**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**





**FORM
      10-K**




**ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE**


**SECURITIES
      EXCHANGE ACT OF 1934**




**For
                the fiscal year ended December
                31, 2005**
            **Commission
                file number:
                0-19771**




**DATA
      SYSTEMS & SOFTWARE INC.**


**(Exact
      name of registrant as specified in charter)**






**Delaware**
              **(State
                or other jurisdiction
                of**
              **incorporation
                or organization)**
            **22-2786081**
              **(I.R.S.
                Employer Identification
                No.)****200
                Route 17, Mahwah, New
                Jersey**
              **(Address
                of principal executive
                offices)**
            **07430**
              **(Zip
                Code)**




**(201)
      529-2026**


**Registrant’s
      telephone number, including area code**









**Securities
      registered pursuant to Section 12(b) of the Act: None**




**Securities
      registered pursuant to Section 12(g) of the Act:**


**Common
      Stock, par value $.01 per share**




(Title
      of
      Class)




Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act . Yes o No
      x




Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Exchange Act. Yes
o No
      x





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days. Yes 
      x No o





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days. Yes x No
      o




Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the best
      of registrant's knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. x




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer.  See definition of
“accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange
      Act.




Large
      accelerated filer o Accelerated filer  o  Non-accelerated filer  x




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). Yes o No x




As
      of
      last day of the second fiscal quarter, the aggregate market value of the
      registrant’s common stock held by non-affiliates of the registrant was
      approximately $9.0
      million based
      on
      the closing sale price on that date as reported on the Over-the-Counter Bulletin
      Board.




As
      of
      March 31, 2006 there were 8,160,024
      shares of Common
      Stock, $0.01 par value per share, outstanding.




**DOCUMENTS
      INCORPORATED BY REFERENCE:**




Certain
      sections of the registrant’s Proxy Statement to be filed pursuant to Regulation
      14A under the Securities Exchange Act of 1934 within 120 days of the end of
      the
      registrant’s fiscal year are incorporated by reference into Part III of this
      Form 10-K.
















**TABLE
      OF CONTENTS**









PAGE




PART
                  IItem
                  1
              Business
              1Item
                  1A.
              Risk
                  Factors
              5Item
                  1B.
              Unresolved
                  Staff Comments
              7Item
                  2.
              Properties
              7Item
                  3.
              Legal
                  Proceedings
              7Item
                  4.
              Submission
                  of Matters to a Vote of Security Holders
              8PART
                  IIItem
                  5.
              Market
                  for Registrant’s Common Equity, Related Stockholder Matters
                  and
                    Issuer Purchases of Equity Securities
              9Item
                  6.
              Selected
                  Financial Data.
              10Item
                  7.
              Management’s
                  Discussion and Analysis of Financial Condition and
                  Results of Operations
              13Item
                  7A.
              Quantitative
                  and Qualitative Disclosures About Market Risk
              27Item
                  8.
              Financial
                  Statements and Supplementary Data
              28Item
                  9.
              Changes
                  in and Disagreements with Accountants on Accounting and
                  Financial
                    Disclosure
              28Item
                  9A.
              Controls
                  and Procedures
              28Item
                  9B.
              Other
                  Information
              28PART
                  IIIItem
                  10.
              Directors
                  and Executive Officers of the Registrant
              29Item
                  11.
              Executive
                  Compensation
              29Item
                  12.
              Security
                  Ownership of Certain Beneficial Owners and
                  Management and Related Stockholder Matters
              29Item
                  13.
              Certain
                  Relationships and Related Transactions
              29Item
                  14.
              Principal
                  Accountant Fees and Services
              29Part
                  IVItem
                  15.
              Exhibits
                  and Financial Statement Schedules.
              30




Certain
      statements contained in this report are forward-looking in nature. These
      statements can be identified by the use of forward-looking terminology such
      as
“believes”, “expects”, “may”, “will”, “should” or “anticipates”, or the
      negatives thereof, or comparable terminology, or by discussions of strategy.
      You
      are cautioned that our business and operations are subject to a variety of
      risks
      and uncertainties and, consequently, our actual results may materially differ
      from those projected by any forward-looking statements. Certain of such risks
      and uncertainties are discussed below under the heading “Item 1.
      Business-Factors That May Affect Future Results.”




*EasyBill* *TM* and *OncoPro* *TM* are
      trademarks of our dsIT Solutions Ltd subsidiary. *Maingate* ® is a
      registered trademark and *PowerCamp* *TM* is a
      trademark of Comverge, Inc.









**PART
      I**




**ITEM
      1.  BUSINESS**




**OVERVIEW**




Through
      March 2006, we operated in two reportable segments: software consulting and
      development and computer hardware sales.




·
            *Software
                Consulting and Development—*Providing
                consulting and development services for computer software and systems,
                primarily through our dsIT Solutions Ltd.
                subsidiary.




·
            *Computer
                Hardware Sales—*Serving
                as an authorized dealer and a value-added-reseller (VAR) of computer
                hardware, through our Databit
                subsidiary.




In
      August
      2005, we completed the sale of our dsIT Technologies outsourcing consulting
      business. In the past, these operations accounted for a significant portion
      of
      our software consulting and development segment revenues (previous years amounts
      have been restated to reflect these discontinued operations). In addition,
      as we
      no longer have control over our formerly consolidated subsidiary Comverge Inc.
      (see Note 4 to the Consolidated Financial Statements), effective as of the
      second quarter of 2003, we account for our investment in Comverge by the equity
      method and no longer consolidate Comverge's balances and operating activity
      into
      our consolidated balance sheets and statements of operations. Comverge’s
      previously consolidated results comprised our energy intelligence solutions
      segment.




In
      March
      2006, we completed
      the sale of our
      Databit computer hardware sales subsidiary to one
      of
      our executive officers .
      As a
      result of the sale, we will no longer have activity in our computer hardware
      segment after the first quarter of 2006. For
      additional disclosure regarding the sale of Databit and certain related
      transactions, see Recent Developments.




**SALES
      BY ACTIVITY**




The
      following table shows, for the years indicated, the dollar amount and the
      percentage of the sales attributable to each of the segments of our
      operations.







2003
            
            2004
            
            2005Amount
            
            %
            
            Amount
            
            %
            
            Amount
            
            %Software
                consulting and development
            
            $
            4,198
            
            
            16
            
            $
            3,300
            
            
            15
            
            $
            4,158
            
            
            19Computer
                hardware sales
            
            
            18,139
            
            
            67
            
            
            18,468
            
            
            85
            
            
            17,677
            
            
            81Energy
                intelligence solutions
            
            
            4,700
            
            
            17
            
            
            —
            
            
            —
            
            
            —
            
            
            —Other
            
            
            39
            
            
            —
            
            
            64
            
            
            —
            
            
            29
            
            
            —Total
            
            $
            27,076
            
            
            100
            
            $
            21,832
            
            
            100
            
            $
            21,864
            
            
            100




**SOFTWARE
      CONSULTING AND DEVELOPMENT**




*Services*




Through
      our dsIT Solutions Ltd. (“dsIT”) subsidiary, we provide globally oriented
      solutions in the areas of real-time & embedded systems (“RT”) and
      information technology (“IT”). In August 2005, we sold our dsIT Technologies
      Ltd. outsourcing consulting business. In previous years, these operations
      accounted for approximately two-thirds of the revenues of the software
      consulting and development segment. The strategic decision to sell this business
      has allowed us to focus our efforts on our RT and IT solutions business, which
      we believe, offers greater potential for growth. Since the sale, segment
      revenues have been generated almost entirely from dsIT’s solutions activities.




dsIT’s
      RT
      solutions activities are focused on two areas - naval solutions and other
      real-time and embedded hardware & software development. Our naval solutions
      include a full range of sonar and acoustic-related solutions to the commercial,
      defense and homeland security markets. These solutions include:









·
            Diver
                Detection Sonar (DDS);




·
            Mobile
                Acoustic Range (MAR);




·
            Harbor
                Surveillance System (HSS); and




·
            Underwater
                Acoustic Signal Analysis system (UASA)







Our
      other
      real-time and embedded hardware & software development solutions expertise
      include:




·
            Computerized
                vision for the Semiconductors industry;




·
            Modems
                & data links;




·
            Bluetooth
                solutions;




·
            VOIP/ROIP
                applications;




·
            Operation
                control consoles and HMI applications;
                and




·
            Command
                & control applications




dsIT’s
      IT
      solutions include its OncoProTM solution for healthcare markets. OncoProTM is a
      state of the art chemotherapy package for oncology and hematology departments,
      based on experience gained in the largest cancer center in Israel. We also
      offer EasyBill TM ,
      an
      easy-to-use, end-to-end, modular customer care and billing system designed
      especially for small and medium-sized enterprises with large and expanding
      customer bases.




dsIT
      has
      initiated discussions for strategic alliances for marketing its sonar technology
      and OncoProTM solutions and as well as marketing products for other software
      developers. We expect some of these discussions to come to fruition during
      the
      coming quarters.




During
      2003, 2004 and 2005, sales from our RT solutions activities were $3.1 million,
      $2.0 million and $2.9 million, respectively, accounting for approximately 74%,
      60% and 69% of segment sales for 2003, 2004 and 2005, respectively. Sales from
      our IT solutions activities were $1.1 million, $1.3 million and $1.3 million,
      respectively, accounting for approximately 26 %,
      40 %
      and 31%
      of segment sales for 2003, 2004 and 2005, respectively.




We
      generally provide our RT and IT solutions on a fixed-price basis. When
      working on a fixed-price basis, we undertake to deliver software or
      hardware/software solutions to a customer’s specifications or requirements for a
      particular project, accounting for these services on the
      percentage-of-completion method. Since the profit margins on these projects
      are
      primarily determined by our success in controlling project costs, the margins
      on
      these projects may vary as a result of various factors, including
      underestimating costs, difficulties associated with implementing new
      technologies and economic and other changes that may occur during the term
      of
      the contract.




*Customers
      and Markets*




Israel
      is
      the primary area of this segment’s operations, accounting for 98%, 100% and 100%
      of segment sales in 2003, 2004 and 2005, respectively. We expect this
      concentration to continue in the future. We have created significant
      relationships with some of Israel’s largest companies in its defense,
      electronics and healthcare industries including Israel’s largest HMO. In
      addition, dsIT is investing considerable effort to penetrate European, Asian
      and
      other markets in order to broaden its geographic sales base, particularly with
      respect to our sonar technology solutions and our OncoProTM healthcare
      application. Four customers accounted for 66% (23%, 17%, 15% and 11%,
      respectively) of segment sales in 2005 (three customers accounted for 60% of
      segment sales in 2004 (27%, 19% and 13%, respectively)).




-2-




*Competition*




Our
      software consulting and development activity faces competition from numerous
      competitors, both large and small, operating in the Israeli and United States
      markets, some with substantially greater financial and marketing resources.
      We
      believe that our wide range of experience and long-term relationships with
      large
      corporations as well as the strategic
      partnerships we
      are
      developing will
      enable us to compete successfully and obtain future business.




*Proprietary
      Rights*




The
      customer, for whom the services are performed, generally owns the intellectual
      property rights resulting from our consulting and development services. We
      own
      two proprietary software packages: *EasyBill* *TM* ,
      a
      comprehensive customer service and billing system aimed at the low to middle
      end
      application market; and *OncoPro* *TM* ,
      which
      manages hospital medical files and has advanced applications for oncology
      departments. These are licenses for use by customers, while we retain ownership
      of the intellectual property.




**COMPUTER
      HARDWARE SALES**




*Products
      and Services*




On
      March
      10, 2006, we sold our Databit computer hardware sales subsidiary .
      In the
      past, Databit provided all the revenue in our computer hardware segment. As
      a
      result of the sale, we will no longer h ave
      activity in our computer hardware segment after the first quarter of 2006. T hrough
      the date of its sale, Databit was
      engaged in the s ale and
      service of PC-based computer hardware, software, data storage, client/server
      and
      networking solutions to large and midsize customers, operating as a
      value-added-reseller and/or an authorized service provider for equipment and
      software from such well-known industry leaders as HP/Compaq, IBM, Microsoft,
      Oracle, 3Com, NEC, Acer, Apple and Dell. Through the operations of the segment,
      we offered our customers a full range of systems integration services, including
      design, implementation, hardware and software selection, and implementation
      of
      local and wide area networks, as well as maintenance and service to customers
      under seperate priced and negotiated extended service agreements.




*Customers
      and Markets*




Computer
      hardware segment sales included sales to two major customers, Montefiore Medical
      Center, a major New York medical center, which accounted for approximately
      28%,
      40% and 33% of segment sales and 19%, 34%, and 27% of consolidated sales in
      2003, 2004 and 2005, respectively, and 67% and 54% of the segment’s receivables
      and 37% and 34% of consolidated receivables, at the end of 2004 and 2005,
      respectively, and a large law firm which accounted for approximately 5%, 5%
      and
      22% of segment sales and 3%, 4%, and 18% of consolidated sales in 2003, 2004
      and
      2005, respectively, and 2% and 6% of the segment’s receivables and 1% and 4% of
      consolidated receivables, at the end of 2004 and 2005. No other customer
      accounted for more than 10% of segment sales. Most of our sales are made in
      the
      New York City Metropolitan area, with sales in this area accounting for 71%,
      75%
      and 70% of segment revenues in 2003, 2004 and 2005, respectively.




**ENERGY
      INTELLIGENCE SOLUTIONS**




Effective
      as of the second quarter of 2003, as a result of Comverge’s successful placement
      of private equity, we ceased to own a controlling interest in Comverge.
      Accordingly, Comverge’s financial results were no longer fully consolidated into
      our results. However, we continue to own a significant minority interest in
      Comverge and its financial results are included in our financial statements
      by
      utilization of the equity method of accounting. Comverge continues to play
      a
      major role in our corporate strategy, and during the periods presented in this
      Annual Report, Comverge continued to have a material effect on our financial
      results.




-3-




Comverge
      designs, develops and markets a full spectrum of products, services and turnkey
      solutions to electric utilities and transmission and distribution companies
      that
      provide capacity during periods of peak electricity demand and allow their
      residential and commercial customers to conserve energy. These Demand Response
      solutions allow Comverge’s customers to reduce usage or “shed load” during peak
      usage periods, such as the summer air conditioning season, thereby reducing
      or
      eliminating the need to buy costly additional power on the spot market, or
      invest in new peaking generation capacity. Demand Response solutions are
      cost-effective and environmentally superior to building new generation
      capabilities.




In
      addition to Demand Response solutions, Comverge also offers a combination of
      intelligent hardware and a suite of software products, which, together or
      separately, help customers address energy usage issues through data
      communications and analysis, real-time pricing and integrated billing and
      reporting. Comverge’s two-way data communications solutions allow utilities to
      gather, transmit, verify and analyze real-time usage information, and can be
      used for automated meter reading, support time-of-use metering, theft detection,
      remote connect/disconnect and other value-added services.




Comverge’s principal offices are located in East Hanover, New Jersey and
      Atlanta, Georgia. In addition, Comverge operates satellite offices in Newark,
      California, Pensacola, Florida and Tel Aviv, Israel.




**BACKLOG**




As
      of
      December 31, 2005, our backlog of work to be completed was $1.8 million, all
      of
      which related to our software consulting and development segment. We estimate
      that we will perform approximately $1.7 million of our backlog work in 2006.




**EMPLOYEES**




At
      December 31, 2005, we employed a total of 94 people, including 55 in engineering
      and technical support, 13 in marketing and sales, and 26 in management,
      administration and finance. A total of 68 of our employees are based in Israel.
      Of the 26 employees in the United States, 25 were in our Databit computer
      hardware sales company (four in engineering and technical support, 12 in
      marketing and sales, and nine in management, administration and finance), which
      we sold in March 2006. We consider our relationship with our employees to be
      satisfactory.




We
      have
      no collective bargaining agreements with any of our employees. However, with
      regard to our Israeli activities, certain provisions of the collective
      bargaining agreements between the Israeli Histadrut (General Federation of
      Labor
      in Israel) and the Israeli Coordination Bureau of Economic Organizations
      (including the Industrialists Association) are applicable by order of the
      Israeli Ministry of Labor. These provisions mainly concern the length of the
      workday, contributions to a pension fund, insurance for work-related accidents,
      procedures for dismissing employees, determination of severance pay and other
      conditions of employment. We generally provide our Israeli employees with
      benefits and working conditions beyond the required minimums. Israeli law
      generally requires severance pay upon the retirement or death of an employee
      or
      termination of employment without due cause. Furthermore, Israeli employees
      and
      employers are required to pay specified amounts to the National Insurance
      Institute, which administers Israel’s social security programs. The payments to
      the National Insurance Institute include health tax and are approximately 5%
      of
      wages (up to a specified amount), of which the employee contributes
      approximately 70% and the employer approximately 30%.




**SEGMENT
      INFORMATION**




For
      additional financial information regarding our operating segments, foreign
      and
      domestic operations and sales, see “Item 7. Management’s Discussion and Analysis
      of Financial Condition and Results of Operations” and Note 16 to our
      Consolidated Financial Statements included in this Annual Report.




-4-




**ITEM
      1A.** **RISK
      FACTORS**




We
      may
      from time to time make written or oral statements that contain forward-looking
      information. However, our actual results may differ materially from our
      expectations, statements or projections. The following risks and uncertainties
      could cause actual results to differ from our expectations, statements or
      projections.




**GENERAL
      FACTORS**




*We
      have a history of operating losses and decreasing cash available for
      operations.*




We
      have a
      history of operating losses, although these losses and our use of cash to fund
      our operating activities have decreased over the years. In 2003, 2004 and 2005,
      we had operating losses of $5.2 million, $2.6 million and $2.2 million,
      respectively. Cash used in operations in 2003, 2004 and 2005 was  $1.0
      million, $0.1 million and $1.7 million, respectively.




Although
      our operating results improved towards the end of 2005, almost achieving
      breakeven in the fourth quarter of 2005, the balance of cash on hand as of
      the
      end of 2005 may not be sufficient to fund our operating activities for the
      next
      12 months, particularly as we expect to require additional resources to fund
      anticipated growth in our dsIT subsidiary in 2006. In addition, in March 2006,
      we sold our Databit computer hardware sales company, which in the past, helped
      to fund our corporate activities in the US. While the sale released previously
      restricted cash to us to help us finance corporate activities, we have no
      guarantee that such amounts will be sufficient. However, we continue to consider
      various restructuring, merger or acquisition and/or additional financing
      transactions, which would give us additional liquidity. Should we need
      additional liquidity to finance our US activities and should we be unsuccessful
      in completing a timely transaction providing the necessary liquidity, we may
      not
      have sufficient funds to finance our US activities. In such event, we might
      need
      to sell additional assets.




We
      believe that the balance of cash available after the release of restricted
      funds
      subsequent to our sale of Databit, the proceeds of our recently settled lawsuit,
      lines of credit available to our dsIT subsidiary and expected profits from
      the
      operations dsIT should provide sufficient liquidity to fund all our activities
      for at least the next 12 months in both our US and Israeli operations.




For
      additional discussion of our liquidity position and factors that may affect
      our
      future liquidity, see the discussion under the captions “Recent Developments”
and “Liquidity and Capital Resources” in “Item 7. Management’s Discussion and
      Analysis of Financial Condition and Results of Operations.”




*Loss
      of the services of a few key employees could harm our operations.*




We
      depend
      on our key management, technical employees and sales personnel. The loss of
      certain managers could diminish our ability to develop and maintain
      relationships with customers and potential customers. The loss of certain
      technical personnel could harm our ability to meet development and
      implementation schedules. The loss of certain sales personnel could have a
      negative effect on sales to certain current customers. Most of our significant
      employees are bound by confidentiality and non-competition agreements. We do
      not
      maintain a “key man” life insurance policy on any of our executives or
      employees. Our future success also depends on our continuing ability to
      identify, hire, train and retain other highly qualified technical and managerial
      personnel. If we fail to attract or retain highly qualified technical and
      managerial personnel in the future, our business could be
      disrupted.




*A
      failure to integrate our new management may adversely affect
      us.*




We
      appointed a new chief financial officer and chief accounting officer in December
      2005 and recently appointed a new president and chief executive officer. Any
      failure to effectively integrate our new management and any new
      management controls, systems and procedures they may
      implement ,
      could
      materially adversely affect our business, results of operations and financial
      condition.




-5-




**RISKS
      RELATED TO THE SOFTWARE CONSULTING AND DEVELOPMENT SEGMENT**




*Failure
      to accurately forecast costs of fixed-priced contracts could reduce our
      margins.*




When
      working on a fixed-price basis, we undertake to deliver software or integrated
      hardware/software solutions to a customer’s specifications or requirements for a
      particular project. The profits from these projects are primarily determined
      by
      our success in correctly estimating and thereafter controlling project costs.
      Costs may in fact vary substantially as a result of various factors, including
      underestimating costs, difficulties with new technologies and economic and
      other
      changes that may occur during the term of the contract. If, for any reason,
      our
      costs are substantially higher than expected, we may incur losses on fixed-price
      contracts.




*Hostilities
      in the Middle East region may slow down the Israeli hi-tech market and may
      harm
      our Israeli operations; our Israeli operations may be negatively affected by
      the
      obligations of our personnel to perform military service.*




Our
      software consulting and development services segment is currently conducted
      in
      Israel. Accordingly, political, economic and military conditions in Israel
      may
      directly affect this segment of our business. Any increase in hostilities in
      the
      Middle East involving Israel could weaken the Israeli hi-tech market, which
      may
      result in a significant deterioration of the results of our Israeli operations.
      In addition, an increase in hostilities in Israel could cause serious disruption
      to our Israeli operations if acts associated with such hostilities result in
      any
      serious damage to our offices or those of our customers or harm to our
      personnel.




Many
      of
      our employees in Israel are obligated to perform military reserve duty. In
      the
      event of severe unrest or other conflict, one or more of our key employees
      could
      be required to serve in the military for extended periods of time. In the past,
      there were numerous call-ups of military reservists to active duty, and it
      is
      possible that there will be additional call-ups in the future. Our Israeli
      operations could be disrupted as a result of such call-ups for military
      service.




*Exchange
      rate fluctuations could increase the cost of our Israeli
      operations* .




The
      sales
      in this segment stem from our Israeli operations and a significant portion
      of
      those sales are in New Israeli Shekels (“NIS”). In addition, many transactions
      that are linked to the dollar are settled in NIS. The dollar value of the
      revenues of our operations in Israel will decrease if the dollar is devalued
      in
      relation to the NIS during the period from the invoicing of a transaction to
      its
      settlement. In addition, significant portions of our expenses in those
      operations are in NIS, so that if the dollar is devalued in relation to the
      NIS,
      the dollar value of these expenses will increase.




*One
      of our major customers has a history of operating deficits and may implement
      cost-cutting measures that may have a material adverse effect on
      us.*




In
      2005,
      17% of the software consulting and development segment’s sales (13% and 11% in
      2004 and 2003, respectively) and 8% of its billed receivables and unbilled
      work-in-process at December 31, 2005 (3% at December 31, 2004) were related
      to
      the Clalit Health Fund. The Clalit Health Fund is the largest HMO in Israel
      and
      one of the largest in the world. The fund has a history of running at a deficit,
      which in the past has required numerous cost cutting plans and periodic
      assistance from the Israeli government. Should the fund have to institute
      additional cost cutting measures in the future, which may include restructuring
      of its terms of payment, this could have a material adverse effect on the
      performance of this segment.




*We
      have sold our outsourcing business, which in the past provided our Israeli
      operations with a steady cash flow; our Israeli operations may be hindered
      by
      future cash flow problems.*




In
      August
      2005, we sold our outsourcing business, which in the past provided our Israeli
      operations with a steady cash flow stream, and, in conjunction with bank lines
      of credit, helped to finance our Israeli operations. Our present operations,
      as
      we are currently structured, places a greater reliance on our meeting project
      milestones in order to generate cash flow to finance our operations. Should
      we
      encounter difficulties in meeting significant project milestones, resulting
      cash
      flow difficulties could have a material adverse effect on our
      operations.




-6-





*If
      we
      are unable to keep pace with rapid technological change, our results of
      operations, financial condition and cash flows may suffer.*






Some
      of
      our RT and IT solutions are characterized by rapidly changing technologies
      and
      industry standards and technological obsolescence. Our competitiveness and
      future success depends on our ability to keep pace with changing technologies
      and industry standards on a timely and cost-effective basis. A fundamental
      shift
      in technologies in could have a material adverse effect on our competitive
      position. Our failure to react to changes in existing technologies could
      materially delay our development of new products, which could result in
      technological obsolescence, decreased revenues, and/or a loss of market share
      to
      competitors. To the extent that we fail to keep pace with technological change,
      our revenues and financial condition could be materially adversely affected.




**RISKS
      RELATED TO OUR COMVERGE INVESTMENT**




*We
      may need to invest additional funds in Comverge in order to avoid dilution
      of
      our holdings.*




We
      currently own approximately 76% of Comverge’s common shares and approximately 7%
      its preferred shares. Comverge has in the past and may in the future to raise
      equity by private equity placements. Should Comverge continue to raise funds
      in
      this manner, we may have to utilize our limited cash or face dilution of our
      holdings in Comverge.




**ITEM
      1B.  UNRESOLVED STAFF COMMENTS**




None




**ITEM
      2.  PROPERTIES**




Prior
      to
      the consummation of the sale of our Databit computer hardware subsidiary,
      o ur
      corporate headquarters and the principal offices for our computer hardware
      sales
      segment were located in Mahwah, New Jersey in approximately 5,000 square feet
      of
      office space, at a rate of $85,000 per year (plus
      annual CPI adjustments), under a lease that expires in September 2006. We leased
      offices of approximately 3,500 square feet in New York City, at a current rate
      of $120,000 per year ,
      under a
      lease that expires in November 2008.




As
      part
      of the sale of our Databit computer hardware subsidiary ,
      we
      assigned all of the US leases to Databit and after the first quarter of 2006
      will no longer have rental expense for facilities in the US. The
      landlords of the properties have not yet consented to the assignments and we
      therefore continue to be contingently liable
      on
      the se lease s .
      Databit
      has agreed to indemnify us for any liability in connection with these leases.
      Under the terms of the sale agreement with Databit, we continue to house
      certain corporate
      headquarter functions in Mahwah, New Jersey. Under a transition services
      arrangement, we have agreed to pay Databit $20,000 per year for the continued
      use of the Mahwah premises and various administrative services.




Our
      Israeli activities are conducted in approximately 18,000 square feet of office
      space in the Tel Aviv metropolitan area under a lease that expires in August
      2009. The annual rent is approximately $298,000. **** These
      facilities are used for the Israeli operations of the software consulting and
      development segment.




**ITEM
      3.  LEGAL PROCEEDINGS**





None.




-7-




**ITEM
      4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**




None.




-8-




**PART
      II**




**ITEM
      5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
      ISSUER PURCHASES OF EQUITY SECURITIES**




Our
      Common Stock is currently traded on the OTC Bulletin
      Board (“OTCBB”) under
      the
      symbol “DSSI”. Prior to January 26, 2005, our Common Stock traded on The Nasdaq
      SmallCap Market. The following table sets forth, for the periods indicated,
      the
      high and low reported sales prices per share of our Common Stock on The Nasdaq
      SmallCap Market and the OTCBB (as applicable).




High
            
            Low2004:First
                Quarter
            
            
            4.05
            
            
            2.76Second
                Quarter
            
            
            3.14
            
            
            1.43Third
                Quarter
            
            
            1.90
            
            
            0.64Fourth
                Quarter
            
            
            1.47
            
            
            0.752005:First
                Quarter
            
            
            1.30
            
            
            0.64Second
                Quarter
            
            
            1.32
            
            
            0.95Third
                Quarter
            
            
            1.74
            
            
            1.05Fourth
                Quarter
            
            
            1.80
            
            
            1.20




As
      of
      April 7, 2006,
      the last reported sales price of our common stock
      on
      the OTCBB was $2 .59 ,
      there
      were 82 record
      holders of our common stock and we estimate that
      there were approximately 1,500 beneficial owners of our common stock.




We
      paid
      no dividends in 2004 or 2005 and presently do not intend to pay any dividends
      in
      2006.




The
      following table provides information about our equity compensation plans as
      of
      December 31, 2005, including both stockholder approved plans and non-stockholder
      approved plans.






**Plan
                  Category**
            
            
            **Number of Securities to**
                **be
                  Issued Upon**
                **Exercise
                  of**
                **Outstanding
                  Options,**
                **Warrants
                  and Rights**
                **(a)**
            
            
            **Weighted-average**
                **Exercise
                  Price of**
                **Outstanding**
                **Options, Warrants**
                **and
                  Rights**
                **(b)**
            
            
            **Number of Securities**
                **Remaining Available for**
                **Future
                  Issuance Under**
                **Equity
                  Compensation**
                **Plans
                  (Excluding**
                **Securities
                  Reflected in**
                **Column
                  (a))**
                **(c)**Equity
                Compensation Plans Approved by Security Holders(1)
            
            
            325,000
            
            $
            1.04
            
            
            70,000Equity
                Compensation Plans Not Approved by Security Holders
            
            
            —
            
            
            —
            
            
            —Total
            
            
            325,000
            
            $
            1.04
            
            
            70,000




(1)
            Issuable
                under our 1995 Stock Option Plan for Outside Directors.




Our
      other
      option plans have expired and additional grants may not be made under those
      plans. Our Board of Directors may, however, approve one or more plans or make
      option grants outside of the framework of any plan.




-9-




**ITEM
      6. SELECTED FINANCIAL DATA**




The
      selected consolidated statement of operations data for the years ended December
      31, 2003, 2004 and 2005 and consolidated balance sheet data as of December
      31,
      2004 and 2005 has been derived from our audited Consolidated Financial
      Statements included in this Annual Report. The selected consolidated statement
      of operations data for the years ended December 31, 2001 and 2002 and the
      selected consolidated balance sheet data as of December 31, 2001, 2002 and
      2003
      has been derived from our unaudited consolidated financial statements not
      included herein.




This
      data
      should be read in conjunction with our Consolidated Financial Statements and
      related notes included herein and “Item 7. Management’s Discussion and Analysis
      of Financial Condition and Results of Operations.”




-10-




*Selected
      Consolidated Statement of Operations Data:*


For
                  the Years Ended December 31,2001**
                (unaudited)
            
            
            2002**
                (unaudited)
            
            
            2003*
            
            
            2004*
            
            
            2005(in
                  thousands, except per share data)Sales
            
            $
            39,146
            
            $
            46,900
            
            $
            27,076
            
            $
            21,832
            
            $
            21,864Cost
                of sales
            
            
            32,212
            
            
            36,351
            
            
            21,909
            
            
            17,215
            
            
            17,446Gross
                profit
            
            
            6,934
            
            
            10,549
            
            
            5,167
            
            
            4,617
            
            
            4,418Research
                and development expenses
            
            
            2,284
            
            
            1,526
            
            
            153
            
            
            30
            
            
            53Selling,
                marketing, general and administrative expenses
            
            
            15,349
            
            
            16,398
            
            
            10,259
            
            
            7,137
            
            
            6,543Impairment
                of goodwill and investment
            
            
            227
            
            
            90
            
            
            —
            
            
            —
            
            
            —Gain
                on issuance of shares in subsidiary
            
            
            397
            
            
            —
            
            
            —
            
            
            —
            
            
            —Operating
                loss
            
            
            (10,529
            )
            
            (7,465
            )
            
            (5,245
            )
            
            (2,550
            )
            
            (2,178
            )Interest
                income
            
            
            1,086
            
            
            229
            
            
            46
            
            
            31
            
            
            29Interest
                expense
            
            
            (357
            )
            
            (1,001
            )
            
            (738
            )
            
            (118
            )
            
            (99
            )Other
                income (loss), net
            
            
            (55
            )
            
            12
            
            
            (322
            )
            
            240
            
            
            6Loss
                from operations before taxes on income
            
            
            (9,745
            )
            
            (8,225
            )
            
            (6,259
            )
            
            (2,397
            )
            
            (2,242
            )Taxes
                on income
            
            
            (37
            )
            
            (35
            )
            
            (40
            )
            
            31
            
            
            (38
            )Loss
                from operations of the Company and its consolidated
                subsidiaries
            
            
            (9,782
            )
            
            (8,190
            )
            
            (6,219
            )
            
            (2,428
            )
            
            (2,204
            )Share
                of losses in Comverge
            
            
            —
            
            
            —
            
            
            (1,752
            )
            
            (1,242
            )
            
            (380
            )Gain
                on sale of shares in Comverge
            
            
            —
            
            
            —
            
            
            —
            
            
            705
            
            
            —Minority
                interests, net of tax
            
            
            —
            
            
            880
            
            
            264
            
            
            (90
            )
            
            (73
            )Loss
                from continuing operations
            
            
            (9,782
            )
            
            (7,310
            )
            
            (7,707
            )
            
            (3,055
            )
            
            (2,657
            )Gain
                on sale of discontinued operations, net of income taxes
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            541Income
                (loss) from discontinued operations, net of income taxes
            
            
            (13
            )
            
            (834
            )
            
            1,425
            
            
            1,883
            
            
            798Net
                loss
            
            $
            (9,795
            )
            $
            (8,144
            )
            $
            (6,282
            )
            $
            (1,172
            )
            $
            (1,318
            )Basic
                and diluted net income (loss) per share:Loss
                from continuing operations
            
            $
            (1.41
            )
            $
            (1.00
            )
            $
            (1.00
            )
            $
            (0.38
            )
            $
            (0.32
            )Discontinued
                operations
            
            
            (0.00
            )
            
            (0.11
            )
            
            0.19
            
            
            0.23
            
            
            0.16Net
                loss per share (basic and diluted)
            
            $
            (1.41
            )
            $
            (1.11
            )
            $
            (0.81
            )
            $
            (0.15
            )
            $
            (0.16
            )Weighted
                average number of shares
              outstanding
                - basic and diluted
            
            
            6,970
            
            
            7,349
            
            
            7,738
            
            
            7,976
            
            
            8,117




*
      Results
      have been restated for the discontinued operations of our Israel based
      consulting business, which was sold in August 2005.




**** The
      selected consolidated statements of operations data for the year s ended
      December 31, 2001 and 2002 ha ve been
      restated for the discontinued operations of our Israel
      and US-based
      consulting business and are unaudited.




