, OmniMetrix attempted to market its PG products primarily to dealers and distributors of the most common brands of generators. While some larger dealers embraced OmniMetrix's business model (a recurring revenue model where monitors are sold at or below cost in exchange for customer commitments for fixed term monitoring contracts), it has not universally resonated within the dealer marketplace and the rate of anticipated adoption (and thus sales of monitors and monitoring subscriptions) has been far slower than anticipated. Revenue in 2013 and expected future monitoring revenues from renewals have been significantly adversely impacted by our inability to make sufficient new sales. OmniMetrix is currently refining a revised strategic direction which includes marketing to end-users as well as to select dealers identified as possessing both substantial maintenance customer bases and a willingness to provide value-added services. Acorn intends to share resources of OmniMetrix with GridSense in order to capitalize on synergies from both companies' machine-to-machine operating models, power assurance focus and complementary personnel, and in July 2013, as a first step appointed the CEO of GridSense (Joe Musanti) to also serve as CEO of OmniMetrix. OmniMetrix is currently engaged in restructuring its operations to better align expenses with revenues as now projected by its new management. This will result in personnel layoffs and significantly reduced utilization of its leased facility in Buford, Georgia. Accordingly, OmniMetrix recorded a restructuring charge of $155,000 related to severance and other termination benefits for employees whose positions were made or are expected to be made redundant. In addition, as a result of the expected significantly reduced utilization of its leased facility, OmniMetrix also recorded a restructuring charge of $202,000 for the expected net contractual rental commitments through the end of its lease in December 2019. Furthermore, OmniMetrix recorded a loss of $415,000 reflecting the write-down of a majority of the remaining book value of leasehold improvements associated with the leased facility net of the landlord's participation in those improvements. While no assurance can be given that we will be successful, management's goal is that following the restructuring changes at both GridSense and OmniMetrix, that the operations of both entities will be able to take advantage of synergies in engineering, marketing, customer relations and administration and that the two companies will, if they meet their sales goals for 2014, be cash neutral to Acorn. In January 2013, the EPA finalized amendments to the National Emissions Standards for Hazardous Air Pollutants for stationary reciprocating internal combustion engines (generators). Now every commercial generator over a certain size needs to collect and report run times and annual emissions or face significant civil penalties. Consequently, some end-user customers as well as environmental engineering firms, see significant value in our offering due to our ability to assist end-user customers in complying with such environmental regulations. As a result, we have increased our marketing efforts to highlight this value we provide to our customers. We are currently providing reports and information to end-user customers to assist them in their environmental compliance, and we have received positive feedback from these customers. However, we have no assurance that we will ultimately be able to generate significant revenues from our ability to assist with the compliance with these regulations. As revenue in 2013 and expected future revenues (for both PG and CP activities) have been significantly adversely impacted by the inability to make expected penetration in the marketplace, future projections for the segments have been adjusted accordingly. Following a goodwill impairment analysis based upon expected discounted cash flows from both the PG and CP segments, the Company determined that the goodwill recorded with respect to both segments were fully impaired and the Company recorded an impairment charge of $1.9 million. The goodwill impairment analysis performed also indicated that acquired intangible assets (technologies, customer relationships and non-compete agreements) were also impaired. Accordingly, in the third quarter of 2013, OmniMetrix recorded an impairment charge of $3.7 million associated with those intangibles. First nine months 2013 gross profit was approximately $874,000 reflecting a gross margin of 54% on revenues compared with a gross profit of $72,000 in the first nine months of 2012. Third quarter gross profit of $273,000 reflected a gross margin of 50%, down from the second quarter's gross margin of 52%. The decrease in the gross margin was due to an increased number of units given away. The gross margin continues to be driven by margins on monitoring