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TMCNet:  ACORN ENERGY, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

[March 17, 2014]

ACORN ENERGY, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) RECENT DEVELOPMENTS GridSense Orders In the first two months of 2014, GridSense received a number of large orders across numerous products lines. The Line IQ® product line has generated orders from a North American Utility and an international distributor totaling $1.0 million. We expect the majority of these orders to ship in the first half of the year. We believe these orders are the result of our updated LIQ product line and our plan of targeting our pilots projects. While, we cannot predict future orders, these customers have indicated interest in further expansion of these projects. In Australia we have seen renewed demand for the PowerMonic™ product line in 2014 which has resulted in new orders for $1.8 million. The shipment of the orders will occur throughout 2014 based on the customers delivery dates on their purchase orders. We believe the increase in PowerMonic™ orders is tied to both pent up demand from limited spending in 2012 and 2013 due the Australian utility consolidation and our focus driven sales strategy. We expect the level of PowerMonic™ orders to level off as the year moves forward and return to more normalized levels.

43-------------------------------------------------------------------------------- Table of Contents OVERVIEW AND TREND INFORMATION 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 "Item 1A. Risk Factors." We operate in four reportable segments: Oil & Gas Sensor Systems (though our USSI subsidiary), Energy & Security Sonar Solutions (through our DSIT subsidiary), Smart Grid Distribution Automation (through our GridSense subsidiaries) and PG Monitoring (through our OmniMetrix subsidiary). In addition, our "Other" segment represents IT and consulting activities at our DSIT subsidiary as well as Cathodic Protection activities in our OmniMetrix subsidiary.

The following analysis should be read together with the segment information provided in Note 21 to our Consolidated Financial Statements included in this 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 our 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. In connection with of our efforts to increase our industry knowledge, in December 2013, USSI announced the addition of Gary V. Morris to its board of directors. Mr. Morris previously served as Executive Vice President at Halliburton Company and also served as Halliburton's Chief Financial Officer. Halliburton Company is a leading provider of oilfield services worldwide. With over 30 years of oil related business experience, Mr. Morris is an executive with a diversified background including Oil and Gas, Oilfield Services, Engineering and Construction, Software and Insurance.

In connection with some of the trials and pilot projects referred to above, USSI has experienced various design and deployment challenges that resulted in components of the array being damaged due to improper handling during either shipping or during installation into a well. USSI has taken the position that mishandling will sometimes occur in the oilfield and has implemented design improvements to make it less susceptible to damage when mishandling occurs.

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 at least the first half of 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 44-------------------------------------------------------------------------------- Table of Contents 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 considering 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.

During 2013, USSI reported revenues of $1.5 million, an amount unchanged from 2012's revenues. Of the 2013 revenues, approximately 83% ($1.2 million) was from a single customer - an oil supermajor as part of their ongoing evaluation of USSI's sensor systems. This customer also represents approximately $1.8 million of USSI's $2.5 million year-end backlog of orders as this customer continues its evaluation of USSI in 2014. USSI anticipates the completion of the evaluation process during 2014 and expects to begin to receive follow-on orders after such completion. Whether the trial will be successful or even if it is, whether and what amount of orders may be received from the customer cannot be determined at this time. A lack of success in the trial or the loss of anticipated orders could have a significant adverse impact on our 2014 financial results.

On a quarterly basis, USSI revenue continues to be erratic due to the number and size of projects that USSI is able to complete and deliver during each quarter.

Fourth quarter 2013 revenues of $320,000 reflects a $173,000 increase compared to fourth quarter 2012 revenues of $147,000. The increase in revenues is attributable to the delivery in the fourth quarter of 2013 of downhole systems to the oil supermajor as part of their ongoing evaluation of USSI's sensor systems.

During 2013, gross profit continued to be negative ($2.3 million) as it was during 2012 ($1.0 million). The negative gross profit and its increase from 2012 is primarily due to large amounts of non-recurring engineering work ("NRE") and provisions for future costs that accompanied the technical challenges (water blocking and more reliable seals and connections) in connection with the fixed price projects for delivering systems for evaluation by the oil supermajor. In addition, approximately $1.8 million of the negative gross profit was attributable to cost overruns of sensor systems built-to-lease and inventory to net realizable values ($1.5 million) and to inventory obsolescence ($0.3 million).

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, currently, only two of the three manufacturing stations are 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.

During 2013, USSI recorded approximately $3.9 million of research and development ("R&D") expense as compared to $3.6 million during 2012. The increased R&D expense is due 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 and an increase in R&D materials used in product development. During the fourth quarter of 2013, USSI recorded approximately $1.0 million of R&D expense as compared to $0.9 million in the fourth quarter 2012. Quarterly R&D expense levels during 2013 varied from $0.8 million to $1.2 million per quarter with the variability arising from increased material usage in R&D. We expect R&D expense to approximate its current levels while USSI continues to work on developing more efficient production versions of its current products and addressees the technical issues encountered in customer field trials.

In June 2012, USSI together with DSIT were awarded a joint $900,000 grant from the BIRD Foundation for the joint development of the PAUSS next generation integrated passive/active threat detection system for underwater site protection. In October 2012, a Cooperation and Project Funding Agreement was signed between the companies and the BIRD Foundation which allows for the commencement of the funding which is expected to take place over a 24 month period. USSI and DSIT may request an extension of this development project, though we have no assurance that such an extension would be granted. USSI anticipates 45-------------------------------------------------------------------------------- Table of Contents receipt of approximately 40% ($360,000) of the grant based on the expected allocation of project costs between DSIT and USSI. To date, USSI has received approximately $135,000 from the BIRD Foundation. Payment of the remainder of the grant is dependent on continued progress being made in accordance with a contractually agreed upon time-line. Whether such funds will be forthcoming cannot be determined at this time.

During 2013, USSI recorded approximately $3.4 million of SG&A expense representing a decrease of approximately $0.5 million (12%) compared to 2012.

The decrease in the year-on-year SG&A costs are due to in part to reduced non-cash stock compensation expense which decreased from $0.3 million to $0.1 million combined with decreased outside consulting costs. Fourth quarter 2013 SG&A expense ($1.0 million) also reflects a decrease of $0.2 million as compared to fourth quarter 2012 SG&A expense of $1.2 million and an increase of $0.2 million compared to third quarter 2013. 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.

As at December 31, 2013, USSI's backlog of projects was approximately $2.5 million which is primarily comprised of a $1.8 million order from an oil supermajor as part of its continuing evaluation of USSI's systems and a $0.5 million order for a microseismic monitoring pilot project for a major international oil company in the Barnett Shale (TX). USSI anticipates recognizing revenue on the oil supermajor evaluation project upon delivery of two complete 36-level fiber optic downhole microseismic monitoring systems designed to operate in a high temperature, deep depth environment which is expected to occur sometime in 2014. USSI anticipates recognizing revenue on the microseismic monitoring pilot project in the second half of 2014 as customer drilling problems have delayed their ability to complete the well that had been selected for our project. We are having discussions with the customer to find a suitable alternate well for the project prior to the second half of 2014. Actual revenue recognition for this project may be over an extended period of time depending upon the customer's ability to select an alternate well site in a timely manner. During the third quarter of 2013, USSI delivered 20 levels of its previously announced 40 level $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 $125,000 leasing arrangement. As at December 31, 2013, USSI's backlog includes this $125,000 lease arrangement with SR2020. USSI anticipates beginning recognition of revenue associated with this lease arrangements when the systems are delivered to the customers, which is expected by the end of the second 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.

During 2013, we grew our employee base from 47 full-time equivalent employees (inclusive of consultants) at the end of 2012 to 50 full-time equivalent employees (inclusive of consultants) as of December 31, 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 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 we invested $7.4 million in USSI to support its working capital requirements and anticipate investing an additional $4.7 million in 2014 (of which $1.3 million has already been transferred). 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.

In November 2013, USSI reached agreement with its bank for an expanded $1.5 million line-of-credit which may be further increased to $2.0 million if USSI reaches certain revenue milestones. Despite the increased line, we have no assurance that USSI's future capital needs will not exceed the amount of the credit line and our budgeted investment for 2014, that USSI will satisfy the covenants necessary to access any or all of the loan amount 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 46-------------------------------------------------------------------------------- Table of Contents 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 and we have no assurance that third party funds will be available in the required amounts or at all.

DSIT Solutions Revenue in our DSIT subsidiary decreased by 4%, from $13.6 million in 2012 to $13.1 million in 2013. The decrease was primarily due to decreased revenue in the Energy & Security Sonar Solutions segment (from $12.2 million in 2012 to $11.8 million in 2013) while certain IT and consulting revenue which is included in our "Other" segment also decreased in 2013 from ($1.4 million in 2012 to $1.3 million). Fourth quarter 2013 revenue for DSIT was $3.4 million reflecting a decrease of 5% compared to fourth quarter 2012 revenue of $3.6 million. Fourth quarter 2013 revenues were above (20%) third quarter 2013 revenues ($2.9 million).

The decrease in revenues in our Energy & Sonar Security Solutions segment was the result of the slowdown in revenue recognition in one of the company's major projects in the third quarter as it neared completion without a similar size project replacing it in the company's backlog. The receipt in the fourth quarter of the $14.5 million contract for the supply, operation and support of an advanced underwater acoustic monitoring system helped mitigate loss of project revenues from the major project that was winding down in the third quarter and was responsible for the increase in revenues as compared to the third quarter of 2013. Revenues from DSIT's other IT and consulting activities which are included in Acorn's Other segment activities decreased slightly in 2013 (a decrease of approximately $150,000 to $1,250,000). The decrease was the result of reduced billable hours in its IT and consulting activities.

Gross profit in DSIT in 2013 was $4.4 million which reflects a decrease of $0.6 million or 12% from $5.1 million in 2012. The decrease in the year-on-year gross profit was attributable to both decreased revenues and gross margins in DSIT's Energy & Sonar Security projects. DSIT's fourth quarter gross profit of $0.8 million reflected a decrease of $0.6 million as compared to the fourth quarter of 2012 and a decrease of $0.2 million as compared to the third quarter of 2013.