-11-




*Selected
      Consolidated Balance Sheet Data:*




As
                of December 31,2001
              (unaudited)
            
            2002
              (unaudited)
            
            2003
              (unaudited)
            
            2004
            
            2005(in
                thousands)Working
                capital
            
            $
            6,809
            
            
            2,845
            
            $
            729
            
            $
            874
            
            $
            1,458Total
                assets
            
            
            39,244
            
            
            33,347
            
            
            17,784
            
            
            17,025
            
            
            10,173Short-term
                and long-term debt
            
            
            8,681
            
            
            10,033
            
            
            2,259
            
            
            1,396
            
            
            365Minority
                interests
            
            
            2,530
            
            
            1,609
            
            
            1,367
            
            
            1,471
            
            
            —Total
                shareholders’ equity
            
            
            14,362
            
            
            7,128
            
            
            3,200
            
            
            2,125
            
            
            820




-12-




**ITEM
      7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
      OF OPERATIONS**





**RECENT
      DEVELOPMENTS**




*Sale
      of Databit and Related Transactions; Appointment of New CEO*




On
      March
      10, 2006 we entered into a Stock Purchase Agreement dated as of March 9, 2006
      (the "SPA"), for the sale of all the outstanding capital stock of Databit to
      Shlomie Morgenstern, President of Databit and a Vice President of the Company.
      The transactions contemplated under the SPA, and the related transactions to
      which we, Shlomie Morgenstern and our CEO George Morgenstern were party to,
      were
      consummated on March 10, 2006 and included the following:




·
            Termination
                of the Employment Agreement dated August 19, 2004 among Shlomie
                Morgenstern, Databit and us and our release from any and all liability
                including the waiver by Shlomie Morgenstern of any and all severance
                or
                change of control payments to which he would have been
                entitled.




·
            Amendment
                of the option and restricted stock agreements between us and Shlomie
                Morgenstern to provide for acceleration of any unvested grants on
                the
                closing of the transactions and for all options to be exercisable
                through
                18 months from the closing.




·
            The
                assignment to and assumption by Databit of our obligations to George
                Morgenstern under the Employment Agreement between the Company and
                George
                Morgenstern dated January 1, 1997, as amended (the "GM Employment
                Agreement") upon the following
                terms:




(i)  Reduction of the amounts owed to George Morgenstern under the GM Employment
      Agreement by the lump sum payment payment of $600,000 and a release by George
      Morgenstern releasing us from any and all liability and obligations to him
      under
      the GM Employment Agreement.




(ii)  The
      amendment of the option agreement with George Morgenstern dated December 30,
      2004 to provide for the acceleration of the 60,000 options that are not
      currently vested and the extension of the exercise period for all options held
      by him to the later of (i) September 2009 and (ii) 18 months after the cessation
      of his services as a director or as a consultant under the new
      consulting agreement described below.




(iii)  The
      amendment of the Restricted Stock Agreement dated August 31, 1998 between George
      Morgenstern and us to provide for the removal of any vesting conditions from
      the
      20,000 shares still subject to such conditions.




·
            The
                assumption by Databit of our obligations under leases for the premises
                in
                New York City and Mahwah, New Jersey, which provide for aggregate
                rents of
                approximately $450,000 over the next three
                years.




·
            A
                new consulting agreement between George Morgenstern and us for a
                period of
                two years, pursuant to which George Morgenstern would serve as a
                consultant to us, primarily to assist in the management of our dsIT
                subsidiary. The agreement provides for de minimus compensation per
                year
                plus a non-accountable expense allowance of $65,000 per year to cover
                expected costs of travel and other
                expenses.




As
      a
      result of the transaction and the above mentioned amendments to various
      restricted stock and options agreements, we expect to record a loss of
      approximately $2.1 million in the first quarter of 2006.




Concurrent
      with the sale of Databit, George Morgenstern ceased to serve as our President
      and CEO but will continue to serve as a member of the Board of Directors and
      as
      Chairman of the Board. Shlomie Morgenstern also ceased to serve as Vice
      President--Operations and will no longer act as an officer or director. In
      addition, John A. Moore was appointed President and CEO as well as one of our
      directors.




-13-




*Settlement
      of Litigation*




In
      March
      2006, we reached a settlement agreement with an Israeli bank with respect to
      our
      claims against the bank and the bank’s counterclaim against us. As part of the
      settlement agreement, the bank will return to us approximately $94,000 plus
      interest and CPI adjustments of attorney fees and court costs we had previously
      paid. As a result of the settlement agreement, the accrued loss for contingent
      performance of bank guarantees of $410,000 will be reversed and the $247,000
      collateralized portion of these guarantees (shown as restricted cash at December
      31, 2005) will no longer be restricted. We expect to record income of
      approximately $330,000 in the first quarter of 2006 as a result of the
      settlement agreement.





*Option
      Grants*





On
      March
      27, 2006, the Board of Directors of the Company approved the following option
      grants, upon the following terms, to John A. Moore:





(a)
            an
                option for the purchase of 200,000 shares of Common Stock at an exercise
                price of $2.00 per share, vesting on September 30, 2006 and expiring
                on
                March 31, 2011; and





(b)
            an
                option to purchase 200,000 shares of Common Stock at an exercise
                price of
                $2.25 per share, vesting on March 30, 2009 and expiring on March
                31, 2011;
                subject to accelerated vesting as to (i) 100,000 shares of Common
                Stock
                upon the Company’s having raised $1 million in gross proceeds from the
                sale of its equity and (ii) 100,000 shares of Common Stock upon the
                Common’s Common Stock achieving a five-day average closing market price
                of
                $5.00 or greater per share.





All
      of
      the above options granted to Mr. Moore are subject to acceleration upon (in
      addition to those events specified with respect to the option in (b) above)
      the
      termination of Mr. Moore’s employment by the Registrant without Cause, a Change
      of Control of the Registrant, or the termination by Mr. Moore of his employment
      with the Registrant for Good Reason (as such terms are defined in such option
      agreements between Mr. Moore and the Registrant).





On
      March
      27, 2006, the Board of Directors also approved the grant of an option to
      purchase 25,000 shares of Common Stock at an exercise price of $2.65 per share,
      to each of the following non-management directors: Elihu Levine, Shane Yurman,
      and Samuel M. Zentman. These options shall vest on the date of the next held
      annual meeting and expire upon the earlier of (i) March 30, 2011 or (ii) 18
      months from the date on which the grantee ceases to be a director.




In
      addition, the Board of Directors of the Registrant approved the modification
      of
      all outstanding options to purchase Common Stock issued under the Registrant’s
      1994 Stock Option Plan for Outside Directors held by Mr. Levine, Mr. Yurman,
      and
      Dr. Zentman, to permit their exercise until 18 months after the grantee ceases
      service as a director.




-14-




*Additional
      Investment in Comverge*




In
      March
      2006, Comverge had an additional round of private equity financing. As a result
      of the most recent financing round, in which we participated at a cost of
      $210,000, we currently own approximately 7% of Comverge’s preferred shares and
      76% of its common shares, representing approximately 25% of its total
      equity.




**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 1. Business- Risk Factors
      Which May Affect Future Results.”




We
      operate in two reportable segments: software consulting and development, and
      computer hardware sales. Until March 31, 2003, we included the results of
      Comverge in our energy intelligence solutions segment. Since March 31, 2003,
      we
      no longer consolidate the results of Comverge (see Note 3 to our Consolidated
      Financial Statements included in this report) and therefore no longer include
      their results in our segment reporting. As we have sold our outsourcing
      consulting business in August 2005, the information provided below does not
      include the results from those activities as they have been reclassified and
      consolidated on one line as net income from discontinued operations, after
      tax.




In
      March
      2006, we sold our Databit computer hardware sales company to Shlomie
      Morgenstern, President
      of Databit and our Vice President, in
      exchange for the release of DSSI from obligations relating to our former CEO’s
      consulting agreement and various lease obligations. As part of the agreement,
      we
      agreed to pay our former CEO $600,000 at closing and pay certain costs for
      Databit. In
      addition, cash, which had previously been restricted with respect to our former
      CEO’s employment agreement, will no longer be restricted (net of transaction
      costs and the $600,000 payment to our former CEO). As a result of the
      transaction, we expect to record a loss of approximately $2.1 million in the
      first quarter of 2006. Subsequent to the first quarter of 2006, we will no
      longer have any activity in our computer hardware segment.




The
      following analysis should be read together with the segment information provided
      in Note 16 to our Consolidated Financial Statements included in this
      report.




*Software
      Consulting and Development*




Segment
      revenues increased by $0.7 million or 16% in 2005 as compared to 2004. The
      increase came from our RT services ($0.5 million from Naval solutions and $0.2
      million from embedded hardware and software development) with revenues from
      our
      IT solutions remaining stable. Within our IT solutions, the revenues from our
      OncoProTM solutions increased in 2005 by $0.3 million. This was offset by a $0.3
      million decrease in revenues from our EasyBillTM billing system. Segment gross
      profits also increased in 2005 as compared to 2004 by $0.4 million or 36%.
      Segment gross profit percentage continued to increase (from 25% in 2004 to
      29%
      in 2005) as we continue to improve our cost structure, though a portion of
      the
      improvement was the result of a non-recurring license sale, which increased
      our
      gross profit and gross profit percentage by $145,000 and 2%, respectively.




Our
      projected growth in sales in 2006 is expected to come primarily from our Naval
      solutions products with slight increases in our OncoProTM solutions being offset
      by slight decreases in embedded hardware and software development and EasyBillTM
billing system. Due to the sale of our outsourcing business in August 2005,
      our
      segment overhead currently is a heavier burden to the segment and we must
      generate a higher level of sales to reach profitability. We anticipate our
      sales
      to increase throughout 2006, with the segment reaching profitability towards
      the
      end of the year.




dsIT
      has
      been successful in bidding (together with our former Databit subsidiary) for
      certain combined hardware/software solutions for the Israeli Ministry of Defense
      (MoD). Despite our recent sale of Databit, we expect this cooperation to
      continue to produce increased revenues in 2006.





-15-




*Computer
      Hardware Sales*




Sales
      in
      2005 were lower than in 2004, and combined with a reduced gross profit margin
      caused gross profit to decrease by more than 15%. The segment’s dependency on
      sales to one particular customer has decreased to a certain extent, however
      during 2005 we remained heavily dependent on two particular customers while
      we
      continued to invest significant efforts to diversify our sales base.




In
      March
      2006, we sold our Databit computer hardware sales company and after the first
      quarter of 2006, will no longer have any further activity in this
      segment.




*Energy
      Intelligence Solutions*




We
      continue to account for Comverge on the equity method; however since our losses
      to date exceed our investment, Comverge’s losses no longer affect our
      consolidated results.




Through
      January 2006, Comverge has continued to strengthen its strategic alliances
      and
      broadened the spectrum of solutions offered, while continuing to perform under
      its Virtual Peaking CapacityTM (“VPC”) contracts. Comverge has recently
      increased its VPC programs to more than 225 Megawatts under
      contract.




Comverge
      has also recently announced that its Maingate® C&I gateway technology and
      PowerCAMP software suite were selected by American Electric Power (AEP) to
      provide a full scale digital cellular AMR solution for AEP’s over 15,000
      commercial and industrial sites. Maingate® C&I is currently in use at
      utilities across the US and provides access to robust meter data in real-time.
      Available in external box and underglass designs, Maingate® C&I offers
      utilities both retrofit and drop in replacement solutions designed to lower
      recurring communications costs and increase data read reliability. The PowerCAMP
      suite enables AEP to collect data and automatically integrate this data with
      existing billing and CRM tools.




Comverge’s
      continued marketing, installation and development of products require
      significant financial resources. To the extent required, it intends to utilize
      and further increase its bank credit lines and seek additional investor
      financing. In February 2006, Comverge completed a Series C Preferred Stock
      financing round, raising approximately $5.2 million. This brought the total
      capital raised by Comverge from 2003 to 2005 to approximately $37 million.
      The
      investing group supporting Comverge includes, in addition to us, Air Products
      and Chemicals, Easton Hunt Capital Partners, Rockport Capital Partners, Nth
      Power Management, EnerTech Capital, Norsk Hydro Technology Ventures, and
      Ridgewood Capital. As a result of the most recent financing round, in which
      we
      participated at a cost of $210,000, we currently own approximately 7% of
      Comverge’s preferred shares and 76% of its common shares, representing
      approximately 25% of its total equity.




*Corporate*




In
      March
      2006, we appointed John Moore as our President and CEO to succeed George
      Morgenstern, our founder and President and CEO since 1986.  Mr.
      Morgenstern will continue to serve on the board of directors and as Chairman
      of
      the Board focusing on efforts to grow our projects and solutions activities
      in
      Israel. As a
      result of the sale of our US operating activities and the assignment of the
      employment agreement with our former CEO and lease agreements for our US
      properties, we expect corporate expenses to be reduced.




For
      disclosure regarding our recently announced agreement for the sale of our
      Databit computer hardware sales company, see “Recent Developments”
above.




**CRITICAL
      ACCOUNTING POLICIES**




The
      Securities and Exchange Commission (“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.




-16-




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; revenue
      recognition; foreign currency transactions; income taxes; 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.
      Minority interests in net losses are limited to the extent of their equity
      capital. Losses in excess of minority interest equity capital are charged
      against us in our consolidated statements of operations.




Investments
      in associated companies are accounted for by the equity method. Our Comverge
      investment is comprised of both common and preferred stock. As of December
      31,
      2005 the balance of our investment was a net liability of $1.8 million comprised
      of our negative investment in common shares of $1.8 million and our investment
      in preferred shares of $3.6 million which we have written down to zero value
      as
      a result of accumulated equity losses against our preferred investment. We
      currently no longer record equity losses in Comverge. Should we begin to record
      equity income on our investment in Comverge, we would record that equity income
      to our preferred investment up to our original $3.6 million preferred share
      investment in Comverge, and thereafter to our investment in Comverge’s common
      shares, of which we currently own approximately 76%. As at December 31, 2005,
      we
      have a provision for unrecognized losses in Comverge of $64,000. As at December
      31, 2005, we will record equity income from our preferred investment in
      Comverge, if and when Comverge records net income in excess of approximately
      $924,000.




*Revenue* *R* *ecognition*




Revenue
      from time-and-materials service contracts, maintenance agreements and other
      services is recognized as services are provided.




Revenues
      from the sale of software licenses are recognized when a license agreement
      exists, delivery has occurred, the license fee is fixed or determinable, and
      collectibility is reasonably assured. Such sales of software licenses are
      incidental to the sale of our hardware products. We also provide integration
      and
      maintenance services along with our computer hardware sales. These integration
      and maintenance services are subject to an agreement separate from our hardware
      sales. Integration services, when provided, are based on hourly rates
      commensurate with market rates. Revenue from these services is recognized at
      the
      time the service is provided.




Maintenance
      and subscription contracts are sold separately and are priced based upon
      predetermined price lists. Maintenance and subscription revenue is recognized
      ratably over the contract period (generally 12 to 24 months).




Revenues
      from the sale of products (primarily hardware which generally includes
      pre-loaded off-the-shelf software) are recognized when the products are shipped
      provided that appropriate signed documentation of the arrangement, such as
      a
      signed contract, purchase order or letter of agreement, has been received,
      the
      fee is fixed or determinable and collectibility is reasonably assured. The
      software included in the sale of these products is incidental to the sale of
      the
      hardware products.




Revenue
      from drop-shipments of third-party hardware and software sales are recognized
      upon delivery, and recorded at the gross amount when a majority of the following
      factors exist:




·
            when
                we are responsible for fulfillment of the customer order




·
            when
                we have latitude in pricing




-17-




·
            when
                we have discretion in the selection of the supplier




·
            when
                we customize the product to the customer’s specifications




·
            when
                we have credit risk from the customer




In
      2005,
      we derived $3.2 million of revenues from fixed-price contracts, all of which
      are
      attributable to our software and consulting development segment, representing
      approximately 14% of consolidated sales in 2005 ($2.8 million and 13%, and
      $3.2
      million and 12%, in 2004 and 2003, respectively), which 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 consulting 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.




*Foreign* *C* *urrency* *T* *ransactions*




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.




Our
      dsIT
      Israeli subsidiary accounts for approximately 21% of our net revenues for the
      year ended December 31, 2005 (16% for the year ended December 31, 2004), and
      45%
      of our assets and 42% of our total liabilities as of December 31, 2005 (71%
      of
      our assets and 39% of our total liabilities as of December 31, 2004). dsIT’s
      functional currency is the New Israeli Shekel (“NIS”) and its 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 exchange rate at date of transaction. In 2003 the resulting translation
      adjustments were not reported, as they were immaterial. All exchange gains
      and
      losses denominated in non-functional currencies are reflected in other income
      (loss), net in the consolidated statement of operations when they
      arise.




*Income* *T* *axes*




We
      have a
      history of unprofitable operations due to losses incurred in a number of our
      operations. These losses generated sizeable state, federal and foreign tax
      net
      operating loss (“NOL”) carryforwards, which as of December 31, 2005 were
      approximately $11.9 million, $9.7 million and $0.9 million,
      respectively.




Generally
      accepted accounting principles require that we record a valuation allowance
      against the deferred income tax asset associated with these NOL carryforwards
      and other deferred tax assets if it is “more likely than not” that we will not
      be able to utilize them to offset future income taxes. Due to our history of
      unprofitable operations, we only recognize net deferred tax assets in those
      subsidiaries in which we believe that it is “more likely than not” that we will
      be able to utilize them to offset future income taxes in the future. We
      currently provide for income taxes only to the extent that we expect to pay
      cash
      taxes on current income or disallowed expenses.




It
      is
      possible, however, that we could be profitable in the future at levels which
      cause management to conclude that it is more likely than not that we will
      realize all or a portion of the NOL carryforwards and other deferred tax assets.
      Upon reaching such a conclusion, we would immediately record the estimated
      net
      realizable value of the deferred tax assets at that time and would then provide
      for income taxes at a rate equal to our combined federal and state effective
      rates or foreign rates. Subsequent revisions to the estimated net realizable
      value of the deferred tax assets could cause our provision for income taxes
      to
      vary significantly from period to period.




-18-




*Stock-based* *C* *ompensation*




In
      December 2002, the FASB issued SFAS No.148--Accounting for Stock-Based
      Compensation--Transition and Disclosure (“FAS 148”). This statement amends SFAS
      No. 123--Accounting for Stock-Based Compensation, providing alternative methods
      of voluntarily transitioning to the fair market value based method of accounting
      for stock based employee compensation. SFAS 148 also requires disclosure of
      the
      method used to account for stock-based employee compensation and the effect
      of
      the method in both the annual and interim financial statements. We elected
      to
      continue to account for stock-based compensation plans using the intrinsic
      value-based method of accounting prescribed by APB No. 25, Accounting for Stock
      Issued to Employees (“APB No. 25”), and related interpretations. Under the
      provisions of APB No. 25, compensation expense is measured at the grant date
      for
      the difference between the fair value of the stock and the exercise price.
      In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued the
      revised Statement of Financial Accounting Standards (“FAS”) No. 123,
“Share-Based Payment” (“FAS 123R”), which addresses the accounting for
      share-based payment transactions in which we obtain employee services in
      exchange for (a) our equity instruments or (b) liabilities that are based on
      the
      fair value of our equity instruments or that may be settled by the issuance
      of
      such equity instruments. This statement eliminates the ability to account for
      employee share-based payment transactions using APB No. 25 and requires instead
      that such transactions be accounted for using the grant-date fair value based
      method. For us, this statement will be effective as of January 1, 2006 and
      we
      expect to apply the modified prospective application transition method, as
      permitted by the statement. We estimate that the cumulative effect of adopting
      FAS 123R as of January 1, 2006, our adoption date, based on the awards
      outstanding as of December 31, 2005, will be immaterial .
      This
      estimate does not include the impact of additional awards, which may be granted,
      or forfeitures, which may occur subsequent to December 31, 2005.




We
      account for stock-based compensation issued to non-employees on a fair value
      basis in accordance with SFAS No. 123 and EITF Issue No. 96-18, “Accounting for
      Equity Instruments That Are Issued to Other Than Employees for Acquiring, or
      in
      conjunction with Selling, Goods or Services” and related interpretations. We use
      the Black-Scholes valuation method to estimate the fair value of
      warrants.




**RESULTS
      OF OPERATIONS**




The
      following table sets forth selected consolidated statement of operations data
      as
      a percentage of our total sales:




Year
                Ended December 31,2001
              (unaudited)
            
            2002
              (unaudited)
            
            2003
            
            2004
            
            2005Sales
            
            
            100
            %
            
            100
            %
            
            100
            %
            
            100
            %
            
            100
            %Cost
                of sales
            
            
            82
            
            
            78
            
            
            81
            
            
            79
            
            
            80Gross
                profit
            
            
            18
            
            
            22
            
            
            19
            
            
            21
            
            
            20Research
                and development expenses
            
            
            6
            
            
            3
            
            
            1
            
            
            —
            
            
            —Selling,
                marketing, general and administrative expenses
            
            
            39
            
            
            35
            
            
            38
            
            
            33
            
            
            30Impairment
                of goodwill and investment
            
            
            1
            
            
            —
            
            
            —
            
            
            —
            
            
            —Gain
                on issuance of shares in subsidiary
            
            
            1
            
            
            —
            
            
            —
            
            
            —
            
            
            —Operating
                loss
            
            
            (27
            )
            
            (16
            )
            
            (19
            )
            
            (12
            )
            
            (10
            )Interest
                income (expense), net
            
            
            2
            
            
            (2
            )
            
            (3
            )
            
            —
            
            
            —Other
                income (loss), net
            
            
            —
            
            
            —
            
            
            (1
            )
            
            1
            
            
            —Loss
                from operations before taxes on income
            
            
            (25
            )
            
            (18
            )
            
            (23
            )
            
            (11
            )
            
            (10
            )Taxes
                on income
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Loss
                from operations of the Company and its consolidated
                subsidiaries
            
            
            (25
            )
            
            (17
            )
            
            (23
            )
            
            (11
            )
            
            (10
            )Share
                of losses in Comverge
            
            
            —
            
            
            —
            
            
            (6
            )
            
            (6
            )
            
            (2
            )Gain
                on sale of shares in Comverge
            
            
            —
            
            
            —
            
            
            —
            
            
            3
            
            
            —Minority
                interests, net of tax
            
            
            —
            
            
            2
            
            
            1
            
            
            —
            
            
            —Loss
                from continuing operations
            
            
            (25
            )
            
            (16
            )
            
            (28
            )
            
            (14
            )
            
            (12
            )Income
                (loss) from discontinued operations, net of income taxes
            
            
            —
            
            
            (2
            )
            
            5
            
            
            9
            
            
            4Gain
                on sale of discontinued operations, net of income taxes
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            2Net
                loss
            
            
            (25
            )%
            
            (17
            )%
            
            (23
            )%
            
            (5
            )%
            
            (6
            )%




-19-




The
      following table sets forth certain information with respect to revenues and
      profits of our reportable business segments for the years ended December 31,
      2003, 2004 and 2005, including the percentages of revenues attributable to
      such
      segments. Until March 31, 2003, we included the results of Comverge in our
      energy intelligence solutions segment. Since March 31, 2003, we no longer
      consolidate the results of Comverge and no longer include their results in
      our
      segment reporting (see Note 4 to our consolidated financial statements). Segment
      information excludes the discontinued results of our US based consulting
      activities, which were discontinued in 2004, and our Israel based outsourcing
      activities, which were discontinued in 2005 (see Note 3 to our consolidated
      financial statements). The column marked “Other” aggregates information relating
      to miscellaneous operating segments, which may be combined for reporting under
      applicable accounting principles.




Software
                Consulting andDevelopment
            
            Energy
              IntelligenceSolutions
            
            ComputerHardware
            
            Other
            
            Total(dollars
                in thousands)Year
                ended December 31, 2005:Revenues
                from external customers
            
            $
            4,158
            
            $
            —
            
            $
            17,677
            
            $
            29
            
            $
            21,864Percentage
                of total revenues from external customers
            
            
            19
            %
            
            —
            
            
            81
            %
            
            —
            
            
            100
            %Gross
                profit
            
            
            1,213
            
            
            —
            
            
            3,176
            
            
            29
            
            
            4,418Segment
                income (loss)before
                income taxes
            
            
            (850
            )
            
            —
            
            
            45
            
            
            19
            
            
            (786
            )Year
                ended December 31, 2004:Revenues
                from external customers
            
            $
            3,300
            
            $
            —
            
            $
            18,468
            
            $
            64
            
            $
            21,832Percentage
                of total revenues from external customers
            
            
            15
            %
            
            —
            
            
            85
            %
            
            —
            
            
            100
            %Gross
                profit
            
            
            809
            
            
            —
            
            
            3,744
            
            
            64
            
            
            4,617Segment
                income (loss)before income taxes
            
            
            (1,461
            )
            
            —
            
            
            19
            
            
            38
            
            
            (1,404
            )Year
                ended December 31, 2003:Revenues
                from external customers
            
            $
            4,199
            
            $
            4,700
            
            $
            18,139
            
            $
            39
            
            $
            27,076Percentage
                of total revenues from external customers
            
            
            16
            %
            
            17
            %
            
            67
            %
            
            —
            
            
            100
            %Gross
                profit
            
            
            690
            
            
            1,313
            
            
            3,125
            
            
            39
            
            
            5,167Segment
                lossbefore income taxes
            
            
            (1,990
            )
            
            (1,422
            )
            
            (191
            )
            
            (17
            )
            
            (3,620
            )




**2005
      COMPARED TO 2004**




*Sales.* The
      marginal increase in sales in 2005, as compared to 2004, was due to an increase
      in sales in our software consulting and development segment offset by a
      corresponding decrease in sales in our computer hardware segment.




*Gross
      profit.* The
      decrease in gross profit in 2005, as compared to 2004, was entirely attributable
      to a decrease in gross profits in our computer hardware segment of $0.6 million.
      This decrease was partially offset by an increase in gross profit in our
      software consulting and development segment of $0.4 million. In the software
      consulting and development segment, the gross profit margin increased to 29%,
      from 25% in 2004, whereas in the computer hardware sales segment, gross profit
      margin decreased to 18%, from 20% in 2004. The decreased gross profit margin
      in
      our computer hardware segment more than offset the increase in our software
      consulting and development gross profit margin.




-20-




*Selling,
      marketing, general and administrative expenses (“SMG&A”).* The
      decrease in SMG&A in 2005, as compared to 2004, was primarily due to a
      decrease in corporate professional fees, as well as compensation expense in
      the
      computer hardware segment.




*Interest
      income (expense), net.* The
      decrease in net finance expenses is attributable to the continued reduction
      of
      our outstanding balances of bank debt.




*Other
      income, net.* During
      the second quarter of 2004, we received a decision from the Israeli Supreme
      Court in our dispute with an Israeli bank. In its decision, the Court reversed
      the district court’s award for costs in favor of the bank for which we had
      previously accrued. The courts also remanded to the district court our claims
      against the bank for a determination as to the amount of damages. As a result
      of
      the decision we recorded other income of approximately $0.2 million in
      2004.




*Taxes
      on Income.* The change in
      income
      tax expense in 2005 as
      compared to 2004 was
      primarily due to a one-time expense due to the reorganization of business at
      dsIT, as a result of which, previously recognized foreign income tax assets
      were
      expensed .
      Those
      expenses were offset by a tax benefit recorded from the sale of our dsIT
      Technologies subsidiary .




*Share
      of Losses in Comverge.* Our
      share of Comverge's $ 6 . 4 million
      and $9.3 million of net losses in 2005 and 2004, respectively, was $0.4 million
      and $1.2 million, respectively. The reduction in our share of losses in 2005
      is
      attributable to our no longer recording equity losses in Comverge, as our
      preferred stock investment has been reduced to zero.




*Gain
      on sale of discontinued operations, net of tax* *.* ** In
      August
      2005, we sold our Israeli outsourcing consulting business for approximately
      $3.7
      million, resulting in a gain of $0. 5 million.




*Minority
      interests.* Minority
      interests reflect the minority interests in income generated by our former dsIT Technologies subsidiary.




*Net
      income from discontinued operations, net of tax.* In
      August
      2005, we sold our Israel based consulting business. As a result, net income
      from
      discontinued operations, net of income taxes for those operations have been
      restated for 2004. The decrease in net income from discontinued operations,
      net
      of tax is due to 2005 results reflected results for a seven and a half month
      period as compared to 2004 which reflects an entire year’s results.




**2004
      COMPARED TO 2003**




*Sales.* The
      decrease in sales in 2004, as compared to 2003, was due almost entirely to
      the
      inclusion of Comverge's sales of $4.7 million in the first quarter of 2003;
      commencing the second quarter of 2003, we no longer consolidated Comverge's
      operations. Sales in our consolidated segments decreased with the decrease
      in
      our software consulting and development segment offsetting the increase in
      our
      computer hardware segment sales.




*Gross
      profit.* The
      decrease in gross profits in 2004, as compared to 2003, was entirely
      attributable to the inclusion of Comverge's gross profit of $1.3 million in
      the
      first quarter of 2003. This decrease was net of an increase in gross profit
      in
      both of our consolidated segments, as a result of improved gross profit margins.
      In the software consulting and development segment the gross profit margin
      increased to 25%, from 16% in 2003, and in the computer hardware sales segment,
      gross profit margin increased to 20%, from 17% in 2003. The improved gross
      profit margins in our consolidated segments offset more than one-half of the
      detraction of Comverge’s gross profit.




*Research
      and development expenses (“R&D”).* The
      decrease in R&D expenses was primarily due to our company no longer
      consolidating Comverge’s operations since the second quarter of
      2003.




*Selling,
      marketing, general and administrative expenses (“SMG&A”).* The
      decrease in SMG&A in 2004, as compared to 2003, was primarily attributable
      to the fact that SMG&A in the 2003 period included $2.2 million of
      Comverge's SMG&A and, since the second quarter of 2003, we no longer
      consolidate Comverge's operations. The remaining decrease in SMG&A was due
      to a decrease in SMG&A in our software consulting and development segment as
      well as decreased corporate G&A.




-21-




*Interest
      income (expense), net.* The
      decrease in net finance expenses is attributable in part to completing the
      accretion of discounts and the amortization of related costs in connection
      with
      convertible debt and warrants in the first few months of 2003, which accounted
      for almost one-half of these expenses in 2003. Finance expense has also
      decreased as a result of the continued reduction in Israel of our outstanding
      balances of bank debt as well as reductions in interest rates throughout 2003
      and 2004.




*Other
      income, net.* During
      the second quarter of 2004, we received a decision from the Israeli Supreme
      Court in our dispute with an Israeli bank. In its decision, the Court reversed
      the district court’s award for costs in favor of the bank for which we had
      previously accrued. The courts also remanded to the district court our claims
      against the bank for a determination as to the amount of damages. As a result
      of
      the decision we recorded other income of approximately $0.2
      million.




*Share
      of Losses in Comverge.* Our
      share of Comverge's $9.3 million and $8.0 million of net losses in 2004 and
      2003, respectively, was $1.2 million and $1.8 million, respectively. Comverge's
      increased losses during 2004 were primarily due to increased SG&A expenses,
      primarily attributable to the marketing expenses associated with its new VPC
      programs.




*Gain
      on sale of shares in Comverge* *.*  In
      the
      third quarter of 2004, we signed an agreement with certain other shareholders
      of
      Comverge’s Preferred Stock for the sale by us to other shareholders of 480,769 shares
      of Comverge Preferred Stock for approximately $1.0 million, resulting in a
      gain
      of $0.7 million.




*Minority
      interests.* Minority
      interests reflect the minority interests in income generated by our dsIT
      subsidiary.




*Discontinued
      operations.* In
      August
      2005, we sold our Israel based outsourcing consulting business. As a result,
      income from discontinued operations, net of income taxes for those operations
      have been restated for 2003 and 2004 ($1.7 million and $1.4 million,
      respectively). The decrease in net income from our discontinued outsourcing
      consulting business was due primarily to decreasing revenues. In addition,
      since
      the latter part of 2003, we have not recorded revenues from our US based
      consulting business. During the second quarter of 2004, we decided to
      discontinue our efforts to reestablish this business as it was previously
      conducted. As a result, in 2004 we recorded income from discontinued operations
      of $0.3 million.




**LIQUIDITY
      AND CAPITAL RESOURCES**




As
      of
      December 31, 2005, we had working capital of $1.5 million, including $0.9
      million in unrestricted cash and cash equivalents. Net cash of $0.2 million
      was
      provided during 2005. Net cash of $1.7 million was used in operating activities
      during 2005. The net loss for the year ended December 31, 2005 of $1.3 million,
      was due primarily to corporate expenses of $1. 5 million, net losses
      of
      $ 0 . 9 million
      from the continuing operations of the software consulting and development
      segment and losses from our investment in Comverge of $0.4 million. These losses
      were partially offset by the gain of $0. 5 million
      on the sale of our outsourcing consulting business and net income from those
      discontinued operations of $0. 8 million.
      Our use of cash of $1.7 million in operating activities during 2005 was
      primarily due to the aforementioned gain of $0.9 million and to reductions
      in
      accounts payable and other liabilities in excess of collections of trade
      accounts receivables, unbilled work-in-process and other assets of $0.3 million,
      net. Net cash of $2.2 million provided by investing activities was primarily
      from the net result of the cash provided by the sale of dsIT of $3.4 million
      less increases in restricted cash of $1.3 million. Net cash of $0.2 million
      used
      in financing activities was primarily for payment of long-term debt of $0.5
      million net of short-term borrowings of $0.2 million, net.




Our
      working capital of $1.5 million at December 31, 2005, included working capital
      of $0.7 million in our dsIT subsidiary. Due to Israeli tax and company law
      constraints and dsIT’s own cash flow requirements, working capital and cash
      flows from dsIT's operations are not readily available to finance US based
      activities. As if December 31, 2005, dsIT was utilizing approximately $0.1
      million of its approximately $0.3 million lines of credit. dsIT's lines of
      credit are denominated in NIS and bear a weighted average interest rate of
      the
      Israeli prime rate plus 2.5% per annum. The Israeli prime rate fluctuates and
      as
      of December 31, 2005 was approximately 6.0%.