revenue which was 66% during the nine month period. As monitoring revenue continues to grow, we expect these margins to increase in the long term as fixed costs are spread over a greater revenue base and the deferred costs associated with the provision of units to certain customers below cost are fully amortized. During the first nine months of 2013, OmniMetrix recorded approximately $499,000 of R&D costs. R&D costs increased in the third quarter of 2013 to $231,000 from $148,000 in the second quarter of 2013. We anticipate that these costs will decline as a result of our restructuring and the synergies we expect to benefit from in working with GridSense. During the first nine months of 2013, OmniMetrix recorded approximately $3.7 million of SG&A costs of which approximately $1.7 million was related to sales and marketing. Such costs were significantly above first nine months 2012 SG&A costs of $1.5 million ($0.5 million in sales and marketing) since our acquisition of OmniMetrix in February of 2012. The growth in SG&A costs reflects the investment in marketing and back-office infrastructure since our acquisition. Third quarter 2013 SG&A 32-------------------------------------------------------------------------------- Table of Contents costs of $1.3 million were slightly above second quarter 2013 SG&A costs of $1.2 million due to increased payroll costs. We anticipate that our SG&A costs will decline as a result of our restructuring and the synergies we expect to benefit from in working with GridSense. OmniMetrix currently has no other sources of financing other than its sales and investments by Acorn. To support OmniMetrix's 2013 marketing and promotion program, Acorn committed to investing $3.0 million in OmniMetrix, all of which had been invested through early October 2013. Despite the restructuring taking place at OmniMetrix, Acorn will continue to need to fund OmniMetrix's operations for the balance of 2013. We have recently lent OmniMetrix $400,000 and anticipate lending them up to an additional $600,000 through the end of 2013. While we have no assurance of such, in 2014, following the restructuring changes at both GridSense and OmniMetrix, if the companies can achieve their sales goals, we believe that the operations of the entities will be net cash neutral to Acorn. As of October 31, 2013, OmniMetrix had cash on hand of approximately $75,000. In 2013 and 2014, OmniMetrix may need additional financing above our expected loans to them as noted above. The level of additional financing will be dependent upon the level of penetration by OmniMetrix into the power generation monitoring market and the realization of synergies with GridSense. Additional financing for OmniMetrix may be in the form of a bank line, new investment by others, a loan by Acorn, or a combination of the above. OmniMetrix was unsuccessful in discussions with a bank to provide working capital financing and there is no assurance that such financing from another bank or any other party will be available in sufficient amounts, in a timely manner or on acceptable terms. The availability and amount of any additional loans from us to OmniMetrix may be limited by the working capital needs of our corporate activities and other operating companies. Corporate Corporate general and administrative expense of $4.0 million in the first nine months of 2013 reflected a slight decrease (less than $65,000) as compared to the first nine months of 2012. Third quarter 2013 corporate general and administrative expense of $1.2 million was approximately $150,000 below the second quarter 2013 expense and approximately $180,000 below first quarter 2013 corporate general and administrative expense. Third quarter 2013 expense was also approximately $100,000 below third quarter 2012's corporate general and administrative expense. First nine months 2012 corporate general and administrative expense included approximately $300,000 of professional fees and costs incurred associated with our acquisition of OmniMetrix. In 2013, these one-time costs were replaced by an increase in non-cash stock compensation expense (an increase of approximately $415,000 in 2013 compared to 2012). In coming quarters, we expect our corporate general and administrative costs to decrease as we expect to incur less investor relation expenses going forward and are beginning to take steps to reduce our salary costs. Most of the impact of these cost reductions will not be felt until 2014. On October, 17, 2013, Acorn closed on a public offering of 3,508,771 shares of its common stock at $2.85 per share for gross proceeds to Acorn of $10.0 million. Acorn received net proceeds of approximately $9.1 million after deducting discounts and commissions to the underwriters and estimated offering expenses. In connection with the Underwriting Agreement, Acorn also issued a warrant to the underwriters to acquire 228,070 shares of common