The fourth quarter decrease in gross profit was due to the reduced gross margin in the quarter.

DSIT's gross margin in 2013 was 34%, down from 2012's gross margin of 37%. The decrease in gross margin in 2013 was attributable to unanticipated delays and installation complications associated with one of the company's AquaShield projects. Fourth quarter 2013 gross margin was 24% as compared to 40% in the fourth quarter of 2012 and 36% in the third quarter of 2013. The decreased gross margins in the fourth quarter of 2013 as compared to the fourth quarter of 2012 and the third quarter of 2013 was due to the aforementioned installation complications which significantly increased projected installation costs in the fourth quarter for one of the company's AquaShieldTM Diver Detection Sonar projects.

During 2013, DSIT recorded approximately $1.5 million of Research and Development (R&D) expense, an increase of approximately $0.5 million compared to 2012. R&D expense in 2013 was net of participations from the BIRD Foundation and MEIMAD ($0.3 million in 2013 and $0.2 million in 2012). R&D expense was $0.4 million and $0.3 million during the fourth quarters of 2013 and 2012, respectively. The increase is primarily attributable efforts to expand DSIT's portfolio of products to include land-based security fiber-optic solutions. DSIT continued to work on joint development (with USSI) of the PAUSS next generation integrated passive/active threat detection system for underwater site protection in 2013, however, progress has been negatively impacted by USSI's increased focus on its oil and gas activities. DSIT anticipates that its R&D costs will decrease to about 2012 levels in 2014.

In June 2012, DSIT together with USSI were awarded a joint $900,000 grant from the BIRD Foundation for the joint development of the PAUSS next generation integrated passive/active threat detection system for underwater site protection. In October 2012, a Cooperation and Project Funding Agreement was signed between the companies and the BIRD Foundation which allows for the commencement of the funding which is expected to take place over a 24 month period. DSIT and USSI may request an extension of this development project, though we have no assurance that such an extension would be granted. DSIT anticipates receipt of approximately 60% of the grant based on the expected allocation of project costs between DSIT and USSI. Payment of the the grant is dependent on continued progress being made in accordance with a contractually agreed upon time-line. Whether such funds will be forthcoming cannot be determined at this time due to USSI's increased focus on oil and gas activities.

In September 2013, DSIT and Ramot, the technology transfer company of Tel-Aviv University, were jointly awarded a grant from MEIMAD. MEIMAD is a collaborative program between the Israeli Ministry of Defense, the Office of the Chief Scientist at the Ministry of Economy and the Ministry of Finance, to jointly promote new ideas and new technologies that can serve both commercial applications and military needs. MEIMAD provides funding money for projects involving joint innovation and development between Israeli industrial companies and universities. The grant is for a 30-month project (16 months for the 47-------------------------------------------------------------------------------- Table of Contents first stage and 14 months for the second stage) for the joint development of a next generation Fiber-Optic Based Perimeter Security System Interrogator. The total amount of the grant is approximately $650,000 for the two stages of the project.

During 2013, DSIT recorded approximately $3.3 million of selling, general and administrative ("SG&A") expense as compared to approximately $3.2 million recorded during 2012. The increase compared to 2012 is attributable to non-cash stock compensation expense ($160,000) associated with the modification of certain options at DSIT (see below). Fourth quarter 2013 SG&A of $0.8 million represents a decrease of $0.2 million compared to fourth quarter 2012's SG&A of $1.0 million due to reduced marketing costs associated with conferences and exhibitions and associated costs. Quarterly SG&A expense during the year ranged from $811,000 to $856,000 during each of the four quarters in 2013. DSIT expects SG&A to decrease slightly during 2014 as a result of salary adjustments made to offset the increased U.S. dollar salary costs of a weakening U.S. dollar and reduced stock compensation expense.

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 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 $160,000 ($116,000 in SG&A) during 2013.

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 January 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.

At December 31, 2013, DSIT had a project backlog of approximately $13.4 million; an increase of $3.8 million as compared to DSIT's backlog of $9.6 million at December 31, 2012. DSIT's December 2013 backlog includes approximately $10.2 million from its recently disclosed contract with an unnamed customer for the supply, operation and support of an advanced underwater acoustic monitoring system. This contract is a long-term project which includes approximately $3.3 million for long-term maintenance and support expected to begin in late 2015. In addition, the contract includes the potential for an additional $3.2 million of options for testing trials that would also begin no earlier than late 2015.

While DSIT has a significant pipeline, most of its major projects come after a lengthy sales cycle over which it has little control.

DSIT recorded a consolidated net loss of $0.5 million in 2013 (following net consolidated net income of $0.5 million in 2012 and $0.1 million in 2011). The decrease of $1.0 million from 2012 to 2013 was primarily due to the decreased gross profit ( $0.6 million - which resulted from both decreased revenues and gross margins) combined with increased developments costs ($0.5 million). DSIT's expects to recognize approximately $7.0 million of its backlog in 2014. DSIT expects to show modest revenue growth in 2014 compared to 2013 due to revenue based upon its existing backlog and additional orders it expects to receive during 2014. DSIT's level of profitability in 2014 will be affected by its ability to receive significant new orders for its DDS and PDDS and other Naval solution products during the year as well as its ability to improve its gross margins.

48-------------------------------------------------------------------------------- Table of Contents Energy & Security Sonar Solutions During 2011, 2012 and 2013, revenues from our Energy & Security Sonar Solutions segment in our DSIT subsidiary were $9.1 million, $12.2 million and $11.8 million, respectively, accounting for approximately 87% , 90% and 90% of DSIT's revenues for 2011, 2012 and 2013, respectively. The balance of DSIT's revenues of $1.4 million, $1.4 million and $1.3 million for the years ending December 31, 2011, 2012 and 2013 were derived from DSIT's other IT and consulting activities which are included in Acorn's Other segment activities.

This segment's revenues decreased by $0.4 million or 3% in 2013 as compared to 2012. The decrease in revenues was due to the slowdown in revenue recognition in one of the company's major projects in the third quarter as it neared completion without a similar size project replacing it in the company's backlog. The receipt in the fourth quarter of the $14.5 million contract for the supply, operation and support of an advanced underwater acoustic monitoring system (see "Recent Developments') helped mitigate some of the loss of project revenues during the year.

Segment gross profit decreased in 2013 as compared to 2012 to $3.8 million from $4.5 million following an increase in 2012 from 2011 from $3.0 million in 2011 to $4.5 million in 2012. The decreased gross profit in 2013 as compared to 2012 was due to decreased revenues of our energy and sonar solutions products combined with reduced gross margins which decreased from 37% in 2012 to 32% in 2013. The reduced margins in 2013 were attributable to unanticipated delays and installation complications associated with one of the company's AquaShield projects.

We anticipate modest growth in revenue in 2014 from this segment. Growth is expected from our acoustic and sonar solutions projects based on our existing backlog with our revenues from embedded hardware and software development projects expected to remain relatively stable. We anticipate new customers from new regions (primarily Asia based) placing orders for our sonar and acoustic products in 2014. We do not anticipate recording significant revenues from land based security solutions in 2014.

GridSense During the second quarter of 2013, following a change in its management, GridSense made a decision to restructure operations in both its USA and Australian entities. This action was taken primarily in order to improve efficiency based on GridSense's revenue mix and skills mix. As part of the restructure, GridSense downsized its Australian operations and moved its operations to a smaller facility. Following this, GridSense's Australian operations no longer have a production line and have minimal research and development activities. Substantially all product production and development now take place at GridSense's U.S. operations facility in Sacramento.

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.

In the past, GridSense has not, however, generally been able to leverage market exposure into high volume sales. We believe this was due to the fact that 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 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.

Under new management, GridSense has reduced its operating loss in the second half of 2013 to $1.6 million from $2.2 million (excluding the second quarter restructuring charge of $0.6 million) in the first half of 2013 on the same level of revenues (approximately $2.5 million in each half of the year). In addition, cash used in operations decreased from $2.1 million in the first half of 2013 to $0.8 million in the second half of 2013. GridSense began 2014 with a backlog of orders of $0.8 million and has recently received and additional $2.4 million of new orders from five different utilities ranging from $200,000 to $1.1 million, primarily from its Australian operations (see Recent Developments). These larger orders are consistent with GridSense's redefined focus over the last several months by concentrating their efforts on higher quality pilot projects.

49-------------------------------------------------------------------------------- Table of Contents In 2013, GridSense reported revenues of $5.0 million, an increase of $1.4 million (37%) compared to 2012 revenues. The increase in 2013 year-on-year revenues was attributable to increased revenues from GridSense's U.S. operations which saw its revenues increase from $1.9 million in 2012 to $3.4 million in 2013. Revenues from GridSense's Australian operations decreased in 2013 to $1.6 million compared to $1.7 million in 2012. 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 delivered in the second half of 2013. The decrease in Australian revenues in 2013 is attributable to decrease in value of the Australian dollar. The nominal value of Australian dollar sales was virtually unchanged in 2013 as compared to 2012. Fourth quarter 2013 revenues of $1.5 million nearly doubled fourth quarter 2012 revenues ($0.8 million) and were $0.4 million (39%) above third quarter 2013 revenues of $1.1 million. The quarter-on-quarter increase in revenues was attributable to the aforementioned order from a major national utility which was fulfilled in 2013.

The increase as compared to the third quarter of 2013 was due to increased sales in Australia.

GridSense's full year revenues by main product lines for 2011, 2012 and 2013 are as follows: 2011 2012 2013 (in thousands of U.S dollars) Transformer IQ® $ 2,696 $ 693 $ 2,091 Line IQ® 1,187 995 1,118 PowerMonic™ 2,891 1,376 995 Other 345 598 822 Total $ 7,119 $ 3,662 $ 5,026 Sales across all major product lines showed a mix of results in 2013 as compared to 2012. Sales of the Transformer IQ increased significantly in 2013 as compared to 2012. Increased sales were due to an order for over 600 units which did not ship until the first quarter of 2013 as well as orders for an additional 650 units which were shipped in the second half of 2013. We believe 2014 will continue to show increased Transformer IQ sales.