-22-




In
        August
        2005, we consummat ed the sale
        of the outsourcing consulting business of our dsIT Technologies subsidiary
        receiving at closing approximately $3.1 million as our share of the gross
        proceeds paid at closing. We also received an additional $0.4 million of
        restricted cash in
        connection with the sale, which was released
        in November 2005. Following the sale, in accordance with the provisions of
        the
        employment agreement with our then CEO, we set aside $1.4 million to secure
        payments to be made under this agreement.




Immediately
      after the sale of the consulting business, dsIT Solutions began to refocus
      its
      activities, initiating measures to improve the results from its remaining
      operations and its liquidity based on these operations. We believe that dsIT
      will have sufficient liquidity to finance its activities from cash flow from
      its
      own operations over the next 12 months. This is based on continued utilization
      of its lines of credit and expected improved operating results stemming from
      anticipated growth in sales. However, there is no assurance the measures taken
      by will be successful and we may need to provide supplementary financing, or
      sell all or part of that business.




As
      described above under Recent Developments, in March 2006, we sold our Databit
      computer hardware sales subsidiary. In connection with the transaction, we
      paid
      our then CEO $0.6 million and our remaining obligations under the employment
      agreement with him were assigned to and assumed by Databit. The balance of
      the
      cash previously restricted was released from any restriction. In addition,
      as
      described above under Recent Developments, we recently settled a litigation
      with
      an Israeli bank which resulted in the release of approximately $250,000 of
      previously restricted cash.




The
      unrestricted cash balance in our US operations as of the end of 2005 was
      $832,000, and as of March 31, 2006 was $677,000. Management currently projects
      significantly reduced corporate expenses for the next 12 months. We believe
      that
      the unrestricted cash available will provide more than sufficient liquidity
      to
      finance DSSI’s activities for the foreseeable future and for the next 12 months
      in particular.




There
      is
      no assurance that we will be able to reduce our corporate expenses to the
      projected levels. Management has formulated contingency plans ,  which
      include various financing options ,  including
      the possible sale of shares in DSSI, to provide additional liquidity to finance
      our US operations. There is no assurance that we will be able to raise
      additional funds on a timely basis and on acceptable terms.




*Contractual
      Obligations and Commitments*




The
      table
      below provides information concerning obligations under certain categories
      of
      our contractual obligations as of December 31, 2005.




As
      noted
      above, in March 2006, we sold our Databit computer hardware sales subsidiary
      and entered into related transactions which resulted in certain payments to
      our
      then CEO and the release
      of DSSI from obligations relating to our former CEO’s consulting agreement and
      various lease obligations. As a result of the sale, the information
      included in the table below related
      to future cash payments due under our agreement
      with our
      then CEO and
      under
      our leases which were assigned as part of the transaction, includes payments
      which we are not, or may not, be obligated to make.




-23-




As
      noted
      above, in March 2006, we reached a settlement agreement with an
      Israeli bank with
      respect to our litigation. As
      a
      result of the settlement agreement, the accrued loss for contingent performance
      of bank guarantees of $410,000 will be reversed in the first quarter of
      2006 and we
      will have no obligation to make any payments under these bank
      guarantees .




Ending
                December 31,(in
                thousands)Cash
                Payments due to Contractual Obligations
            
            Total
            
            2006
            
            2007-
              2008
            
            2009-
              2010
            
            2011
                and thereafterLong-term
                debt
            
            
            191
            
            
            149
            
            
            34
            
            
            8
            
            
            —Contingent
                performance of bank guarantees (1)
            
            
            410
            
            
            410
            
            
            —
            
            
            —
            
            
            —Operating
                leases
            
            
            1,933
            
            
            728
            
            
            1,007
            
            
            198
            
            
            —Potential
                severance obligations to Israeli employees (2)
            
            
            2,540
            
            
            277
            
            
            —
            
            
            —
            
            
            2,263Consulting
                agreement with CEO (3)
            
            
            1,350
            
            
            300
            
            
            600
            
            
            300
            
            
            150Purchase
                commitments
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Total
                contractual cash obligations
            
            $
            6,424
            
            $
            1,864
            
            $
            1,641
            
            $
            506
            
            $
            2,413




We
      expect
      to finance these contractual commitments in 2005 from cash currently on hand
      and
      cash generated from operations.




(1)
      Previously, we accrued a loss for contingent performance of bank guarantees,
      the
      balance of which was $0.4 million at December 31, 2005, included in other
      current liabilities. A portion of these guarantees was collateralized by means
      of a deposit of $0.2 million as of December 31, 2005. As
      a
      result of the abovementioned settlement agreement, we no longer have this liability contractual
      obligation.




(2)
      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, 2005, we accrued a total of $2.6 million for potential severance
      obligations ($0.3 million in other current liabilities and $2.3 million in
      long
      term liabilities) of which approximately $1.7 million was funded with cash
      to
      insurance companies ($0.3 million in other current assets and $1.4 million
      in
      non-current assets).




(3)
      Under
      the terms of his employment agreement with us, as amended, we ha d an
      obligation to continue to pay our former Chief Executive Officer consulting
      fees
      over a seven-year period starting January 1, 2005. As described above , in
      connection with our sale of our Databit computer hardware sales company, made
      a
      cash payment of $600,000 to our then CEO and were released from any further
      obligations under this agreement.




*Certain
      Information Concerning Off-Balance Sheet Arrangements.*




Our
      Israeli subsidiary provided various performance, advance and tender guarantees
      as required in the normal course of its operations. As of December 31, 2005,
      such guarantees totaled approximately $0.1 million and are due to expire through
      November 2006.




We
      ha d certain
      obligations to pay consulting fees to our former CEO over the next seven years
      as described above in Note 3 to the table included under Contractual Obligations
      and Commitments. As described above, as a result of the recently announced
      sale
      of our Databit computer hardware sales company, and upon the payment of $600,000
      to our former CEO, the employment agreement with our former CEO has been
      terminated.




Under
      the
      employment agreement with our then Vice President who served as the Chief
      Executive Officer of Databit, we had certain obligations to him if his
      employment agreement was not renewed after the initial term and certain
      additional obligations if it was terminated by us other than for cause
      and certain other circumstances. As a result of the recently announced sale
      of
      Databit, this agreement has been terminated  and
      we
      were released from all obligations without
      payment of any of the additional considerations discussed above .




-24-




*Impact
      of Inflation and Currency Fluctuations*




A
      majority of our sales are denominated in dollars. The remaining portion is
      either in NIS or denominated in NIS, linked to the dollar. Such sales
      transactions are negotiated in dollars; however, for the convenience of the
      customer they are 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. The
      majority of our expenses in Israel are in NIS, 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, should it be
      significantly different from the rate of inflation. In 2005 the depreciation
      of
      the NIS against the dollar was 6.8%, whereas in 2004 the appreciation of the
      NIS
      against the dollar was 1.6%. Inflation in Israel was 2.4% in 2005 and 1.2%
      during 2004. During the first two months of 2006, the NIS was devalued against
      the dollar by 2.2% and inflation during this period was
      0.3 %.




As
      of
      December 31, 2005, virtually all of our 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.




-25-




**SUMMARY
      QUARTERLY FINANCIAL DATA (Unaudited)**




The
      following table sets forth certain of our unaudited quarterly consolidated
      financial information for the years ended December 31, 2004 and 2005. This
      information should be read in conjunction with our Consolidated Financial
      Statements and the notes thereto.




2004
            
            2005First
                  Quarter*
            
            Second
                  Quarter*
            
            Third
                  Quarter*
            
            Fourth
                  Quarter*
            
            First
                  Quarter*
            
            Second
                  Quarter*
            
            Third
                  Quarter*
            
            Fourth
                  Quarter(in
                  thousands, except per share amounts)Sales
            
            $
            5,040
            
            $
            5,363
            
            $
            5,507
            
            $
            5,922
            
            $
            6,340
            
            $
            5,014
            
            $
            5,273
            
            $
            5,237Cost
                of sales
            
            
            4,022
            
            
            4,188
            
            
            4,527
            
            
            4,478
            
            
            4,998
            
            
            4,034
            
            
            4,300
            
            
            4,114Gross
                profit
            
            
            1,018
            
            
            1,175
            
            
            980
            
            
            1,444
            
            
            1,342
            
            
            980
            
            
            973
            
            
            1,123Research
                and development expenses
            
            
            —
            
            
            —
            
            
            —
            
            
            30
            
            
            9
            
            
            17
            
            
            16
            
            
            11Selling,
                marketing, general and administrative expenses
            
            
            1,764
            
            
            1,457
            
            
            2,112
            
            
            1,804
            
            
            1,858
            
            
            1,676
            
            
            1,764
            
            
            1,245Operating
                income (loss)
            
            
            (746
            )
            
            (282
            )
            
            (1,132
            )
            
            (390
            )
            
            (525
            )
            
            (713
            )
            
            (807
            )
            
            (133
            )Interest
                income (expense), net
            
            
            (32
            )
            
            (7
            )
            
            (25
            )
            
            (23
            )
            
            (22
            )
            
            (28
            )
            
            (21
            )
            
            1Other
                income (loss), net
            
            
            83
            
            
            193
            
            
            6
            
            
            (42
            )
            
            10
            
            
            51
            
            
            (23
            )
            
            (32
            )Income
                (loss) before taxes on income
            
            
            (695
            )
            
            (96
            )
            
            (1,151
            )
            
            (455
            )
            
            (537
            )
            
            (690
            )
            
            (851
            )
            
            (164
            )Taxes
                on income
            
            
            (12
            )
            
            (21
            )
            
            30
            
            
            34
            
            
            13
            
            
            (4
            )
            
            (42
            )
            
            (5
            )Loss
                from operations of the Company and its consolidated
                subsidiaries
            
            
            (683
            )
            
            (75
            )
            
            (1,181
            )
            
            (489
            )
            
            (550
            )
            
            (686
            )
            
            (809
            )
            
            (159
            )Minority
                interests, net of tax
            
            
            (15
            )
            
            (33
            )
            
            (11
            )
            
            (31
            )
            
            (42
            )
            
            (17
            )
            
            (14
            )
            
            —Gain
                on sale of shares in Comverge
            
            
            —
            
            
            —
            
            
            705
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Share
                of loss in Comverge
            
            
            (353
            )
            
            (331
            )
            
            (382
            )
            
            (176
            )
            
            (201
            )
            
            (179
            )
            
            —
            
            
            —Net
                loss from continuing operations
            
            
            (1,051
            )
            
            (439
            )
            
            (869
            )
            
            (696
            )
            
            (793
            )
            
            (882
            )
            
            (823
            )
            
            (159
            )Gain
                on sale of discontinued operations, net of tax
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            542
            
            
            (1
            )Net
                income (loss) from discontinued operations, net of tax
            
            
            456
            
            
            646
            
            
            397
            
            
            384
            
            
            354
            
            
            310
            
            
            154
            
            
            (20
            )Net
                income (loss)
            
            $
            (595
            )
            $
            207
            
            $
            (472
            )
            $
            (312
            )
            $
            (439
            )
            $
            (572
            )
            $
            (127
            )
            $
            (180
            )Basic
                and diluted net income (loss) per share:Net
                income (loss) per share from continuing operations
            
            $
            (0.14
            )
            $
            (0.05
            )
            $
            (0.11
            )
            $
            (0.09
            )
            $
            (0.09
            )
            $
            (0.11
            )
            $
            (0.14
            )
            $
            (0.02
            )Discontinued
                operations
            
            
            0.06
            
            
            0.08
            
            
            0.05
            
            
            0.05
            
            
            0.04
            
            
            0.04
            
            
            0.12
            
            
            —Net
                income (loss) per share
            
            $
            (0.08
            )
            $
            0.03
            
            $
            (0.06
            )
            $
            (0.04
            )
            $
            (0.05
            )
            $
            (0.07
            )
            $
            (0.02
            )
            $
            (0.02
            )Weighted
                average number of shares outstanding - basic
            
            
            7,920
            
            
            7,922
            
            
            7,936
            
            
            8,117
            
            
            8,117
            
            
            8,117
            
            
            8,117
            
            
            8,117Weighted
                average number of shares outstanding - diluted
            
            
            7,920
            
            
            7,964
            
            
            7,936
            
            
            8,117
            
            
            8,117
            
            
            8,117
            
            
            8,117
            
            
            8,117







*
      Results
      have been restated for the discontinued operations of our Israel based
      consulting business which was sold in August 2005.




-26-




**ITEM
      7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**




*General*




We
      are
      required to make certain disclosures regarding our financial instruments,
      including derivatives, if any.




A
      financial instrument is defined as cash, evidence of an ownership interest
      in an
      entity, or a contract that imposes on one entity a contractual obligation either
      to deliver or receive cash or another financial instrument to or from a second
      entity. Examples of financial instruments include cash and cash equivalents,
      trade accounts receivable, loans, investments, trade accounts payable, accrued
      expenses, options and forward contracts. The disclosures below include, among
      other matters, the nature and terms of derivative transactions, information
      about significant concentrations of credit risk, and the fair value of financial
      assets and liabilities.




*Foreign
      Currency Risk*




The
      translation of the balance sheets of our Israeli operations from NIS into U.S.
      dollars is sensitive to changes in foreign currency exchange rates. These
      translation gains or losses are recorded either as cumulative translation
      adjustments (“CTA) within stockholders’ equity, or foreign exchange gains or
      losses in the statement of operations. In 2005 the NIS weakened in relation
      to
      the U.S. dollar by 6.8%. To test the sensitivity of these operations to
      fluctuations in the exchange rate, the hypothetical change in CTA and foreign
      exchange gains and losses is calculated by multiplying the net assets of these
      non-U.S. operations by a 10% change in the currency exchange rates.




As
      of
      December 31, 2005, a 10% unfavorable change in the exchange rate of the U.S.
      dollar against the NIS would have increased stockholders’ equity by
      approximately $114,000 (arising from a CTA adjustment of approximately $45,000
      net exchange gains of approximately $159,000). These hypothetical changes
      are based on increasing the December 31, 2005 exchange rates by
      10%.




We
      do not
      employ specific strategies, such as the use of derivative instruments or
      hedging, to manage exchange rate exposures.




*Fair
      Value of Financial Instruments*




Fair
      values of financial instruments included in current assets and current
      liabilities are estimated to approximate their book values due to the short
      maturity of such investments. Fair value for long-term debt and long-term
      deposits are estimated based on the current rates offered to us for debt and
      deposits with similar terms and remaining maturities. The fair value of our
      long-term debt and long-term deposits are not materially different from their
      carrying amounts.




*Concentrations
      of Credit Ri* sk




Financial
      instruments, which potentially subject us to concentrations of credit risk,
      consist principally of cash and cash equivalents, short and long-term bank
      deposits, and trade receivables. The counterparty to a majority of our cash
      equivalent deposits as well as our short and long-term bank deposits is a major
      financial institution of high credit standing. We do not believe there is
      significant risk of non-performance by this counterparty. Approximately 34%
      of
      the trade accounts receivable at December 31, 2005 was due from a U.S. customer
      that pays its trade receivables over usual credit periods. Credit risk with
      respect to the balance of trade receivables is generally diversified due to
      the
      large number of entities comprising our customer base.




**ITEM
      8.** **FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA**




Furnished
      at the end of this report commencing on page F-1.




-27-




**ITEM
      9.**  **CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE**




**None.**




**ITEM
      9A.  CONTROLS AND PROCEDURES**




**Evaluation
      of Controls and Procedures**




We
      carried out an evaluation, under the supervision and with the participation
      of
      our management, including the Chief Executive Officer and the Chief Financial
      Officer, of the design and operation of our disclosure controls and procedures.
      Based on this evaluation, our Chief Executive Officer and Chief Financial
      Officer concluded that as of December 31, 2005, our disclosure controls and
      procedures were effective to ensure that information required to be disclosed
      by
      us in the reports that we file or submit under the Securities Exchange Act
      of
      1934 is recorded, processed, summarized and reported, within the time periods
      specified in the SEC’s rules and forms and to ensure that information required
      to be disclosed by us in the reports that we file or submit under the Securities
      Exchange Act of 1934 is accumulated and communicated to our management,
      including our principal executive and principal financial officers, or persons
      performing similar functions, as required to allow timely decisions regarding
      required disclosure.




**Changes
      in Controls and Procedures**




There
      have been no significant changes in our internal controls or in other factors
      that could significantly affect disclosure controls and procedures subsequent
      to
      the date of our most recent evaluation.




**ITEM
      9B.  OTHER INFORMATION**





The
      following is being disclosed pursuant to Item 1.01 of Form 8-K (Entry into
      Material Definitive Agreement).




In
      March
      2006, we reached a settlement agreement with an Israeli bank with respect to
      our
      claims against the bank and the bank’s counterclaim against us. As part of the
      settlement agreement, the bank will return to us approximately $94,000 plus
      interest and CPI adjustments of attorney fees and court costs we had previously
      paid. As a result of the settlement agreement, the accrued loss for contingent
      performance of bank guarantees of $410,000 will be reversed and the $247,000
      collateralized portion of these guarantees (shown as restricted cash at December
      31, 2005) will no longer be restricted. We expect to record income of
      approximately $330,000 in the first quarter of 2006 as a result of the
      settlement agreement.




-28-




**PART
      III**




**ITEM
      10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE
      REGISTRANT**




The
      information relating to each of our directors and nominees for director and
      the
      information relating to our executive officers will appear under the captions
      “Election of Directors - Certain Information Regarding Directors and Officers”
and “Compliance with Section 16(a) of the Securities and Exchange Act of 1934”
in our definitive proxy statement for the 2006 Annual Meeting of Stockholders
      (the “2006 Proxy Statement”), and is hereby incorporated by
      reference.




The
      information required by this Item pursuant to Item 401(h) and 401(i) of
      Regulation S-K relating to an audit committee financial expert and
      identification of the Audit Committee of our Board of Directors will appear
      under the heading “Corporate Governance” in the 2006 Proxy Statement, and is
      hereby incorporated by reference.




We
      have
      adopted a written code of ethics that applies to our principal executive
      officer, principal financial officer, and principal accounting officer or
      controller, and/or persons performing similar functions. Our code of ethics
      is
      being filed with this Annual Report as an exhibit hereto.




**ITEM
      11.  EXECUTIVE COMPENSATION**




The
      information relating to compensation of directors and executive officers will
      appear under the captions “Executive and Director Compensation - Compensation of
      Directors”, “Executive and Director Compensation - Compensation Committee
      Interlocks and Insider Participation”, “Executive and Director Compensation -
      Employment Arrangements”, “Executive and Director Compensation - Executive
      Compensation” and “Compensation Report of the Board of Directors” in the 2006
      Proxy Statement, and is hereby incorporated by reference.




**ITEM
      12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
      RELATED STOCKHOLDER MATTERS**




The
      information relating to security ownership will appear under the caption “Stock
      Ownership of Certain Beneficial Owners and Management” in the 2006 Proxy
      Statement ,
      and is
      hereby
      incorporated by reference.




**ITEM
      13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**




The
      information relating to certain relationships and transactions will appear
      under
      the caption “ Executive
      and Director Compensation - Certain
      Related Party Transactions” in the 2006 Proxy Statement, and is hereby
      incorporated by reference.




**ITEM
      14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES**




The
      information relating to principal accountant fees and services and audit
      committee pre-approval policies and procedures will appear under the caption
      “Principal Accountant Fees and Services” in
      the
      2006 Proxy Statement, and is hereby incorporated by reference.




-29-




**PART
      IV**







**ITEM
      15.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**




**(a)(1)** **List of Financial Statements of the Registrant**




The
        consolidated financial statements of the Registrant and the report thereon
        of
        the Registrant’s Independent Registered Public Accounting
 Firm
        are
        included in this Annual Report beginning on page F-1.




Report
      of
      Kesselman & Kesselman


Consolidated
      Balance Sheets as of December 31, 2004 and 2005


Consolidated
      Statements of Operations for the years ended December 31, 2003, 2004 and
      2005


Consolidated
      Statements of Changes in Shareholders’ Equity for the years ended December 31,
      2003,


2004
      and
      2005


Consolidated
      Statements of Cash Flows for the years ended December 31, 2003, 2004 and
      2005


Notes
      to
      Consolidated Financial Statements




**(a)(2)
      List of Financial Statement Schedules**




Financial
        Statement Schedules:


The
        financial statement schedule of the Registrant and the report thereon of
        the
        Registrant’s Independent Registered Public Accounting Firm are
 included
        in this Annual Report beginning on page S-1.




Schedule
      II - Valuation and Qualifying Accounts




Separate
      Financial Statements of 50 Percent or Less Owned Persons:


The
        consolidated financial statements of Comverge, Inc. and the report thereon
        of
        Comverge’s Independent Registered Public Accounting Firm
 are
        included in this Annual Report beginning on page C-1.


Consolidated
      Financial Statements of Comverge, Inc.:





Report
      of
      PricewaterhouseCoopers LLP


Consolidated
      Balance Sheets as of December 31, 200 5 and
      200 4


Consolidated
      Statements of Operations for the years ended December 31, 200 5,
      2004 and
      2003


Consolidated
      Statement of Changes in Shareholders’ Equity for the years ended December 31,
      200 5,
      2004 and
      2003.


Consolidated
      Statements of Cash Flows for the years ended December 31, 200 5 and
      200 4


Notes
      to
      Consolidated Financial Statements




**(a)(3)
      List of Exhibits**






No.3.1
            Certificate
                of Incorporation of the Registrant, with amendments thereto (incorporated
                herein by reference to Exhibit 3.1 to the Registrant’s Registration
                Statement on Form S-1 (File No. 33-70482) (the “1993 Registration
                Statement”)).3.2
            By-laws
                of the Registrant (incorporated herein by reference to Exhibit 3.2
                to the
                Registrant’s Registration Statement on Form S-1 (File No. 33-44027) (the
                “1992 Registration Statement”)).3.3
            Amendments
                to the By-laws of the Registrant adopted December 27, 1994 (incorporated
                herein by reference to Exhibit 3.3 of the Registrant’s Current Report on
                Form 8-K dated January 10, 1995).4.1
            Specimen
                certificate for the Common Stock (incorporated herein by reference
                to
                Exhibit 4.2 to the 1992 Registration Statement).4.2
            Warrant
                to Purchase Common Stock of the Registrant, dated October 12, 1999
                (incorporated herein by reference to Exhibit 4.4 to the Registrant’s
                Annual Report on Form 10-K for the year ended December 31, 2000 (the
“2000
                10-K”)).




-30-




4.3
            Securities
                Purchase Agreement, dated as of June 11, 2002, by and among the
                Registrant, Databit, Inc. and Laurus Master Fund, Ltd. (“Laurus”)
                (including the forms of convertible note and warrant) (incorporated
                herein
                by reference to Exhibit 10.1 to the Registrant’s Current Report on Form
                8-K dated June 11, 2002).4.4
            Purchase
                and Security Agreement, dated as of December 4, 2002, made by and
                between
                Comverge (“Comverge”) and Laurus (incorporated herein by reference to
                Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated December
                5, 2002 (the “December 2002 8-K”)).4.5
            Convertible
                Note, dated December 4, 2002, made by and among Comverge, Laurus
                and, as
                to Articles III and V only, the Registrant (incorporated herein by
                reference to Exhibit 10.2 to the December 2002 8-K).4.6
            Common
                Stock Purchase Warrant, dated December 5, 2002, issued by the Registrant
                to Laurus (incorporated herein by reference to Exhibit 10.3 to the
                December 2002 8-K).4.7
            Registration
                Rights Agreement, dated as of December 4, 2002, by and between the
                Registrant and Laurus (incorporated herein by reference to Exhibit
                10.4 to
                the December 2002 8-K).10.1
            Employment
                Agreement between the Registrant and George Morgenstern, dated as
                of
                January 1, 1997 (incorporated herein by reference to Exhibit 10.1
                to the
                Registrant’s Annual Report on Form 10-K for the year ended December 31,
                1997 (the “1997 10-K”)).*10.2
            Employment
                Agreement between the Registrant and Yacov Kaufman, dated as of January
                1,
                1999 (incorporated herein by reference to Exhibit 10.22 of the Registrants
                Annual Report on Form 10-K for the year ended December 31, 1999 (the
“1999
                10-K”)).*10.3
            1991
                Stock Option Plan (incorporated herein by reference to Exhibit 10.4
                to the
                1992 Registration Statement).*10.4
            1994
                Stock Incentive Plan, as amended. (incorporated herein by reference
                to
                Exhibit 10.4 to the Registrant’s Annual Report on Form 10-K for the year
                ended December 31, 2004(the “2004 10-K”)).*10.5
            1994
                Stock Option Plan for Outside Directors, as amended (incorporated
                herein
                by reference to Exhibit 10.5 to the Registrant’s Form 10-K for the year
                ended December 31, 1995 (the “1995 10-K”)).*10.6
            1995
                Stock Option Plan for Non-management Employees, as amended (incorporated
                herein by reference to Exhibit 10.6 to the 2004 10-K).*10.7
            Agreement
                dated January 26, 2002, between the Registrant and Bounty Investors
                LLC
                (incorporated herein by reference to Exhibit 10.12 to the 2000
                10-K).10.8
            Lease
                Agreement, dated February 5, 2002, between Duke-Weeks Realty Limited
                Partnership and Comverge, (incorporated herein by reference to Exhibit
                10.13 to the 2000 10-K).10.9
            Share
                Purchase Agreement, dated as of November 29, 2001, by and among the
                Registrant, Decision Systems Israel Ltd., Endan IT Solutions Ltd.,
                Kardan
                Communications Ltd., Neuwirth Investments Ltd., Jacob Neuwirth (Noy)
                and
                Adv. Yossi Avraham, as Trustee for Meir Givon (incorporatedhereinby
                reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K
                dated December 13, 2001).10.10
            Registration
                Rights Agreement, dated as of December 13, 2002, by and among the
                Registrant, Kardan Communications Ltd. and Adv. Yossi Avraham, as
                Trustee
                for Meir Givon (incorporated herein by reference to Exhibit 10.2
                to the
                Registrant’s Current Report on Form 8-K dated December 13,
                2002).




-31-




10.11
            First
                Amendment to Employment Agreement, dated as of May 17, 2002, by and
                between the Registrant and George Morgenstern (incorporated herein
                by
                reference to Exhibit 10.23 to theRegistrant’s
                Annual Report on Form 10-K for the year ended December 31,
                2001.*10.12
            Agreement,
                dated as of February 25, 2003, between the Registrant and J.P. Turner
                & Company, L.L.C. (incorporated herein by reference to Exhibit 10.25
                to theRegistrant’s
                Annual Report on Form 10-K for the year ended December 31, 2002 (the
                “2002
                10-K”).10.13
            Second
                Amendment to Employment Agreement, dated as of March 12, 2002, between
                the
                Registrant and George Morgenstern (incorporated herein by reference
                to
                Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for the
                quarter ended March 31, 2002).*10.14
            Amendment
                to Employment Agreement, dated as of June 1, 2002, between the Registrant
                and Yacov Kaufman (incorporated herein by reference to Exhibit 10.1
                to the
                Registrant’s Quarterly Report on Form 10-Q for the quarter ended September
                30, 2002).*10.15
            Preferred
                Stock Purchase Agreement, dated as of April 7, 2003, by and among
                Comverge, the Registrant and the other investors named therein
                (incorporated herein by reference to Exhibit 10.29 to the 2002
                10-K).10.16
            Investors’
                Rights Agreement, dated as of April 7, 2003, by and among Comverge,
                the
                Registrant and the investors and Comverge management named therein
                (incorporated herein by reference to Exhibit 10.30 to the 2002
                10-K).10.17
            Co-Sale
                and First Refusal Agreement, dated as of April 7, 2003, by and among
                Comverge, the Registrant and the investors and stockholders named
                therein
                (incorporated herein by reference to Exhibit 10.31 to the 2002
                10-K).10.18
            Voting
                Agreement, dated as of April 7, 2003, by and among Comverge, the
                Registrant and the other investors named therein (incorporated herein
                by
                reference to Exhibit 10.32 to the 2002 10-K).10.19
            Letter
                Agreement, dated as of April 1, 2003, by and between the Registrant
                and
                Laurus (incorporated herein by reference to Exhibit 10.33 to the
                2002
                10-K).10.20
            Employment
                Agreement dated as of August 19, 2004 and effective as of January
                1, 2004
                by and between the Registrant and Shlomie Morgenstern (incorporated
                herein
                by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form
                10-Q for the quarter ended September 30, 2004).*10.21
            Restricted
                Stock Award Agreement dated as of August 19, 2004, by and between
                the
                Registrant and Shlomie Morgenstern (incorporated herein by reference
                to
                Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q for the
                quarter ended September 30, 2004).*10.22
            Stock
                Option Agreement dated as of August 19, 2004, by and between Shlomie
                Morgenstern and the Registrant (incorporated herein by reference
                to
                Exhibit 10.3 to the Registrant’s Quarterly Report on Form 10-Q for the
                quarter ended September 30, 2004).*10.23
            Second
                Amended and Restated Co-Sale And First Refusal Agreement dated as
                of
                October 26, 2004, by and among Comverge, Inc., the Registrant and
                other
                persons party thereto (incorporated herein by reference to Exhibit
                10.4 to
                the Registrant’s Quarterly Report on Form 10-Q for the quarter ended
                September 30, 2004).10.24
            Third
                Amendment to Employment Agreement, dated as of December 30, 2004,
                between
                the Registrant and George Morgenstern(incorporated
                herein by reference to Exhibit 10.34 of the Registrant’s Annual Report on
                Form 10-K for the year ended December 31, 2004 (the “2004
                10-K”).*10.25
            Form
                of Stock Option Agreement to employees under the 1994 Stock Incentive
                Plan(incorporated
                herein by reference to Exhibit 10.35 of the 2004
                10-K).




-32-




10.26
            Form
                of Stock Option Agreement under the 1994 Stock Option Plan for Outside
                Directors(incorporated herein by reference to Exhibit 10.36 of the 2004
                10-K).10.27
            Form
                of Stock Option Agreement under the 1995 Stock Option Plan for
                Nonmanagement Employees(incorporated herein by reference to Exhibit 10.37 of the 2004
                10-K).10.28
            Stock
                Option Agreement dated as of December 30, 2004 by and between George
                Morgenstern and the Registrant(incorporated herein by reference to Exhibit 10.38 of the 2004
                10-K).*10.29
            Stock
                Option Agreement dated as of December 30, 2004 by and between Yacov
                Kaufman and the Registrant(incorporated herein by reference to Exhibit 10.39 of the 2004
                10-K).*10.30
            Stock
                Option Agreement dated as of December 30, 2004 by and between Sheldon
                Krause and the Registrant(incorporated herein by reference to Exhibit 10.35 of the 2004
                10-K).*10.31
            Stock
                Purchase Agreement dated as of March 9, 2006 by and between Shlomie
                Morgenstern, Databit Inc., and Data Systems & Software Inc.
                (incorporated herein by reference to Exhibit 10.1 tothe
                Registrant’s Current Report on Form 8-K dated March 16, 2006 (the “2006
                8-K”)).10.32
            Termination
                and Release Agreement dated as of March 9, 2006 by and between Shlomie
                Morgenstern and Data Systems and Software Inc. (incorporated herein
                by
                reference to Exhibit A to Exhibit 10.1 to the 2006 8-K).*10.33
            Amendment
                Agreement to GM Employment Agreement dated as of March 9, 2006 by
                and
                between George Morgenstern and Data Systems & Software Inc.
                (incorporated herein by reference to Exhibit B to Exhibit 10.1 to
                the 2006
                8-K).*10.34
            Amendment
                Agreement to Purchaser Option Agreements and Restricted Stock Award
                Agreement dated as of March 9, 2006 by and between Shlomie Morgenstern
                and
                Data System’s and Software Inc. (incorporated herein by reference to
                Exhibit C to Exhibit 10.1 to the 2006 8-K).*10.35
            Amendment
                Agreement to GM Option Agreements and Restricted Stock Agreement
                dated as
                of March 9, 2006 by and between George Morgenstern and Data System’s &
                Software Inc. (incorporated herein by reference to Exhibit D to Exhibit
                10.1 to the 2006 8-K).*10.36
            Consulting
                Agreement dated as of March 9, 2006 by and between George Morgenstern
                and
                Data Systems & Software Inc. (incorporated by reference to Exhibit E
                to Exhibit 10.1 to the 2006 8-K).*10.37
            Form
                of Consent Agreement (incorporated herein by reference to Exhibit
                F to
                Exhibit 10.1 to the 2006 8-K.).14.1
            Code
                of Ethics of the Registrant (incorporated herein by reference to
                Exhibit
                14.1 to the Registrant’s Annual Report on Form 10-K for the year ended
                December 31, 2003).#21.1
            List
                of subsidiaries.#23.1
            Consent
                of Kesselman & Kesselman CPA.#23.2
            Consent
                ofPricewaterhouseCoopers
                LLP.#31.1
            Certification
                pursuant to Section 302 of the Sarbanes-Oxley Act of
                2002.#31.2
            Certification
                pursuant to Section 302 of the Sarbanes-Oxley Act of
                2002.#32.1
            Certification
                pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002.#32.2
            Certification
                pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002.


________________


*
            This
                exhibit includes a management contract, compensatory plan or arrangement
                in which one or more directors or executive officers of the Registrant
                participate.


#
            This
                Exhibit is filed or furnished
                herewith.




-33-




**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, the Registrant has duly caused this report to be signed on its behalf
      by
      the undersigned, thereunto duly authorized, in the Township of Mahwah, State
      of
      New Jersey, on April 11, 2006.




Data
                Systems & Software Inc.By:
            /s/
              John
              A. MooreJohn
                A. MoorePresident
              and Chief Executive Officer


Pursuant
        to the requirements of the Securities Exchange Act of 1934, this report has
        been
        signed by the following persons on behalf of the registrant, in the capacities
        and on the dates indicated.
 