stock at $3.14 per share which shall be exercisable for five years. This was followed by a second closing on October 23, 2013, whereby Acorn closed on a sale of 526,316 shares of its common stock following the full exercise of the over-allotment option granted to the underwriters at $2.85 per share for gross proceeds to Acorn of $1.5 million. A second warrant for 34,211 shares exercisable at $3.14 for five years was issued to the underwriters in connection with this closing. Acorn received net proceeds of $1.4 million from the over-allotment option exercise or a total of $10.5 million from both closings after deducting discounts and commissions to the underwriters and estimated offering expenses. As of October 31, 2013, Acorn's corporate operations (not including cash at any of our subsidiaries) held a total of approximately $15.4 million in cash and cash equivalents ($12.9 million in U.S. banks and $2.5 million in Israeli banks (all of which can be repatriated without any tax consequence)). In addition, Acorn anticipates receipt of its Federal income tax refund of approximately $1.7 million during the fourth quarter of 2013. We believe that our current cash plus the cash generated from operations and borrowing from available lines of credit, if necessary, will provide more than sufficient liquidity to finance the operating activities of Acorn and the operations of its operating subsidiaries at their current level of operations for the foreseeable future and for the next 12 months in particular. 33-------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth certain information with respect to the consolidated results of operations of the Company for the three and nine month periods ended September 30, 2012 and 2013, including the percentage of total revenues during each period attributable to selected components of the operations statement data and for the period to period percentage changes in such components. For segment data see Note 10 to the Unaudited Condensed Consolidated Financial Statements included in this quarterly report. The financial results of OmniMetrix are included in our condensed consolidated financial statements effective February 15, 2012. Accordingly, there are only partial comparative results reported for these activities for the nine month period ended September 30, 2012. Nine months ended September 30, Three months ended September 30, Change Change 2012 2013 from 2012 2013 from 2012 2012 to to ($,000) % of revenues ($,000) % of revenues 2013 ($,000) % of revenues ($,000) % of revenues 2013 Revenues $ 14,623 100% $ 15,931 100% 9% $ 4,713 100% $ 4,982 100% 6% Cost of sales 10,449 71% 11,475 72% 10% 3,225 68% 3,923 79% 22% Gross profit 4,174 29% 4,456 28% 7% 1,488 32% 1,059 21% (29)% R&D expenses 4,771 33% 6,336 40% 33% 1,754 37% 2,219 45% 27% SG&A expenses 13,891 95% 15,221 96% 10% 5,272 112% 4,995 100% (5)% Impairment of intangibles - -% 6,731 42% - -% 5,615 113% Restructuring and related charges - -% 1,366 9% - -% 772 15% Operating loss (14,488 ) (99)% (25,198 ) (158)% 74% (5,538 ) (118)% (12,542 ) (252)% 126% Finance income, net (53 ) -% 80 1% (251)% (160 ) (3)% (9 ) -% (94)% Loss before taxes on income (14,541 ) (99)% (25,118 ) (158)% 73% (5,698 ) (121)% (12,551 ) (252)% 120% Income tax benefit (expense) 2,476 17% (228 ) (1)% (109)% 1,487 32% (143 ) (3)% (110)% Net loss (12,065 ) (83)% (25,346 ) (159)% 110% (4,211 ) (89)% (12,694 ) (255)% 201% Net loss attributable to non-controlling interests 737 5% 885 6% 20% 276 6% 382 8% 38% Net loss attributable to Acorn Energy, Inc. $ (11,328 ) (77)% $ (24,461 ) (154)% 116% $ (3,935 ) (83)% $ (12,312 ) (247)% 213% Revenues. Revenues in the first nine months of 2013 increased by $1.3 million or 9% from $14.6 million in the first nine months of 2012 to $15.9 million in the first nine months of 2013. The increased revenues was driven primarily by increased revenues at OmniMetrix whose reported revenues increased by $1.2 million to $1.6 million compared to first nine months of 2012 revenues of $0.4 million since our acquisition of them in February of 2012 and GridSense revenues which increased by $0.7 million (23%) to $3.5 million compared to first nine month 2012 revenues. DSIT's revenues ($9.6 million) were decreased $0.4 million (4%) from 2012's nine month revenues of $10.0 million while USSI's revenues decreased by $0.2 million (13%) to $1.1 million compared to first nine month 2012 revenues of $1.3 million. OmniMetrix recorded revenues of $1.6 million which were comprised of $1.2 million in its PG segment and $0.4 million in its CP segment as compared to $0.3 million and $0.1 million, respectively for the first nine months of 2012. The increase in revenues is driven by the increase in the number of units being monitored. The increase in GridSense revenues was due to increased sales activity from U.S. operations which was attributable to the fulfillment of an order for 