The Line IQ was a product in transition during 2012. The redesigned product was released at the end of 2012 pushing sales into 2013. Due to the reduced cost of deploying this line monitoring system, utilities will be able to justify larger scale roll-outs. Management expects increases in the size of deployment with existing Line IQ users as well as adoption by new utility customers. We have seen a significant increase in orders for the Line IQ® in the second half of 2013 during which we received orders valued at over $400,000. This trend of increased orders has carried into the first quarter of 2014 (see Recent Developments). In early 2014, the Line IQ product line has generated orders from three North American Utilities totaling $1.5 million. We expect the majority of these orders to ship in the first half of the year. We believe these orders are the result of our updated Line IQ product line and our plan of targeting our pilots projects. While, we cannot predict future orders, these customers have indicated interest in further expansion of these projects.

The continued decline in PowerMonic sales was related to a restructuring by the Australian government bringing three separate power utilities under a single state owned utility in 2012. While we expected higher levels of sales in 2013, these sales did not materialize due as we believe budget processes were still being approved. However, in early 2014, we have seen an increase in orders having received $1.8 million of new PowerMonic orders which we expect to deliver during 2014 (see Recent Developments). We believe the increase in PowerMonic orders is tied to both pent up demand from reduced utility spending in 2012 and 2013 as a result of the Australian utility consolidation and our focus driven sales strategy. We expect the level of PowerMonic orders to level off as the year moves forward and return to more normalized levels.

GridSense's gross profit in 2013 ($1.8 million) increased by approximately $0.9 million or 89% compared to 2012's gross profit. The increase in gross profit was attributable to the abovementioned increase in revenues and an increase in gross margins. Gross margins increased from 26% in 2012 to 36% in 2013. The increase in the gross margin was due to a combination of a number of factors which negatively impacted on the 2012 gross margin. During 2012, a portion of the decrease was attributable to product delays of the latest version of the company's line monitoring platform which resulted in the fulfillment of orders based on the higher costing predecessor product. Also, additional costs were incurred in freight as the company shifted production from its Sydney facility to its Sacramento facility. Furthermore, during the fourth quarter of 2012, the company recorded an inventory charge of approximately $350,000 due to a write-off of obsolete inventory and an increase in the reserve for obsolete inventory.

50-------------------------------------------------------------------------------- Table of Contents While the 2013 gross margin was 10% greater than 2012's, it was also negatively impacted by a number of one-time events such as inventory obsolescence recorded as part of our restructuring and a lower than normal margin for a particularly large order in 2013. In 2014, we expect gross margins to increase above 2013's levels as we continue to work towards managing inventory more efficiently, improving forecasting for purchasing and procurement, and reducing production cycle times.

During 2013, GridSense recorded $2.1 million of R&D expense as compared to $1.6 million during 2012. Of the 2013 R&D expense, $1.4 million was recorded in the first half of the year prior to the downsizing of GridSense's Australian operations and reduction of the engineering staff in the U.S. First half 2013 R&D expense was impacted by additions to GridSense's engineering team in 2012 to accelerate the development of some key projects. Fourth quarter 2013 R&D expense was $0.3 million compared to $0.5 million in the fourth quarter of 2012 and $0.4 million in the third quarter of 2013. GridSense expects that R&D expense going forward will stabilize at or about their current levels going forward.

During 2013, GridSense recorded $3.5 million of SG&A expense representing a decrease of approximately $1.0 million (23%) compared to 2012 SG&A expense.

Fourth quarter SG&A expense of $0.8 million reflects a decrease of $0.2 million from the fourth quarter of 2012, and a slight ($50,000) decrease from the SG&A expense recorded in the third quarter of 2013. 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. We expect that SG&A costs will stabilize at or about their current levels going forward.

During 2013, Acorn continued to provide funds for GridSense's working capital needs. During 2013, Acorn invested $1.5 million in GridSense for its working capital needs plus an additional $480,000 to help fund the costs of the restructuring noted above. In addition, during the second half of 2013, we also lent GridSense $1,125,000 to support the order it received from a major national utility based on a partnership with a regional smart grid company and other working capital needs. This loan was repaid in part in 2013 ($850,000) with the balance of $275,000 being repaid in February 2014.

In December 2013, GridSense completed the sale of its Bushing IQ product line for $281,000 and recorded a gain on the sale of $116,000.

In December 2013, GridSense signed an amendment to its Loan and Security Agreement with a bank to provide it with an expansion of its revolving line-of-credit to $1.5 million. Acorn has guaranteed to the bank amounts outstanding under the line-of-credit. The line-of-credit expires on June 30, 2014. 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 December 31, 2013) or 6.5%. The line-of-credit is also subject to certain financial covenants. GridSense was in compliance with its financial covenants at December 31, 2013. As of December 31, 2013, GridSense was utilizing $958,000 of this line-of-credit.

On February 28, 2014, GridSense had cash on hand of approximately $0.1 million and was utilizing approximately $1.4 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 year ended December 31, 2012.

In 2013, OmniMetrix recorded revenues of $2.2 million ($1.7 million in its Power Generation Monitoring ("PG") segment and $0.5 million in its Cathodic Protection ("CP") segment) as compared to revenues of $0.7 million recorded in 2012 following our acquisition. The increase in revenues is driven by increased monitoring revenue. Quarterly revenue over 2013 showed slight improvement with fourth quarter revenue of $0.6 million following third and second quarter 2013 revenues of $0.5 million each.

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 did not universally resonate within the dealer marketplace and the rate of anticipated adoption (and thus sales of monitors and monitoring subscriptions) was 51-------------------------------------------------------------------------------- Table of Contents far slower than anticipated. Despite the increase in revenues in 2013 as compared to 2012, revenue in 2013 and expected future monitoring revenues from renewals have been significantly adversely impacted by our inability to make sufficient new sales to match the investment in infrastructure and staff growth.

OmniMetrix is revising its 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 continually evaluate the extent to which is appropriate to share the 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.

In the second half of 2013, OmniMetrix engaged in restructuring its operations to better align expenses with revenues as now projected by its new management.

This resulted in personnel layoffs and significantly reduced utilization of its leased facility in Buford, Georgia. In the third quarter of 2013, OmniMetrix recorded a restructuring charge of $0.8 million related to severance and other termination benefits for employees whose positions were made or are expected to be made redundant, the expected net contractual rental commitments through the end of its lease in December 2019 and 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.

As revenue in 2013 and expected future revenues (for both PG and CP activities) were 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, we determined that the goodwill recorded with respect to both segments were fully impaired and an impairment charge of $1.9 million was recorded in the third quarter. The goodwill impairment analysis performed also indicated that acquired intangible assets (technologies, customer relationships and non-compete agreements) were also impaired. Accordingly, we also recorded an impairment charge of $3.7 million associated with those intangibles. This followed a second quarter impairment of customer relationship charge of $1.1 million that was recorded following the decision by a major customer to begin disconnecting their units.

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.

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.

Gross profit during 2013 was approximately $1.2 million reflecting a gross margin of 56% on revenues compared with a gross profit of $0.2 million (28% gross margin) in 2012. The increase in the gross margin from 2012 was due to certain one-time adjustments recorded in 2012 which negatively impacted on the gross margin. Fourth quarter gross profit of $360,000 reflected a gross margin of 61%, up from third quarter 2013 gross margin of 50%. The increase in the quarter's gross margin was due to the elimination of amortization allocated to cost of sales ($58,000 in the third quarter) following the impairment of all of OmniMetrix's intangibles at the end of the third quarter. The gross margin is driven by margins on monitoring revenue which was 71% during the year and 84% during the fourth quarter. As monitoring revenue continues to grow, we expect OmniMetrix's 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 2013, OmniMetrix recorded approximately $647,000 of R&D costs as compared to $341,000 in 2012. R&D costs in the fourth quarter decreased to $148,000 as compared to $231,000 in the third quarter of 2013 following our third quarter restructuring. We anticipate that these costs will continue at approximately our fourth quarter pace going forward as a result of our restructuring and the synergies we expect to benefit from in working with GridSense.

During 2013, OmniMetrix recorded approximately $4.5 million of SG&A costs of which approximately $2.0 million was related to sales and marketing. Such costs were significantly above 2012 SG&A costs of $2.5 million ($0.8 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. Fourth quarter 2013 of $0.9 million was down $0.4 million from third quarter 2013 G&A costs of $1.3 million following our restructuring. We anticipate that our SG&A costs will continue to decline as a result of our restructuring and the synergies we expect to benefit from in working with GridSense.

52-------------------------------------------------------------------------------- Table of Contents OmniMetrix currently has no other sources of financing other than its sales and investments by Acorn. During 2013, Acorn invested in or lent to OmniMetrix a total of $3.7 million. Based on new potential sales opportunities being developed at OmniMetrix, we have reevaluated our decision not to provide additional cash for the business. As previously reported, we had anticipated lending up to $1.0 million to OmniMetrix in 2013, but they required only $0.7 million. Our Board recently approved an additional $0.5 million loan to OmniMetrix to provide working capital to pursue the new sales opportunities discussed above. We also have begun sharing resources between OmniMetrix and GridSense in areas such as information technology, and have identified other areas where potential synergies exist. In order to best position each company for growth in value, we will continue to evaluate the degree to which combining the businesses makes sense.

On February 28, 2014, OmniMetrix had approximately $20,000 of cash on hand. In 2014, OmniMetrix is expected to need additional financing 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 in 2013 reflected a $0.2 million decrease to $5.1 million as compared to $5.3 million of expense in 2012. The decrease is due primarily to decreased investor relation activities ($0.2 million) and professional fees and costs incurred associated with our acquisition of OmniMetrix (approximately $0.3 million) in February 2012 as well as other professional fees. These decreases were partially offset by increased non-cash stock compensation expense which increased $0.4 million in 2013 in part due to number of options granted at the end of 2012.