 **Signature**
              
              **Title**
              **Date**/s/
John
                  A. MooreJohn
                  A. Moore
              
              President;
                  Chief Executive Officer; and Director
              April
                  11, 2006/s/
                  George MorgensternGeorge
                  Morgenstern
              
              Chairman
                  of the Board and Director
              April
                    11, 2006/s/
                    Michael BarthMichael
                  Barth
              
              Chief
                  Financial Officer (Principal Financial Officer and Principal Accounting
                  Officer)
              April
                    11, 2006/s/
                  Shane YurmanShane
                  Yurman
              
              Director,
                  Chairman of the Audit Committee
              April
                    11, 2006/s/
                  Elihu LevineElihu
                  Levine
              
              Director,
                  Member of the Audit Committee
              April
                    11, 2006/s/
                  Samuel ZentmanSamuel
                  Zentman
              
              Director,
                  Member of the Audit Committee
              April
                    11, 2006





-34-







**DATA
      SYSTEMS & SOFTWARE INC.**


**INDEX
      TO CONSOLIDATED FINANCIAL STATEMENTS**







CONSOLIDATED
      FINANCIAL STATEMENTS OF DATA SYSTEMS & SOFTWARE INC.:




Report
                  of Independent Registered Public Accounting Firm
              F-2Consolidated
                  Balance Sheets
                as
                    of December 31, 2005 and December 31, 2004
              F-3Consolidated
                  Statements of Operations
                  for
                    the years ended December 31, 2005, December 31, 2004 and December
                    31,
                    2003
              F-4Consolidated
                  Statements of Changes in Shareholders’ Equity
                for
                    the years ended December 31, 2005, December 31, 2004 and December
                    31,
                    2003
              F-5Consolidated
                  Statements of Cash Flows
                for
                  the years ended December 31, 2005, December 31, 2004 and December
                  31,
                  2003
              F-6Notes
                  to Consolidated Financial Statements.
              F-8










**Report
      of Independent Registered Public Accounting Firm**












To
      the
      Board of Directors and Shareholders of


Data
      Systems & Software Inc.





We
      have
      audited the consolidated balance sheets of Data Systems & Software Inc. (the
“Company”) and its subsidiaries as of December 31, 2005 and 2004, and the
      related consolidated statements of operations, changes in shareholders’ equity
      and cash flows for each of the three years in the period ended December 31,
      2005. These financial statements are the responsibility of the Company’s Board
      of Directors and management. Our responsibility is to express an opinion on
      these financial statements based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by the Company’s Board of Directors and management,
      as well as evaluating the overall financial statement presentation. We believe
      that our audits provide a reasonable basis for our opinion.





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the consolidated financial position of the Company and its
      subsidiaries as of December 31, 2005 and 2004 and the results of their
      operations and of their cash flows for each of the three years in the period
      ended December 31, 2005, in conformity with accounting principles generally
      accepted in the United States of America.











April
      11,
      2006





/s/
      Kesselman & Kesselman


Certified
      Public Accountants


A
      member
      of PricewaterhouseCoopers International Limited


Tel-Aviv,
      Israel







F-
          2




**DATA
      SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES**


**CONSOLIDATED
      BALANCE SHEETS**


**(IN
      THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)**




ASSETS
            
            **As
                of December 31,****2004**
            
            **2005**Current
                assets:Cash
                and cash equivalents
            
            $
            685
            
            $
            913Short-term
                bank deposits
            
            
            72
            
            
            —Restricted
                cash
            
            
            354
            
            
            247Restricted
                cash (under agreement with a related party)
            
            
            —
            
            
            300Accounts
                receivable, net
            
            
            6,069
            
            
            4,096Unbilled
                work-in-process
            
            
            533
            
            
            348Inventory
            
            
            61
            
            
            25Other
                current assets
            
            
            540
            
            
            709Total
                current assets
            
            
            8,314
            
            
            6,638Property
                and equipment, net
            
            
            649
            
            
            500Other
                assets
            
            
            737
            
            
            334Funds
                in respect of employee termination benefits
            
            
            2,836
            
            
            1,441Restricted
                cash - non-current (under agreement with a related party)
            
            
            —
            
            
            1,050Goodwill
            
            
            4,408
            
            
            129Other
                intangible assets, net
            
            
            81
            
            
            81Total
                assets
            
            $
            17,025
            
            $
            10,173LIABILITIES
                AND SHAREHOLDERS’ EQUITYCurrent
                liabilities:Short-term
                bank credit
            
            $
            729
            
            $
            130Current
                maturities of long-term debt
            
            
            466
            
            
            160Trade
                accounts payable
            
            
            2,283
            
            
            1,950Accrued
                payroll, payroll taxes and social benefits
            
            
            1,735
            
            
            740Other
                current liabilities
            
            
            2,227
            
            
            2,200Total
                current liabilities
            
            
            7,440
            
            
            5,180Long-term
                liabilities:Investment
                in Comverge, net
            
            
            1,444
            
            
            1,824Long-term
                debt
            
            
            201
            
            
            75Liability
                for employee termination benefits
            
            
            4,279
            
            
            2,264Other
                liabilities
            
            
            65
            
            
            10Total
                long-term liabilities
            
            
            5,989
            
            
            4,173Commitments
                and contingencies (Note 12)Minority
                interests
            
            
            1,471
            
            
            —Shareholders’
                equity:Common
                stock - $0.01 par value per share:Authorized
                - 20,000,000 shares; Issued -8,937,395 shares
              At
                December 31, 2004 and 2005
            
            
            88
            
            
            88Additional
                paid-in capital
            
            
            39,733
            
            
            40,011Warrants
            
            
            461
            
            
            183Deferred
                stock-based compensation
            
            
            (59
            )
            
            (36
            )Accumulated
                deficit
            
            
            (34,290
            )
            
            (35,608
            )Treasury
                stock, at cost - 820,704 shares for December 31, 2004 and 2005
            
            
            (3,791
            )
            
            (3,791
            )Accumulated
                other comprehensive loss
            
            
            (17
            )
            
            (27
            )Total
                shareholders’ equity
            
            
            2,125
            
            
            820Total
                liabilities and shareholders’ equity
            
            $
            17,025
            
            $
            10,173




The
      accompanying notes are an integral part of these consolidated financial
      statements.




F-
          3




**DATA
      SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**(IN
      THOUSANDS, EXCEPT NET LOSS PER SHARE DATA)**






**Year
                  Ended December 31,****2003**
              
              **2004**
              
              **2005**Sales:Products
              
              $
              22,006
              
              $
              18,034
              
              $
              17,471Projects
              
              
              5,070
              
              
              3,798
              
              
              4,239Other
              
              
              —
              
              
              —
              
              
              154Total
                  sales
              
              
              27,076
              
              
              21,832
              
              
              21,864Cost
                  of sales:Products
              
              
              18,201
              
              
              14,609
              
              
              14,397Projects
              
              
              3,708
              
              
              2,606
              
              
              2,929Other
              
              
              —
              
              
              —
              
              
              120Total
                  cost of sales
              
              
              21,909
              
              
              17,215
              
              
              17,446Gross
                  profit
              
              
              5,167
              
              
              4,617
              
              
              4,418Operating
                  expenses:Research
                  and development expenses, net
              
              
              153
              
              
              30
              
              
              53Selling,
                  marketing, general and administrative expenses
              
              
              10,259
              
              
              7,137
              
              
              6,543Total
                  operating expenses
              
              
              10,412
              
              
              7,167
              
              
              6,596Operating
                  loss
              
              
              (5,245
              )
              
              (2,550
              )
              
              (2,178
              )Interest
                  income
              
              
              46
              
              
              31
              
              
              29Interest
                  expense
              
              
              (738
              )
              
              (118
              )
              
              (99
              )Other
                  income (expense), net
              
              
              (322
              )
              
              240
              
              
              6Loss
                  before taxes on income
              
              
              (6,259
              )
              
              (2,397
              )
              
              (2,242
              )Taxes
                  on income
              
              
              (40
              )
              
              31
              
              
              (38
              )Loss
                  from operations of the Company and its consolidated
                  subsidiaries
              
              
              (6,219
              )
              
              (2,428
              )
              
              (2,204
              )Share
                  in losses of Comverge
              
              
              (1,752
              )
              
              (1,242
              )
              
              (380
              )Gain
                  on sale of shares in Comverge
              
              
              —
              
              
              705
              
              
              —Minority
                  interests
              
              
              264
              
              
              (90
              )
              
              (73
              )Net
                  loss from continuing operations
              
              
              (7,707
              )
              
              (3,055
              )
              
              (2,657
              )Gain
                  on sale of discontinued operations, net of tax
              
              
              —
              
              
              —
              
              
              541Net
                  income from discontinued operations, net of tax
              
              
              1,425
              
              
              1,883
              
              
              798Net
                  loss
              
              $
              (6,282
              )
              $
              (1,172
              )
              $
              (1,318
              )Basic
                  and diluted net income (loss) per share:Loss
                  per share from continuing operations
              
              $
              (1.00
              )
              $
              (0.38
              )
              $
              (0.32
              )Discontinued
                  operations
              
              
              0.19
              
              
              0.23
              
              
              0.16Net
                  loss per share
              
              $
              (0.81
              )
              $
              (0.15
              )
              $
              (0.16
              )Weighted
                  average number of shares
                outstanding
                  - basic and diluted
              
              
              7,738
              
              
              7,976
              
              
              8,117




The
      accompanying notes are an integral part of these consolidated financial
      statements.





F-
          4




**DATA
      SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY**


**(IN
      THOUSANDS)**





Number
                of Shares
            
            Common
                Stock
            
            Additional
              Paid-In
              Capital
            
            Warrants
            
            Stock-Based
                Deferred Compensation
            
            Accumulated
                Deficit
            
            Treasury
                Stock
            
            Shareholder’s
                Note
            
            Accumulated
                Other Comprehensive Loss
            
            TotalBalances
                as of December 31, 2002
            
            
            8,162
            
            $
            82
            
            $
            37,687
            
            $
            364
            
            $
            (7
            )
            $
            (26,787
            )
            $
            (3,913
            )
            $
            (298
            )
            $
            —
            
            $
            7,128Net
                loss
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (6,282
            )
            
            —
            
            
            —
            
            
            —
            
            
            (6,282
            )Amortization
                of stock-based deferred compensation
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            7
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            7Issuance
                of restricted shares as compensation
            
            
            50
            
            
            *
            
            
            50
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            50Exercise
                of options
            
            
            2
            
            
            *
            
            
            (25
            )
            
            —
            
            
            —
            
            
            —
            
            
            41
            
            
            —
            
            
            —
            
            
            16Issuance
                of shares in lieu of debt repayment
            
            
            127
            
            
            1
            
            
            239
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            240Conversion
                of line of credit, net of professional fees
            
            
            400
            
            
            4
            
            
            559
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            563Issuance
                of warrants for professional services
            
            
            —
            
            
            —
            
            
            —
            
            
            97
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            97Purchase
                of treasury shares
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (2
            )
            
            —
            
            
            —
            
            
            (2
            )Write
                off of stockholder’s note
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            298
            
            
            —
            
            
            298Equity
                from issuance of shares by Comverge
            
            
            —
            
            
            —
            
            
            1,085
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            1,085Balances
                as of December 31, 2003
            
            
            8,741
            
            $
            87
            
            $
            39,595
            
            $
            461
            
            $
            —
            
            $
            (33,069
            )
            $
            (3,874
            )
            $
            —
            
            $
            —
            
            $
            3,200Net
                loss
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (1,172
            )
            
            —
            
            
            —
            
            
            —
            
            
            (1,172
            )Differences
                from translation of subsidiaries’ financial statements
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (17
            )
            
            (17
            )Comprehensive
                loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (1,189
            )Issuance
                of restricted shares as compensation
            
            
            195
            
            
            1
            
            
            70
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            71Exercise
                of options
            
            
            1
            
            
            *
            
            
            —
            
            
            —
            
            
            —
            
            
            (49
            )
            
            83
            
            
            —
            
            
            —
            
            
            34Issuance
                of stock-based deferred compensation
            
            
            —
            
            
            —
            
            
            68
            
            
            —
            
            
            (68
            )
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Amortization
                of stock-based deferred compensation
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            9
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            9Balances
                as of December 31, 2004
            
            
            8,937
            
            $
            88
            
            $
            39,733
            
            $
            461
            
            $
            (59
            )
            $
            (34,290
            )
            $
            (3,791
            )
            $
            —
            
            $
            (17
            )
            $
            2,125Net
                loss
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (1,318
            )
            
            —
            
            
            —
            
            
            —
            
            
            (1,318
            )Differences
                from translation of subsidiaries’ financial statements associated with
                sale of dsIT Technologies
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            22
            
            
            22Differences
                from translation of subsidiaries’ financial statements
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (32
            )
            
            (32
            )Comprehensive
                loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (1,328
            )Amortization
                of stock-based deferred compensation
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            23
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            23Expiration
                of warrants
            
            
            —
            
            
            —
            
            
            278
            
            
            (278
            )
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Balances
                as of December 31, 2005
            
            
            8,937
            
            $
            88
            
            $
            40,011
            
            $
            183
            
            $
            (36
            )
            $
            (35,608
            )
            $
            (3,791
            )
            $
            —
            
            $
            (27
            )
            $
            820




*
      Less
      than $1


The
      accompanying notes are an integral part of these consolidated financial
      statements.




F-
          5




**DATA
      SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(IN
      THOUSANDS)**




**2003**
            
            **2004**
            
            **2005**Cash
                flows used in operating activities:Net
                loss
            
            $
            (6,282
            )
            $
            (1,172
            )
            $
            (1,318
            )Adjustments
                to reconcile net loss to net cash used in operating activities (see
                Schedule A)activities--see
                Schedule A
            
            
            5,332
            
            
            1,081
            
            
            (431
            )Net
                cash used in operating activities
            
            
            (950
            )
            
            (91
            )
            
            (1,749
            )Cash
                flows provided by investing activities:Withdrawal
                of long-term deposit
            
            
            5,700
            
            
            —
            
            
            —Investment
                in short-term bank deposits
            
            
            —
            
            
            (72
            )
            
            —Maturity
                of short-term bank deposits
            
            
            —
            
            
            —
            
            
            72Amounts
                funded for employee termination benefits
            
            
            (474
            )
            
            (495
            )
            
            (558
            )Utilization
                of employee termination benefits
            
            
            235
            
            
            38
            
            
            687Acquisitions
                of property and equipment
            
            
            (231
            )
            
            (94
            )
            
            (240
            )Acquisitions
                of intangibles
            
            
            —
            
            
            —
            
            
            (36
            )Proceeds
                from the sale of Comverge shares
            
            
            —
            
            
            975
            
            
            —Proceeds
                from the sale of property and equipment
            
            
            16
            
            
            65
            
            
            152Restricted
                cash (under agreement to a related party)
            
            
            —
            
            
            —
            
            
            (1,350
            )Restricted
                cash
            
            
            21
            
            
            (3
            )
            
            (3
            )Business
                dispositions - see Schedule C
            
            
            (3,644
            )
            
            —
            
            
            3,431Net
                cash provided by investing activities
            
            
            1,623
            
            
            414
            
            
            2,155Cash
                flows provided by (used in) financing activities:Purchase
                of treasury stock
            
            
            (2
            )
            
            —
            
            
            —Issuance
                of subsidiary shares to minority interests
            
            
            22
            
            
            —
            
            
            —Proceeds
                from employee stock option exercises
            
            
            16
            
            
            34
            
            
            —Proceeds
                from note payable to a related party
            
            
            —
            
            
            —
            
            
            425Repayment
                of note payable to a related party
            
            
            —
            
            
            —
            
            
            (425
            )Short-term
                bank credit, net
            
            
            (881
            )
            
            (239
            )
            
            182Proceeds
                from borrowings of long-term debt
            
            
            835
            
            
            —
            
            
            90Repayments
                of long-term debt
            
            
            (600
            )
            
            (646
            )
            
            (450
            )Net
                cash used in financing activities
            
            
            (610
            )
            
            (851
            )
            
            (178
            )Net
                increase (decrease) in cash and cash equivalents
            
            
            63
            
            
            (528
            )
            
            228Cash
                and cash equivalents at beginning of year
            
            
            1,150
            
            
            1,213
            
            
            685Cash
                and cash equivalents at end of year
            
            $
            1,213
            
            $
            685
            
            $
            913Supplemental
                cash flow information:Cash
                paid during the year for:Interest
            
            $
            328
            
            $
            151
            
            $
            144Income
                taxes
            
            $
            136
            
            $
            90
            
            $
            52




The
      accompanying notes are an integral part of these consolidated financial
      statements.




F-
          6




**DATA
      SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES**


**SCHEDULES
      TO CONSOLIDATED STATEMENTS OF CASH FLOWS**


**(DOLLARS
      IN THOUSANDS)**





**2003**
            
            **2004**
            
            **2005**A.
                Adjustments to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization.
            
            $
            527
            
            $
            227
            
            $
            254Change
                inminority
                interestsactivities--see
                Schedule A
            
            
            (264
            )
            
            90
            
            
            73Share
                in losses of ComvergeProducts
            
            
            1,752
            
            
            1,242
            
            
            380Change
                in deferred taxes
            
            
            (98
            )
            
            24
            
            
            (81
            )Increase
                (decrease) in liability for employee termination benefits
            
            
            739
            
            
            558
            
            
            (277
            )Gain
                on sale of Comverge shares
            
            
            —
            
            
            (705
            )
            
            —Gain
                on sale of dsIT Technologies Ltd.
            
            
            —
            
            
            —
            
            
            (541
            )Loss
                on write-off of stockholder’s note
            
            
            298
            
            
            —
            
            
            —Gain
                on sale of property and equipment, net
            
            
            (47
            )
            
            (2
            )
            
            (6
            )Stock
                and stock option compensation
            
            
            57
            
            
            80
            
            
            23Accretion
                of discount on convertible debt and amortization of related
                costs
            
            
            500
            
            
            —
            
            
            —Other
            
            
            70
            
            
            21
            
            
            (71
            )Changes
                in operating assets and liabilities:Decrease
                in accounts receivable, unbilled work-in- process, other current
                assets
                and other assets
            
            
            3,108
            
            
            424
            
            
            1,210Decrease
                in inventory
            
            
            293
            
            
            27
            
            
            36Decrease
                in accounts payable, other current liabilities and other
                liabilities
            
            
            (1,603
            )
            
            (483
            )
            
            (1,431
            )Decrease
                in the liabilities of US based consulting business
            
            
            —
            
            
            (422
            )
            
            —$
            5,332
            
            $
            1,081
            
            $
            (431
            )B.
                Non-cash investing and financing activities:Issuance
                of common stock in lieu of debt repayment
            
            $
            803Increase
                in investment in Comverge from issuance of preferred and common stock
                credited to additional paid-in capital
            
            $
            1,085Accrued
                expenses incurred in investment of Comverge
            
            $
            200Issuance
                of subsidiary shares to minority interest in lieu of balance
                due
            
            
            
            
            $
            22Increase
                in goodwill from sale of dsIT Technologies
            
            
            
            
            
            
            
            $
            79C.Net
                cash provided by the sale of dsIT Technologies.:Current
                assets
            
            
            
            
            
            
            
            $
            1,152Non-current
                assets
            
            
            
            
            
            
            
            
            1,114Goodwill
                disposed
            
            
            
            
            
            
            
            
            4,358Differences
                from translation of dsIT Technologies financial statements
            
            
            
            
            
            
            
            
            22Goodwill
                acquired
            
            
            
            
            
            
            
            
            (79
            )Short-term
                debt
            
            
            
            
            
            
            
            
            (781
            )Current
                liabilities
            
            
            
            
            
            
            
            
            (256
            )Other
                liabilities
            
            
            
            
            
            
            
            
            (1,461
            )Minority
                interests
            
            
            
            
            
            
            
            
            (1,552
            )Gain
                on sale of dsIT Technologies Ltd.
            
            
            
            
            
            
            
            
            541Deferred
                taxes on gain on sale of dsIT Technologies Ltd.
            
            
            
            
            
            
            
            
            373$
            3,431Net
                cash used in the disposition of Comverge:Current
                assets
            
            $
            4,634Property,
                equipment and other assets
            
            
            1,190Goodwill
            
            
            499Intangibles
            
            
            214Short-term
                debt
            
            
            (3,880
            )Current
                liabilities
            
            
            (2,340
            )Other
                liabilities
            
            
            (517
            )Cash
                investment in Comverge
            
            
            (3,444
            )$
            (3,644
            )




The
      accompanying notes are an integral part of these consolidated financial
      statements.




F-
          7




**NOTE
      1—NATURE OF OPERATIONS**




(a)
      Description of Business




Data
      Systems & Software Inc., a Delaware corporation (“DSSI”), through its
      subsidiaries (collectively, the “Company”) and its equity investment in Comverge
      Inc. (“Comverge”), (i) provides software consulting and development services
      (ii) is an authorized dealer
      and a value-added-reseller of computer hardware, and (iii) provides energy
      intelligence solutions for utilities and energy companies (through Comverge,
      whose results were consolidated up to March 31, 2003 (see Note 4)). The
      Company’s operations are based in the United States and in Israel .
      DSSI’s
      shares are traded on the OTC Bulletin Board. In June 2005, the Company’s Israeli
      operations were reorganized with all project activities being conducted through
      its dsIT Solutions Ltd. subsidiary and all outsourcing consulting services
      being
      conducted through its dsIT Technologies Ltd. subsidiary. In August 2005, dsIT
      Technologies and its associated outsourcing consulting activities was sold
      by
      the Company and the other shareholders of dsIT Technologies (see Note 3). On
      March 10, 2006, the Company sold its Databit Inc. subsidiary which comprises
      the
      entire computer hardware segment (see Note 18(a)).




(b)
      Financing of Operations




The
      working capital of $1,458 at December 31, 2005, included working capital of
      $664
      in the Company’s Israeli subsidiary (dsIT Solutions). Due to Israeli tax and
      company law constraints and dsIT Solutions’ own cash flow requirements, working
      capital and cash flows from dsIT Solutions are not readily available to finance
      US based activities.




dsIT
      Solutions was utilizing approximately $130 of its approximately $335 lines
      of
      credit as of December 31, 2005. dsIT Solutions’ lines of credit are denominated
      in NIS and bear a weighted average interest rate of the Israeli prime rate plus
      2.5% per
      annum. The Israeli prime rate fluctuates and as of December 31, 2005 was
      approximately 6.0%.




The
      Company intends to fund its US activities with the cash available, including
      from the sale of Databit and restricted funds released as a result of the
      Databit sales transaction (see Note 18(a)). The Company continues to consider
      additional financing transactions. Should the Company need additional liquidity
      to finance its US activities and should it be unsuccessful in completing a
      timely transaction providing the necessary liquidity, it may not have sufficient
      funds to finance its US activities.




(c)
      Accounting Principles




The
      consolidated financial statements have been prepared in conformity with
      accounting principles generally accepted in the United States of
      America.




(d)
      Use
      of Estimates in Preparation of Financial Statements




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




**NOTE
      2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**




**Functional
      Currency and Foreign Currency Transactions**




The
      currency of the primary economic environment in which the operations of DSSI
      and
      its US subsidiaries are conducted is the United States dollar (“dollar”).
      Accordingly, the Company and all of its US subsidiaries use the dollar as their
      functional currency. The financial statements of the Company’s Israeli
      subsidiary whose functional currency is the New Israeli Shekel (“NIS”) have been
      translated in accordance with Statement of Financial Accounting Standards
      (“SFAS”) 52 of the Financial Accounting Standards Board of the United States
      (“FASB”) assets and liabilities are translated at year-end exchange rates, while
      operating results items are translated at the exchange rate in effect on the
      date of the transaction. Differences resulting from translation are presented
      in
      shareholders’ equity as accumulated other comprehensive loss. All exchange gains
      and losses denominated in non-functional currencies are reflected in other
      income (loss), net, in the consolidated statement of operations when they arise.




F-
          8




**Principles
      of Consolidation and Presentation**




The
      consolidated financial statements of the Company include the accounts of all
      majority-owned subsidiaries. All intercompany balances and transactions have
      been eliminated. Minority interests in net losses are limited to the extent
      of
      their equity capital. Losses in excess of minority interest equity capital
      are
      charged against the Company.




**Cash
      Equivalents**




The
      Company considers all highly liquid investments, which include short-term bank
      deposits (up to three months from date of deposit) that are not restricted
      as to
      withdrawal or use, to be cash equivalents.




**Inventory**




Inventories
      are stated at the lower of cost or market. Cost is determined on the first-in,
      first-out method for merchandise inventory and parts and supplies. Inventory
      is
      primarily comprised of merchandise inventory.




**Investment
      in Associated Companies**




An
      associated company is a company over which significant influence is exercised.
      The Company’s investment in Comverge is comprised of investment in common and
      preferred shares. The Company considers Comverge preferred shares to be
      in-substance common stock as defined in Emerging Issues Task Force (“EITF”)
      Issue No. 02-14 “Whether the Equity Method of Accounting Applies When an
      Investor Does Not Have an Investment in Voting Stock of an Investee but
      Exercises Significant Influence Through Other Means”. Thus, since March 31,
      2003, the entire investment in Comverge is accounted for by the equity method.




**Property
      and Equipment**




Property
      and equipment are presented at cost at the date of acquisition. Depreciation
      and
      amortization is calculated based on the straight-line method over the estimated
      useful lives of the depreciable assets, or in the case of leasehold
      improvements, the shorter of the lease term or the estimated useful life of
      the
      asset. Improvements are capitalized while repairs and maintenance are charged
      to
      operations as incurred.




**Goodwill
      and Acquired Intangible Assets**




Goodwill
      represents the excess of cost over the fair value of net assets of businesses
      acquired. Under SFAS No. 142, goodwill and intangible assets determined to
      have
      an indefinite useful life are not amortized, but instead are tested for
      impairment at least annually. SFAS No. 142 also requires that intangible assets
      with estimable useful lives be amortized over their respective estimated useful
      lives to their estimated residual values, and reviewed for impairment in
      accordance with SFAS No. 144, “Accounting for Impairment or Disposal of
      Long-Lived Assets”.




SFAS
      No.
      142 requires the Company to assess annually whether there is an indication
      that
      goodwill is impaired, or more frequently if events and circumstances indicate
      that the asset might be impaired during the year. The Company performs its
      annual impairment test at the conclusion of its annual budget process, in the
      fourth quarter of each year. The Company has identified its operating segments
      as its reporting units for purposes of the impairment test and assigned its
      goodwill and intangible assets to its software consulting and development
      segment. The Company determines the carrying value of each reporting unit by
      assigning the assets and liabilities, including the existing goodwill and
      intangible assets, to those reporting units. The Company then determines the
      fair value of each reporting unit and compares 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.




Identifiable
      intangible assets deemed to have an indefinite life are tested annually for
      impairment, or more frequently if events and circumstances indicate that the
      asset might be impaired during the year. An impairment loss is recognized to
      the
      extent that the carrying amount exceeds the asset's fair value as determined
      based on discounted cash flows associated with the asset. The Company has not
      identified any indefinite life intangible assets.




F-
          9




The
      costs
      of software licenses are presented at estimated fair value at acquisition date.
      These costs are amortized on a straight-line basis over the term of the license
      or estimated useful life of the software licenses, generally five years.




**Impairment
      of Long-Lived Assets**




Under
      SFAS No. 144, long-lived assets including certain intangible assets are to
      be reviewed for impairment whenever events or changes in circumstances indicate
      that the carrying amount of an asset may not be recoverable. Recoverability
      of
      assets to be held and used is measured by a comparison of the carrying amount
      of
      an asset to the undiscounted future net cash flows expected to be generated
      by
      the asset. If the carrying amount of an asset exceeds its estimated future
      undiscounted cash flows, an impairment charge is recognized by the amount by
      which the carrying amount of the asset exceeds the fair value of the asset.




**Treasury
      Stock**




Company
      shares held by the Company are presented as a reduction of shareholders’ equity,
      at their cost to the Company. Losses, from the reissuance of treasury stock
      are
      reflected in accumulated deficit.




**Revenue
      Recognition**




Revenues
      from time-and-materials service contracts, maintenance agreements and other
      services are recognized as services are provided.




In
      accordance with Statement of Position (“SOP”) No. 97-2 “Software Revenue
      Recognition”, revenues from fixed-price contracts which require significant
      production, modification and/or customization to customer specifications are
      recognized using the percentage-of-completion method in conformity with
      Accounting Research Bulletin (“ARB”) No. 45 “Long-Term Construction-Type
      Contracts” and SOP No. 81-1 “Accounting for Performance of Construction-Type and
      Certain Production-Type Contracts . The
      percentage-of-completion is determined based on labor hours incurred.
      Percentage-of-completion estimates are reviewed periodically, and any
      adjustments required are reflected in the period when such estimates are
      revised. Losses on contracts, if any, are recognized in the period in which
      the
      loss is determined.




Unbilled
      work-in-process represents revenues, primarily from fixed price projects, that
      have not been invoiced to the customer as of the end of the period. Such amounts
      are generally billed upon the completion of a project milestone.




Revenues
      from the sale of software licenses are recognized when a license agreement
      exists, delivery has occurred, the license fee is fixed or determinable, and
      collectibility is reasonably assured. Such sales of software licenses are
      incidental to the Company’s sale of hardware products. The Company also provides
      integration and maintenance services along with its computer hardware sales.
      These integration and maintenance services are subject to an agreement separate
      from the Company’s sale of its primary hardware sales. Integration services,
      when provided, are based on hourly rates commensurate with market rates. Revenue
      from these services is recognized at the time the service is provided.




Maintenance
      and subscription contracts are sold separately and are priced based upon
      predetermined price lists. Maintenance and subscription revenue is recognized
      ratably over the contract period (generally 12 to 24 months).




Revenues
      from the sale of products (primarily hardware which generally includes
      pre-loaded off-the-shelf software) are recognized when the products are shipped
      provided that appropriate signed documentation of the arrangement, such as
      a
      signed contract, purchase order or letter of agreement, has been received,
      the
      fee is fixed or determinable and collectibility is reasonably assured. The
      software included in the sale of these products is incidental to the sale of
      the
      hardware products .




In
      accordance with EITF Issue No. 99-19 “Recording Revenue Gross as a Principal
      Versus Net as an Agent”, revenue from drop-shipments of third-party hardware and
      software sales are recognized upon delivery, and recorded at the gross amount
      when the Company is responsible for fulfillment of the customer order, has
      latitude in pricing, has discretion in the selection of the supplier, customizes
      the product to the customer’s specifications and has credit risk from the
      customer.




F-
          10




**Shipping
      and Handling of Products**




Amounts
      billed to customers for shipping and handling of products are included in net
      sales and were approximately $373, $452 and $392 for the years ended December
      31, 2003, 2004 and 2005, respectively. Costs incurred related to shipping and
      handling of products are included in cost of goods sold.




**Warranty
      Provision**




The
      Company grants its customers one-year product warranty. No provision was made
      in
      respect of warranties based on the Company’s previous history.




**Concentration
      of Credit Risk - Allowance for Doubtful Accounts**




Financial
      instruments, which potentially subject the Company to concentrations of credit
      risk, consist principally of cash and cash equivalents and trade receivables.
      The counter-party to a majority of the Company’s cash equivalent deposits as
      well as its short-term bank deposits is a major financial institution of high
      credit standing. The Company does not believe there is significant risk of
      non-performance by the counterparty. Approximately 34 %
      and 37%
      of the trade accounts receivable at December 31, 2005 and 2004, respectively,
      were due from a US customer that pays its trade receivables over usual credit
      periods (as to revenues from such customer - see Note 16(d)). Credit risk with
      respect to the balance of trade receivables is generally diversified due to
      the
      large number of entities comprising the Company’s customer base.




An
      appropriate allowance for doubtful accounts is included in respect of specific
      debts of
      which collection
      is in doubt. The Company performs ongoing credit evaluations of its customers
      and does not require collateral.




**Research
      and Development Expenses**




Research
      and development costs consisting primarily of labor and related costs are
      charged to operations as incurred. Participation by third parties in the
      Company’s research and development costs are netted against costs
      incurred.




**Advertising
      Expenses**




Advertising
      expenses are charged to operations
      as incurred. Advertising expense was
      $30,
      $14 and $43
      for the years ended December 31, 2003, 2004 and 2005, respectively.




**Issuance
      of Stock of Subsidiary**




The
      Company recognizes gains and losses from the issuance of subsidiary stock
      through the consolidated statement of operations. In non-cash transactions,
      when
      the assurance as to the reliability of the fair value of the non-cash asset
      received is difficult to determine, gains are recorded in additional paid-in
      capital.




**Stock-Based
      Compensation**




The
      Company applies Accounting Principles Board Opinion (“APB”) No. 25, “Accounting
      for Stock Issued to Employees” and the related interpretations in accounting for
      its stock option grants to employees and directors, with the disclosure
      provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”. Under APB
      No. 25, compensation expense is computed under the intrinsic value method of
      accounting to the extent that the fair value of the underlying shares on the
      date of the grant exceed the exercise price of the share option, and thereafter
      amortized on a straight-line basis against income over the expected service
      period.




Had
      compensation cost for the Company’s option plans been determined based on the
      fair value at the grant dates of awards, consistent with the method prescribed
      in SFAS No. 123, the Company’s net loss and loss per share would have been as in
      the pro forma amounts indicated below:




F-
          11




Year
                Ended December 31,2003
            
            2004
            
            2005Net
                loss as reported
            
            $
            (6,282
            )
            $
            (1,172
            )
            $
            (1,318
            )Plus:
                Stock-based employee compensation expense included in reported net
                income
            
            
            57
            
            
            80
            
            
            23Less:
                Total stock-based employee compensation expense determined under
                fair
                value based method for all awards
            
            
            502
            
            
            188
            
            
            387Pro
                forma net loss
            
            $
            (6,727
            )
            $
            (1,280
            )
            $
            (1,682
            )Basic
                and diluted net income (loss) per share - as reported:From
                continuing operations
            
            $
            (1.00
            )
            $
            (0.35
            )
            $
            (0.32
            )From
                discontinued operations
            
            
            0.19
            
            
            0.20
            
            
            0.16Basic
                and diluted
            
            $
            (0.81
            )
            $
            (0.15
            )
            $
            (0.16
            )Basic
                and diluted net income (loss) per share -pro forma:From
                continuing operations
            
            $
            (1.06
            )
            $
            (0.36
            )
            $
            (0.37
            )From
                discontinued operations
            
            
            0.19
            
            
            0.20
            
            
            0.16Basic
                and diluted
            
            $
            (0.87
            )
            $
            (0.16
            )
            $
            (0.21
            )




The
      pro
      forma information in the above table also gives effect to the application of
      SFAS No. 123 on the share option plans of the Company’s subsidiaries.




The
      Company accounts for stock-based compensation issued to non-employees on a
      fair
      value basis in accordance with SFAS No. 123 and EITF Issue No. 96-18,
“Accounting for Equity Instruments That Are Issued to Other Than Employees for
      Acquiring, or in Conjunction with Selling, Goods or Services” and related
      interpretations.