800 Transformer IQ® units from a California based investor owned utility that was received in late 2012 as well as the partial delivery in the third quarter 2013 of an order received from a major national utility in excess of $1.0 million received in June 2013. At DSIT, revenues in its Energy & Sonar Security Solutions segment decreased (from $9.2 million to $8.7 million). This decrease was attributable to the slowdown in revenue recognition in one of the company's major projects as it nears completion without a similar size project replacing it in the company's backlog. Revenues in DSIT's other IT and consulting activities which are included in Acorn's Other segment activities increased marginally ($46,000) in the first nine months of 2013. The decrease in revenues at USSI was due to the timing of the delivery of USSI's sensor systems. Gross profit. Gross profit in the first nine months of 2013 reflected an increase of $0.3 million (7%) as compared to the first nine months of 2012. DSIT's first nine month 2013 gross profit was unchanged at $3.6 million. DSIT maintained its gross profit despite decreased revenues due to increased gross margins which improved from 36% in 2012 to 38% in 2013. DSIT's 34-------------------------------------------------------------------------------- Table of Contents increased gross margins in the first nine months of 2013 were due to higher margin projects being worked on in 2013 as compared to 2012. GridSense's first nine month 2013 gross profit increased by $0.3 million (21%) over first nine month 2012 gross profit. The increase in GridSense's gross profit was attributable to increased revenues which offset a slight decrease in gross margins which fell to 42% in 2013 from 43% in 2012. USSI continued to show a negative gross profit in the first nine months of 2013 ($1.5 million) as it continues to incur increased engineering and production costs as it transitions from development of its products to production in its proof-of-concept projects. Approximately $1.0 million of the negative gross profit was attributable to adjustments of sensor systems built-to-lease and inventory to net realizable values. OmniMetrix recorded gross profit of $0.9 million (reflecting a 54% gross margin) in the first nine months of 2013 as compared to a $0.1 million gross profit recorded in 2012 since our acquisition of OmniMetrix in February 2012. The increased gross margin at OmniMetrix reflects the increasing levels monitoring of revenue recorded which are high margin revenues. Research and development ("R&D") expenses. R& D expenses increased $1.6 million to $6.3 million in the first nine months of 2013. The bulk of the increase in R&D expenses was at GridSense and DSIT whose R&D expense increased $0.7 million and $0.4 million, respectively, as compared to the first nine months of 2012. The increase at GridSense was due to the growth in GridSense's engineering team over the course of 2012 in order to accelerate the development of some key products. DSIT's increased R&D expense is related to work on the joint development (with USSI) of the PAUSS next generation integrated passive/active threat detection system for underwater site protection and efforts to expand DSIT's portfolio of products to include land-based security fiber-optic solutions. OmniMetrix also recorded an increase in R&D expense of $0.3 million as compared to the first nine months of 2012 (OmniMetrix's R&D expense in the first nine months of 2012 was only for the period since our acquisition in February 2012) while USSI's R&D expense in the first nine months of 2013 increased slightly ($0.2 million) to $2.9 million from $2.7 million in the first nine months of 2012. Selling, general and administrative ("SG&A") expenses. SG&A costs in the first nine months of 2013 increased by $1.3 million as compared to the first nine months of 2012. The increased SG&A was attributable to increases recorded at OmniMetrix and DSIT while GridSense, USSI and corporate SG&A decreased in the first nine months of 2013 as compared to the first nine months of 2012. OmniMetrix recorded $3.7 million of SG&A in the current period as compared to $1.5 million for the period in 2012 following our acquisition. The increase in SG&A costs at OmniMetrix is due to the increased personnel costs (primarily in sales and marketing) and other costs associated with developing the necessary infrastructure for previously expected growth. DSIT's SG&A increased from $2.2 million in the first nine months of 2012 to $2.5 million in the first nine months of 2013. DSIT's increased SG&A was related to increased salary costs as well as increased marketing expenses as well as non-cash stock compensation expense recorded in the third quarter associated with the modification of certain options at DSIT. In the first nine months of 2013, as compared to the first nine months of 2012, GridSense recorded a decrease of $0.8 million of SG&A expense to $2.7 million. GridSense's decreased SG&A expense was attributable to headcount reduction due to role consolidation and cost cutting measures that were commenced in late 2012 and continued into 2013. USSI's SG&A decreased from $2.6 million in the first nine months of 2012 to $2.4 million in the first nine months of 2013. USSI's decreased SG&A expense was attributable to stock compensation expense recorded in 2012. Corporate general and administrative expense of $4.0 million in the first nine months of 2013 reflected a slight decrease (less than $65,000) as compared to the first nine months of 2012. Impairment of intangibles. As revenue at OmniMetrix in 2013 and expected future revenues have been significantly adversely impacted by the inability to make expected penetration in the marketplace, future projections for the segments have been adjusted. Following a goodwill impairment analysis based upon expected discounted cash flows, OmniMetrix determined that the goodwill recorded upon its acquisition by Acorn was fully impaired and an impairment charge of $1.9 million was recorded. The goodwill impairment analysis performed also indicated that the acquired intangible assets (technologies, customer relationships and non-compete agreements) were also impaired. Accordingly, in the third quarter of 2013, OmniMetrix recorded an impairment charges of $3.7 million associated with those intangibles. Previously, during the second quarter of 2013, a customer with whom OmniMetrix had a significant on-going relationship at the time of Acorn's acquisition of OmniMetrix in February 2012 indicated that they would be disconnecting all of their monitoring units over a period of time. Following the decision to disconnect their monitoring units, OmniMetrix recorded an impairment of approximately $1.1 million associated with the customer relationship intangible. Restructuring and related charges. In the third quarter of 2013, following the change in the top-level management at OmniMetrix, it engaged in restructuring its operations to better align expenses with revenues as now projected by its new management. As a result, during the third quarter of 2013, OmniMetrix recorded a total restructuring charge of $0.8 million. In the second quarter of 2013, following the change in the top-level management at GridSense, the company undertook a number of cost cutting measures in GridSense's U.S. and Australian operations. This action was taken primarily in order to improve efficiency based on GridSense's revenue mix and skills mix in order to position the company to meet its cash flow goals. As a result, during the second quarter of 2013, GridSense recorded a total restructuring charge of $0.6 million. Net loss attributable to Acorn Energy. We had a net loss attributable to Acorn Energy of $24.5 million in the first nine months of 2013 compared to a net loss of $11.3 million in the first nine months of 2012. Our loss in 2013 was primarily due to 35-------------------------------------------------------------------------------- Table of Contents losses at OmniMetrix ($10.8 million which includes the loss of $0.8 million on restructuring and related charges and non-cash losses on the impairment of goodwill and intangibles of $6.7 million noted above) USSI (losses of $6.8 million), GridSense losses of $3.5 million (which includes the loss of $0.6 million on restructuring and related charges noted above) and DSIT's losses of $0.2 million (which includes non-cash stock compensation expense of $0.2 million recorded in the third quarter) with corporate expenses contributing an additional $4.0 million. These losses were offset by the non-controlling interest's share of our operations of approximately $0.9 million. 36-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources As of September 30, 2013, we had working capital of $17.3 million. Our working capital includes $7.4 million of cash and cash equivalents and restricted deposits of approximately $0.8 million. Net cash decreased during the nine months ended September 30, 2013 by $18.8 million, of which approximately $16.5 million was used in operating activities. The primary use of cash in operating activities during the first nine months of 2013 was the cash used in operations by our subsidiaries ($6.2 million, $2.3 million, $3.4 million and $1.2 million used by USSI, GridSense, OmniMetrix and DSIT, respectively) in their operations combined with the $3.4 million of cash used in our corporate operating activities. Of USSI's $6.2 million of cash used in operations, $1.0 million was used for the build-up of inventory. Cash used in investment activities of $2.7 million was primarily due to the acquisition of property and equipment. Such acquisitions of property and equipment were primarily at USSI ($1.5 million of which approximately $1.1 million was related to the building of sensor systems to be