Fourth quarter 2013 corporate general and administrative expense was $1.1 million reflecting a decrease of approximately $0.1 million compared to both the fourth quarter of 2012 and third quarter of 2013. The decrease in fourth quarter 2013 corporate general and administrative expense compared to fourth quarter 2012's balance was primarily due to decreased investor relations expenses while the decrease compared to third quarter 2013's balance was primarily due to a reduction in general corporate activity .

During the fourth quarter of 2013, Acorn took steps to reduce its corporate overhead expense and cash burn. In November 2013, Acorn's President and CEO, John A. Moore, voluntarily agreed to reduce his base salary by 25% from $425,000 per annum to $318,750 per annum, effective retroactively as of the October 16, 2013 payroll period; its Executive Vice President, Richard S. Rimer, agreed to reduce his consulting fees by 20% from $30,720 per month to $24,576, effective retroactively as of November 1, 2013, and to end the consulting agreement whereby he served as EVP effective December 31, 2013 in exchange for a lump sum payment of $73,728, which represented 80% of the amounts that otherwise would be payable upon termination of the agreement; its CFO, Michael H. Barth, agreed to a $10,000 reduction in his salary commencing January 1, 2014; its outside Directors (including the Chairman) agreed to reduce their annual cash retainer for 2014 by $10,000 per Director; and its Chairman agreed to a reduction in his annual chairman fee for 2014 by $15,000. Acorn plans to continue to reduce its investor relations activities in 2014 as well. As a result of these steps, we expect our corporate general and administrative costs to decrease dramatically from current levels. We anticipate that we will achieve an approximate 35% overall reduction in cash burn. Actual results are dependent upon our corporate activity during 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 $10.4 million from both closings after deducting discounts and commissions to the underwriters, professional fees and other offering related expenses.

As of February 28, 2014, Acorn's corporate operations (not including cash at any of our subsidiaries) held a total of approximately $13.0 million in cash and cash equivalents ($10.5 million in U.S. banks and $2.5 million in Israeli banks (all of which can be repatriated without any tax consequence)).

53-------------------------------------------------------------------------------- Table of Contents 54-------------------------------------------------------------------------------- Table of Contents CRITICAL ACCOUNTING POLICIES The SEC defines "critical accounting policies" as those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.

The following discussion of critical accounting policies represents our attempt to report on those accounting policies, which we believe are critical to our consolidated financial statements and other financial disclosure. It is not intended to be a comprehensive list of all of our significant accounting policies, which are more fully described in Note 2 of the Notes to the Consolidated Financial Statements included in this Annual Report. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management's judgment in their application. There are also areas in which the selection of an available alternative policy would not produce a materially different result.

We have identified the following as critical accounting policies affecting our Company: principles of consolidation and investments in associated companies; business combinations, impairments in goodwill and intangible assets, revenue recognition, foreign currency transactions and stock-based compensation.

Principles of Consolidation and Investments in Associated Companies Our consolidated financial statements include the accounts of all majority-owned subsidiaries. All intercompany balances and transactions have been eliminated.

Investments in other entities are accounted for using the equity method or cost basis depending upon the level of ownership and/or our ability to exercise significant influence over the operating and financial policies of the investee. Investments of this nature are recorded at original cost and adjusted periodically to recognize our proportionate share of the investee's net income or losses after the date of investment. When net losses from an investment accounted for under the equity method exceed its carrying amount, the investment balance is reduced to zero and additional losses are not recorded. We resume accounting for the investment under the equity method when the entity subsequently reports net income and our share of that net income exceeds the share of net losses not recognized during the period the equity method was suspended. Investments are written down only when there is clear evidence that a decline in value that is other than temporary has occurred. As at December 31, 2013, we no longer have cost or equity basis investments.

On February 15, 2012, we began consolidating the results of OmniMetrix LLC, a Georgia limited liability company following our acquisition of all of the issued and outstanding limited liability company membership interests (see Note 3(a)) to our Consolidated Financial Statements). On August 31, 2011, we ceased consolidating the results of CoaLogix following the sale of all of our common stock in the company (see Notes 4 and 5 to our Consolidated Financial Statements). The results of CoaLogix are presented as discontinued operations for all the periods since our acquisition of them in November 2007.

Business combination accounting We have acquired a number of businesses during the last several years, and we may acquire additional businesses in the future. Business combination accounting, often referred to as purchase accounting, requires us to determine the fair value of all assets acquired, including identifiable intangible assets, and liabilities assumed. The cost of the acquisition is allocated to the assets acquired and liabilities assumed in amounts equal to the estimated fair value of each asset and liability, and any remaining acquisition cost is classified as an amortizable intangible asset, a non-amortizable intangible asset or goodwill. This allocation process requires extensive use of estimates and assumptions, including estimates of future cash flows to be generated by the acquired assets. Certain identifiable intangible assets, such as customer relationships and covenants not to compete, are amortized based on the pattern in which the economic benefits of the intangible assets are consumed over the intangible asset's estimated useful life. The estimated useful life of our amortizable identifiable intangible assets ranges from three to twenty years. Goodwill is not amortized. Accordingly, the acquisition cost allocation and its subsequent amortization has had, and will continue to have, a significant impact on our current operating results.

Goodwill and Intangibles As a result of our various acquisitions, we have recorded goodwill and various amortizable intangible assets. Businesses acquired are recorded at their fair value on the date of acquisition. The excess of the purchase price over the fair value of assets acquired and liabilities assumed is recognized as goodwill.

55-------------------------------------------------------------------------------- Table of Contents Our goodwill at December 31, 2013 was approximately $4.4 million representing approximately 9% of our total assets. Our goodwill is allocated to our segments as follows: Energy & Security Sonar Solutions - approximately $0.6 million, GridSense - approximately $2.4 million and Oil and Gas Sensor Systems - approximately $1.4 million.

Our intangible assets that have finite useful lives are recorded at fair value at the time of the acquisition, and are carried at such value less accumulated amortization. Our net intangible asset balance at December 31, 2013 was approximately $3.7 million representing approximately 7% of our total assets.

The composition of our intangible assets at December 31, 2013 consisted of Naval Technologies in our Energy & Security Sonar Solutions segment ($0.1 million, net of accumulated amortization), Software and Customer Relationships in our GridSense segment ($1.5 million, net of accumulated amortization) and Sensor Technologies and an acquired license in our Oil and Gas Sensor Systems segment ($2.2 million, net of accumulated amortization). We amortize these intangible assets on a straight-line basis over their estimated useful lives.

We review our goodwill for impairment annually at the reporting unit level in the fourth quarter of each fiscal year. Each of our reportable operating segments (Energy & Security Sonar Solutions, GridSense, Oil and Gas Sensor Systems and Power Generation) is deemed to be a reporting unit. These reporting units have been identified based on appropriate accounting principles, which considers, among other things, the manner in which we operate our business and the availability of discrete financial information. Assets acquired and liabilities assumed are assigned to a reporting unit as of the date of acquisition. In the event we reorganize our business, we reassign the assets (including goodwill) and liabilities among the affected reporting units. Our corporate activities and those relating to our non-reporting segment are not assigned to our reporting units. We periodically review these reporting units to ensure that they continue to reflect the manner in which the business is operated.

We also analyze whether any indicators of impairment for goodwill and intangibles exist each quarter. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include a sustained, significant decline in our share price and market capitalization, a decline in our expected future cash flows, a significant adverse change in legal factors or in the business climate, unanticipated competition, the testing for recoverability of our long-lived assets, and/or slower growth rates, among others.

In September 2011, the Financial Accounting Standards Board ("FASB") issued guidance that simplified how entities test for goodwill impairment. This guidance permits entities to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform a two-step goodwill impairment test. This guidance was effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, and early adoption was permitted. As discussed more fully in Note 12 to the Consolidated Financial Statements, we adopted this guidance for our annual goodwill impairment test that was conducted in the fourth quarter of 2011.

If we had determined that it was necessary to perform a two-step goodwill impairment test, we would determine the fair value of each reporting unit and compare it to the carrying amount of the reporting unit. Calculating the fair value of the reporting units requires significant estimates and assumptions by management. To the extent the carrying amount of a reporting unit exceeds the fair value of the reporting unit, there is an indication that the reporting unit goodwill may be impaired and a second step of the impairment test is performed to determine the amount of the impairment to be recognized, if any.

If the carrying amount of a reporting unit exceeds its estimated fair value, we conduct a second step, in which we calculate the implied fair value of goodwill.

If the carrying amount of the reporting unit's goodwill exceeds the calculated implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination.

The fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets such as the assembled workforce) as if the reporting unit had been acquired in a business combination at the date of assessment and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit.

We estimate the fair value of our reporting units using discounted expected future cash flows. We perform a valuation analysis, utilizing an income approach in our goodwill assessment process. The following describes the valuation methodology typically used to derive the fair value of our reporting units.

Income Approach: To determine each reporting unit's estimated fair value, we discount the expected cash flows of our reporting units. We estimate our future cash flows after considering current economic conditions and trends; estimated future operating results, growth rates, anticipated future economic and regulatory conditions; and the availability of necessary technology. The discount rate used represents the estimated weighted average cost of capital, which reflects the overall level of inherent risk involved in our operations and the rate of return an outside investor would expect to earn. To estimate cash flows beyond the final year of our model, we use a terminal value approach.

Under this approach, we use estimated operating income before depreciation 56-------------------------------------------------------------------------------- Table of Contents and amortization in the final year of our model, adjust it to estimate a normalized cash flow, apply a perpetuity growth assumption and discount by a perpetuity discount factor to determine the terminal value. We incorporate the present value of the resulting terminal value into our estimate of fair value.

The preparation of the long-range forecasts, the selection of the discount rates and the estimation of the multiples used in valuing the terminal year involve significant judgments. Changes to these assumptions could affect the estimated fair value of our reporting units and could result in a goodwill impairment charge in a future period.