Restricted
        stock awards are subject to risk of forfeiture and vesting conditions. Typically
        the vesting occurs over a prescribed period of time and requires continued
        service and employment by the recipient. Restricted stock is valued at fair
        market value at the date of the grant and is amortized over the vesting
        period.




**Deferred
      Income Taxes**




Deferred
      income taxes reflect the net tax effects of temporary differences between the
      carrying amounts of assets and liabilities for financial reporting purposes
      and
      the amounts used for income tax purposes, as well as operating loss, capital
      loss and tax credit carryforwards. Deferred tax assets and liabilities are
      classified as current or non-current based on the classification of the related
      assets or liabilities for financial reporting, or according to the expected
      reversal dates of the specific temporary differences, if not related to an
      asset
      or liability for financial reporting. Valuation allowances are established
      against deferred tax assets if it is more likely than not that they will not
      be
      realized. Deferred tax assets and liabilities are measured using enacted tax
      rates expected to apply to taxable income in the years in which those temporary
      differences are expected to be recovered or settled. The effect on deferred
      tax
      assets and liabilities of a change in tax rates or laws is recognized in
      operations in the period that includes the enactment date.




**Basic
      and Diluted Net Loss Per Share**




Basic
      net
      loss per share is computed by dividing the net loss by the weighted average
      number of shares outstanding during the year, excluding treasury stock. Diluted
      net loss per share is computed by dividing the net loss by the weighted average
      number of shares outstanding plus the dilutive potential of common shares which
      would result from the exercise of stock options and warrants or conversion
      of
      convertible securities. However, the dilutive effects of stock options, warrants
      and convertible securities are excluded from the computation of diluted net
      loss
      per share if doing so would be antidilutive. The number of options and warrants
      that were excluded from the computation of basic and diluted net loss per share,
      as they had an antidilutive effect, were
      approximately 1,743,000, 2,155,000 and 1,765,000 for
      the
      years ending December 31, 2003, 2004 and 2005, respectively.




**Comprehensive
      Loss**





The
      components of the Company’s comprehensive loss for the period presented are net
      loss and differences from the translation of subsidiaries’ financial
      statements.




F-
          12




**Recently
      Issued Accounting Principles**




On
      June 7, 2005, FASB issued Statement No. 154, “Accounting Changes and
      Error Corrections, a replacement of APB Opinion No. 20, Accounting Changes,
      and Statement No. 3, Reporting Accounting Changes in Interim Financial
      Statements” (“SFAS No. 154”). SFAS No. 154 changes the requirements
      for the accounting for, and reporting of, a change in accounting principle.
      Previously, most voluntary changes in accounting principles were required to
      be
      recognized by way of a cumulative effect adjustment within net income during
      the
      period of the change. SFAS No. 154 requires retrospective application to
      prior periods’ financial statements, unless it is impracticable to determine
      either the period-specific effects or the cumulative effect of the change.
      SFAS
      No. 154 is effective for accounting changes made in fiscal years beginning
      after December 15, 2005; however, SFAS No. 154 does not change the
      transition provisions of any existing accounting pronouncements. The Company
      does not expect that the adoption of SFAS No. 154 will have a material
      effect on its consolidated financial position, results of operations or cash
      flows.




In
      November 2004, the FASB issued FAS No. 151, “Inventory Costs - an Amendment of
      ARB 43, Chapter 4” (“SFAS 151”). SFAS 151 requires idle facility expenses,
      freight, handling costs and wasted material (spoilage) costs to be recognized
      as
      current-period charges. It also requires that allocation of fixed production
      overheads to the costs of conversion be based on the normal capacity of the
      production facilities. SFAS No. 151 will be effective for inventory costs
      incurred during fiscal years beginning after June 15, 2005 (January 1, 2006
      for
      the Company). The Company does not expect this statement to have a material
      effect on the Company’s financial statements or its results of
      operations.




In
      December 2004, FASB issued the revised SFAS No. 123, “Share-Based Payment”
(“SFAS No. 123R”), which addresses the accounting for share-based payment
      transactions in which the Company obtains employee services in exchange for
      (a) equity instruments of the Company or (b) liabilities that are
      based on the fair value of the Company’s equity instruments or that may be
      settled by the issuance of such equity instruments. SFAS No. 123R
      eliminates the ability to account for employee share-based payment transactions
      using APB No. 25, and requires instead that such transactions be accounted
      for using the grant-date fair value based method. SFAS No. 123R provided
      for an effective date as of the beginning of the first interim or annual
      reporting period that begins after June 15, 2005 (July 1, 2005 for the
      Company). Early adoption of SFAS No. 123R is encouraged.




On
      April 15, 2005, the SEC approved a new rule, under which SFAS No. 123R
      is effective for public companies at the beginning of their next fiscal year
      that begins after June 15, 2005 (January 1, 2006 for the Company). SFAS
      No. 123R applies to all awards granted or modified after the effective date
      of SFAS No. 123R. In addition, compensation cost for the unvested portion
      of previously granted awards that remain outstanding on the effective date
      of
      SFAS No. 123R shall be recognized on or after the effective date, as the
      related services are rendered, based on the awards’ grant-date fair value as
      previously calculated for the pro forma disclosure under SFAS No. 123.




The
      Company estimates that the cumulative effect of adopting SFAS No. 123R as
      of its adoption date (January 1, 2006), based on the awards outstanding as
      of
      December 31, 2005, immaterial. This estimate does not include the impact of
      additional awards, which may be granted, or forfeitures, which may occur after
      December 31, 2005. Upon adoption of SFAS No. 123R, the Company will apply
      the modified prospective application transition method, as permitted by SFAS
      No. 123R. Under such transition method, upon the adoption of SFAS
      No. 123R, the Company’s financial statements for periods prior to the
      effective date of SFAS No. 123R will not be restated. The impact in the
      2006 fiscal year and beyond will depend upon various factors, among them the
      Company’s future compensation strategy. At December 31,2005, unamortized
      compensation expense related to outstanding unvested options, as determined
      in
      accordance with SFAS 123(R), that the company expects to record during fiscal
      2006 was approximately $122 before taxation and any adjustment for
      forfeitures.




In
      March
      2005, the SEC issued Staff Accounting Bulletin 107, “Shared-Based Payment” (“SAB
      107”), which offers guidance on SFAS No. 123R. SAB 107 was issued to assist
      companies by simplifying some of the implementation challenges of SFAS
      No. 123R while enhancing the information that investors receive. The
      Company will apply the principles of SAB 107 in conjunction with the Company’s
      adoption of SFAS No. 123R.




F-
          13




In
      February 2006, the FASB issued SFAS No.155, "Accounting for Certain Hybrid
      Financial Instruments, an amendment of FASB statements No. 133 and 140." This
      statement permits fair value measurement for any hybrid financial instrument
      that contains an embedded derivative that otherwise would require bifurcation.
      This statement is effective for all financial instruments acquired or issued
      after the beginning of an entity's first fiscal year that begins after September
      15, 2006. Earlier adoption is permitted as of the beginning of an entity's
      fiscal year, provided that no interim period financial statements have bee
      issued for the financial year. Management expects that the adoption of SFAS
      155
      will have no material effect on the Company's financial statements or its
      results of operations.




**Reclassifications**




Certain
      reclassifications have been made to the Company’s prior years’ consolidated
      financial statements to conform to the current year’s consolidated financial
      statement presentation.




**NOTE
      3—DISCONTINUED OPERATIONS**




(a)
      dsIT
      Technologies Ltd.




In
      August
      2005, the Company completed the sale of its 68% owned dsIT Technologies
      subsidiary and its associated outsourcing consulting business. The operations
      that were sold are comprised of dsIT Technologies’ business of providing
      computer software and systems professionals on a time and materials basis to
      clients in Israel. In connection with the transaction, the Company increased
      its
      holdings in dsIT Solutions to 80%. Total proceeds of the transaction were
      approximately $3,661 (not including transaction costs of approximately $230).
      As
      a result of the transaction, the Company recorded a gain from the sale of
      discontinued operations of $541, net of taxes of $373. As part of the
      transaction, goodwill of $4,358 (net of associated cumulative translation
      adjustment of $22) associated with dsIT Technologies was allocated to the
      discontinued component based on the fair value of dsIT Technologies and dsIT
      Solutions. Together with the transaction, the Company issued to the purchaser
      a
      warrant to purchase 10% of dsIT Solutions for $200. The fair value of the
      warrant was estimated using the Black-Scholes model to be of an immaterial
      amount. Although the Company continues to provide certain professional time
      and
      materials services to clients in Israel on a limited basis, these continuing
      activities are limited to existing customers and are not material. Therefore,
      the classification of dsIT Technologies as a discontinued operation under SFAS
      No. 144 is appropriate.




Profit
      and loss of the discontinued operations associated with Technologies were as
      follows:


Year
                ended December 31,2003
            
            2004
            
            2005*Sales
            
            $
            7,958
            
            $
            8,281
            
            $
            5,636Cost
                of sales
            
            
            6,067
            
            
            6,372
            
            
            4,440Gross
                profit
            
            
            1,891
            
            
            1,909
            
            
            1,196Operating
                income
            
            
            1,652
            
            
            1,677
            
            
            1,001Interest
                expense, net
            
            
            35
            
            
            54
            
            
            59Net
                income from discontinued operations, net of income taxes
            
            $
            1,425
            
            $
            1,535
            
            $
            798




*
      Includes the results of operations up to August 18, 2005.









Assets
      and liabilities of the discontinued operation were as follows:


As
                at December 31,2004
            
            2005Cash
                and cash equivalents
            
            $
            2
            
            $
            —Restricted
                cash
            
            $
            113
            
            $
            —Accounts
                receivable and unbilled work-in-process, net
            
            $
            1,504
            
            $
            —Other
                current assets
            
            $
            118
            
            $
            —Funds
                in respect of employee termination benefits
            
            $
            1,056
            
            $
            —Other
                assets
            
            $
            103
            
            $
            —Goodwill
            
            $
            4,358
            
            $
            —Short-term
                bank credit
            
            $
            170
            
            $
            —Accrued
                payroll, payroll taxes, social benefits and other current
                liabilities
            
            $
            1,392
            
            $
            —Liability
                for employee termination benefits
            
            $
            1,563
            
            $
            —




F-
          14




(b)
      US
      based consulting




Since
      the
      latter part of 2003, the Company has not recorded revenues from its US-based
      consulting business. During the second quarter of 2004, the Company decided
      to
      discontinue its efforts to reestablish this business as it was previously
      conducted. As a result, the Company recorded a gain from discontinued operations
      of $348, net of tax.




As
      at
      December 31, 2005 and 2004, these discontinued operations had liabilities of
      $217 and $307, respectively.




Profit
      and loss of these discontinued operations within consulting segment were as
      follows:




Year
                ended December 31, 2004Sales
            
            $
            —Cost
                of sales
            
            
            —Gross
                profit
            
            
            —Income
                (loss) from operations
            
            
            (2
            )Interest
                expense
            
            
            4Other
                income
            
            
            346Net
                income (loss) from discontinued operations
            
            $
            348




The
      consolidated statements of operations and cash flow for the year ended December
      31, 2003 have not been restated to reflect the discontinued operations since
      the
      effect years is immaterial.





**NOTE
      4—INVESTMENT IN COMVERGE**




On
      April
      7, 2003, the Company and its then consolidated Comverge subsidiary, signed
      and
      closed on a definitive agreement with a syndicate of venture capital firms
      raising an aggregate of $13,000 in capital funding. The Company purchased $3,250
      of Series A Convertible Preferred Stock issued by Comverge in the equity
      financing and incurred transaction costs of an additional $294. In connection
      with the transaction, the Company converted to equity intercompany balances
      of
      $9,673.




The
      Series A Convertible Preferred Stock is convertible into Comverge’s common stock
      initially on a one-for-one basis subject to adjustment for the achievement
      of
      certain performance criteria. Conversion is mandatory (i) in the event that
      the
      holders of at least a majority of the then-outstanding shares of Series A
      Preferred consent to such conversion or (ii) upon the closing of a firmly
      underwritten public offering of shares of Common Stock of Comverge at a per
      share price not less than five times the original per-share purchase price
      of
      the Preferred Stock. The holders of Preferred Stock have no mandatory redemption
      rights.




In
      connection with Comverge's April 2003 equity financing transactions and the
      Company’s dilution and the valuation of Comverge’s common stock reflected in the
      transaction, the Company recorded an increase of $1,085 to its common stock
      investment in Comverge. The adjustment was recorded to additional paid-in
      capital.




As
      a
      result of the private equity financing transactions and other agreements
      described above, effective April 1, 2003, Comverge is no longer a controlled
      subsidiary of the Company and thus, the Company no longer consolidates
      Comverge's balance sheet and results of operations, accounting for its
      investment in Comverge on the equity method.




The
      Company has entered into various agreements with Comverge and the syndicate
      of
      venture capital investors. These agreements provide for, among other things,
      restrictions and other provisions relating to the transfer, voting and
      registration of the Comverge shares owned by the Company, and the Company's
      right to receive quarterly and annual financial reports from Comverge.




F-
          15




Until
      December 31, 2003, the Company had an option to purchase from Comverge up to
      $1,500 of Series A-2 Convertible Preferred Stock. The Series A-2 Preferred
      Stock
      has the same purchase price as the Series A-1 Preferred Stock. The Series A-2
      Preferred Stock has the same rights as the Series A and the Series A-1 Preferred
      Stock, except the Series A-2 Preferred Stock is junior in priority in
      liquidation (which includes the sale of Comverge) to both the Series A and
      Series A-1 Preferred Stock. On December 22, 2003, the Company exercised its
      option and invested an additional $100 in Series A-2 Convertible Preferred
      Stock.




In
      September 2004, the Company sold 480,769 shares
      of Comverge Series A Preferred Stock for approximately $1,000, resulting in
      a
      gain of $705.




In
      October 2004, Comverge closed on the sale of additional Series B Preferred
      Stock
      in the amount of $13,600. The Series B Preferred Stock is senior to the
      preferred stock of Comverge owned by the Company. This round of financing
      diluted the Company’s holdings to approximately 7% of Comverge’s preferred
      equity and approximately 25% of its total equity. In 2005, there were no changes
      to the Company’s holdings in Comverge.




Summary
      financial information for Comverge as at December 31, 2004 and 2005 and for
      the
      period from April 1, 2003 to December 31, 2003 and years ended December 31,
      2004
      and 2005, respectively, is as follows:




As
                at December 31,**Financial
                Position**
            
            2004
            
            2005Cash
                and cash equivalents
            
            $
            8,761
            
            $
            2,606Other
                current assets
            
            
            7,779
            
            
            10,066Property
                and equipment, net
            
            
            5,342
            
            
            10,545Goodwill
                and other intangible assets
            
            
            726
            
            
            677Other
                assets
            
            
            1,353
            
            
            42Total
                assets
            
            $
            23,961
            
            $
            23,936Current
                liabilities
            
            $
            5,642
            
            $
            8,298Long-term
                debt
            
            
            —
            
            
            4,000Other
                non-current liabilities
            
            
            2,211
            
            
            1,802Total
                liabilities
            
            
            7,853
            
            
            14,100Common
                stock and paid-in capital
            
            
            19,111
            
            
            19,204Convertible
                preferred stock
            
            
            35,106
            
            
            35,106Deferred
                compensation
            
            
            (30
            )
            
            —Accumulated
                deficit
            
            
            (38,079
            )
            
            (44,474
            )Total
                liabilities and shareholders’ equity
            
            $
            23,961
            
            $
            23,936







**Results
                of Operations**
            
            Nine
                Months Ended December 31, 2003
            
            Year
                Ended December 31, 2004
            
            Year
                Ended December 31, 2005UnauditedSales
            
            $
            10,942
            
            $
            18,159
            
            $
            25,711Gross
                profit
            
            $
            3,691
            
            $
            7,603
            
            $
            13,083Operating
                loss
            
            $
            (7,578
            )
            $
            (9,029
            )
            $
            (6,341
            )Net
                loss
            
            $
            (7,955
            )
            $
            (9,258
            )
            $
            (6,395
            )




F-
          16




The
      activity in the Company’s investments in Comverge is as follows:




Common
                Stock
            
            Preferred
                Stock
            
            Net
                InvestmentAccumulated
                deficit at March 31, 2003
            
            $
            (12,582
            )
            $
            —
            
            $
            (12,582
            )Conversion
                of inter-company balances to equity
            
            
            9,673
            
            
            —
            
            
            9,673Adjustment
                of the Company’s investment from dilution of
              common
                shares and new valuation of Comverge common shares
            
            
            1,085
            
            
            —
            
            
            1,085Cash
                paid for preferred stock of Comverge
            
            
            —
            
            
            3,350
            
            
            3,350Transaction
                costs
            
            
            —
            
            
            294
            
            
            294Equity
                loss in Comverge - nine months ended December 31, 2003
            
            
            —
            
            
            (1,752
            )
            
            (1,752
            )Balances
                as of December 31, 2003
            
            
            (1,824
            )
            
            1,892
            
            
            68Preferred
                shares sold
            
            
            —
            
            
            (270
            )
            
            (270
            )Equity
                loss in Comverge - year ended December 31, 2004
            
            
            —
            
            
            (1,242
            )
            
            (1,242
            )Balances
                as of December 31, 2004
            
            
            (1,824
            )
            
            380
            
            
            (1,444
            )Equity
                loss in Comverge - year ended December 31, 2005
            
            
            —
            
            
            (380
            )
            
            (380
            )Balances
                as of December 31, 2005
            
            $
            (1,824
            )
            $
            —
            
            $
            (1,824
            )




The
      percentage share of Comverge’s loss recognized by the Company as equity loss
      against its preferred stock investment in 2003 through 2005 can be found in
      the
      table below:





Percentage
                of
              Comverge
                Loss
              Recognized
                Against
              Preferred
                StockApril
                1, 2003 - September 30, 2003
            26%October
                1, 2003 - March 8, 2004
            17%March
                9, 2004 - September 9, 2004
            15%September
                10, 2004 - October 20, 2004
            11%October
                21, 2004 - December 31, 2005
            7%






Following
      Comverge’s April 2003 equity transaction, the Company held approximately 51% of
      the outstanding capital voting stock of Comverge (approximately 76% of
      Comverge’s common stock and approximately 26% of Comverge’s Preferred Stock). As
      a result of the transaction, the Company was no longer obligated to fund
      Comverge. Additionally, as a result of the April 2003 equity transaction, the
      Company had a negative investment balance in Comverge’s common stock of $1,824.
      Due to the fact that the Company was no longer committed to fund Comverge,
      the
      Company ceased recording equity losses against its negative common stock
      investment. The Company’s negative common stock investment will only be adjusted
      upon disposition of the Company’s common stock investment or when the Company
      realizes equity income from Comverge in excess of any accumulated equity losses
      recorded on its Preferred Stock investment.




In
      the
      future, equity income from the Company’s preferred investment may be recorded up
      to the Company’s original $3,644 preferred share investment in Comverge, and
      thereafter to its investment in Comverge’s common shares, of which the Company
      currently owns approximately 76%. As at December 31, 2005, the Company has
      a
      provision for unrecognized losses in Comverge of $64. As at December 31, 2005,
      the Company will record equity income from its preferred investment in Comverge,
      if and when Comverge records net income in excess of approximately $924.




F-
          17




**NOTE
      5—ACCOUNTS RECEIVABLE, NET**




Accounts
                receivable, net, consists of the following:
            
            As
                of December 31,2004
            
            2005Trade
                accounts receivable
            
            $
            6,101
            
            $
            4,114Allowance
                for doubtful accounts
            
            
            (32
            )
            
            (18
            )Accounts
                receivable, net
            
            $
            6,069
            
            $
            4,096




Bad
      debt
      expense (income) related to trade accounts receivable was $50, $(38) and $5
      for the years ended December 31, 2003, 2004 and 2005, respectively.




**NOTE
      6--OTHER CURRENT ASSETS**




Other
                current assets consist of the following:
            
            As
                of December 31,2004
            
            2005Prepaid
                expenses
            
            $
            125
            
            $
            137Employees
            
            
            104
            
            
            37Income
                tax receivable
            
            
            99
            
            
            58Funds
                in respect of employee termination benefits
            
            
            —
            
            
            277Claim
                receivable
            
            
            127
            
            
            123Deferred
                income taxes
            
            
            62
            
            
            28Other
            
            
            23
            
            
            49$
            540
            
            $
            709




**NOTE
      7--PROPERTY AND EQUIPMENT, NET**




Property
      and equipment consist of the following:




Estimated
              Useful
                Life
              (in
                years)
            
            As
                of December 31,Cost:
            
            
            
            2004
            
            2005Computer
                hardware and software
            
            
            1.5
                - 5
            
            $
            1,149
            
            
            992Office
                furniture and equipment
            
            
            4-10
            
            
            496
            
            
            438Motor
                vehicles
            
            
            4-7
            
            
            315
            
            
            110Leasehold
                improvements
            
            
            Term
                of lease
            
            
            218
            
            
            2082,178
            
            
            1,748Accumulated
                depreciation and amortizationComputer
                hardware and software
            
            
            
            
            
            910
            
            
            776Office
                furniture and equipment
            
            
            
            
            
            335
            
            
            299Motor
                vehicles
            
            
            
            
            
            166
            
            
            38Leasehold
                improvements
            
            
            
            
            
            118
            
            
            1351,529
            
            
            1,248Property
                and equipment, net
            
            
            
            
            $
            649
            
            $
            500




Depreciation
      and amortization in respect of property and equipment amounted to $451, $195
      and
      $220 for 2003, 2004 and 2005, respectively.




**NOTE
      8--GOODWILL AND OTHER INTANGIBLE ASSETS**




As
      required by SFAS No. 142, the Company performs an annual impairment test of
      recorded goodwill (during the fourth quarter of each year), or more frequently
      if impairment indicators are present. The Company’s goodwill is entirely in its
      software consulting and development segment. The fair value of the software
      consulting and development segment was determined by applying a market-rate
      multiple to the estimated near-term future revenue stream expected to be
      produced by the segment. In each of the year ending December 31, 2003, 2004
      and
      2005, the Company performed its annual impairment test and no goodwill
      impairment resulted.




In
      August
      2005, the Company sold its dsIT Technologies subsidiary (see Note 3). As a
      result of the transaction, goodwill of $4,358 (net of associated cumulative
      translation adjustment of $22) associated with dsIT Technologies was allocated
      to the discontinued component based on the fair value of dsIT Technologies
      and
      dsIT Solutions. In addition, the Company recorded an addition to goodwill of
      $79
      resulting from its increased holdings in dsIT Solutions.




F-
          18





TotalBalance
                as of December 31, 2003
            
            $
            4,430Cumulative
                translation adjustment
            
            
            (22
            )Balance
                as of December 31, 2004
            
            
            4,408Goodwill
                associated with sale of Technologies
            
            
            (4,358
            )Goodwill
                added from increased holdings in Solutions
            
            
            79Balance
                as of December 31, 2005
            
            $
            129






The
      Company’s intangible assets as of December 31, 2004 and 2005 was comprised of
      software licenses valued at $188 and $224, respectively, being amortized over
      their estimated useful lives of five years, with a net carrying amount of $81,
      as of both December 31, 2004 and 2005.




Amortization
      in respect of license, patents, software licenses and acquired backlog amounted
      to $76, $32 and $34 for 2003, 2004 and 2005, respectively.




Nominal
      amortization expense with respect to intangible assets is estimated as $39,
      $26,
      $7, $7 and $5 for the years ending December 31, 2006, 2007, 2008, 2009 and
      2010,
      respectively.




**NOTE
      9—SHORT-TERM BANK CREDIT AND OTHER DEBT**




(a)
       Lines of credit




At
      December 31, 2005, the Company had approximately $335 in Israeli credit lines
      available to dsIT, of which $130 was then being used and $205 was available
      for
      future draws. These credit lines are generally for a term of one year,
      denominated in NIS and bear interest at a weighted average rate of the Israeli
      prime rate per annum plus 2.5% (at December 31, 2004, plus 2.6%). The Israeli
      prime rate fluctuates and as of December 31, 2005 was 6.0% (December 31, 2004,
      5.2%). The Company has a floating lien and provided guarantees with respect
      to
      dsIT’s outstanding lines of credit.





(b) Short
      and
      Long-Term Debt




Short
      and
      long-term debt includes bank debt representing loans received by the Company’s
      Israeli subsidiaries from Israeli banks denominated in NIS. Also included is
      other debt taken to finance the purchase of automobiles. Other debt is
      denominated in U.S. dollars.






As
                of December 31,2004
            
            2005Bank
                debt
            
            $
            667
            
            $
            170Other
                debt
            
            
            —
            
            
            65Total
                debt
            
            
            667
            
            
            235Less:
                current portion
            
            
            (466
            )
            
            (160
            )Long-term
                bank debt
            
            $
            201
            
            $
            75






At
      December 31, 2005, the bank debt bears a weighted average interest rate of
      7.9%
      (December 31, 2004, 7.8%). At December 31, 2005, all bank debt was denominated
      in NIS and was unlinked. At December 31, 2004, $36 of the bank debt was linked
      to the Israeli Consumer Price Index, $25 was linked to the US dollar and $606
      was unlinked. At December 31, 2005, other debt bears a weighted average interest
      rate of 5.3%. In connection with the bank debt and lines of credit (see (a)
      above), a lien in favor of the Israeli banks was placed on some of dsIT’s
      assets. In addition, the Company has guaranteed dsIT’s lines of credit to
      Israeli banks up to $335. Other debt is secured by the automobiles
      purchased.




F-
          19




The
      aggregate maturities of debt are as follows:




Year
                  ending December 31,2006
              
              $
              1602007
              
              
              402008
              
              
              162009
              
              
              172010
              
              
              2$
              235




**NOTE
      10—OTHER CURRENT LIABILITIES**




Other
      current liabilities consists of the following:


As
                of December 31,2004
            
            2005Taxes
                payable
            
            $
            824
            
            $
            796Lien
                allowance
            
            
            410
            
            
            410Advances
                from customers
            
            
            160
            
            
            102Accrued
                expenses
            
            
            463
            
            
            461Liability
                for employee termination benefits
            
            
            —
            
            
            277Value
                added taxes payable
            
            
            203
            
            
            65Other
            
            
            167
            
            
            89$
            2,227
            
            $
            2,200




**NOTE
      11—LIABILITY FOR EMPLOYEE TERMINATION BENEFITS**




(a)
              Israeli
                  labor law and certain employee contracts generally requires payment
                  of
                  severance pay upon dismissal of an employee or upon termination
                  of
                  employment in certain other circumstances. The Company has recorded
                  a
                  severance pay liability for the amount that would be paid if all
                  its
                  Israeli employees were dismissed at the balance sheet date, on
                  an
                  undiscounted basis, in accordance with Israeli labor law. This
                  liability
                  is computed based upon the employee’s number of years of service and
                  salary components, which in the opinion of management create entitlement
                  to severance pay in accordance with labor agreements in
                  force.




The
      liability is partially offset by sums deposited in dedicated funds in respect
      of
      employee termination benefits. The Company may only utilize the insurance
      policies for the purpose of disbursement of severance pay. For certain Israeli
      employees, the Company’s liability is covered mainly by regular contributions to defined
      contribution plans. The amounts funded as above are not reflected in the balance
      sheets, since they are not under the control and management of the
      Company.




(b)
                Severance
                    pay expenses amounted toapproximately,
                    $868, $684 and $463 forthe years ended December 31, 2003, 2004 and 2005,
                    respectively.




(c)
              The
                  Company expects to contribute approximately $156 to the insurance
                  policies
                  in respect of its severance pay obligations in the year ended December
                  31,
                  2006.




(d)
            The
                Company expects to pay the following future benefits to its employees
                upon
                their normal retirement age in the next ten
                years:




‏Years
                ending December 31,2006
              
              $
              —2007
              
              
              —2008
              
              
              —2009
              
              
              —2010
              
              
              —2011
                  - 2015
              
              
              1,130$
              1,130




F-
          20




The
      liability as at December 31, 2005 for future benefit payments in the next ten
      years is included in these financial statements in “liability for employee
      termination benefits”. The liability for future benefits does not reflect any
      amounts already deposited in dedicated funds with respect to those employees
      (see “a” above). The above amounts were determined based on the employees’
current salary rates and the number of service years that will be accumulated
      upon their retirement date. These amounts do not include amounts that might
      be
      paid to employees that will cease working with the Company before their normal
      retirement age.




(e)
      Employee Retirement Savings Plan




The
      Company sponsors a tax deferred retirement savings plan that permits eligible
      US
      employees to contribute varying percentages of their compensation up to the
      limit allowed by the Internal Revenue Service. This plan also provides for
      discretionary Company contributions, of which none were made for the years
      ended
      December 31, 2003, 2004 and 2005.




**NOTE
      12--COMMITMENTS AND CONTINGENCIES**




(a)
      Leases of Property and Equipment




Office
      rental and automobile leasing expenses, for 2003, 2004 and 2005, were $984,
      $723
      and $746, respectively. The Company and its subsidiaries lease office space
      and
      equipment under operating lease agreements. Those leases will expire on
      different dates from 2006 to 2009. The lease payments are mainly in dollars
      or
      are linked to the exchange rate of the dollar. Future minimum lease payments
      on
      non-cancelable operating leases as of December 31, 2005 are as follows:




Year
                  ending December 31,2006
              
              $
              7282007
              
              
              5902008
              
              
              4172009
              
              
              199$
              1,934




(b)
      Guarantees




Previously,
      the Company accrued a loss for contingent performance of bank guarantees. The
      Company’s remaining commitment under these guarantees (included in other current
      liabilities) is $410 at December 31, 2004 and 2005. The Company has
      collateralized a portion of these guarantees by means of a deposit (classified
      as restricted cash) of $241 and $247 as of December 31, 2004 and 2005,
      respectively. (See Note 18(b) for additional developments).




The
      Company’s subsidiary has provided various performance, advance and tender
      guarantees as required in the normal course of its operations. As at December
      31, 2005, such guarantees totaled approximately $120 and were due to expire
      through November 2006.




See
      Note
      9(a) with respect to guarantees on the Company’s lines of credit.




(c)
      Litigation




The
      Company is involved in various other legal actions and claims arising in the
      ordinary course of business.
      In the opinion of management and its legal counsel, the ultimate disposition of these matters
      will
      not have a material adverse effect on the Company’s consolidated financial
      position, results of operations or cash flow.




F-
          21




**NOTE
      13--SHAREHOLDERS’ EQUITY**




(a)
            Stock
                Option Plans




The
      Company’s stock option plans provide for the grant to officers, directors and
      other key employees of options to purchase shares of common stock at not less
      than 85% of the market value of the Company’s common stock on the date of grant.
      The purchase price must be paid in cash. Each option is exercisable to one
      share
      of the Company’s common stock. All options expire within five to ten years from
      the date of the grant, and generally vest over a two to three year period from
      the date of the grant. At December 31, 2005 ,
      no
      options or other equity instruments were available for grant under the various
      plans as
      the
      plans have expired, other than the 70,000 shares available for grant under
      the
      1994 Outside Director Stock plan.




A
      summary
      status of the Company’s option plans as of December 31, 2003, 2004 and 2005, as
      well as changes during each of the years then ended, is presented below:




2003
            
            2004
            
            2005Number
                of Options
              (in
                shares)
            
            Weighted
                Average Exercise
              Price
            
            Number
                of Options
              (in
                shares)
            
            Weighted
                Average Exercise
              Price
            
            Number
                of Options
              (in
                shares)
            
            Weighted
                Average Exercise
              PriceOutstanding
                at beginning of year
            
            
            1,738,767
            
            $
            5.18
            
            
            1,308,051
            
            $
            4.83
            
            
            1,720,435
            
            $
            2.88Granted
                at market price
            
            
            17,000
            
            $
            1.86
            
            
            790,000
            
            $
            0.96
            
            
            30,000
            
            $
            1.80Exercised
            
            
            (10,666
            )
            $
            1.70
            
            
            (19,666
            )
            $
            1.74
            
            
            —
            
            
            —Forfeited
                and expired
            
            
            (437,050
            )
            $
            6.17
            
            
            (357,950
            )
            $
            5.83
            
            
            (175,100
            )
            $
            6.33Outstanding
                at end of year
            
            
            1,308,051
            
            $
            4.83
            
            
            1,720,435
            
            $
            2.88
            
            
            1,575,335
            
            $
            2.48Exercisable
                at end of year
            
            
            1,282,048
            
            $
            4.88
            
            
            956,267
            
            $
            4.47
            
            
            1,061,151
            
            $
            3.27




The
      Company granted to related parties 15,000 and 600,000 options in the years
      ending December 31, 2003 and 2004, respectively, under various employee option
      plans. No options were granted to related parties in 2005. No options were
      exercised by related parties to purchase shares of common stock of the Company,
      during 2003, 2004, and 2005 and as of December 31, 2003, 2004, and 2005, the
      number of outstanding options held by the related parties was
      932,250 ,
      1,159,750 and 807,500 options, respectively.