leased to customers) and at OmniMetrix (approximately $1.0 million, nearly all of which was related to leasehold improvements and equipment at its new facilities). Net cash of $0.5 million was provided by financing activities primarily from the net change in short and long-term debt ($1.1 million) which was partially offset by the payment of dividends during the first nine months of 2013 ($0.5 million). At September 30, 2013, DSIT had approximately $0.4 million of unrestricted cash in banks and NIS 4 million (approximately $1.1 million) in Israeli credit lines available to it from two Israeli banks (approximately $550,000 from each bank), of which approximately $0.1 million was then being used. The lines-of-credit are subject to maintaining certain financial covenants. At September 30, 2013, DSIT was in compliance with its financial covenants. As at September 30, 2013, DSIT also had an outstanding term loan from an Israeli bank in the amount of approximately $38,000. The loan is denominated in NIS and bears interest at the rate of the Israeli prime rate per annum plus 0.9%. The loan is to be repaid in equal payments of approximately $12,500 per month (principal and interest) through December 2013. DSIT is currently examining the possibility of obtaining Israeli government backed loans for additional working capital. In accordance with the terms of the loan, DSIT has deposited with an Israeli bank approximately $38,000 as a restricted deposit. In addition to this restricted deposit, DSIT has also deposited with two Israeli banks approximately $761,000 as collateral for various performance and bank guarantees for various projects as well as for its credit facilities at the banks. As restricted deposits are released, DSIT generally expects to redeposit these funds again as collateral for new guarantees for new projects and for renewing its credit facilities. On October 31, 2013, DSIT had approximately $1.0 million of cash of which approximately $0.6 million was restricted (all current) and was utilizing approximately $0.2 million of its lines-of-credit. In July 2013, Acorn entered into a new Stock Purchase Agreement with DSIT pursuant to which the Acorn converted a prior loan of approximately $0.8 million into additional ordinary (common) shares of DSIT. Acorn also converted $2.8 million in advances and loans into DSIT's participating preferred stock and purchased an additional $0.8 million of participating preferred stock. In September 2013, the Company informed DSIT that it would suspend payment of funds it committed to invest in DSIT over the remainder of 2013 and into 2014, such that DSIT will be dependent solely on its own cash sources to finance its activities. The Stock Purchase Agreement will need to be amended to reflect this decision. Acorn is unable to predict the terms of the amendment at this time. We believe that DSIT will have sufficient liquidity to finance its activities from cash flows from its own operations over the next 12 months based on its current cash balance, continued utilization of its lines-of-credit and its operating results. In August 2012, GridSense signed a Loan and Security Agreement with a bank to provide it with up to a $1.0 million revolving line of credit (subject to a calculated borrowing base). Advances from the line-of-credit bear interest at a variable annual interest rate equal to the greater of 3.25% above the Prime Rate in effect (3.25% at September 30, 2013) or 6.5%. The line-of-credit is also subject to certain financial covenants. GridSense was in compliance with its financial covenants at September 30, 2013. As of October 31, 2013, GridSense was utilizing $175,000 of this line-of-credit. The line-of-credit expired on November 1, 2013. The bank has extended the expiration date of the line-of-credit for a period of three months. GridSense is continuing to negotiate with the bank regarding the terms of a longer extension of the line-of-credit. In the period from January 1 to July 31, 2013, Acorn provided GridSense with $1.5 million for its working capital needs plus an additional $480,000 to help fund the costs of the restructuring. If GridSense is able to meet its sales goals for the second half of 2013, we believe that no additional funding would be required. However, from time to time, GridSense may need working capital support due to the timing of its cash receipts from customers and payments to suppliers. Since July 2013, we lent GridSense $750,000 to support the order it received from a major national utility based on a partnership with a regional smart grid company. We anticipate making an additional short-term loan of approximately $300,000 to GridSense this week to offset a delay in the expected payment of a customer receivable. We believe the risk of default by the customer is low. We anticipate that all loan 37-------------------------------------------------------------------------------- Table