During the second quarter of 2013, a customer with whom OmniMetrix had a significant on-going relationship at the time of the Company's acquisition of OmniMetrix in February 2012, indicated that they would be disconnecting all of their power generator monitoring units over a period of time. Accordingly, the Company recorded an impairment of the customer relationship intangible asset associated with that customer in its Power Generation Monitoring segment of $1.1 million.

For 2013, as required, the Company performed an annual impairment test of recorded goodwill during the fourth quarter (or earlier if impairment indicators or triggering events are present). As previously noted, in September 2011, the FASB issued guidance that simplified how entities test for goodwill impairment by permitting entities to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform a two-step goodwill impairment test.

In performing the 2013 goodwill impairment test for each of our Oil & Gas Sensor Systems, Energy & Security Sonar Solutions and GridSense reporting units, we assessed the relevant qualitative factors and concluded that it is more likely than not that the fair values of our reporting units are greater than their carrying amounts. After reaching this conclusion, no further testing was performed. The qualitative factors we considered included, but were not limited to, general economic conditions, industry and market conditions, pipeline and backlog, our recent and projected financial performance and the price of the Company's common stock.

With respect to our OmniMetrix PG and CP (which is included in our "Other" segment) reporting units, we quantitatively evaluated the goodwill for impairment in the third quarter of 2013 following what we considered to be a "triggering event". OmniMetrix operates primarily on a recurring revenue model where monitors are sold at or below cost in exchange for customer commitments for fixed term monitoring contracts. During the first half of 2013, OmniMetrix marketed primarily to dealers and distributors of the most common brands of generators. While some larger dealers have embraced this business model, it did not universally resonate within the dealer marketplace and the rate of adoption (and thus sales of monitors and monitoring subscriptions) has been far slower than anticipated. Revenue in 2013 and future years (for both PG and CP segments) have been significantly adversely impacted by the inability to make expected penetration in the marketplace and future projections for the segments have been adjusted accordingly (the "triggering event"). Following a goodwill impairment analysis based upon expected discounted cash flows using Level 3 inputs from both the Company's 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 with respect to goodwill and $3.7 million with respect to the remaining amortizing intangibles.

Revenue Recognition Revenue from time-and-materials service contracts, maintenance agreements and other services is recognized as services are provided, all significant contractual obligations have been satisfied and collections assured.

In the year ended December 31, 2013, we recorded approximately $13.1 million of revenues representing approximately 60% of our consolidated revenues in our DSIT subsidiary. In 2013, DSIT derived approximately $11.7 million or 90% of its revenues from fixed-price type contracts. Fixed-price type contracts require the accurate estimation of the cost, scope and duration of each engagement. Revenue and the related costs for these projects are recognized for a particular period, using the percentage-of-completion method as costs (primarily direct labor) are incurred, with revisions to estimates reflected in the period in which changes become known. If we do not accurately estimate the resources required or the scope of work to be performed, or do not manage our projects properly within the planned periods of time or satisfy our obligations under the contracts, then future revenue and margins may be significantly and negatively affected and losses on existing contracts may need to be recognized. Any such resulting changes in revenues and reductions in margins or contract losses could be material to our results of operations. In 2013, DSIT encountered a significant change in estimate for a material project due to increased estimated installation costs of its AquaShieldTM Diver Detection Sonar system. The aggregate net changes in the contract estimates recognized using the cumulative catch-up method of accounting increased operating income by $1.6 million ($0.06 per basic share) in 2013, decreased operating income by $0.7 million ($0.01 per basic share) in 2012 and decreased operating income by $0.9 million ($0.04 per basic share and $0.04 per diluted share) in 2011.

57-------------------------------------------------------------------------------- Table of Contents In 2013, GridSense recorded approximately $5.0 million of revenue representing approximately 23% of our consolidated revenue for the year.

Revenue from sales of GridSense monitoring equipment is recognized at the time title to the equipment and significant risks of ownership pass to the customer based on shipping terms, when all significant contractual obligations have been satisfied and collection is reasonably assured. Revenue from customer support services on monitoring equipment includes sales of parts and servicing of equipment. Sales of parts revenue is recognized when the parts are shipped to the customer or when the part is installed in the customer's equipment.

Servicing of equipment revenue is recognized as the related service work is performed.

In 2013, USSI recorded approximately $1.5 million of revenue representing approximately 7% of our consolidated revenue for the year.

Revenue from sales of USSI equipment is recognized at the time title to the equipment and significant risks of ownership pass to the customer (which is generally upon shipment and/or customer acceptance), when all significant contractual obligations have been satisfied and collection is reasonably assured.

In 2013, OmniMetrix recorded approximately $2.2 million of revenue representing approximately 10% of our consolidated revenue for the year. Of OmniMetrix's 2013 revenue, $0.8 million or 36% represents the revenue from the sales of monitoring units and $1.4 million or 64% represents the revenue recognized from the monitoring fees.

Sales of OmniMetrix monitoring systems have multiple elements, including equipment, installation and monitoring services. OmniMetrix equipment and related installations do not qualify as a separate unit of accounting. As a result, revenues (and related costs) associated with sale of equipment and related installations are recorded to deferred revenue (and deferred charges) upon activation for PG units or upon shipment for CP units. Revenue and related costs with respect to the sale of equipment and related installations are recognized over the estimated life of the customer relationship. Revenues from the prepayment of monitoring fees (generally paid 12 months in advance) are initially recorded as deferred revenue upon receipt of payment from the customer and then amortized to revenue over the monitoring service period.

Foreign Currency Transactions The currency of the primary economic environment in which our corporate headquarters and our U.S. subsidiaries operate is the United States dollar ("dollar"). Accordingly, the Company and all of its U.S. subsidiaries use the dollar as their functional currency.

DSIT's functional currency is the New Israeli Shekel ("NIS") while GridSense's functional currency for its Australian operations is the Australian dollar ("AUS$"). In the year ended December 31, 2013, 60% of our consolidated revenues (70% and 55% in the years ended December 31, 2012 and 2011 respectively) came from our DSIT subsidiary while 7% of our consolidated revenue in the year ended December 31, 2013 (9% and 18% in the years ended December 31, 2012 and 2011, respectively) came from GridSense's Australian subsidiary. Their financial statements have been translated using the exchange rates in effect at the balance sheet date. Statements of operations amounts have been translated using the average exchange rate for the year or the specific exchange rate on the date of a specific transaction. All exchange gains and losses denominated in non-functional currencies are reflected in finance expense, net in the consolidated statement of operations when they arise.

Stock-based Compensation We recognize stock-based compensation expense based on the fair value recognition provision of applicable accounting principles, using the Black-Scholes option valuation method. Accordingly, we are required to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and to recognize that cost over the period during which an employee is required to provide service in exchange for the award. Under the Black-Scholes method, we make assumptions with respect to the expected lives of the options that have been granted and are outstanding, the expected volatility, the dividend yield percentage of our common stock and the risk-free interest rate at the respective dates of grant.

For our Acorn options, the expected volatility factor used to value stock options in 2013 was based on the historical volatility of the market price of the Company's common stock over a period equal to the expected term of the options. For the expected term of the option, we used an estimate of the expected option life based on historical experience. The risk-free interest rate used is based upon U.S. Treasury yields for a period consistent with the expected term of the options. Our expected dividend rate was based upon our quarterly dividend of $0.035 per share for options granted up until the suspension of our quarterly dividend 58-------------------------------------------------------------------------------- Table of Contents in March 2013. Thereafter, we assumed no quarterly dividend rate. We recognize stock-based compensation expense on an accelerated basis over the requisite service period. Due to the numerous assumptions involved in calculating share-based compensation expense, the expense recognized in our consolidated financial statements may differ significantly from the value realized by employees on exercise of the share-based instruments. In accordance with the prescribed methodology, we do not adjust our recognized compensation expense to reflect these differences. Recognition of stock-based compensation expense had, and will likely continue to have, a material effect on our selling, general and administrative and other items within our consolidated statements of operations and also may have a material effect on our deferred income taxes and additional paid-in capital line items within our consolidated balance sheets. We are also required to use judgment in estimating the amount of stock-based awards that are expected to be forfeited. If actual forfeitures differ significantly from the original estimate, stock-based compensation expense and our results of operations could be materially impacted.

In 2012, our USSI subsidiary adopted the USSI 2012 Stock Option Plan to be administrated by the board of directors of USSI. In September 2012, USSI granted options to purchase 637,375 of its common shares, to senior management, employees, outside directors and a consultant of USSI under the Plan. The options were granted with an exercise price based on a valuation performed by an independent third party.

In 2013, our DSIT subsidiary modified the vesting period for options previously granted under its Key Employee Stock Option Plan such that options would vest either upon the occurrence of an initial public offering of DSIT or a merger, acquisition, reorganization, consolidation or similar transaction involving DSIT (the previous vesting terms) or upon the option grantee achieving 25 years of service with DSIT. As a result of the modified vesting terms, DSIT recorded stock compensation expense of $160,000 during the year ended December 31, 2013.

For each of the years ended December 31, 2013, 2012 and 2011, we incurred stock compensation expense with respect to options of approximately $1.2 million, $0.9 million and $0.5 million, respectively.

See Note 17(e) to the consolidated financial statements for the assumptions used to calculate the fair value of share-based employee compensation for our Acorn options.