Summary
      information regarding the options outstanding and exercisable at December 31,
      2005 is as follows:




Outstanding
            
            ExercisableRange
                of Exercise Prices
            
            Number
                Outstanding
            
            Weighted
                Average Remaining Contractual Life
            
            Weighted
                Average Exercise Price
            
            Number
                Exercisable
            
            Weighted
                Average Exercise Price(in
                shares)
            
            (in
                years)
            
            
            
            (in
                shares)$0.71
                - 1.78
            
            
            751,668
            
            
            5.84
            
            $
            0.84
            
            
            250,821
            
            $
            0.96$1.80
                - 2.85
            
            
            313,500
            
            
            1.26
            
            $
            2.05
            
            
            300,163
            
            $
            2.02$3.50
                - 4.80
            
            
            235,167
            
            
            1.05
            
            $
            4.28
            
            
            235,167
            
            $
            4.28$5.25
                - 6.40
            
            
            275,000
            
            
            0.70
            
            $
            5.88
            
            
            275,000
            
            $
            5.881,575,335
            
            
            
            
            
            
            
            
            1,061,151




F-
          22




The
      weighted average grant-date fair value of the options granted during 2003,
      2004
      and 2005, amounted to $1.51, $0.73 and $0.57 per option, respectively. The
      Company utilized the Black-Scholes option-pricing model to estimate fair value,
      utilizing the following assumptions for the respective years (all in weighted
      averages):




2003
            
            2004
            
            2005Risk-free
                interest rate
            3.9%
            
            3.7%
            
            4.3%Expected
                life of options, in years
            9.4
            
            6.9
            
            1.1Expected
                annual volatility
            78%
            
            91%
            
            120%Expected
                dividend yield
            None
            
            None
            
            None




(b)
      Warrants




The
      Company has issued warrants at exercise prices equal to or greater than market
      value of the Company’s common stock at the date of issuance. A summary of
      warrants activity follows:




2003
            
            2004
            
            2005Number
                of Warrants
              (in
                shares)
            
            Weighted
                Average Exercise
              Price
            
            Number
                of Warrants
              (in
                shares)
            
            Weighted
                Average Exercise Price
            
            Number
                of Warrants
              (in
                shares)
            
            Weighted
                Average Exercise
              PriceOutstanding
                at beginning of year
            
            
            315,000
            
            $
            3.36
            
            
            435,000
            
            $
            3.06
            
            
            435,000
            
            $
            3.06Granted
            
            
            120,000
            
            $
            2.25
            
            
            —
            
            $
            —
            
            
            —
            
            $
            —Expired
            
            
            —
            
            $
            —
            
            
            —
            
            $
            —
            
            
            245,000
            
            $
            3.24Outstanding
                at end of year
            
            
            435,000
            
            $
            3.06
            
            
            435,000
            
            $
            3.06
            
            
            190,000
            
            $
            2.81Exercisable
                end of year
            
            
            435,000
            
            $
            3.06
            
            
            435,000
            
            $
            3.06
            
            
            190,000
            
            $
            2.81




The
      following table summarized information about warrants outstanding and
      exercisable at December 31, 2005:




Exercise
                Price
            
            Number
              Outstanding
            
            Weighted
              Average
              Remaining
              Contractual
              Life(in
                shares)
            
            (in
                years)$2.00
            
            
            30,000
            
            
            1.93$2.34
            
            
            60,000
            
            
            1.93$3.34
            
            
            100,000
            
            
            1.93190,000




In
      June
      2002, the Company completed a transaction with an investor, pursuant to which
      $2,000 was invested in the Company in exchange for a 10% convertible note and
      a
      three-year warrant to purchase 125,000 shares of the Company’s common stock at
      an exercise price of $4.20 per share. The Company used the Black-Scholes
      valuation method to estimate the fair value of the 125,000 warrants to purchase
      common stock of the Company, using a risk free interest rate of 3.0%, its
      contractual life of three years, an annual volatility of 73% and no expected
      dividends. The Company estimated the fair value of the beneficial conversion
      feature and related warrant at the issuance of the convertible note to be
      approximately $692. Such amount was credited to additional paid-in capital
      and
      was charged to interest expense over the conversion period (with respect to
      the
      note) and the term of the note (with respect to the warrants), using the
      effective interest method. In the year ended December 31, 2003, the Company
      recorded $176 of the interest expense with respect to the beneficial conversion
      feature and warrants. In addition, the Company incurred other debt issuance
      costs of $167 with respect to the issuance of the convertible note. In the
      year
      ended December 31, 2003, the Company recorded interest expense of $42 with
      respect other debt issuance costs. In 2005, the warrants associated with this
      transaction expired.




F-
          23




In
      December 2002, the Company’s then consolidated subsidiary, Comverge, Inc.,
      secured a three-year $2,000 revolving line of credit. In connection with this
      line of credit, the Company also issued a five-year warrant to purchase 190,000
      shares of the Company’s common stock, exercisable in three tranches at exercise
      prices ranging from $2.00 to $3.34 per share, all of which were immediately
      exercisable. The Company used the Black-Scholes valuation method to estimate
      the
      fair value of the warrants to purchase 190,000 shares of common stock of the
      Company, using a risk free interest rate of 3.1%, its contractual life of five
      years, an annual volatility of 82% and no expected dividends. The Company
      estimated the fair value of the beneficial conversion feature and related
      warrants at the issuance of the convertible line of credit to be approximately
      $244 and credited such amount to additional paid-in capital. The Company
      recorded interest expense of $178 with respect to the beneficial conversion
      feature of the warrants during the year ended December 31, 2003. In addition,
      Comverge recorded debt issuance costs of $86 with respect to the issuance of
      the
      line of credit. The Company recorded amortization of such costs of $7 during
      the
      year ended December 31, 2003 (amortization is only for the period during which
      the Company consolidated the results of Comverge - see Note 4).




In
      2003,
      the Company engaged a third party for the purposes of providing investor
      awareness and business advisory services for a period of one year. As part
      of
      the consideration paid, the Company granted the service provider common stock
      purchase warrants for the purchase of 120,000 shares of the Company’s common
      stock (60,000 at $2.00 per share and 60,000 at $2.50 per share). The warrants
      became fully vested in May, 2003 and expired on February 25, 2005. The Company
      used the Black-Scholes valuation method to estimate the fair value of the
      warrants, using a risk free interest rate of 1.75%, their contractual life
      of
      two years, an annual volatility of 88% and no expected dividends. The Company
      estimated the fair value of the warrants to be approximately $97, which was
      charged to selling, general and administrative expense in 2003.




(c)
      Stock
      Awards




In
      September 2001, the Company entered into a restricted stock purchase agreement
      with the then newly hired Chief Executive Officer (CEO) of the Company’s energy
      intelligence solutions segment subsidiary. Pursuant to this agreement, the
      Company issued to the segment CEO 50,000 shares of its common stock at a
      purchase price of $5.95 per share. The common stock was paid for by assigning
      and endorsing to the Company a subordinated note in the amount of $298 issued
      by
      a public company. The subordinated note was reflected as a reduction in
      shareholders’ equity. In 2003,
      the issuer of the note filed for bankruptcy and the Company wrote off this
      note
      to other expense.




In
      January 2003, the CEO of the energy
      intelligence solutions segment subsidiary received a restricted stock grant
      of
      50,000 shares of common stock of the Company. The Company recognized an expense
      of $50, which was charged to selling, general and administrative expense in
      2003.




In
      August
      2004, the CEO of the computer hardware segment
      subsidiary received a stock grant of 100,000 shares of common stock of the
      Company. The Company recognized an expense of $71, which has been charged to
      selling, general and administrative expense. In addition, the CEO of
      the computer
      hardware segment
      subsidiary received a restricted stock grant of 95,000 shares of common stock
      of
      the Company, which vest one third each on the second, third and fourth
      anniversaries of the grant. The Company recognized deferred compensation of
      $68
      with respect to the restricted stock grant and recognized an expense
      (amortization) of $9 and $23, which has been charged to selling, general and
      administrative expense in the years ending December 31, 2004 and 2005,
      respectively.




(d)
      Stock
      Repurchase Program




In
      September 2000, the Company’s Board of Directors authorized the purchase of up
      to 500,000 shares of the Company’s common stock. In August 2002, the Company’s
      Board of Directors authorized the purchase of up to 300,000 more shares of
      the
      Company’s common stock. During 2003, the Company purchased 2,000 of its common
      stock (in 2003 and 2004, the Company also issued 9,000 and 18,000, respectively,
      of its treasury shares with respect to options exercised), and at December
      31,
      2005 owned in the aggregate 820,704 of its own shares.




F-
          24




(e)
      Other




In
      March
      1996, the Company’s Board of Directors adopted a stockholder rights plan
      providing for the distribution of common stock purchase rights at the rate
      of
      one right for each share of the Company’s common stock held by shareholders of
      record as of the close of business on April 1, 1996. The rights plan is designed
      to deter coercive takeover tactics, including the accumulation of shares in
      the
      open market or through private transactions, and to prevent an acquirer from
      gaining control of the Company without offering a fair price to all of the
      Company’s shareholders. Each right initially entitles shareholders to buy
      one-half of a share of common stock of the Company for $15. Generally, the
      right
      will be exercisable only if a person or group acquires beneficial ownership
      of
      15% or more of the Company’s common stock or commences a tender or exchange
      offer upon consummation of which such person or group would beneficially own
      15%
      or more of the Company’s common stock.




If
      any
      person (“Acquiring Person”) becomes the beneficial owner of 15% or more of the
      Company’s common stock, other than pursuant to a tender or exchange offer for
      all outstanding shares of the Company approved by a majority of the Company’s
      independent directors, then, subject to certain exceptions set forth in the
      rights plan, each right not owned by the Acquiring Person or related parties
      will entitle its holder to purchase, at the right’s then current exercise price,
      shares of the Company’s common stock (or in certain circumstances, as determined
      by the Board of Directors, cash, other property or other securities) having
      a
      value of twice the right’s then current exercise price. The Company will
      generally be entitled to redeem the rights at one half of one cent per right
      at
      any time until 10 days (subject to extension) following a public announcement
      that a 15% position has been acquired. The rights plan expired in March
      2006.




**NOTE
      14--INCOME TAXES**




(a)
            Composition
                of loss from continuing operations before income taxes is as
                follows:




Year
                Ended December 31,2003
            
            2004
            
            2005Domestic
            
            $
            (3,739
            )
            $
            (1,157
            )
            $
            (1,414
            )Foreign
            
            
            (2,520
            )
            
            (1,240
            )
            
            (828
            )$
            (6,259
            )
            $
            (2,397
            )
            $
            (2,242
            )




Income
      tax expense (benefit) consists of the following:




Year
                Ended December 31,2003
            
            2004
            
            2005Current:Federal
            
            $
            —
            
            $
            —
            
            $
            —State
                and local
            
            
            18
            
            
            —
            
            
            5Foreign
            
            
            33
            
            
            7
            
            
            10051
            
            
            7
            
            
            105Deferred:Federal
            
            $
            —
            
            $
            —
            
            $
            —State
                and local
            
            
            (10
            )
            
            5
            
            
            (6
            )Foreign
            
            
            (81
            )
            
            19
            
            
            (137
            )(91
            )
            
            24
            
            
            (143
            )Total
                income tax expense (benefit)
            
            $
            (40
            )
            $
            31
            
            $
            (38
            )




F-
          25




(b)
      Effective Income Tax Rates




Set
      forth
      below is reconciliation between the federal tax rate and the Company’s effective
      income tax rates with respect to continuing operations:




Year
                Ended December 31,2003
            
            2004
            
            2005Statutory
                Federal rates
            
            
            34
            %
            
            34
            %
            
            34
            %Increase
                (decrease) in income tax rate resulting from:Non-deductible
                expenses
            
            
            1
            
            
            (29
            )
            
            (1
            )State
                and local income taxes, net
            
            
            5
            
            
            6
            
            
            (1
            )Other
            
            
            —
            
            
            1
            
            
            (1
            )Tax
                benefit on sale of dsIT Technologies
            
            
            —
            
            
            —
            
            
            16Valuation
                allowance
            
            
            (39
            )
            
            (13
            )
            
            (45
            )Effective
                income tax rates
            
            
            1
            %
            
            (1
            )%
            
            2
            %




(c)
      Analysis of Deferred Tax Assets and (Liabilities)




Deferred
                tax assets consist of the following:
            
            As
                of December 31,2004
            
            2005Employee
                benefits
            
            $
            591
            
            $
            324Negative
                investment in Comverge
            
            
            620
            
            
            620Other
                temporary differences
            
            
            526
            
            
            496Net
                operating and capital loss carryforwards
            
            
            7,271
            
            
            5,5159,008
            
            
            6,955Valuation
                allowance
            
            
            (8,794
            )
            
            (6,924
            )Net
                deferred tax assets
            
            
            214
            
            
            31Deferred
                tax liabilities consist of the following:Intangible
                asset basis differences
            
            
            (27
            )
            
            (16
            )Net
                deferred tax assets, net
            
            $
            187
            
            $
            15Deferred
                tax assets - current
            
            $
            62
            
            $
            28Deferred
                tax assets - non-current
            
            
            152
            
            
            3Deferred
                tax liabilities - non-current
            
            
            (27
            )
            
            (16
            )Net
                deferred tax assets
            
            $
            187
            
            $
            15




Valuation
      allowances relate principally to net operating loss and capital loss
      carryforwards and foreign tax credit carryforwards. The change in the valuation
      allowance was an increase of $242 and an decrease of $1,811 in 2004 and 2005,
      respectively. The increase in 2004 was primarily attributable to the Company’s
      negative investment in Comverge partially offset by a reduction in future tax
      rates in Israel (see (f) below), whereas the decrease in 2005 was primarily
      attributable to the Company’s sale of its outsourcing consulting business (see
      Note 3).




(d)
      Summary of Tax Loss Carryforwards




As
      of
      December 31, 2005, the Company had various net operating loss carryforwards
      expiring as follows:




Expiration:
            
            Federal
            
            State
            
            Foreign2006-2007
            
            $
            —
            
            $
            47
            
            $
            —2008
            
            
            —
            
            
            801
            
            
            —2009
            
            
            —
            
            
            2,291
            
            
            —2010
            
            
            —
            
            
            2,861
            
            
            —2011
            
            
            —
            
            
            992
            
            
            —2012
            
            
            —
            
            
            2,721
            
            
            —2019-2025
            
            
            11,866
            
            
            —
            
            
            —Unlimited
            
            
            —
            
            
            —
            
            
            895Total
            
            $
            11,866
            
            $
            9,713
            
            $
            895




F-
          26




(e)
      Tax
      Reform in the United States




On
      October 22, 2004, The American Jobs Creation Act (the “Act”) was signed into
      law. The Act includes a deduction of 85% of certain foreign earnings that are
      repatriated, as defined in the Act. The Company’s foreign earnings are solely
      derived from the Company’s Israeli subsidiaries. Due to Israeli tax and company
      law constraints, the significant minority interest in dsIT and dsIT’s own cash
      and finance needs, the Company does not expect any foreign earnings to be
      repatriated to the Company in the near future.




(f)
      Tax
      Reform in Israel




The
      income of the Company’s Israeli subsidiaries is taxed at the regular Israeli
      corporate tax rates. Through December 31, 2003, the corporate tax was 36%.
      In July 2004, Amendment No. 140 to the Income Tax Ordinance was enacted.
      One of the provisions of this amendment is that the corporate tax rate would
      be
      gradually reduced from 36% to 30%. In August 2005, a further amendment
      (No. 147) was published, which makes a further revision to the corporate
      tax rates prescribed by Amendment No. 140. As a result of the
      aforementioned amendments, the corporate tax rates for 2004 and thereafter
      are
      as follows: 2004 - 35%, 2005 - 34%, 2006 - 31%, 2007 - 29%, 2008 - 27%, 2009
      -
      26% and for 2010 and thereafter - 25%. The reduction in the future income tax
      rates caused a reduction of deferred tax assets and associated valuation
      allowance of approximately $597 in 2004 and $58 in 2005.




**NOTE
      15--RELATED PARTY BALANCES AND TRANSACTIONS**




(a)  The
      Company paid consulting and other fees to directors of $112, $95 and $64 for
      the
      years ended December 31, 2003, 2004 and 2005, respectively, which are included
      in selling, general and administrative expenses.




(b)  The
      Company paid legal fees for services rendered and out-of-pocket disbursements
      to
      a firm in which a principal is a former director and is the son-in-law of the
      Company’s Chief Executive Officer, of approximately $403, $479 and $360 for the
      years ended December 31, 2003, 2004 and 2005, respectively. Approximately $99
      and $75 was owed to this firm as of December 31, 2004 and 2005, respectively,
      and is included in other current liabilities and trade accounts payable.




(c)  The
      Company received $6 of rent from a company controlled by the Chief Executive
      Officer for the year ended December 31, 2003.




(d)  The
      chief
      executive officer of the Company’s Israeli subsidiary has a loan from the
      subsidiary that was acquired in 2001. The loan balance and accrued interest
      at
      December 31, 2004 and 2005 was $112 and $104, respectively. The loan has no
      defined maturity date, is denominated in NIS, is linked to the Index and bears
      interest at 4%.




(e)  During
      2005, the president of the Company’s Databit subsidiary and son of the Chief
      Executive officer lent the Company $425 on a note payable. The note bore
      interest at the rate of prime plus 3% during the time it was outstanding. The
      note was repaid in full during 2005. The Company paid $3 of interest with
      respect to the note.




(f)  At
      December 31, 2005, the Company had set aside as restricted cash, $1,350 ($300
      current and $1,050 non-current) with respect to the Company’s CEO’s consulting
      agreement (see Note 18(a)).




See
      Notes
      13(a) and 13(c) for information related to options and stock awards to related
      parties.




See
      Note
      18(a) with respect to the sale of the Company’s Databit subsidiary to a related
      party in March 2006.




F-
          27




**NOTE
      16--SEGMENT REPORTING AND GEOGRAPHIC INFORMATION**




(a)
      General Information




As
      of
      December 31 2005, the Company has two reportable segments:




(i)
      Software consulting and development services




(ii)
      The
      computer hardware segment is an authorized dealer and value-added reseller
      of
      computer hardware.




Until
      March 31, 2003, the Company’s included the results of Comverge in its energy
      intelligence solutions segment. Since March 31, 2003, the Company no longer
      consolidates the results of Comverge (see Note 4) and no longer includes their
      results in segment reporting.




In
      August
      2005, the Company sold
      dsIT Technologies and its associated outsourcing consulting business (see Note
      3).




In
      March
      2006, the Company sold Databit, which comprised the entire computer hardware
      segment (see Note 18(a)).




The
      Company’s reportable segments are strategic business units, offering different
      products and services and are managed separately as each business requires
      different technology and marketing strategies. Similar operating segments
      operating in different countries are aggregated into one reportable
      segment.




(b)
      Information about Profit or Loss and Assets




The
      accounting policies of all the segments are those described in the summary
      of
      significant accounting policies. The Company evaluates performance based on
      the
      profit or loss from operations before other income (expense) and before income
      taxes not including nonrecurring gains and losses.




F-
          28




The
      Company accounts for intersegment sales and transfers as if the sales or
      transfers were to third parties, that is, at current market prices. The Company
      does not systematically allocate assets to the divisions of the subsidiaries
      constituting its consolidated group, unless the division constitutes a
      significant operation. Accordingly, where a division of a subsidiary constitutes
      a segment that does not meet the quantitative thresholds of SFAS No. 131,
      depreciation expense is recorded against the operations of such segment, without
      allocating the related depreciable assets to that segment. However, where a
      division of a subsidiary constitutes a segment that does meet the quantitative
      thresholds of SFAS No. 131, related depreciable assets, along with other
      identifiable assets, are allocated to such division.




The
      following tables represent segmented data for the years ended December 31,
      2005,
      2004 and 2003:




**Software
                Consulting and****Development(*)**
            
            **Energy**
              **Intelligence****Solutions(**)**
            
            **Computer****Hardware(***)**
            
            **Other
                (****)**
            
            **Total**Year
                ended December 31, 2005:Revenues
                from external customers
            
            $
            4,158
            
            $
            —
            
            $
            17,677
            
            $
            29
            
            $
            21,864Intersegment
                revenues
            
            
            —
            
            
            —
            
            
            15
            
            
            —
            
            
            15Depreciation
                and amortization
            
            
            221
            
            
            —
            
            
            21
            
            
            —
            
            
            242Segment
                gross profit
            
            
            1,213
            
            
            —
            
            
            3,176
            
            
            29
            
            
            4,418Interest
                expense, net
            
            
            83
            
            
            —
            
            
            5
            
            
            —
            
            
            88Segment
                income (loss)
            
            
            (850
            )
            
            —
            
            
            45
            
            
            19
            
            
            (786
            )Segment
                assets
            
            
            4,669
            
            
            —
            
            
            3,431
            
            
            —
            
            
            8,100Expenditures
                for segment assets
            
            
            152
            
            
            —
            
            
            34
            
            
            —
            
            
            186Year
                ended December 31, 2004:Revenues
                from external customers
            
            $
            3,300
            
            $
            —
            
            $
            18,468
            
            $
            64
            
            $
            21,832Intersegment
                revenues
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Depreciation
                and amortization
            
            
            209
            
            
            —
            
            
            16
            
            
            —
            
            
            225Segment
                gross profit
            
            
            809
            
            
            —
            
            
            3,744
            
            
            64
            
            
            4,617Interest
                expense, net
            
            
            157
            
            
            —
            
            
            —
            
            
            —
            
            
            157Segment
                income (loss)
            
            
            (1,461
            )
            
            —
            
            
            19
            
            
            38
            
            
            (1,404
            )Segment
                assets
            
            
            12,109
            
            
            —
            
            
            4,156
            
            
            —
            
            
            16,265Expenditures
                for segment assets
            
            
            81
            
            
            —
            
            
            13
            
            
            —
            
            
            94Year
                ended December 31, 2003:Revenues
                from external customers
            
            $
            4,198
            
            $
            4,700
            
            $
            18,139
            
            $
            39
            
            $
            27,076Intersegment
                revenues
            
            
            —
            
            
            284
            
            
            20
            
            
            —
            
            
            304Depreciation
                and amortization
            
            
            350
            
            
            158
            
            
            16
            
            
            —
            
            
            524Segment
                gross profit
            
            
            690
            
            
            1,313
            
            
            3,125
            
            
            39
            
            
            5,167Interest
                expense, net
            
            
            135
            
            
            108
            
            
            159
            
            
            —
            
            
            402Segment
                loss
            
            
            (1,990
            )
            
            (1,422
            )
            
            (191
            )
            
            (17
            )
            
            (3,620
            )Segment
                assets
            
            
            11,640
            
            
            —
            
            
            4,324
            
            
            —
            
            
            15,964Expenditures
                for equity investments
            
            
            —
            
            
            3,444
            
            
            —
            
            
            —
            
            
            3,444Expenditures
                for segment assets
            
            
            162
            
            
            54
            
            
            15
            
            
            —
            
            
            231




(*)
            Segment
                information excludes the discontinued results of the Israel based
                outsourcing activities and US-based consulting activities - see
              Note
                3.




(**)
            Operating
                results of Comverge (the Energy Intelligence Solutions segment) are
                no
                longer consolidated beginning the second quarter of 2003 - see Note
                4.
                Segment loss in 2003 includes the Company’s consolidated share of
                Comverge’s losses from January 1 to March 31, 2003 of $1,124 and other
                expense of $298, relating to the write-off of a stockholder’s note
                received from Comverge’s CEO. Not included above are equity losses from
                Comverge of $380, $1,242 and $1,752 in 2005, 2004 and 2003, respectively,
                and a gain of $705 in 2004 from the sale of shares in
                Comverge.




(***)
            See
                Note 18(a) for information regarding the sale of the Company’s Databit
                computer hardware subsidiary in March
                2006.




(****)
            Represents
                segments below the quantitative thresholds of SFAS No. 131 - a VAR
                software operation in Israel.




F-
          29




(c)   The
      following tables represent a reconciliation of the segment data to consolidated
      statement of operations and balance sheet data for the years ended and as of
      December 31, 2003, 2004 and 2005:




Year
                Ended December 31,2003
            
            2004
            
            2005Revenues:Total
                consolidated revenues for reportable segments
            
            $
            27,037
            
            $
            21,768
            
            $
            21,835Other
                operational segment revenues
            
            
            39
            
            
            64
            
            
            29Total
                consolidated revenues
            
            $
            27,076
            
            $
            21,832
            
            $
            21,864Income
                (loss)Total
                loss for reportable segments
            
            $
            (3,620
            )
            $
            (1,442
            )
            $
            (805
            )Other
                operational segment operating income (loss)
            
            
            (17
            )
            
            38
            
            
            19Total
                operating loss
            
            
            (3,637
            )
            
            (1,404
            )
            
            (786
            )Cost
                of corporate headquarters
            
            
            (2,300
            )
            
            (1,233
            )
            
            (1,462
            )Other
                income (expense)
            
            
            (322
            )
            
            240
            
            
            6Income
                taxes
            
            
            40
            
            
            (31
            )
            
            38Minority
                interests
            
            
            264
            
            
            (90
            )
            
            (73
            )Equity
                loss in Comverge
            
            
            (1,752
            )
            
            (1,242
            )
            
            (380
            )Gain
                on sale of shares in Comverge
            
            
            —
            
            
            705
            
            
            —Discontinued
                operations, net of tax
            
            
            1,425
            
            
            1,883
            
            
            798Gain
                on sale of discontinued operations, net of tax
            
            
            —
            
            
            —
            
            
            541Consolidated
                loss
            
            $
            (6,282
            )
            $
            (1,172
            )
            $
            (1,318
            )





As
                of December 31,2003
            
            2004
            
            2005Assets:Total
                assets for reportable segments
            
            $
            16,032
            
            $
            16,265
            
            $
            8,100Unallocated
                amounts: Net assets of corporateheadquarters
                *
            
            
            1,642
            
            
            760
            
            
            2,073Total
                consolidated assets
            
            $
            17,674
            
            $
            17,025
            
            $
            10,173




*
      In 2005
      includes restricted cash (current and non-current) of $1,597 ($241 in 2004)
      (See
      Notes 18(a) and 18(b)).





Other
                Significant Items
            
            Segment
                Totals
            
            Adjustments
            
            Consolidated
                TotalsYear
                ended December 31, 2005Depreciation
                and amortization
            
            $
            242
            
            $
            12
            
            $
            254Expenditures
                for assets
            
            
            186
            
            
            54
            
            
            240Year
                ended December 31, 2004Depreciation
                and amortization
            
            $
            225
            
            $
            2
            
            $
            227Expenditures
                for assets
            
            
            94
            
            
            —
            
            
            94Year
                ended December 31, 2003Depreciation
                and amortization
            
            $
            524
            
            $
            3
            
            $
            527Expenditures
                for assets
            
            
            231
            
            
            —
            
            
            231




F-
          30




The
      reconciling items are all corporate headquarters data, which are not included
      in
      the segment information. None of the other adjustments are
      significant.




Year
                Ended December 31,2003
            
            2004
            
            2005Revenues
                based on location of customer:United
                States
            
            $
            21,682
            
            $
            17,389
            
            $
            16,696Israel
            
            
            5,129
            
            
            4,172
            
            
            4,554Other
            
            
            265
            
            
            271
            
            
            624$
            27,076
            
            $
            21,832
            
            $
            21,864






As
                  at December 31,2003
            
            2004
            
            2005Long-lived
                assets located in the following countries:Israel
            
            $
            780
            
            $
            624
            
            $
            418United
                States
            
            
            34
            
            
            25
            
            
            82$
            814
            
            $
            649
            
            $
            500




(d)
              Revenues
                  from Major Customers




Consolidated
                Sales
              Year
                Ended December 31,2003
            
            2004
            
            2005Customer
            
            Segment
            
            Revenues
            
            %
                of Total
              Revenues
            
            Revenues
            
            %
                of
              Total
              Revenues
            
            Revenues
            
            %
                of Total
              RevenuesA
            
            Computer
                Hardware
            
            $5,143
            
            19.0%
            
            $7,412
            
            34.0%
            
            $5,888
            
            26.9%B
            
            Computer
                Hardware
            
            $868
            
            3.2%
            
            $836
            
            3.8%
            
            $3,943
            
            18.0%




**NOTE
      17--FINANCIAL INSTRUMENTS**




Fair
      values of financial instruments included in current assets and current
      liabilities are estimated to approximate their book values, due to the short
      maturity of such instruments. Fair values for long-term debt as of December
      31,
      2005 and 2004 are estimated based on the current rates offered to the Company
      for debt with similar terms and remaining maturities. The fair value of the
      Company’s long-term debt is not materially different from its carrying amounts.




**NOTE
      18—SUBSEQUENT EVENTS**




(a)
      Sale
      of Databit




On
      March
      10, 2006 the Company entered into a Stock Purchase Agreement dated as of March
      9, 2006 (the "SPA"), for the sale of all the outstanding capital stock of its
      Databit Inc. subsidiary ("Databit") to Shlomie Morgenstern, President of Databit
      and a Vice President of the Company. The transactions contemplated under the
      SPA, and the related transactions to which the Company, Shlomie Morgenstern
      and
      the Company’s CEO George Morgenstern were party to, were consummated on March
      10, 2006 and included the following:




F-
          31




(i)
      Termination of the Employment Agreement dated August 19, 2004 among Shlomie
      Morgenstern, Databit and the Company and the release of the Company from any
      and
      all liability (other than under the related stock option and restricted stock
      agreements which would be modified as described below) including the waiver
      by
      Shlomie Morgenstern of any and all severance or change of control payments
      to
      which he would have been entitled.




(ii)
      Amendment of the option and restricted stock agreements between the Company
      and
      Shlomie Morgenstern to provide for acceleration of any unvested grants on the
      closing of the transactions and for all options to be exercisable through 18
      months from the closing.




(iii)
      The
      assignment to and assumption by Databit of the obligations of Company to George
      Morgenstern under the Employment Agreement between the Company and George
      Morgenstern dated January 1, 1997, as amended (the "GM Employment Agreement")
      upon the following terms:




(A)
      Reduction of the
      amounts owed to George Morgenstern under the GM Employment Agreement by the
      lump
      sum payment described below and the modifications to options and restricted
      stock agreements described below.




(B)
      A release by
      George Morgenstern releasing Company from any and all liability and obligations
      to him under the GM Employment Agreement, subject to a lump sum payment of
      $600.




(iv)
      The
      assumption by Databit of the Company's obligations under the Company's leases
      for the premises in New York City and Mahwah, New Jersey, which provide for
      aggregate rents of approximately $450 over the next three years.




(v)
      The
      amendment of the option agreement with George Morgenstern dated December 30,
      2004 to provide for the acceleration of the 60,000 options that are not
      currently vested and the extension of the exercise period for all options held
      by George Morgenstern to the later of (i) September 2009 and (ii) 18 months
      after the cessation of his services as a director of the Company or as
      a consultant under the new consulting agreement described
      below.




(vi)
      The
      amendment of the Restricted Stock Agreement dated August 31, 1998 between George
      Morgenstern and the Company to provide for the removal of any vesting conditions
      from the 20,000 shares still subject to such conditions.




(vii)
      Execution and delivery by George Morgenstern and the Company of a new consulting
      agreement for a period of two years, pursuant to which George Morgenstern would
      serve as a consultant to the Company, primarily to assist in the management
      of
      the Company's dsIT subsidiary, which agreement provides for de minimus
      compensation per year plus a non-accountable expense allowance of $65 per year
      to cover expected costs of travel and other expenses.




As
      a result
      of the transaction and above mentioned amendments to various restricted stock
      and option agreements, the Company expects to record a loss of approximately
      $2,100 in the first quarter of 2006. In addition, cash, which had previously
      been restricted with respect to the GM Employment Agreement, will no longer
      be
      restricted. Subsequent to the second quarter of 2006, the Company will no longer
      have any activity in its Computer Hardware segment.




(b)
      Litigation Settlement Agreement




In
      March
      2006, the Company reached a settlement agreement with an Israeli bank with
      respect to the Company’s claims against the bank and the bank’s counterclaims
      against the Company. As part of the settlement agreement, all claims and
      counterclaims by the parties are dismissed. The bank will return to the Company
      approximately $94 plus interest and CPI adjustments of attorney fees and court
      costs previously paid by the Company. As a result of the settlement agreement,
      the accrued loss for contingent performance of bank guarantees of $410 will
      be
      reversed and the $247 collateralized portion of these guarantees (shown as
      restricted cash at December 31, 2005) will no longer be restricted. The Company
      expects to record income of approximately $330 in the first quarter of 2006
      as a
      result of the settlement agreement.




F-
          32




**Report
        of Independent**  **Registered
        Public Accounting Firm**
 **on**
 **Financial
        Statement Schedule**
 
 
 
 To
        the
        Board of Directors of Data Systems &
        Software Inc.:
 
 Our
        audits of the consolidated financial
        statements referred to in our report dated April 11, 2006 of Data
        Systems & Software Inc. related
        to the consolidated financial statements of Data Systems & Software Inc. which are included in
        this Annual Report on Form 10-K also included an audit of the financial
        statement Schedule II - Valuation and Qualifying Accounts listed in Item
        15(a)(2) of this Annual Report on Form 10-K. In our opinion, this
        financial statement schedule presents fairly,
        in all material respects, the information set forth therein when read in
        conjunction with the related consolidated
        financial statements.
    April
          11,
          2006
 
 /s/
          Kesselman & Kesselman
 Certified
          Public Accountants
 A
          member
          of PricewaterhouseCoopers International Limited
 Tel-Aviv,
          Israel
 
 S-1






**DATA
      SYSTEMS & SOFTWARE INC.**


**SCHEDULE
      II**


**VALUATION
      AND QUALIFYING ACCOUNTS**


**FOR
      THE YEARS ENDED DECEMBER 31, 2003, 2004 AND 2005**


**(in
      thousands)**






**Description**
            
            **Balance
                at the Beginning of the Year**
            
            **Charged
                to Costs and Expenses**
            
            **Other
                Adjustments**
            
            **Balance
                at the End of the Year**Allowance
                for unrecognized losses in ComvergeYear
                ended December 31, 2003
            
            
            —
            
            
            —
            
            
            —
            
            
            —Year
                ended December 31, 2004
            
            
            —
            
            
            —
            
            
            —
            
            
            —Year
                ended December 31, 2005
            
            
            —
            
            
            —
            
            
            64
            
            
            64Allowance
                for doubtful accountsYear
                ended December 31, 2003
            
            
            214
            
            
            50
            
            
            (210
            )
            
            55Year
                ended December 31, 2004
            
            
            55
            
            
            (38
            )
            
            15
            
            
            32Year
                ended December 31, 2005
            
            
            32
            
            
            5
            
            
            (19
            )
            
            18Allowance
                for inventory valuationYear
                ended December 31, 2003
            
            
            43
            
            
            —
            
            
            (30
            )
            
            13Year
                ended December 31, 2004
            
            
            13
            
            
            —
            
            
            (12
            )
            
            1Year
                ended December 31, 2005
            
            
            1
            
            
            —
            
            
            (1
            )
            
            —Valuation
                allowance for deferred tax assetsYear
                ended December 31, 2003
            
            
            12,634
            
            
            —
            
            
            (4,082
            )
            
            8,552Year
                ended December 31, 2004
            
            
            8,552
            
            
            —
            
            
            242
            
            
            8,794Year
                ended December 31, 2005
            
            
            8,794
            
            
            298
            
            
            (2,168
            )
            
            6,924






S-2


**Comverge,
          Inc. and Subsidiaries**
 **Consolidated
          Financial Statements**
 **December
          31, 2005 and 2004**
 
 
   **Page(s)****Report
                      of Independent Auditors**
                  C-1**Consolidated
                      Financial Statements**Consolidated
                      Balance Sheets
                  C-2Consolidated
                      Statements of Operations
                  C-3Consolidated
                      Statements of Changes in Shareholders' Equity
                  C-4Consolidated
                      Statements of Cash Flows
                  C-5Notes
                      to Consolidated Financial Statements
                  C-6
   **Report
          of Independent Auditors**
  
  To
          Board
          of Directors and Shareholders of
  Comverge,
          Inc.
  In
          our
          opinion, the accompanying consolidated balance sheets and the related
          consolidated statements of operations, shareholders' equity and cash flows
          present fairly, in all material respects, the financial position of Comverge,
          Inc. and its subsidiaries at December 31, 2005, and 2004, and the results
          of
          their operations and their cash flows for each of the three years in the
          period
          ended December 31, 2005 in conformity with accounting principles generally
          accepted in the United States of America. These financial statements are
          the
          responsibility of the Company’s management. Our responsibility is to express an
          opinion on these financial statements based on our audits. We conducted
          our
          audits of these statements in accordance with auditing standards generally
          accepted in the United States of America. Those standards require that
          we plan
          and perform the audit to obtain reasonable assurance about whether the
          financial
          statements are free of material misstatement. An audit includes examining,
          on a
          test basis, evidence supporting the amounts and disclosures in the financial
          statements, assessing the accounting principles used and significant estimates
          made by management, and evaluating the overall financial statement presentation.
          We believe that our audits provide a reasonable basis for our
          opinion.
 