of Contents amounts would be repaid, subject to bank approval and assuming it is able to access funds under its bank credit line as discussed below, by year end. These loans are unsecured and subordinated to the bank providing a credit facility to GridSense. Following the restructuring of activities at GridSense, we believe that with a reduced cost structure and improving sales, GridSense will be significantly less reliant on us for working capital support. We have no assurance that GridSense will meet its goal of being cash flow neutral in the second half of 2013 or increase its sales and reduce its need for additional financing to support its working capital needs. Additional working capital support may be in the form of an additional or expanded bank line, new investment by others, additional loans by Acorn, or a combination of the above. There is no assurance that GridSense will be able to obtain an additional or expanded line-of-credit or other support in sufficient amounts, in a timely manner or on acceptable terms. The availability and amount of any additional investment from us in GridSense may be limited by the working capital needs of our corporate activities and other operating companies. On October 31, 2013, GridSense had cash on hand of approximately $0.1 million and was utilizing approximately $0.2 million of its line-of-credit. OmniMetrix currently has no other sources of financing other than its sales and investments by Acorn. To support OmniMetrix's 2013 marketing and promotion program, Acorn committed to investing $3.0 million in OmniMetrix, all of which had been invested through early October 2013. Despite the restructuring taking place at OmniMetrix, Acorn will continue to need to fund OmniMetrix's operations for the balance of 2013. We have recently lent OmniMetrix $400,000 and anticipate lending them up to an additional $600,000 through the end of 2013. While we have no assurance of such, in 2014, following the restructuring changes at both GridSense and OmniMetrix, if the companies can achieve their sales goals, we believe that the operations of the entities will be net cash neutral to Acorn. As of October 31, 2013, OmniMetrix had cash on hand of approximately $75,000. In 2013 and 2014, OmniMetrix may need additional financing above our expected loans to them as noted above. The level of additional financing will be dependent upon the level of penetration by OmniMetrix into the power generation monitoring market and the realization of synergies with GridSense. Additional financing for OmniMetrix may be in the form of a bank line, new investment by others, a loan by Acorn, or a combination of the above. OmniMetrix was unsuccessful in discussions with a bank to provide working capital financing and there is no assurance that financing from any bank or any other party will be available in sufficient amounts, in a timely manner or on acceptable terms. The availability and amount of any additional loans from us to OmniMetrix may be limited by the working capital needs of our corporate activities and other operating companies. As of October 31, 2013, USSI had cash on hand of approximately $20,000. On November 4, 2013, we transferred an additional $370,000 to USSI. USSI reached agreement with a bank for a $1 million line-of-credit in November 2012. At September 30, 2013, USSI was in compliance with its financial covenants. As of October 31, 2013, USSI was utilizing $960,000 of its line-of-credit. Although the line-of-credit has technically expired, USSI and the bank are currently discussing a new bank facility which we expect to reflect an increase in USSI's line-of-credit. Assuming the credit facility is renewed, we have no assurance that USSI's future capital needs will not exceed the amount of the credit line or that USSI will generate sufficient cash flow in the future to fund its operations in the absence of additional funding sources. USSI may need additional funds if revenues fail to meet projections or to fund a rapid expansion to meet product demand, respond to competitive pressures or acquire complementary products, businesses or technologies. Additional financing for USSI may be in the form of an expanded bank line, new investment by others, a loan or investment by Acorn, or a combination of the above. The availability and amount of any additional investment from us in USSI may be limited by the working capital needs of our corporate activities and other operating companies. USSI will continue to require working capital support while it continues to transition from development to production and as it continues to work on refining its manufacturing capabilities. During 2013 (through October 31) we invested $6.6 million in USSI to support its working capital requirements. We expect that USSI's working capital requirements will ultimately lessen if and when it begins to have commercial scale orders. We