59-------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS The following table sets forth selected consolidated statement of operations data as a percentage of our total sales: Year ended December 31, 2009 2010 2011 2012 2013 Revenues 100 % 100 % 100 % 100 % 100 % Cost of sales 57 58 63 73 76 Gross profit 43 42 37 27 24 Research and development expenses, net 5 7 16 34 38 Selling, general and administrative expenses 62 73 63 100 91 Impairments 1 8 - - 31 Restructuring and related charges - - - - 6 Operating loss (25 ) (46 ) (42 ) (107 ) (142 ) Finance income (expense), net (1 ) (2 ) - - 1 Gain on sale of shares in Comverge 15 - - - - Gain on investment in GridSense - 9 - - - Distributions received from EnerTech - 1 - - - Gain on sale of HangXing - - 3 - - Loss on sale of EnerTech - (13 ) - - - Loss from operations before taxes on income (10 ) (50 ) (40 ) (107 ) (142 ) Income tax benefit (expense) 8 (5 ) 67 15 (1 ) Income (loss) from operations of the Company and its consolidated subsidiaries (3 ) (55 ) 27 (91 ) (142 ) Share of income (losses) in Paketeria 3 - - - - Share of losses in GridSense (1 ) - - - - Net income (loss) from continuing operations (1 ) (55 ) 27 (91 ) (142 ) Loss from discontinued operations, net of income taxes (66 ) (126 ) (10 ) - - Gain on the sale of discontinued operations, net of income taxes - - 164 - - Non-controlling interest share of loss from discontinued operations 7 - 3 - - Net income (loss) (60 ) (181 ) 184 (91 ) (142 ) Net income (loss) attributable to non-controlling interests (2 ) 4 3 5 6 Net income (loss) attributable to Acorn Energy, Inc.

shareholders (62 ) (177 ) 187 (86 ) (137 ) The following table sets forth certain information with respect to revenues and profits of our reportable business segments for the years ended December 31, 2013, 2012 and 2011, including the percentages of revenues attributable to such segments. (See Note 21 to our consolidated financial statements for the definitions of our reporting segments). The column marked "Other" aggregates information relating to certain IT activities (protocol management software for cancer patients and billing software) and outsourced consulting activities performed by our DSIT subsidiary as well as Cathodic Protection activities in our OmniMetrix subsidiary.

60-------------------------------------------------------------------------------- Table of Contents Energy & Security Oil & Gas Power Generation Sonar Solutions GridSense Sensor Systems Monitoring Other Total (in thousands, except percentages) Year ended December 31, 2013: Revenues from external customers $ 11,815 $ 5,026 $ 1,468 $ 1,671 $ 1,776 $ 21,756 Percentage of total revenues from external customers 54 % 23 % 7 % 8 % 8 % 100 % Segment gross profit 3,817 1,828 (2,347 ) 867 991 5,156 Year ended December 31, 2012: Revenues from external customers $ 12,229 $ 3,662 $ 1,464 $ 502 $ 1,562 $ 19,419 Percentage of total revenues from external customers 63 % 19 % 8 % 3 % 8 % 100 % Segment gross profit 4,465 968 (1,021 ) 129 662 5,203 Year ended December 31, 2011: Revenues from external customers $ 9,104 $ 7,119 $ 1,316 $ - $ 1,389 $ 18,928 Percentage of total revenues from external customers 48 % 38 % 7 % - % 7 % 100 % Segment gross profit 3,019 3,327 (98 ) - 665 6,913 61-------------------------------------------------------------------------------- Table of Contents 2013 COMPARED TO 2012 Revenues. Revenues during 2013 increased by $2.3 million or 12% from $19.4 million during 2012 to $21.8 million in 2013. The increase in revenues was driven primarily by increased revenues at OmniMetrix and GridSense whose revenues increased by $1.5 million and $1.4 million to $2.2 million and $5.0 million, respectively. During 2013, USSI's revenue was unchanged at $1.5 million while DSIT's revenue decreased from $13.6 million in 2012 to $13.1 million in 2013.

The increase in OmniMetrix revenues was driven by increased monitoring revenue.

The increase in GridSense revenues was primarily due to increased revenues from GridSense's U.S. operations which saw its revenues increase from $1.9 million in 2012 to $3.4 million in 2013. This was partially offset by a slight decrease in revenues from GridSense's Australian operations ($0.1 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 delivered in the second half of 2013. The decrease in DSIT revenues was primarily due to the slowdown in revenue recognition in one of the company's major projects in the third quarter as it neared completion without a similar size project replacing it in the company's backlog.

Gross profit. Gross profit of $5.2 million during 2013 was unchanged as compared to 2012 gross profit. Gross profit at OmniMetrix and GridSense both increased ($1.0 million and $0.9 million, respectively) while DSIT's 2013 gross profit decreased by $0.6 million as compared to 2012 gross profit. USSI continued to show a negative gross profit ($2.3 million, an increase of $1.3 million compared to the negative gross profit in 2012 of $1.0 million). The increase in both OmniMetrix's and GridSense's gross profit was attributable to increased revenues as well as an increased gross margin. OmniMetrix gross margin increased due to due to certain one-time adjustments recorded in 2012 which negatively impacted on the gross margin while GridSense's gross margin also increased due to a combination of a number of factors which negatively impacted on the 2012 gross margin such as product delays causing the fulfillment of orders based on the higher costing products and an inventory charge of approximately $350,000 due to a write-off of obsolete inventory and an increase in the reserve for obsolete inventory. The decrease in DSIT's gross profit was attributable to both decreased revenues combined with a decreased gross margin. DSIT's gross margin decreased from 37% in 2012 to 34% in 2013. DSIT's reduced gross margin in 2013 was due to unanticipated delays and installation complications associated with one of the company's AquaShield projects. USSI's negative gross profit and its increase from 2012 is primarily due to large amounts of NRE and provisions for future costs that accompanied the technical challenges (water blocking, noise cancellation, improved clamping mechanisms and more reliable seals and connections) in connection with the fixed price projects for delivering systems for evaluation by the oil supermajor. In addition, approximately $1.8 million of the negative gross profit was attributable to adjustments of sensor systems built-to-lease and inventory to net realizable values ($1.5 million) and to inventory obsolescence ($0.3 million).

Research and development ("R&D") expenses. R&D expenses increased $1.6 million (24%) from $6.6 million in 2012 to $8.2 million in 2013. R&D expenses increased at all companies with increases varying between $0.3 million and $0.5 million.

USSI's R&D expense of $3.9 million represents an increase of $0.3 million as a result of 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 and an increase in R&D materials used in product development. DSIT's R&D expense ($1.5 million) increased $0.5 million from efforts to expand DSIT's portfolio of products to include land-based security fiber-optic solutions and DSIT's continued work on joint development (with USSI) of the PAUSS next generation integrated passive/active threat detection system for underwater site protection. Increased R&D expense at GridSense (from $1.6 million in 2012 to $2.1 million in 2013) was due to GridSense adding to its engineering team in 2012 in order to accelerate the development of projects. OmniMetrix recorded approximately $0.6 million of R&D expense during the year compared to $0.3 million in 2012.

Selling, general and administrative expenses ("SG&A"). SG&A costs in 2013 increased by $0.5 million (2%) as compared to 2012. OmniMetrix SG&A increased dramatically from $2.5 million in 2012 to $4.5 million. This increase was attributable to Acorn's investment in marketing and back-office infrastructure since its acquisition of OmniMetrix. DSIT's SG&A increased slightly ($3.3 million in 2013 compared to $3.2 million in 2012), the increase being attributable non-cash stock compensation costs. USSI's decreased SG&A expense (from $3.8 million in 2012 to $3.4 million in 2013) was attributable to decreased non-cash stock compensation expense associated with USSI's stock option plan and decreased consulting fees. During 2013, GridSense recorded $3.5 million of SG&A expense representing a decrease of approximately $1.0 million (23%) compared to 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. Corporate general and administrative costs decreased by $0.2 million from $5.3 in 2012 to $5.1 million in 2013 primarily due to decreased investor relation activities ($0.2 million) and professional fees and costs incurred associated with our acquisition of OmniMetrix (approximately $0.3 million) in February 2012 as well as other 62-------------------------------------------------------------------------------- Table of Contents professional fees. These decreases were partially offset by increased non-cash stock compensation expense which increased $0.4 million in 2013.

Impairments. In the second quarter of 2013, we recorded a $1.1 million impairment of a customer relationship intangible following an indication from a major customer at OmniMetrix that they would be disconnecting their PG monitoring units over a period of time. In addition, during the third quarter 2013, we recorded a goodwill impairment of $1.9 million and an impairment of other amortizing intangibles of $3.7 million in our OmniMetrix subsidiary following the determination that the rate of adoption (sales of monitors and monitoring subscriptions) of its products was far slower than anticipated and that revenue in 2013 and future years have been significantly adversely impacted by the inability to make expected penetration in the marketplace.

Restructuring. During 2013, following changes in management at both GridSense and OmniMetrix, we recorded restructuring charges of $0.6 million and $0.8 million, respectively. The restructuring charge at GridSense was recorded in the second quarter and was made in connection with the downsizing of its Australian operations and personnel cutbacks in the U.S. The restructuring charge at OmniMetrix was recorded in the third quarter and was related primarily to its underutilized facility as well as personnel reductions.

Net loss attributable to Acorn Energy. We had a net loss attributable to Acorn Energy of $29.7 million in 2013 compared with a net loss of $16.7 million in 2013. Our loss in 2013 was due to losses in each of our subsidiaries OmniMetrix ($11.5 million which includes impairments of $6.7 million and a restructuring charge of $0.8 million), USSI, ($9.6 million), GridSense ($4.3 million which includes a restructuring charge of $0.6 million), and DSIT ($0.5 million).

Corporate expenses contributed an additional $5.0 million. These losses were offset by the non-controlling interest's share of our operations of approximately $1.3 million.

2012 COMPARED TO 2011 Revenues. Revenues during 2012 increased by $0.5 million or 3% from $18.9 million during 2011 to $19.4 million in 2012. The increase in revenues was driven primarily by increased revenues at DSIT whose revenues increased by $3.1 million (30%) to $13.6 million compared to 2011 revenues of $10.5 million and USSI revenues which increased by approximately $150,000 (11%) to $1.5 million compared to 2011 revenues of $1.3 million. In addition, we recorded approximately $0.7 million of revenues associated with our newly acquired OmniMetrix subsidiary. GridSense revenues decreased by $3.5 million (49%) to $3.7 million compared to 2011 revenues of $7.1 million.