 
 /s/
          PricewaterhouseCoopers LLP  Atlanta,
          Georgia
 March
          29,
          2006
  C-1
   **Comverge,
          Inc. and Subsidiaries**
 **Consolidated
          Balance Sheets**
 **December
          31, 2005 and 2004**
 
 *(in
                      thousands of dollars, except share and per share
                      data)*
                  
                  **2005**
                  
                  **2004****Assets**Current
                      assetsCash
                      and cash equivalents
                  
                  $
                  2,606
                  
                  $
                  8,761Accounts
                      receivable
                  
                  
                  5,288
                  
                  
                  4,620Inventory
                  
                  
                  1,768
                  
                  
                  2,102Prepaid
                      employee termination benefits
                  
                  
                  343
                  
                  
                  -Other
                      current assets
                  
                  
                  2,667
                  
                  
                  1,057Total
                      current assets
                  
                  
                  12,672
                  
                  
                  16,540Property
                      and equipment, net
                  
                  
                  10,545
                  
                  
                  5,342Goodwill
                      and other intangible assets
                  
                  
                  677
                  
                  
                  726Other
                      assets
                  
                  
                  42
                  
                  
                  1,353Total
                      assets
                  
                  $
                  23,936
                  
                  $
                  23,961**Liabilities
                      and Shareholders' Equity**Current
                      liabilitiesAccounts
                      payable
                  
                  $
                  2,600
                  
                  $
                  2,225Deferred
                      revenue
                  
                  
                  2,625
                  
                  
                  1,963Accrued
                      incentive payments
                  
                  
                  693
                  
                  
                  33Accrued
                      expenses
                  
                  
                  1,160
                  
                  
                  953Liability
                      for employee termination benefits
                  
                  
                  580
                  
                  
                  -Other
                      current liabilities
                  
                  
                  640
                  
                  
                  468Total
                      current liabilities
                  
                  
                  8,298
                  
                  
                  5,642Long-term
                      liabilitiesLong-term
                      trade payable
                  
                  
                  1,362
                  
                  
                  1,362Long-term
                      bank debt
                  
                  
                  4,000
                  
                  
                  -Other
                      liabilities
                  
                  
                  440
                  
                  
                  849Total
                      long-term liabilities
                  
                  
                  5,802
                  
                  
                  2,211Commitments
                      and contingencies (Note 12)Shareholders'
                      EquityConvertible
                      Preferred StockSeries
                      A, $.001 par value per share, authorized 10,402,000 shares;
                      issuedand
                      outstanding 10,401,146 shares at December 31, 2005 and 2004;liquidation
                      preference of $32,516 at December 31, 2005 and 2004
                  
                  
                  21,438
                  
                  
                  21,438Series
                      A-2, $.001 par value per share, authorized 36,076 shares;issued
                      and outstanding 36,706 shares at December 31, 2005and
                      2004; liquidation preference of $150 at December 31, 2005 and
                      2004
                  
                  
                  100
                  
                  
                  100Series
                      B, $.001 par value per share, authorized 7,875,377 shares;
                      issuedand
                      outstanding 5,640,878 shares at December 31, 2005 and 2004;liquidation
                      preference of $20,449 at December 31, 2005 and 2004
                  
                  
                  13,568
                  
                  
                  13,568Common
                      stock $.001 par value per share, authorized 28,185,739 shares;issued
                      and outstanding 6,154,373 and 5,903,598 sharesat
                      December 31, 2005 and 2004, respectively
                  
                  
                  6
                  
                  
                  6Additional
                      paid-in capital
                  
                  
                  19,198
                  
                  
                  19,105Deferred
                      compensation
                  
                  
                  -
                  
                  
                  (30
                  )Accumulated
                      deficit
                  
                  
                  (44,474
                  )
                  
                  (38,079
                  )Total
                      shareholders' equity
                  
                  
                  9,836
                  
                  
                  16,108Total
                      liabilities and shareholders' equity
                  
                  $
                  23,936
                  
                  $
                  23,961
 The
          accompanying notes are an integral part of these
          financial statements.
  C-2
 **Comverge,
          Inc. and Subsidiaries**
 **Consolidated
          Statements of Operations**
 **Years
          Ended December 31, 2005, 2004 and 2003**
 
  *(in
                      thousands of dollars)***2005**
                  
                  **2004**
                  
                  **2003**RevenueProduct
                  
                  $
                  12,829
                  
                  $
                  13,028
                  
                  $
                  12,592Service
                  
                  
                  12,882
                  
                  
                  5,131
                  
                  
                  3,050Total
                      revenue
                  
                  
                  25,711
                  
                  
                  18,159
                  
                  
                  15,642Cost
                      of revenueProduct
                  
                  
                  9,464
                  
                  
                  8,876
                  
                  
                  9,763Service
                  
                  
                  3,164
                  
                  
                  1,680
                  
                  
                  875Total
                      cost of revenue
                  
                  
                  12,628
                  
                  
                  10,556
                  
                  
                  10,638Gross
                      profit
                  
                  
                  13,083
                  
                  
                  7,603
                  
                  
                  5,004General
                      and administrative expenses
                  
                  
                  11,655
                  
                  
                  8,251
                  
                  
                  8,943Marketing
                      and selling expenses
                  
                  
                  6,675
                  
                  
                  7,335
                  
                  
                  4,177Research
                      and development expenses
                  
                  
                  1,094
                  
                  
                  1,046
                  
                  
                  615Operating
                      loss
                  
                  
                  (6,341
                  )
                  
                  (9,029
                  )
                  
                  (8,731
                  )Interest
                      and other expense, net
                  
                  
                  54
                  
                  
                  229
                  
                  
                  586Loss
                      before income taxes
                  
                  
                  (6,395
                  )
                  
                  (9,258
                  )
                  
                  (9,317
                  )Provision
                      for income taxes
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -Net
                      loss
                  
                  $
                  (6,395
                  )
                  $
                  (9,258
                  )
                  $
                  (9,317
                  )
  The
            accompanying notes are an integral part of these
            financial statements.
 C-3
 **Comverge,
          Inc. and Subsidiaries**
 **Consolidated
          Statements of Changes in Shareholders’ Equity**
 **Years
          Ended December 31, 2005, 2004 and 2003**
 
  *(in
                      thousands of dollars,*
                    *except
                      share data)*
                  
                  **Series
                        A
                        Convertible****Preferred
                      Stock**
                  
                  **Series
                        A-1
                        Convertible****Preferred
                      Stock**
                  
                  **Series
                        A-2
                        Convertible****Preferred
                      Stock**
                  
                  **Series
                        B
                        Convertible****Preferred
                      Stock**
                  
                  **Common
                      Stock**
                  
                  **Additional**
                    **Paid-in**
                    **Capital**
                  
                  
                  
                  
                  
                  **Total****Shareholders'**
                    **Equity**
                    **(Deficit)****Number
                      of**
                    **Shares**
                  
                  **Amount**
                  
                  **Number
                      of**
                    **Shares**
                  
                  **Amount**
                  
                  **Number
                      of**
                    **Shares**
                  
                  **Amount**
                  
                  **Number
                      of**
                    **Shares**
                  
                  **Amount**
                  
                  **Number
                      of**
                    **Shares**
                  
                  **Amount**
                  
                  
                  **Deferred**
                    **Compensation**
                  
                  **Accumulated**
                    **Deficit****Balances
                      at December 31, 2002**
                  
                  
                  -
                  
                  $
                  -
                  
                  
                  -
                  
                  $
                  -
                  
                  
                  -
                  
                  $
                  -
                  
                  
                  -
                  
                  $
                  -
                  
                  
                  4,937,748
                  
                  $
                  5
                  
                  $
                  8,631
                  
                  $
                  -
                  
                  $
                  (19,504
                  )
                  $
                  (10,868
                  )Issuance
                      of Series A Convertible Preferred Stock
                  
                  
                  8,945,350
                  
                  
                  18,425
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  18,425Issuance
                      of Series A-1 Convertible Preferred Stock
                  
                  
                  -
                  
                  
                  -
                  
                  
                  721,527
                  
                  
                  2,000
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  2,000Issuance
                      of Series A-2 Convertible Preferred Stock
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  36,076
                  
                  
                  100
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  100Repurchase
                      of Series A-1 Convertible Preferred Stock
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (721,527
                  )
                  
                  (2,000
                  )
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (2,000
                  )Issuance
                      of common stock
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  877,000
                  
                  
                  1
                  
                  
                  509
                  
                  
                  -
                  
                  
                  -
                  
                  
                  510Contribution
                      of debt by affiliated investor
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  9,673
                  
                  
                  -
                  
                  
                  -
                  
                  
                  9,673Executive
                      compensation payable by affiliated investor
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  200
                  
                  
                  -
                  
                  
                  -
                  
                  
                  200Net
                      loss
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (9,317
                  )
                  
                  (9,317
                  )**Balances
                      at December 31, 2003**
                  
                  
                  8,945,350
                  
                  
                  18,425
                  
                  
                  -
                  
                  
                  -
                  
                  
                  36,076
                  
                  
                  100
                  
                  
                  -
                  
                  
                  -
                  
                  
                  5,814,748
                  
                  
                  6
                  
                  
                  19,013
                  
                  
                  -
                  
                  
                  (28,821
                  )
                  
                  8,723Issuance
                      of Series A Convertible Preferred stock
                  
                  
                  1,455,796
                  
                  
                  3,013
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  3,013Issuance
                      of Series B Convertible Preferred stock
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  5,604,878
                  
                  
                  13,568
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  13,568Issuance
                      of common stock upon exercise of stock options
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  4,052
                  
                  
                  -
                  
                  
                  5
                  
                  
                  -
                  
                  
                  -
                  
                  
                  5Treasury
                      stock
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (8,000
                  )
                  
                  -
                  
                  
                  (14
                  )
                  
                  -
                  
                  
                  -
                  
                  
                  (14
                  )Deferred
                      compensation
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  30
                  
                  
                  (30
                  )
                  
                  -
                  
                  
                  -Issuance
                      of common stock with Series B financing
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  92,798
                  
                  
                  -
                  
                  
                  34
                  
                  
                  -
                  
                  
                  -
                  
                  
                  34Shareholder
                      loans
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  37
                  
                  
                  -
                  
                  
                  -
                  
                  
                  37Net
                      loss
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (9,258
                  )
                  
                  (9,258
                  )**Balances
                      at December 31, 2004**
                  
                  
                  10,401,146
                  
                  
                  21,438
                  
                  
                  -
                  
                  
                  -
                  
                  
                  36,076
                  
                  
                  100
                  
                  
                  5,604,878
                  
                  
                  13,568
                  
                  
                  5,903,598
                  
                  
                  6
                  
                  
                  19,105
                  
                  
                  (30
                  )
                  
                  (38,079
                  )
                  
                  16,108Issuance
                      of common stock upon exercise of stock options
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  775
                  
                  
                  -
                  
                  
                  1
                  
                  
                  -
                  
                  
                  -
                  
                  
                  1Deferred
                      compensation
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  30
                  
                  
                  -
                  
                  
                  30Issuance
                      of common stock
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  250,000
                  
                  
                  -
                  
                  
                  92
                  
                  
                  -
                  
                  
                  -
                  
                  
                  92Net
                      loss
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (6,395
                  )
                  
                  (6,395
                  )**Balances
                      at December 31, 2005**
                  
                  
                  10,401,146
                  
                  $
                  21,438
                  
                  
                  -
                  
                  $
                  -
                  
                  
                  36,076
                  
                  $
                  100
                  
                  
                  5,604,878
                  
                  $
                  13,568
                  
                  
                  6,154,373
                  
                  $
                  6
                  
                  $
                  19,198
                  
                  $
                  -
                  
                  $
                  (44,474
                  )
                  $
                  9,836
   The accompanying notes are
          an
          integral part of these financial statements.
 C-4
 **Comverge,
            Inc. and Subsidiaries**
 **Consolidated
            Statements of Cash Flows**
 **Years
            Ended December 31, 2005, 2004 and 2003**
 
  *(in
                        thousands of dollars)***2005**
                    
                    **2004**
                    
                    **2003****Cash
                        flows from operating activities**Net
                        loss
                    
                    $
                    (6,395
                    )
                    $
                    (9,258
                    )
                    $
                    (9,317
                    )Adjustments
                        to reconcile net loss to net cash used in operating
                        activitiesDepreciation
                        and amortization
                    
                    
                    1,394
                    
                    
                    1,212
                    
                    
                    1,166Noncash
                        stock compensation
                    
                    
                    122
                    
                    
                    -
                    
                    
                    200Loss
                        on disposal of property and equipment
                    
                    
                    54
                    
                    
                    69
                    
                    
                    62Provision
                        for inventory
                    
                    
                    355
                    
                    
                    45
                    
                    
                    -Provision
                        for doubtful accounts
                    
                    
                    60
                    
                    
                    -
                    
                    
                    -Changes
                        in operating assets and liabilitiesAccounts
                        receivable
                    
                    
                    (728
                    )
                    
                    (1,599
                    )
                    
                    579Inventories
                    
                    
                    (1,759
                    )
                    
                    1,256
                    
                    
                    (1,364
                    )Prepaid
                        expenses and other assets
                    
                    
                    (291
                    )
                    
                    (1,474
                    )
                    
                    (286
                    )Accounts
                        payable
                    
                    
                    375
                    
                    
                    (568
                    )
                    
                    1,596Accrued
                        expenses and other liabilities
                    
                    
                    1,285
                    
                    
                    1,774
                    
                    
                    114Deferred
                        revenue
                    
                    
                    662
                    
                    
                    1,592
                    
                    
                    117Net
                        cash used in operating activities
                    
                    
                    (4,866
                    )
                    
                    (6,951
                    )
                    
                    (7,133
                    )**Cash
                        flows from investing activities**Purchases
                        of property and equipment
                    
                    
                    (5,215
                    )
                    
                    (4,156
                    )
                    
                    (1,485
                    )Funding
                        of termination benefits
                    
                    
                    (75
                    )
                    
                    -
                    
                    
                    (69
                    )Net
                        cash used in investing activities
                    
                    
                    (5,290
                    )
                    
                    (4,156
                    )
                    
                    (1,554
                    )**Cash
                        flows from financing activities**Proceeds
                        from exercise of stock options
                    
                    
                    1
                    
                    
                    5
                    
                    
                    -Purchase
                        of treasury stock
                    
                    
                    -
                    
                    
                    (14
                    )
                    
                    -Proceeds
                        from Series A Preferred Stock, net of $20 and $218issuance
                        costs, respectively
                    
                    
                    -
                    
                    
                    3,014
                    
                    
                    18,425Proceeds
                        from Series A-1 Preferred Stock
                    
                    
                    -
                    
                    
                    -
                    
                    
                    2,000Repurchase
                        of Series A-1 Preferred Stock
                    
                    
                    -
                    
                    
                    -
                    
                    
                    (2,000
                    )Proceeds
                        from Series A-2 Preferred Stock
                    
                    
                    -
                    
                    
                    -
                    
                    
                    100Proceeds
                        from Series B Preferred Stock, net of $31 issuance costs
                    
                    
                    -
                    
                    
                    13,602
                    
                    
                    -Repayments
                        of long-term debt
                    
                    
                    -
                    
                    
                    (1,346
                    )
                    
                    (8,200
                    )Proceeds
                        from repayment of shareholder loans
                    
                    
                    -
                    
                    
                    37
                    
                    
                    -Borrowings
                        under credit facility
                    
                    
                    -
                    
                    
                    -
                    
                    
                    2,822Proceeds
                        from long-term debt
                    
                    
                    4,000
                    
                    
                    -
                    
                    
                    -Net
                        cash provided by financing activities
                    
                    
                    4,001
                    
                    
                    15,298
                    
                    
                    13,147Net
                        change in cash
                    
                    
                    (6,155
                    )
                    
                    4,191
                    
                    
                    4,460Cash
                        and cash equivalents at beginning of year
                    
                    
                    8,761
                    
                    
                    4,570
                    
                    
                    110Cash
                        and cash equivalents at end of year
                    
                    $
                    2,606
                    
                    $
                    8,761
                    
                    $
                    4,570Cash
                        paid for interest
                    
                    $
                    130
                    
                    $
                    91
                    
                    $
                    190**Supplemental
                        disclosure of noncash investing and****financing
                        activities**Recording
                        of asset retirement obligation
                    
                    $
                    67
                    
                    $
                    102
                    
                    $
                    -Increase
                        in fixed assets resulting from transfer of inventory
                    
                    $
                    1,738
                    
                    $
                    686
                    
                    $
                    685Assets/liabilities
                        acquired in acquisitionProperty
                        and equipment
                    
                    
                    -
                    
                    
                    -
                    
                    
                    (472
                    )Identified
                        intangible
                    
                    
                    -
                    
                    
                    -
                    
                    
                    (104
                    )Other
                        current liabilities
                    
                    
                    -
                    
                    
                    -
                    
                    
                    66Issuance
                        of shares in respect of acquisition
                    
                    
                    -
                    
                    
                    -
                    
                    
                    510
  The
                  accompanying notes are an integral part of these financial
                  statements.
 C-5
  **Comverge,
            Inc. and Subsidiaries**
 **Notes
            to Consolidated Financial Statements**
 
 ***(All
            notes in thousands of dollars, except share and per share
            data)***
   **1.**
                  **Description
                      of Business and Summary of Significant Accounting Policies**
  **Description
            of Business**
 Comverge,
            Inc., a Delaware corporation, and its subsidiaries (collectively, the
            "Company"), provides (i) demand response systems comprised of hardware,
            software
            and installation services, to utilities and other energy customers (“Solutions
            Business”) and (ii) on-call capacity relief to electricity providers and
            transmitters (“Enterprise Business”). Prior to April 2003, the Company was a
            wholly-owned subsidiary of Data Systems & Software, Inc. (“DSSI”). In April
            2003 and continuing thereafter, the Company completed a series of equity
            financings. After giving effect to the equity financings, DSSI remains
            the
            Company’s largest shareholder, owning approximately 25 percent of the Company’s
            issued and outstanding voting equity at December 31, 2005 and 2004.
  **Liquidity**
 The
            Company has experienced losses since inception and expects to incur losses
            in
            2006. During 2005, the Company raised additional funds from a convertible
            subordinated debt financing (“Subordinated Debt”) and renegotiated its credit
            facility, increasing its availability thereunder. In March 2006, the
            Company
            completed an additional equity financing through the sale of its Series
            C
            Preferred Stock. Management believes these financings, along with working
            capital provided by operating activities and available borrowing capacity
            under
            its Credit Facility, will be sufficient to meet the operating needs of
            the
            Company over the next twelve months. The Company’s Enterprise Business requires
            significant capital to support (i) planned operating losses incurred
            during the
            installation phase of long-term contracts, (ii) capital requirements
            of
            providing on-call demand response systems available to its utility customers,
            and (iii) working capital and credit requirements incident to the provision
            of
            long-term capacity commitments. While capital expenditure requirements
            are
            discretionary, additional financing may be required if the Company continues,
            as
            expected, to develop its Enterprise Business.
  **Use
            of Estimates in Preparation of Financial Statements**
 The
            preparation of financial statements in conformity with accounting principles
            generally accepted in the United States of America requires management
            to make
            estimates and assumptions that affect the reported amounts of assets
            and
            liabilities and the disclosure of contingent assets and liabilities as
            of the
            date of the financial statements, and the reported amounts of revenues
            and
            expenses during the reporting periods. Significant estimates include
            management’s estimate of provisions required for non-collectible accounts
            receivable, obsolete or slow-moving inventory, and potential product
            warranty
            liability. Actual results could differ from those estimates.
  **Foreign
            Currency Translations**
 The
            currency of the primary economic environment in which the operations
            of the
            Company are conducted is the United States Dollar ("dollar"). Accordingly,
            Comverge and its subsidiaries use the dollar as their functional currency.
            All
            exchange gains and losses denominated in non-dollar currencies are presented
            on
            a net basis in operating expense in the consolidated statement of operations
            when they arise. Foreign currency gain (loss) amounted to $14, ($4) and
            ($15)
            for the years ended December 31, 2005, 2004 and 2003 respectively.
  **Principles
            of Consolidation and Presentation**
 The
            consolidated financial statements of the Company include the accounts
            of its
            subsidiaries. The consolidated financial statements have been prepared
            in
            conformity with accounting principles generally accepted in the United
            States of
            America. All intercompany balances and transactions have been eliminated.
            Certain amounts in the prior year have been reclassed to conform to the
            current
            year presentation.
  C-6
 
  **Comverge,
                Inc. and Subsidiaries**
 **Notes
                to Consolidated Financial Statements**
 
 ***(All
                notes in thousands of dollars, except share and per share
                data)***
 **Cash
            and Cash Equivalents**
 The
            company considers all highly liquid investments with an original maturity
            of
            three months or less to be cash equivalents. Cash and cash equivalents
            consist
            of cash and demand deposits in banks and short-term investments.
  **Allowance
            for Doubtful Accounts**
 The
            allowance for doubtful accounts is based on specific identification of
            accounts
            considered to be doubtful of collection as well as historical experience.
            As of
            December 31, 2005 and 2004 there were $60 and $0 accounts identified
            as doubtful
            of collection, respectively.
  **Inventory**
 Inventories
            are stated at the lower of cost or market. Inventory cost is determined
            on the
            basis of specific identification based on acquisition cost, and due provision
            is
            made to reduce all slow-moving, obsolete, or unusable inventories to
            their
            estimated useful or scrap values. As of December 31, 2005 and 2004 there
            were provisions of $400 and $45, respectively, for inventory identified
            as
            slow-moving, obsolete, or unusable.
  **Property
            and Equipment**
 Property
            and equipment are presented at cost less accumulated depreciation. Depreciation
            is calculated using the straight-line method over the estimated useful
            lives of
            the depreciable assets. In the case of installed assets that are part
            of
            long-term contracts, the assets are depreciated over the shorter of the
            useful
            life or the term of the contract. In respect of these installed assets,
            depreciation expense is recognized as a component of cost of revenue.
            Leasehold
            improvements are depreciated over the shorter of the lease term or useful
            life.
            Improvements are capitalized while repairs and maintenance are expensed
            as
            incurred.
  In
            accordance with Statement of Financial Accounting Standards (“SFAS”) No. 143,
            Accounting for Asset Retirement Obligations, the Company recognizes the
            fair
            value of liabilities for asset retirement obligations in the period in
            which it
            is incurred if a reasonable estimate of fair value can be made. Any associated
            asset retirement costs are capitalized as part of the carrying amount
            of the
            long-lived asset and recognized as depreciation expense over the assets
            useful
            life. As part of the Company’s Enterprise Business, the Company installs
            hardware at the places of residence of select utility customers’ homes. At the
            request of the homeowner, the Company is obligated to remove this hardware.
            Accordingly, in 2005 and 2004, the Company recognized an asset retirement
            obligation liability and an associated increase in the value of long-lived
            assets of $67 and $102, respectively. In
            2003,
            the estimated cost of these obligations was immaterial. As such, there
            was no
            obligation recorded.
  **Impairment
            of Long-Lived Assets**
 The
            Company evaluates the recoverability of its long-lived assets and certain
            identifiable intangible assets in accordance with SFAS No. 144, *Accounting
            for the Impairment or Disposal of Long-Lived Assets.* SFAS No.
            144 requires recognition of impairment in the event the net book value
            of such
            assets exceeds the future undiscounted cash flows attributable to such
            assets.
            If impairment is indicated, the carrying amount of the asset is written
            down to
            fair value. The Company has identified no such impairments.
  C-7
 
  **Comverge,
                Inc. and Subsidiaries**
 **Notes
                to Consolidated Financial Statements**
 
 ***(All
                notes in thousands of dollars, except share and per share
                data)***
 **Goodwill
            and Intangibles**
 Goodwill
            represents the excess of cost over the fair value of the net tangible
            assets of
            subsidiaries acquired in purchase transactions. In accordance with SFAS
            No. 142, *Goodwill
            and Other Intangible Assets,* goodwill
            is not being amortized. Goodwill and other indefinite-lived intangible
            assets
            are tested for impairment on at least an annual basis, on December 31
            of each
            year. Based on the Company’s most recent impairment test, there has been no
            impairment loss recognized for goodwill.
  The
            costs
            of licensed technology are presented at their fair value at acquisition
            date.
            These costs are amortized on a straight-line basis over the term of the
            license,
            generally five years.
  The
            costs
            of registered patents and patents pending acquired from third parties
            are
            presented at their fair value at acquisition date. In addition, registration
            costs and fees for patents are capitalized. Registered patent costs are
            amortized over the estimated remaining useful life of the patents, from
            four to
            fourteen years. Costs for patents pending are not amortized until they
            are
            issued.
  **Revenue
            Recognition**
 In
            accordance with Staff Accounting Bulletin (“SAB”) 104, *Revenue
            Recognition* ,
            the
            Company recognizes revenues when the following criteria have been met:
            delivery
            has occurred, the price is fixed and determinable, collection is probable,
            and
            persuasive evidence of an arrangement exists.
  Revenue
            from time-and-materials service contracts and other services are recognized
            as
            services are provided. Revenue from maintenance contracts is recognized
            on a
            straight-line basis over the life of the contract.
  In
            accordance with SAB 104, the Company defers revenues and associated costs
            of
            revenues related to certain long term contracts until such time as the
            contract
            price is fixed and determinable. These contracts require the Company
            to provide
            on-call electricity capacity through demand reduction to utility customers,
            and
            require a measurement and verification of such capacity on an annual
            basis in
            order to determine final contract consideration for a given contract
            year.
            Contract years begin at the end of a control season (generally, at the
            end of a
            utility’s summer cooling season that correlates to the end of the utility’s peak
            demand for electricity) and continue for twelve months thereafter. For
            the year
            ended December 31, 2005, the Company deferred $2,425 of revenues and
            $873 of
            corresponding costs of revenues in respect of these contracts. For the
            year
            ended December 31, 2004, the Company deferred $1,713 of revenues and
            $281 of
            corresponding costs of revenues, of which amounts were recognized in
            the year
            ended December 31, 2005, upon the successful measurement and verification
            calculation that occurred in the fourth quarter of 2005.
  In
            accordance with Emerging Issues Task Force (“EITF”) 00-21, *Accounting
            for Revenue Arrangements with Multiple Deliverables* ,
            the
            Company assesses revenue arrangements to determine when multiple deliverables
            exist in order to determine if separate accounting is required for these
            deliverables separately per EITF 00-21.
  In
            certain contracts, the Company provides multiple deliverables to its
            customers,
            including software licenses. AICPA Statement of Position (“SOP”) 97-2, *Software
            Revenue Recognition* ,
            requires that each element of these arrangements be recorded to revenue
            based on
            its fair value, which is determined based on vendor specific objective
            evidence
            (“VSOE”). Establishment of VSOE is generally based on what price is charged
            for
            the element when sold on a standalone basis. Since the Company does not
            generally sell the separate elements of these contracts on a standalone
            basis,
            revenue for all elements is recognized ratably over the life of the contract,
            once all related revenue recognition requirements are met.
  C-8
 
  **Comverge,
                Inc. and Subsidiaries**
 **Notes
                to Consolidated Financial Statements**
 
 ***(All
                notes in thousands of dollars, except share and per share
                data)***
 In
            accordance with EITF 00-10, *Accounting
            for Shipping and Handling Fees and Costs* ,
            the
            Company reports shipping and handling revenues and their associated costs
            in
            revenue and cost of revenue, respectively.
  In
            accordance with EITF 01-9, *Accounting
            for Consideration Given by a Vendor to a Customer (Including a Reseller
            of the
            Vendor’s Products),* the
            Company records incentive payments made to customers as cost of
            revenue.
  During
            2005, to correct a misclassification of cost of revenue components, the
            Company
            reclassified certain costs of revenue related to its 2004 statement of
            operations. The revision resulted in a decrease in product cost of revenue
            and a
            corresponding increase in service cost of revenue of $602. Accordingly,
            the 2004
            statement of operations in these financial statements reflects this revision.
            This revision had no impact on previously reported amounts of net income,
            gross
            profit, cash flows, or balance sheet accounts.
  **Warranty
            Provision**
 Comverge
            generally warrants its products against certain manufacturing and other
            defects.
            These product warranties are provided for specific periods of time and/or
            usage
            of the product depending on the nature of the product, the geographic
            location
            of its sale and other factors. In late 2004, the Company began to outsource
            manufacturing operations to a contract manufacturer that provides warranty
            coverage pursuant to the contractual terms of the agreement.
  **2005**
                    
                    **2004**Warranty
                        provision at beginning of period
                    
                    $
                    161
                    
                    $
                    152Accruals
                        for warranties issued during the period
                    
                    
                    49
                    
                    
                    100Warranty
                        settlements during the period
                    
                    
                    (227
                    )
                    
                    (91
                    )Changes
                        in liability for pre-existing warrantiesduring
                        the period, including expirations
                    
                    
                    68
                    
                    
                    -Warranty
                        provision at the end of period
                    
                    $
                    51
                    
                    $
                    161
 **Advertising
            Expenses**
 Advertising
            costs are expensed as incurred. Advertising expense amounted to $3,457,
            $2,816,
            and $813 for the years ended December 31, 2005, 2004 and 2003, respectively.
            Substantially all advertising costs were incurred to acquire electricity
            capacity in fulfillment of certain long-term capacity contracts with
            utility
            customers of the Company’s Enterprise Business.
  **Internal
            Use Software**
 Software
            development costs of $59 incurred in 2005 were capitalized in accordance
            with
            SOP No. 98-1, *Accounting
            for the Costs of Computer Software Developed or Obtained for Internal
            Use* , ** and
            will
            be amortized over a three-year period in accordance with Company policy
            and
            expected life.
  C-9
 
 **Comverge,
                  Inc. and Subsidiaries**
 **Notes
                  to Consolidated Financial Statements**
 
 ***(All
                  notes in thousands of dollars, except share and per share
                  data)***
 **Research
            and Development Expenses**
 All
            research and development costs are expensed as incurred.
  **Stock-Based
            Compensation**
 The
            Company accounts for employee and director stock-based compensation in
            accordance with Accounting Principles Board Opinion No. 25, *Accounting
            for Stock Issued to Employees* (“APB”),
            and related interpretations. In accordance therewith, the Company records
            compensation expense on fixed stock options and restricted common stock
            granted
            to employees and directors at the date of grant if the current market
            price of
            the Company’s common stock exceeds the exercise price of the options and
            restricted common stock. Compensation expense on variable stock option
            grants is
            estimated until the measurement date. Deferred compensation is amortized
            to
            compensation expense over the vesting period of the underlying options.
            The
            Company complies with the disclosure provisions of SFAS
            No.
            123 , *Accounting
            for Stock-Based Compensation* .
            As
            such, the Company provides pro forma net loss disclosures for employee
            and
            director stock option grants as if the fair-value-based method defined
            in SFAS
            No. 123 had been applied. The Company’s stock-based employee compensation plan
            is described more fully in Note 14.
  Total
            stock-based compensation expense determined under the fair-value method
            for all
            awards was $99, $105, and $122 for the years ended December 31, 2005,
            2004 and
            2003, respectively. See the pro forma net loss reconciliation in the
            table
            below.
  **Year
                      ended****December
                      31,**
                  
                  **December
                      31,**
                  
                  **December
                      31,****2005**
                  
                  **2004**
                  
                  **2003**Net
                      loss as reported
                  
                  $
                  (6,395
                  )
                  $
                  (9,258
                  )
                  $
                  (9,317
                  )Add:Stock-based
                      employee compensationexpense
                      included in reported net income
                  
                  
                  30
                  
                  
                  -
                  
                  
                  -Deduct:Total
                      stock-based employee compensationexpense
                      determined under fair value method-based
                      methods for all awards
                  
                  
                  (99
                  )
                  
                  (105
                  )
                  
                  (122
                  )Pro
                      forma net loss
                  
                  $
                  (6,464
                  )
                  $
                  (9,363
                  )
                  $
                  (9,439
                  )
  The
            Company accounts for stock-based compensation issued to consultants on
            a fair
            value basis in accordance with SFAS No. 123 and EITF 96-18, *Accounting
            for Equity Instruments That Are Issued to Other Than Employees for Acquiring,
            or
            in Conjunction with Selling, Goods or Services.*
  **Income
            Taxes**
 Deferred
            income taxes reflect the net tax effects of temporary differences between
            the
            carrying amounts of assets and liabilities for financial reporting purposes
            and
            the amounts used for income tax purposes, as well as operating loss,
            capital
            loss and tax credit carry forwards. Deferred tax assets and liabilities
            are
            classified as current or noncurrent based on the classification of the
            related
            assets or liabilities for financial reporting, or according to the expected
            reversal dates of the specific temporary differences, if not related
            to an asset
            or liability for financial reporting. Valuation allowances are established
            against deferred tax assets if it is more likely than not that they will
            not be
            realized.
  C-10
 