cannot however, provide any assurance as to whether or when such orders will be received. Accordingly, USSI is proactively monitoring its operating expenses to ensure that they are in line with its current and expected near term activities and will make adjustments as necessary. We expect that we will be investing additional funds in USSI before year-end 2013 and into 2014, though the amounts to be invested will be dependent on USSI's needs at that time. In October 17, 2013, Acorn closed on a public offering of its common and received net proceeds of approximately $9.1million after deducting discounts and commissions to the underwriters and estimated offering expenses. This was followed by a second closing on October 23, 2013 in which Acorn sold over-allotment shares raising an additional $1.4 million after deducting discounts and commissions to the underwriters and estimated offering expenses. As of October 31, 2013, the Company's corporate operations (not including cash at any of our subsidiaries) had a total of approximately $15.4 million in cash and cash equivalents ($12.9 million in U.S. banks and $2.5 million in Israeli banks (all of which can be repatriated without any tax consequence)) representing an increase of $9.1 million from our balance of September 38-------------------------------------------------------------------------------- Table of Contents 30, 2013. The increase in cash was the result of the abovementioned sale of shares which brought in a total of $10.5 million (net of expenses). This was offset by investments of $625,000 in USSI and $130,000 in OmniMetrix and a loan to OmniMetrix of $200,000 in October. The balance of cash used in the month of October was for corporate expenses. Acorn anticipates receipt of its Federal income tax refund of approximately $1.7 million during the fourth quarter of 2013. We believe that our current cash plus the cash generated from operations and borrowing from available lines of credit, if necessary, will provide more than sufficient liquidity to finance the operating activities of Acorn and the operations of its operating subsidiaries at their current level of operations for the foreseeable future and for the next 12 months in particular. Contractual Obligations and Commitments The table below provides information concerning obligations under certain categories of our contractual obligations as of September 30, 2013. CASH PAYMENTS DUE TO CONTRACTUAL OBLIGATIONS Years Ending September 30, (in thousands) 2019 and Total 2014 2015 - 2016 2017 - 2018 thereafterBank and other debt, utilized lines-of-credit and capital leases $ 1,212 $ 1,212 $ - $ - $ - Operating leases 2,923 951 1,526 275 171 Potential severance obligations (1) 5,048 254 1,287 - 3,507 Minimum royalty payments (2) (3) 450 50 100 100 200 Purchase commitments (4) 207 207 - - - Total contractual cash obligations $ 9,840 $ 2,674 $ 2,913 $ 375 $ 3,878 We expect to finance these contractual commitments from cash currently on hand and cash generated from operations. (1) Under Israeli law and labor agreements, DSIT is required to make severance payments to dismissed employees and to employees leaving employment under certain other circumstances. The obligation for severance pay benefits, as determined by the Israeli Severance Pay Law, is based upon length of service and last salary. These obligations are substantially covered by regular deposits with recognized severance pay and pension funds and by the purchase of insurance policies. As of September 30, 2013, we accrued a total of $4.8 million for potential severance obligations to our Israeli employees of which approximately $3.4 million was funded. (2) In April 2012, USSI and Northrop Grumman signed a license agreement involving several of Northrop Grumman's fiber-optic technology patents. The license agreement is subject to an annual minimum royalty payment of 10% of the net selling price of each unit of licensed products used or sold during the term of the agreement. The agreement also calls for a minimum annual payment of $50,000 for the first ten years of the agreement beginning in 2012. The table above includes as a royalty payment only the minimum payment due. (3) Two of the employees of GridSense are entitled to a combined royalty of 6% of the sales of a particular product in excess of cumulative product sales of $4.0 million provided that the product remained substantially the same from the original date of the royalty agreement. The above table does not include any royalties that may be paid under this arrangement. (4) OmniMetrix has an agreement with a third party equipment assembler, pursuant to which it commits to purchase a specified amount of product based upon its submitted forecasted needs. The table reflects the amount outstanding under an open purchase order. 39-------------------------------------------------------------------------------- Table of Contents |