The increase in DSIT revenues was primarily due to progress on a major AquaShieldTM DDS order (valued at $12.3 million) which was received in the end of 2011. The increase in USSI revenues for 2012 was due to the increase in the number of proof-of-concept projects being worked on in 2012 as compared to 2011.

The decrease in GridSense revenues was primarily due to 2011 revenues including the beginning of the fulfillment a major order of transformer monitors to a southeastern US electric utility which began in the second quarter of 2011 and ended in the fourth quarter of 2011 combined with decreased revenues in Australia due to a restructuring by the New South Wales government of three major utilities into a single new state owned corporation.

Gross profit. Gross profit during 2012 of $5.2 million reflected a decrease of $1.7 million (25%) as compared to 2011. DSIT's 2012 gross profit increased by $1.4 million (38%) over 2011 gross profit. The increase in DSIT's gross profit was attributable to increased revenues as well as an increased gross margin.

DSIT's gross margin improved from 35% in 2011 to 37% in 2012. DSIT's improved gross margin in 2012 was due to greater revenue being recognized on higher margin projects being worked on in 2012 (the SBS project in particular) as compared to 2011. GridSense's 2012 gross profit decreased by $2.4 million (71%) compared to 2011 gross profit. The decrease in GridSense's gross profit was attributable to decreased revenues as well as reduced gross margins which deteriorated to 26% in 2012 from 47% in 2011. GridSense's gross margins were negatively impacted by a number of factors including delays in product launch and additional logistical expenses incurred in the transfer of production from one facility to another and an inventory charge for obsolescence of approximately $350,000. USSI continued to show a negative gross profit ($1.0 million, an increase of $0.9 million compared to the negative gross profit in 2011 of $0.1 million) as it continues to incur large amounts of up front engineering design costs (non-recurring engineering costs) for its proof-of-concept projects. In addition, we recorded approximately $0.2 million of gross profit associated with our newly acquired OmniMetrix subsidiary during the period since our acquisition in February.

Research and development ("R&D") expenses. R&D expenses increased $3.6 million from $3.0 million in 2011 to $6.6 million in 2012. R&D expenses increased at all companies with most of the increase ($2.5 million) being attributable to USSI due to an increase in its engineering headcount, the development of automated stations for the assembly and testing of fiber optic sensors, as well as an increase in R&D materials used in product development. Increased R&D expense at GridSense ($0.3 million) 63-------------------------------------------------------------------------------- Table of Contents and at DSIT ($0.5 million) were due to GridSense adding to its engineering team in order to accelerate development of projects and DSIT's work on 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 sonar products and land based perimeter security. In addition, OmniMetrix recorded approximately $0.3 million of R&D expense during the period since our acquisition.

Selling, general and administrative expenses ("SG&A"). SG&A costs in 2012 increased by $7.4 million (62%) as compared to 2011. The inclusion of OmniMetrix's SG&A costs contributed approximately $2.5 million of this increase.

DSIT's SG&A increased slightly ($3.1 million in 2011 compared to $3.2 million in 2012), the increase being attributable to increased marketing costs. Both GridSense and USSI recorded increases in SG&A expenses. GridSense recorded an increase of $1.2 million (35%) while USSI recorded an increase of $2.2 million (136%). GridSense's increased SG&A expense was primarily attributable to increased personnel costs as increased advertising and marketing related expenses. USSI's increased SG&A expense was attributable to increased sales and marketing activities combined with the costs of additional personnel associated with the facility, obtaining ISO 9001 quality certification and implementation of an SAP enterprise resource planning (ERP) system to handle the expected increase in business volume. USSI's increased SG&A expense also includes approximately $0.3 million of non-cash stock compensation expense associated with USSI's stock option plan. Corporate general and administrative costs increased by $1.4 million from $3.9 in 2011 to $5.3 million in 2012 primarily due to increased investor relations and personnel costs as well as professional fees and costs incurred in the acquisition of OmniMetrix (approximately $300,000) .

Income tax benefit. In 2012, the income tax benefit of $3.0 million includes an income tax benefit of $3.3 million with respect to an expected net operating loss carryback of its expected consolidated tax loss in 2012. Such benefit was partially offset by income tax expense of approximately $0.3 million on DSIT's taxable income.

Loss from discontinued operations. In August 2011, we sold our entire investment in CoaLogix. Accordingly, all of CoaLogix' activity for 2011 (a loss of $1.9 million prior to attribution of $0.5 million to non-controlling interests) is presented as a loss from discontinued operations.

Gain on the sale of discontinued operations. In 2011, we recorded a gain, net of income taxes of $31.1 million, following the sale of our investment in CoaLogix.

Net loss attributable to Acorn Energy. We had a net loss attributable to Acorn Energy of $16.7 million in 2012 compared with net income of $35.4 million in 2011. Our loss in 2012 was primarily due to GridSense, USSI and OmniMetrix (in the period since our acquisition) losses of $5.4 million, $8.4 million and $2.6 million, respectively with corporate expenses contributing an additional $5.3 million. These losses were offset by DSIT's net income after tax of approximately $0.5 million for 2012, Acorn's income tax benefit of $3.3 million with respect to an expected net operating loss carryback and the non-controlling interest's share of our operations of approximately $1.0 million.

LIQUIDITY AND CAPITAL RESOURCES As of December 31, 2013, we had working capital of $22.1 million, including $17.3 million of cash and cash equivalents, and current restricted deposits of $0.3 million. Net cash and cash equivalents decreased during the year ended December 31, 2013 by $8.9 million. Approximately $17.8 million was used in operating activities of our continuing operations during the year.

The primary use of cash in operating activities during 2013 was the cash used in operations by our subsidiaries ($6.8 million, $4.2 million, $2.8 million and $1.4 million used by USSI, OmniMetrix, GridSense and DSIT, respectively) in their operations combined with the $2.4 million of cash used in our corporate operating activities.

Net cash used in investment activities was $2.9 million. Cash used in investment activities was primarily due to the acquisition of property and equipment ($3.5 million). Such acquisitions of property and equipment were primarily at USSI ($2.0 million of which approximately $1.6 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). In addition, approximately $0.3 million was used to fund severance assets at DSIT. Partially offsetting those uses of cash were the proceeds received from the sale of OMI ($0.3 million) by GridSense and the net cash from restricted cash ($0.6 million) activity at DSIT.

Net cash of $12.0 million was provided by financing activities during 2013. Cash of approximately $10.4 million was received from our October capital raise plus and additional $2.3 million was provided from the net change in short-term bank credit. Partially offsetting these proceeds was the payment of dividends ($0.5 million) and long-term debt repayments ($0.2 million) during the year.

64-------------------------------------------------------------------------------- Table of Contents At December 31, 2013, DSIT had approximately $200,000 of unrestricted cash in banks and NIS 4.0 million (approximately $1.2 million) in Israeli credit lines available to it from two Israeli banks (approximately $576,000 from each bank), $184,000 of which was then being used. The lines-of-credit are subject to maintaining certain financial covenants. At December 31, 2013, DSIT was in compliance with its financial covenants. At December 31, 2013, DSIT also had deposited with two Israeli banks approximately $306,000 as collateral for various performance and bank guarantees for various projects as well as for its credit facilities at the banks. However, DSIT expects to redeposit a portion of these funds again as collateral for new guarantees for new projects and for renewing its credit facilities.

In July 2013, Acorn entered into a new Stock Purchase Agreement with DSIT pursuant to which 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. 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, cash generated from operations and continued utilization of its lines-of-credit, though from time-to-time, DSIT may encounter short-term cash shortfalls due to the timing and/or delays in customer payments. In January 2014, Acorn lent DSIT $1.0 million for short-term working capital needs. DSIT anticipates repaying this loan prior to its expiration date of March 31, 2014.

On February 28, 2013, DSIT had approximately $0.7 million of unrestricted cash in banks and was not utilizing any of its lines-of-credit.

In December 2013, GridSense signed an amendment to its Loan and Security Agreement with a bank to provide it with an expansion of its revolving line-of-credit to $1.5 million. The line-of-credit expires on June 30, 2014.

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 December 31, 2013) or 6.5%. The line-of-credit is also subject to certain covenants. GridSense was in compliance with its covenants at December 31, 2013.

As of December 31, 2013, GridSense was utilizing $958,000 of this line-of-credit. Acorn has guaranteed to the bank amounts outstanding under the GridSense line-of-credit. Acorn was in compliance with the covenants applicable to it under the guaranty at December 31, 2013.

During 2013, Acorn continued to provide funds for GridSense's working capital needs. During 2013, Acorn invested $1.5 million in GridSense for its working capital needs plus an additional $480,000 to help fund the costs of the restructuring noted above. In addition, during the second half of 2013, we also lent GridSense $1,125,000 to support the order it received from a major national utility based on a partnership with a regional smart grid company and for additional working capital. This loan was repaid in part in 2013 ($850,000) with balance of $275,000 being repaid in February 2014.

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. The Acorn Board has approved providing GridSense with a $550,000 revolving working capital loan during 2014.

We have no assurance that GridSense will meet its goal of being cash flow neutral in 2014 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 funding from us in GridSense may be limited by the working capital needs of our corporate activities and other operating companies. On February 28, 2014, GridSense had cash on hand of approximately $0.1 million and was utilizing approximately $1.4 million of its line-of-credit.

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. Acorn continues to provide funds for USSI's working capital needs and expects to do so in the future. During 2013 we invested $7.4 million in USSI to support its working capital requirements and an additional $1.3 million in 2014. 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 continue investing additional funds in USSI and anticipate not less than an additional $3.4 million to be invested in USSI in 2014.

In November 2013, USSI reached agreement with its bank for an expanded $1.5 million line-of-credit which may be further increased to $2.0 million if USSI reaches certain revenue milestones. Advances from the line-of-credit bear interest at a variable annual interest rate equal to the greater of 1.0% above the Prime Rate in effect (3.25% at December 31, 2013) or 6.5%. The line-of-credit is also subject to certain financial covenants. USSI was in compliance with its financial covenants on December 31, 2013.

65-------------------------------------------------------------------------------- Table of Contents Despite the increased line, we have no assurance that USSI's future capital needs will not exceed the amount of the credit line and our budgeted investment for 2014, that USSI will satisfy the covenants necessary to access any or all of the loan amount 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.

On February 28, 2014, USSI had $70,000 of cash and was utilizing $850,000 of its line-of-credit.

OmniMetrix currently has no other sources of financing other than its sales and investments by Acorn. During 2013, Acorn invested in or lent to OmniMetrix a total of $3.7 million. Based on new potential sales opportunities being developed at OmniMetrix, we have reevaluated our decision not to provide additional cash for the business. As previously reported, we had anticipated lending up to $1.0 million to OmniMetrix in 2013, but they required only $0.7 million. Our Board recently approved an additional $0.5 million loan to OmniMetrix to provide working capital to pursue the new sales opportunities discussed above. We also have begun sharing resources between OmniMetrix and GridSense in areas such as information technology, and have identified other areas where potential synergies exist. In order to best position each company for growth in value, we will continue to evaluate the degree to which combining the businesses makes sense.

On February 28, 2014, OmniMetrix had cash on hand of approximately $20,000. In 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.

On December 31, 2013, the Company had approximately $2.8 million of unrestricted cash and cash equivalents held in banks outside the United States ($2.7 million in banks in Israel, of which $2.5 million belongs to Acorn and $0.2 million belongs to DSIT, and $0.1 million in a bank in Australia which belongs to GridSense). Due to Israeli tax and company law constraints and DSIT's own cash and finance needs as well as GridSense's cash needs, the Company does not expect any foreign earnings to be repatriated to the United States in the near future.

If the approximately $2.8 million of unrestricted cash and cash equivalents held in banks outside the United States were to be repatriated, we would expect that approximately $0.3 million of that cash to be subject to additional taxation upon repatriation.

As at February 28, 2014, the Company's corporate operations (not including cash at any of our subsidiaries) had a total of approximately $13.0 million in cash and cash equivalents ($10.5 million in U.S. banks and $2.5 million in Israeli banks (all of which can be repatriated without any tax consequence)) reflecting a $2.8 million decrease from the December 31, 2013 balance of $15.8 million. The decrease in corporate cash is primarily due to the $1.3 million transferred to USSI, the $1.0 million lent to DSIT and $330,000 lent to OmniMetrix and corporate expenses offset by the $275,000 we received from GridSense as repayment of the balance of our loan to them.

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 December 31, 2013.

66-------------------------------------------------------------------------------- Table of Contents CASH PAYMENTS DUE TO CONTRACTUAL OBLIGATIONS Years Ending December 31, (in thousands) 2019 and Total 2014 2015-2016 2017-2018 thereafter Bank and other debt, utilized lines-of-credit and capital leases $ 2,303 $ 2,303 $ - $ - $ - Operating leases 2,695 978 1,351 257 109 Potential severance obligations (1) 5,072 249 1,326 135 3,362 Minimum royalty payments (2) (3) (4) 400 50 100 100 150 Total contractual cash obligations $ 10,470 $ 3,580 $ 2,777 $ 492 $ 3,621 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 December 31, 2013, we accrued a total of $5.0 million for potential severance obligations to our Israeli employees of which approximately $3.7 million was funded. The timing of actual payment of severance obligations are uncertain as employees may continue to work beyond the legal retirement age.

(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) In June 2012, the Company's DSIT and USSI subsidiaries were awarded a joint $900,000 grant from the BIRD Foundation for the joint development of the next generation integrated passive/active threat detection system for underwater site protection. Under the terms of the grant agreement between the BIRD Foundation, DSIT and USSI, both DSIT and USSI will have to repay the grant based on 5% of gross sales of the commercialized product, if any. The above table does not include any royalties that may be paid under this arrangement.

(4) GridSense is required to pay an aggregate royalty of 6% of the sales of a particular product to two employees. The royalty amount for the year ended December 31, 2013 was $25,000. The above table does not include any royalties that may be paid under this arrangement.

Certain Information Concerning Off-Balance Sheet Arrangements Our DSIT subsidiary provides various performance, advance and tender guarantees as required in the normal course of its operations. As at December 31, 2013, such guarantees totaled approximately $1.2 million and were due to expire in 2014. As security for a portion of these guarantees, DSIT has deposited approximately $0.3 million which is shown as current restricted cash on our Consolidated Balance Sheets. As DSIT's restricted cash is released from the completion of projects and the end of the guarantees, it expects to provide additional security deposits for new guarantees for new projects throughout the 2014 calendar year.

Impact of Inflation and Interest Rate & Currency Fluctuations In the normal course of business, we are exposed to fluctuations in interest rates on our lines-of-credit ($1.2 million available) to finance our operations in Israel. Such lines-of-credit and loan bear interest at interest rates that are linked to the Israeli prime rate (2.50% at December 31, 2013 and 3.25% at December 31, 2012). Our GridSense and USSI subsidiaries are also exposed to fluctuations in interest rates on their lines of credit ($1.5 million for each).

Their lines of credit are linked to the U.S. prime rate (3.25% at both December 31, 2013 and December 31, 2012).

67-------------------------------------------------------------------------------- Table of Contents Our non-US dollar monetary assets and liabilities (net liabilities of approximately $1.1 million at December 31, 2013) in Israel are exposed to fluctuations in exchange rates.

Historically, a majority of DSIT's sales have been denominated in dollars or denominated in NIS linked to the dollar. Such sales transactions are negotiated in dollars; however, for the convenience of the customer they are often settled in NIS. These transaction amounts are linked to the dollar between the date the transactions are entered into until the date they are effected and billed. From the time these transactions are effected and billed through the date of settlement, amounts are primarily unlinked. As DSIT increases its sales to customers outside of Israel, a greater portion of its receipts from customers will be settled in dollars. In 2014, we expect a significant portion of DSIT's sales to be settled in dollars. A significant majority of DSIT's expenses in Israel are in NIS (primarily labor costs), while a portion is in dollars or dollar-linked NIS.

The dollar cost of our operations in Israel may be adversely affected in the future by a revaluation of the NIS in relation to the dollar. In 2013 the appreciation of the NIS against the dollar was 7.0% and in 2012 the NIS appreciated against the dollar by 2.3%.

As of December 31, 2013, virtually all of DSIT's monetary assets and liabilities that were not denominated in dollars or dollar-linked NIS were denominated in NIS. In the event that in the future we have material net monetary assets or liabilities that are not denominated in dollar-linked NIS, such net assets or liabilities would be subject to the risk of currency fluctuations. At times, DSIT purchases forward contracts to attempt to reduce its exposure to currency fluctuations. Furthermore, $3.7 million of our backlog of projects are contracts and orders that are not denominated in US dollars.

In addition, our non-US dollar assets and liabilities (net liability of less than $0.1 million at December 31, 2013) in Australia at our GridSense subsidiary's Australian operations are also exposed to fluctuations in exchange rates. The dollar cost of our operations in Australia may also be adversely affected in the future by a revaluation of the Australian dollar in relation to the U.S. dollar. During 2013, the U.S. dollar appreciated against the Australian dollar by 13.8%. During 2012, the Australian dollar appreciated against the U.S.

dollar by 2.2%.

68-------------------------------------------------------------------------------- Table of Contents SUMMARY QUARTERLY FINANCIAL DATA (Unaudited) The following table sets forth certain of our unaudited quarterly consolidated financial information for the years ended December 31, 2012 and 2013. This information should be read in conjunction with our Consolidated Financial Statements and the notes thereto.

2012 2013 First Second Third Fourth First Second Third Fourth Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Revenues $ 4,183 $ 5,727 $ 4,713 $ 4,796 $ 5,716 $ 5,233 $ 4,982 $ 5,825 Cost of sales 2,983 4,241 3,225 3,767 3,591 3,961 3,923 5,125 Gross profit 1,200 1,486 1,488 1,029 2,125 1,272 1,059 700 Research and development expenses, net 1,318 1,699 1,754 1,819 2,001 2,116 2,219 1,839 Selling, general and administrative expenses 4,229 4,390 5,272 5,470 5,256 4,970 4,995 4,595 Impairments of goodwill and intangibles - - - - - 1,116 5,615 - Restructuring and related charges - - - - - 594 772 23 Operating loss (4,347 ) (4,603 ) (5,538 ) (6,260 ) (5,132 ) (7,524 ) (12,542 ) (5,757 ) Finance income (expense), net (23 ) 130 (160 ) 110 14 75 (9 ) 42 Loss before taxes on income (4,370 ) (4,473 ) (5,698 ) (6,150 ) (5,118 ) (7,449 ) (12,551 ) (5,715 ) Income tax benefit (expense) (75 ) 1,064 1,487 480 (69 ) (16 ) (143 ) 72 Net loss (4,445 ) (3,409 ) (4,211 ) (5,670 ) (5,187 ) (7,465 ) (12,694 ) (5,643 ) Net loss attributable to non-controlling interests 256 205 276 287 212 291 382 390 Net loss attributable to Acorn Energy, Inc $ (4,189 ) $ (3,204 ) $ (3,935 ) $ (5,383 ) $ (4,975 ) $ (7,174 ) $ (12,312 ) $ (5,253 ) Basic and diluted net loss per share attributable to Acorn Energy, Inc. shareholders: Total attributable to Acorn Energy, Inc. shareholders. $ (0.24 ) $ (0.18 ) $ (0.22 ) $ (0.30 ) $ (0.28 ) $ (0.40 ) $ (0.68 ) $ (0.24 ) Weighted average number of shares outstanding attributable to Acorn Energy, Inc. - basic and diluted 17,680 17,912 17,934 18,038 18,077 18,091 18,091 21,450 69-------------------------------------------------------------------------------- Table of Contents

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