 **Comverge,
                    Inc. and Subsidiaries**
 **Notes
                    to Consolidated Financial Statements**
 
 ***(All
                    notes in thousands of dollars, except share and per share
                    data)***
 Income
            taxes associated with the undistributed earnings of a subsidiary are
            provided
            for in accordance with APB No. 23, when the Company has sufficient evidence
            that
            the subsidiary has invested or will invest the undistributed earnings
            indefinitely. If it is determined that the undistributed earnings of
            a
            subsidiary will be remitted in the foreseeable future, all taxes related
            to the
            remittance of such undistributed earnings are provided for in the current
            period
            as income tax expense.
  **Impact
            of Recent Accounting Pronouncements**
 On
            December 16, 2004, the FASB issued SFAS No. 123(R), *Share-Based
            Payment* ,
            which
            is a revision of SFAS No. 123. SFAS No. 123(R) supersedes APB 25, and
            amends
            SFAS No. 95, *Statement
            of Cash Flows* .
            Generally, the approach in SFAS No. 123(R) is similar to the approach
            described
            in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments
            to
            employees, including grants of employee stock options, to be recognized
            in the
            income statement based on their fair values. Pro forma disclosure is
            no longer
            an alternative. As permitted by SFAS No. 123, the Company currently accounts
            for
            share-based payments to employees using APB 25’s intrinsic value method and, as
            such, recognizes no compensation cost on grants of employee stock options
            when
            the exercise price of an option is at or below the fair market value
            of the
            underlying stock. Accordingly, the adoption of SFAS No. 123(R) could
            have a
            significant impact on the Company’s results of operations. The impact of
            adoption of SFAS No. 123(R) cannot be predicted at this time because
            it will
            depend on levels of share-based payments granted in the future.
  The
            Company will adopt SFAS No. 123(R) on January 1, 2006 using the prospective
            method. The Company used the minimum-value method of measuring the fair-value
            of
            share based payments granted prior to January 1, 2006. Pursuant to SFAS
            No.
            123(R), after January 1, 2006, the Company will continue to account for
            the
            remaining unvested portion of those previously granted awards, unless
            modified,
            using the minimum-value method. No compensation cost is expected to be
            recognized for awards previously issued. For awards granted on or after
            January
            1, 2006 the Company will apply SFAS No. 123 (R), which requires a fair-value
            measurement of all options grants.
  **2.**
                  **Other Current
                    Assets**
  Other
            current assets at December 31, 2005
            and
            2004 consisted of the following:
 **2005**
                      
                      **2004**Finished
                          product held for return
                      
                      $
                      1,262
                      
                      $
                      -Deferred
                          costs
                      
                      
                      873
                      
                      
                      450Prepaid
                          expenses
                      
                      
                      446
                      
                      
                      533Other
                      
                      
                      86
                      
                      
                      74Total
                          other current assets
                      
                      $
                      2,667
                      
                      $
                      1,057
 
 The
            Company has reached an agreement in principle with a supplier to repurchase
            certain finished products sold to the Company in 2003 and carried on
            the
            Company’s books as inventory and as a trade payable. The inventory is classified
            as a current asset as it is probable of disposition in 2006 through such
            repurchase commitment. The associated liability to the vender is classified
            as
            long-term pursuant to extended payment terms granted by the supplier
            to the
            Company.
  C-11
 
 **Comverge,
                    Inc. and Subsidiaries**
 **Notes
                    to Consolidated Financial Statements**
 
 ***(All
                    notes in thousands of dollars, except share and per share
                    data)***
 **3.**
                  **Property
                      and Equipment**
  Property
            and equipment at December 31, 2005 and 2004 consisted of the following:
  **Estimated****Useful
                        Life****(in
                        years)**
                    
                    **2005**
                    
                    **2004**Load
                        control equipment
                    
                    
                    Contract
                        term
                    
                    $
                    11,310
                    
                    $
                    4,775Computer
                        hardware and software
                    
                    
                    3
                    
                    
                    1,271
                    
                    
                    1,259Office
                        furniture, software andother
                        equipment
                    
                    
                    5-7
                    
                    
                    1,019
                    
                    
                    1,660Leasehold
                        improvements
                    
                    
                    Lease
                        term
                    
                    
                    170
                    
                    
                    17713,770
                    
                    
                    7,871Accumulated
                        depreciation
                    
                    
                    
                    
                    
                    3,225
                    
                    
                    2,529Property
                        and equipment, net
                    
                    
                    
                    
                    $
                    10,545
                    
                    $
                    5,342
 Depreciation
            in respect of property and equipment amounted to $1,345, $743, and $831
            for the
            years ended December 31, 2005, 2004 and 2003, respectively. Of such amounts,
            $921, $140, and $47 were included in cost of revenue, and $424, $603,
            and $784
            were included in general and administrative expense for the years ended
            December
            31, 2005, 2004 and 2003, respectively.
  **4.**
                  **Goodwill
                      and Intangible Assets**
  The
            Company’s goodwill balance as of December 31, 2005 and 2004 was $499 .
  Intangible
            assets and accumulated amortization as of December 31, 2005 and 2004
            consisted
            of the following:
  **Estimated****Useful
                        Life****(in
                        years)**
                    
                    **2005**
                    
                    **2004**Technological
                        know-how
                    
                    
                    5
                    
                    $
                    1,436
                    
                    $
                    1,436Acquired
                        software
                    
                    
                    3
                    
                    
                    104
                    
                    
                    104Patents
                    
                    
                    4-14
                    
                    
                    287
                    
                    
                    2871,827
                    
                    
                    1,827Accumulated
                        amortization
                    
                    
                    
                    
                    
                    1,649
                    
                    
                    1,600Identified
                        intangible assets with finite lives, net
                    
                    
                    
                    
                    $
                    178
                    
                    $
                    227
 
 The
            Company uses the straight line method of computing amortization expense.
            Amortization expense for the years ended December 31, 2005, 2004 and
            2003 was
            $49, $266, and $335, respectively. Estimated amortization expense for
            the next
            five years is as follows:
  C-12
 
 **Comverge,
                    Inc. and Subsidiaries**
 **Notes
                    to Consolidated Financial Statements**
 
 ***(All
                    notes in thousands of dollars, except share and per share
                    data)***
 **Year
                        Ending December 31,**2006
                    
                    $
                    242007
                    
                    
                    152008
                    
                    
                    152009
                    
                    
                    152010
                    
                    
                    15Thereafter
                    
                    
                    93
 **5.**
                  **Other
                      Assets**
  Other
            assets at December 31, 2005 and 2004 consisted of the following:
  **2005**
                    
                    **2004**Long-term
                        inventory
                    
                    $
                    -
                    
                    $
                    975Prepaid
                        employee termination benefits
                    
                    
                    -
                    
                    
                    336Other
                    
                    
                    42
                    
                    
                    42Total
                        other assets
                    
                    $
                    42
                    
                    $
                    1,353
 
 The
            inventory balance of $975 as of December 31, 2004 represents certain
            finished
            goods inventory not anticipated to be sold during the next twelve months
            primarily due to the necessary completion of certain firmware to be integrated
            into the products. The inventory was obtained pursuant to a purchase
            agreement
            with the vendor that provides for extended payment terms.
  **6.**
                  **Liability for Employer Termination
                    Benefits**
  Under
            Israeli law and labor agreements, one of the Company’s subsidiaries, Comverge
            Control Systems, is required to make severance and pension payments to
            dismissed
            employees and to employees leaving employment in 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.
            The
            pension plans are multi-employer and independent of the Company. Pension
            and
            severance costs for the years ended December 31, 2005, 2004 and 2003
            was $89,
            $143, and $217, respectively, and is included in general and administrative
            expenses.
  On
            December 27, 2005, the Company notified the employees of its Comverge
            Control
            Systems subsidiary of its intent to close the Israel office of such subsidiary
            effective June 30, 2006. Accordingly, the Company’s liability for employee
            termination benefits of $580 accrued as of December 31, 2005 is classified
            as a
            current liability and the unfunded amount representing the difference
            between
            the liability and the prepaid employee termination benefits of $343 as
            of
            December 31, 2005 will be funded in 2006.
  **7.**
                  **Other
                      Current Liabilities**
  Other
            current liabilities at December 31, 2005 and 2004 consisted of the
            following:
  C-13
 
 **Comverge,
                    Inc. and Subsidiaries**
 **Notes
                    to Consolidated Financial Statements**
 
 ***(All
                    notes in thousands of dollars, except share and per share
                    data)***
 **2005**
                    
                    **2004**Accrued
                        payroll and related
                    
                    $
                    515
                    
                    $
                    273Other
                    
                    
                    125
                    
                    
                    195Total
                        other current liabilities
                    
                    $
                    640
                    
                    $
                    468
 
 **8.**
                  **Long-Term
                      Trade Payable**
  At
            December 31, 2005 and 2004, the Company owed a trade vendor $1,362 in
            consideration of certain inventory obtained pursuant to a purchase agreement
            executed in September of 2003. An amendment to the terms of the purchase
            agreement in November 2005 changed the due date of this trade obligation
            to June
            30, 2007. The amount owed bears no interest and is not collateralized
            by any
            assets of the Company.
  **9.**
                  **Long-Term
                      Debt**
  The
            Company maintains a senior credit facility (“Credit Facility”) with a major
            United States commercial bank. On September 24, 2004, the Company modified
            the
            Credit Facility to (i) increase the revolving line credit amount to $7,000,
            (ii)
            increase the letter of credit sublimit to $3,000 and (iii) extend the
            maturity
            date of the Credit Facility to September 15, 2007. On October 25, 2005,
            the
            Company amended the Credit Agreement to include in the definition of
            eligible
            receivables certain amounts owing but not yet invoiced to account debtors.
            The
            Credit Facility, as amended, bears interest between prime +2.0 percent
            and prime
            +2.75 percent per annum. No interest was paid on the Credit Facility
            in 2005 and
            $85 was paid in 2004. The Credit Facility is collateralized by virtually
            all of
            the assets of the Company including the Company’s intellectual property.
            Borrowings under the Credit Facility can be requested, from time to time,
            up to
            an amount that, based on a formula, includes 80 percent of (i) eligible
            receivables and (ii) eligible inventory limited to the lesser of (A)
            25 percent
            of FMV, (B) 80 percent of net orderly liquidation value or (C) $500.
            At December
            31, 2005 and 2004 the Company had no borrowings under the Credit Facility.
            As of
            December 31, 2005, the Company had borrowing availability under its Credit
            Facility of approximately $4,000.
  On
            June
            10, 2005, the Company entered into a $4,000 Subordinated Convertible
            Debt
            (“Convertible Debt”) agreement with a U.S. based lender with a maturity date of
            June 2010. The Convertible Debt bears interest at 3 percent plus the
            3-month
            LIBOR rate. The Convertible Debt requires payment of interest only provided
            that
            the Company meets or exceeds certain pro forma revenue targets calculated
            on a
            quarterly basis during the term. If the Company does not meet or exceed
            such
            revenue targets, at the option of the lender, the Convertible Debt will
            amortize
            ratably over the remaining term. No principal payments have been required
            to
            date and none are expected to be during 2006. The lender may convert
            the
            principal amount of the loan into the Company’s Series B Convertible Preferred
            Stock at a price of $3.62 per share at any time during its term. The
            Company may
            convert the principal amount of the loan under the same terms upon a
            qualified
            public offering of its common stock. The principal amount of the Convertible
            Debt may be prepaid at any time, provided however, that the payment shall
            include an amount calculated to compensate the lender for interest that
            would
            have been paid through the maturity date of the Convertible Debt, determined
            by
            multiplying the principal balance by the current interest rate for each
            interest
            paying period from the prepayment date to the maturity date and then
            discounting
            the results to the repayment date at an annual rate of 20%. Additionally,
            in the
            event of a prepayment of the principal amount, the lender has been provided
            a
            warrant to purchase 1,103,387 shares of the Company’s Series B Preferred Stock
            at a price of $3.62 per share. The Convertible Debt is collateralized
            by a
            second lien on substantially all of the assets of the Company and is
            subordinated to the Credit Facility. Borrowings were used for general
            corporate
            purposes.
  C-14
 
 **Comverge,
                    Inc. and Subsidiaries**
 **Notes
                    to Consolidated Financial Statements**
 
 ***(All
                    notes in thousands of dollars, except share and per share
                    data)***
 Long-term
            debt at December 31, 2005 and 2004 consisted of the following:
  **2005**
                    
                    **2004**Credit
                        Facility with a U.S. bank, collateralized by substantiallyall
                        of the Company's assets, maturing in September 2007,interest
                        payable at a variable rate
                    
                    $
                    -
                    
                    $
                    -Subordinated
                        Convertible Debt, collateralized by a second lienon
                        substantially all of the Company's assets, maturing inJune
                        2010, interest payable monthly at a variable rate ofinterest
                        (7.08% at December 2005)
                    
                    
                    4,000
                    
                    
                    -Total
                        long-term debt
                    
                    $
                    4,000
                    
                    $
                    -
 
 **10.**
                  **Other
                    Liabilities**
  Other
            liabilities at December 31, 2005 and 2004 consisted of the
            following:
  **2005**
                    
                    **2004**Accrued
                        executive compensation
                    
                    $
                    285
                    
                    $
                    210Deferred
                        revenue
                    
                    
                    34
                    
                    
                    -Liability
                        for employee termination benefits
                    
                    
                    -
                    
                    
                    559Asset
                        retirement obligation
                    
                    
                    121
                    
                    
                    80Total
                        other liabilities
                    
                    $
                    440
                    
                    $
                    849
 
 **11.**
                  **Income
                      Taxes**
  The
            Company has Federal, state, and foreign net operating losses of approximately
            $32,689, $23,234 and $3,241, respectively, at December 31, 2005. The
            Federal net
            operating loss carryforwards begin expiring in 2019 and state net operating
            loss
            carryforwards begin expiring in 2006. During year ended December 31,
            2003,
            certain substantial changes in the Company’s ownership, as defined in the
            provisions of the Internal Revenue Code, resulted in a limitation on
            the
            utilization of a significant portion of the Federal and state net operating
            losses on an annual basis.
  At
            December 31, 2005, the Company has provided a valuation allowance for
            the full
            amount of its net deferred tax asset since realization of any future
            tax benefit
            cannot be sufficiently assured.
  C-15
 
 **Comverge,
                    Inc. and Subsidiaries**
 **Notes
                    to Consolidated Financial Statements**
 
 ***(All
                    notes in thousands of dollars, except share and per share
                    data)***
 A
            reconciliation of income tax expense (benefit) at the statutory federal
            income
            tax rate and income taxes as reflected in the consolidated financial
            statements
            is as follows:
  **2005**
                    
                    **2004**
                    
                    **2003**Federal
                        income tax at statutory federal rate
                    
                    
                    34.0
                    %
                    
                    34.0
                    %
                    
                    34.0
                    %State
                        income tax expense (net of Federal benefit)
                    
                    
                    4.0
                    %
                    
                    4.0
                    %
                    
                    4.0
                    %Other
                    
                    
                    0.1
                    %
                    
                    (1.4
                    %)
                    
                    (0.4
                    %)Valuation
                        allowance
                    
                    
                    (38.1
                    %)
                    
                    (36.6
                    %)
                    
                    (37.6
                    %)Effective
                        tax rate
                    
                    
                    0
                    %
                    
                    0
                    %
                    
                    0
                    %
  Deferred
            tax assets (liabilities) consist of the following:
  **2005**
                    
                    **2004**
                    
                    **2003**Deferred
                        tax assetsNet
                        operating loss carryforwards
                    
                    $
                    13,251
                    
                    $
                    10,283
                    
                    $
                    7,981Other
                    
                    
                    966
                    
                    
                    1,161
                    
                    
                    735Deferred
                        tax liabilitiesOther
                    
                    
                    (423
                    )
                    
                    (171
                    )
                    
                    (185
                    )13,794
                    
                    
                    11,273
                    
                    
                    8,531Valuation
                        allowance
                    
                    
                    (13,794
                    )
                    
                    (11,273
                    )
                    
                    (8,531
                    )Net
                        deferred tax assets
                    
                    $
                    -
                    
                    $
                    -
                    
                    $
                    -
 
 **12.**
                  **Commitments
                      and Contingencies**
  (a)
            Leases of Property and Equipment
  Rental
            and leasing expenses for the years ended December 31, 2005, 2004 and
            2003 were
            $751, $624, and $532, respectively. Future minimum rental payments and
            lease
            payments on noncancelable operating leases as of December 31, 2005 are
            as
            follows:
  **Year
                        Ending December 31,**2006
                    
                    $
                    4982007
                    
                    
                    2182008
                    
                    
                    1812009
                    
                    
                    1662010
                    
                    
                    14
 
 (b)
            Employee Retirement Savings Plan
  The
            Company sponsors a tax deferred retirement savings plan that permits
            eligible
            U.S. employees to contribute varying percentages of their compensation
            up to the
            limit allowed by the Internal Revenue Service. This plan also provides
            for
            discretionary Company contributions. No discretionary contributions were
            made
            for the years ended December 31, 2005 or 2004.
  C-16
 
 **Comverge,
                    Inc. and Subsidiaries**
 **Notes
                    to Consolidated Financial Statements**
 
 ***(All
                    notes in thousands of dollars, except share and per share
                    data)***
 (c)
            Royalties
  The
            Company’s subsidiary, Comverge Control Systems, is obligated to pay royalties
            to
            the Government of Israel on proceeds from the sale of certain products
            that
            incorporate intellectual property developed in whole or in part through
            grants
            from the Chief Scientist of the State of Israel. Royalties are payable
            at a rate
            of 4.5 percent of the annual sales of such products. Royalties payable
            under
            this arrangement are not to exceed the original amount of the grants,
            which was
            $595. At December 31, 2005, the maximum amount payable on the future
            sale of
            products, if any, was approximately $388. With the announcement of the
            Company’s
            intention to close the Israel office effective June 30, 2006, the Chief
            Scientist could require payment of the remaining amount of the unamortized
            grant
            proceeds or such lesser amount as may be negotiated as a condition to
            the
            transfer of the intellectual property developed with the grant proceeds
            to the
            Company. The Company is not under any obligation to repay the grant if
            the
            intellectual property is not transferred.
  (d)
            Certain Intellectual Property
  In
            connection with its decision to close its Israel research and development
            center
            in 2006, the Company is assessing alternatives in respect of the transfer
            to its
            United States operations certain intellectual property developed with
            grants
            from the Office of the Chief Scientist. The Company has held preliminary
            conversations with the Chief Scientist and can transfer such intellectual
            property without restriction provided that it pays to the Chief Scientist
            $388,
            the unamortized balance of the grants, or such lesser amount as it may
            be able
            to negotiate. It may also replicate such intellectual property in the
            United
            States provided that it does not do so with work product developed in
            Israel and
            does not utilize Israeli employees who originally created such intellectual
            property to do so. The Company is also investigating the viability of
            transferring the intellectual property and corresponding obligation to
            the Chief
            Scientist to another Israel corporation and licensing the use of such
            intellectual property as is necessary to incorporate into its
            products.
  **13.**
                  **Shareholders'
                      Equity**
  **Common
            Stock**
 Holders
            of the Company’s common stock are entitled to dividends if and when declared by
            the board of directors. The holders of common stock, voting as a separate
            class,
            are entitled to elect two members of the Board of Directors at each meeting
            or
            pursuant to each consent of the Corporation’s stockholders for the election of
            directors, and to remove from office such directors and to fill any vacancy
            caused by the resignation, death or removal of such directors.
  **Convertible
            Preferred Stock**
 During
            2003, the Company sold to investors (i) 8,945,350 shares of its Series
            A
            Convertible Preferred Stock (“Series A Preferred”) for $18,643, (ii) 721,527
            shares of its Series A-1 Convertible Preferred Stock (“Series A-1 Preferred”)
            for $2,000 and (iii) 36,076 of its Series A-2 Convertible Preferred Stock
            (“Series A-2 Preferred”) for $100. The Company repurchased its Series A-1
            Preferred in 2003, pursuant to a put right of an investor for $2,000
            plus
            accrued dividends of $74 which dividends were recognized as a financial
            expense
            in 2003.
  During
            2004, the Company sold to investors (i) 1,455,796 of its Series A Preferred
            for
            $3,034 and (ii) 5,640,878 shares of its Series B Convertible Preferred
            Stock
            (“Series B Preferred”) for $13,633. As part of the Series B Preferred
            transaction, the Company issued 92,798 shares of common stock for no
            monetary
            consideration to one of the investors. The fair value of these shares,
            based on
            an independent third party valuation, is $34. Accordingly, the Company
            made a
            pro rata allocation of the total consideration received to the Series
            B
            Preferred and the common stock, resulting in $13,599 allocated to the
            Series B
            Preferred and $34 to the common stock.
  C-17
 **Comverge,
                Inc. and Subsidiaries**
 **Notes
                to Consolidated Financial Statements**
 
 ***(All
                notes in thousands of dollars, except share and per share
                data)***
  The
            rights, preferences and privileges attached to the Series A Preferred,
            Series
            A-2 Convertible Preferred and Series B Preferred (Collectively, the “Preferred
            Stock”) are as follows:
  (a)
            Conversion
  The
            Preferred Stock is convertible into the Company’s common stock on a one-for-one
            basis subject to certain adjustments to affect anti-dilution rights.
            Conversion
            is mandatory (i) in the event that the holders of at least a majority
            of the
            then-outstanding shares of Preferred Stock consent to such conversion
            or (ii)
            upon the closing of a firmly underwritten public offering of shares of
            common
            stock of the Company at a per share price not less than $7.00 and in
            which gross
            proceeds to the Company are at least $30,000. The holders of Preferred
            Stock
            have no redemption rights.
  (b)
            Board
            of Directors
  In
            any
            election of Directors, the holders of Preferred Stock, voting as a separate
            class, are entitled to elect three members of the Board of Directors
            and to
            remove from office such directors and to fill any vacancy caused by the
            resignation, death or removal of such directors. The holders of Common
            Stock,
            voting as a separate class, are entitled to elect two directors, one
            of whom
            shall serve as the Chief Executive Officer of the Company and to remove
            from
            office such directors and to fill any vacancy caused by the resignation,
            death
            or removal of such directors. The board can be increased by no more than
            two
            additional seats based on a majority vote of the then members of the
            board. The
            additional two seats shall be filled by Independent Directors, who shall
            be
            selected by unanimous vote of the then members of the Board of Directors
            other
            than the Independent Directors.
  (c)
            Dividends
  In
            the
            event the Company declares and pays any dividend on its common stock
            other than
            stock or other dividends payable solely in shares of common stock, the
            Company
            must also pay to the holders of Preferred Stock the dividends that would
            have
            been payable had all of the outstanding Preferred Stock been converted
            to common
            stock immediately prior to the record date of the dividend.
  The
            holders of shares of Preferred Stock, on a pari passu basis and in preference
            to
            the holders of any shares of any other class of capital stock of the
            Company,
            shall be entitled to receive, when, as and if declared by the Board of
            Directors, but only out of funds legally available therefore, dividends
            at the
            rate of 8 percent per annum based, in each case, on the original Preferred
            Stock
            issue price. Dividends are noncumulative.
  (d)
            Voting
  The
            Preferred Stock shall vote together with all other classes and series
            of stock
            of the Company as a single class on all actions to be taken by the stockholders
            of the Company.
  C-18
 
 **Comverge,
                    Inc. and Subsidiaries**
 **Notes
                    to Consolidated Financial Statements**
 
 ***(All
                    notes in thousands of dollars, except share and per share
                    data)***
 (e)
            Liquidation Preferences
  Upon
            any
            liquidation, dissolution or winding up of the Company, whether voluntary
            or
            involuntary, the holders of shares of Series A Preferred and the Series
            B
            Preferred shall be entitled to be paid, on a pari passu basis, before
            any
            distribution or payment is made upon the Series A-2 Preferred Stock or
            on the
            common stock an amount equal to 1.5 times the original Series A issue
            price per
            share or original Series B price per share, respectively, plus all declared
            and
            unpaid dividends. After payment to the holders of Series A Preferred
            and the
            Series B Preferred of the full amounts to which they are entitled the
            holders of
            Series A-2 Preferred Stock shall be entitled to be paid, before any distribution
            or payment is made upon the common stock, an amount equal to 1.5 times
            the
            original Series A-2 issue price per share plus all declared but unpaid
            dividends. After the preferential payments have been made in full, any
            additional remaining assets shall be distributed ratably to the holders
            of
            Preferred Stock (on an as-converted basis) and common stock until such
            holders
            of Preferred Stock have received, inclusive of their liquidation amount,
            an
            amount equal to 5 times their original issue price per share. After payment
            of
            all preferential amounts, the entire remaining assets of the Company
            legally
            available for distribution, if any, shall be distributed ratably among
            the
            holders of its common stock.
  Unless
            otherwise agreed by holders of at least 66 2/3 percent of the then-outstanding
            shares of Preferred Stock, a liquidation, dissolution or winding up of
            the
            Company shall also include (i) the acquisition or sale of the Company
            unless the
            Company’s stockholders of record as constituted immediately prior to such
            acquisition or sale will, immediately after such acquisition or sale
            hold at
            least 50 percent of the voting power of the surviving or acquiring entity
            or
            (ii) a sale, lease or other conveyance or disposition of all or
            substantially all of the assets of the Company, including a sale of all
            or
            substantially all of the assets of the Company’s subsidiaries, if such assets
            constitute substantially all of the assets of the Company and such subsidiaries
            taken as a whole.
  (f)
            Anti-dilution Rights
  The
            conversion prices of Preferred Stock are subject to broad-based weighted
            average
            anti-dilution adjustments to reduce dilution in the event that the Company
            issues additional equity securities (other than Board approved employee
            incentives, including stock options) at a purchase price less than the
            then-applicable conversion price of the Series A Preferred, Series A-2
            Preferred
            and Series B Preferred, respectively. The conversion price is also subject
            to
            proportional adjustment for stock splits, stock dividends, recapitalizations
            and
            the like.
  C-19
 
 **Comverge,
                    Inc. and Subsidiaries**
 **Notes
                    to Consolidated Financial Statements**
 
 ***(All
                    notes in thousands of dollars, except share and per share
                    data)***
 (g)
            Protective Provisions
  For
            so
            long as at least 100,000 shares of Preferred Stock remain outstanding,
            consent
            of the holders of at least 60% of the then outstanding Preferred Stock
            shall be
            required to (i) alter or change the rights, preferences or privileges
            of the
            Preferred Stock, (ii) create (by reclassification or otherwise) any new
            class or
            series of shares having rights, preferences or privileges senior to or
            on a
            parity with the Preferred Stock, (iii) amend or waive any provision of
            the
            Company’s Articles of Incorporation or Bylaws, (iv) increase or decrease the
            authorized number of shares of common or Preferred Stock, (v) redeem
            any shares
            of common stock (other than pursuant to equity incentive agreements with
            service
            providers giving the Company the right to repurchase shares upon the
            termination
            of services), (vi) consummate any merger, other corporate reorganization,
            sale
            of control, or any transaction in which all or substantially all of the
            assets
            of the Company are sold, (vii) increase or decrease the authorized size of
            the Company’s Board of Directors or the Compensation Committee of the Board of
            Directors, (viii) pay or declare any dividend on any shares of common
            or
            Preferred Stock, (ix) liquidate or dissolve the Company, (x) increase
            the number
            of shares reserved for issuance under the Option Plan, (xi) issue any
            shares of
            capital stock of the Company or options to acquire capital stock of the
            Company
            under the Option Plan, unless such issuance is approved by the Board
            of
            Directors and the Compensation Committee of the Board of Directors, or
            (xii)
            authorize or incur any additional indebtedness in excess of $500 (other
            than the
            revolving Credit Facility), unless such incurrence of indebtedness is
            approved
            by the Board of Directors, including at least two of the directors designated
            by
            the holders of Preferred Stock.
  **Stock
            Warrant**
 In
            June
            2005, in conjunction with the Convertible Debt financing, the Company
            issued a
            warrant to the lender to purchase, under certain circumstances, 1,103,387
            shares
            of Series B Preferred stock for $3.62 per share. The warrant is exercisable
            only
            if the Company prepays the principal amount of the Convertible Debt.
            The warrant
            will expire in June 2010 or earlier upon the conversion of any portion
            of the
            principal amount of the Convertible Debt into shares of the
            Company.
  **14.**
                  **Stock
                      Option Plan**
  The
            Company's stock option plan provides for the granting to officers, directors
            and
            other key employees of options to purchase shares of common stock at
            not less
            than 85 percent of the estimated fair value of the Company’s common stock on the
            date of grant. The purchase price must be paid in cash. At December 31,
            2005,
            the Company had 3,421,513 issued and outstanding options under the various
            plans
            of which 79,266 options had been exercised by optionees. Options expire
            between
            five years and ten years from the date of the grant. The options generally
            vest
            over a two to four year period from the date of the grant. At December
            31, 2005,
            701,250 options were available for grant under the various plans.
  C-20
 A
            summary
            status of the Company's option plans as of December 31, 2005, 2004 and
            2003, as
            well as changes during the year then ended, is presented below:
  **2005**
                    
                    **2004**
                    
                    **2003****Weighted**
                    
                    
                    
                    **Weighted**
                    
                    
                    
                    **Weighted****Number
                        of**
                    
                    **Average**
                    
                    **Number
                        of**
                    
                    **Average**
                    
                    **Number
                        of**
                    
                    **Average****Options**
                    
                    **Exercise**
                    
                    **Options**
                    
                    **Exercise**
                    
                    **Options**
                    
                    **Exercise****(in
                        Shares)**
                    
                    **Price**
                    
                    **(in
                        Shares)**
                    
                    **Price**
                    
                    **(in
                        Shares)**
                    
                    **Price****Outstanding
                        at beginning of year**
                    
                    
                    2,600,996
                    
                    $
                    0.95
                    
                    
                    2,216,049
                    
                    $
                    1.20
                    
                    
                    943,530
                    
                    $
                    1.20Granted
                    
                    
                    934,507
                    
                    
                    0.37
                    
                    
                    980,525
                    
                    
                    0.44
                    
                    
                    1,278,800
                    
                    
                    1.20Exercised
                    
                    
                    (775
                    )
                    
                    1.02
                    
                    
                    (4,052
                    )
                    
                    1.27
                    
                    
                    -
                    
                    
                    1.20Forfeited
                    
                    
                    (113,215
                    )
                    
                    0.54
                    
                    
                    (591,526
                    )
                    
                    1.06
                    
                    
                    (6,281
                    )
                    
                    1.20**Outstanding
                        at end of year**
                    
                    
                    3,421,513
                    
                    
                    0.80
                    
                    
                    2,600,996
                    
                    
                    0.95
                    
                    
                    2,216,049
                    
                    
                    1.20Exercisable
                        at end of year
                    
                    
                    1,908,980
                    
                    $
                    0.98
                    
                    
                    1,260,078
                    
                    $
                    1.13
                    
                    
                    921,094
                    
                    $
                    1.16
  **Outstanding
                        as of December 31, 2005****Average****Remaining****Number**
                    
                    **Contractual**
                    
                    **Number****Exercise
                        Prices**
                    
                    **Outstanding**
                    
                    **Life**
                    
                    **Exercisable****(In
                        Shares)**
                    
                    **(In
                        Years)**
                    
                    **(In
                        Shares)**$0.29
                    
                    
                    786,401
                    
                    
                    5.77
                    
                    
                    483,088$0.37
                    
                    
                    772,256
                    
                    
                    6.36
                    
                    
                    600$0.40
                    
                    
                    114,460
                    
                    
                    3.19
                    
                    
                    79,092$1.20
                    
                    
                    1,663,059
                    
                    
                    3.42
                    
                    
                    1,260,863$1.31
                    
                    
                    50,687
                    
                    
                    5.87
                    
                    
                    50,687$2.00
                    
                    
                    10,191
                    
                    
                    0.01
                    
                    
                    10,191$4.00
                    
                    
                    24,459
                    
                    
                    0.24
                    
                    
                    24,4593,421,513
                    
                    
                    4.62
                    
                    
                    1,908,980
 The
            weighted average grant-date fair value of 934,507, 980,525 and 1,278,800
            options
            granted during 2005, 2004, and 2003 was $60, $53, and $354 respectively.
            The
            Company utilized the Black-Scholes option pricing model to estimate fair
            value,
            utilizing the following assumptions for the respective years (all in
            weighted
            averages):
  **2005**
                    
                    **2004**
                    
                    **2003**Risk-free
                        interest rate
                    
                    
                    3.92
                    %
                    
                    3.50
                    %
                    
                    5.38
                    %Expected
                        life of options, in years
                    
                    
                    5.0
                    
                    
                    5.0
                    
                    
                    5.0Expected
                        annual volatility
                    
                    
                    0
                    %
                    
                    0
                    %
                    
                    0
                    %Expected
                        dividend yield
                    
                    
                    0
                    %
                    
                    0
                    %
                    
                    0
                    %
 
 C-21
 
 **Comverge,
                    Inc. and Subsidiaries**
 **Notes
                    to Consolidated Financial Statements**
 
 ***(All
                    notes in thousands of dollars, except share and per share
                    data)***
 During
            2002, the Company repriced certain incentive stock options of ten employees.
            One
            of these employee’s options were repriced, pursuant to his employment agreement,
            from $4.00 to $1.20 per share. The Company also repriced certain incentive
            stock
            options of ten employees (including the aforementioned employee) who
            held
            certain anti-dilution options from $1.94 to $1.31 per share. As a result
            of
            these repricings, the options are accounted for as variable awards with
            a
            compensation charge recognized for periodic changes in the intrinsic
            value of
            the option until the award expires, is exercised, or is forfeited. No
            compensation charge was recognized during 2005 or 2004 related to these
            repriced
            option grants since the fair market value of the common stock was below
            the
            exercise prices. During 2004, the Company incurred $30 in deferred compensation
            related to option grants which was recognized into expense during 2005.
  **15.**
                  **Major
                      Customers**
  During
            the year ended December 31, 2005, the Company had three customers which
            accounted for 18%, 15% and 12% of the Company’s total revenue. The total
            accounts receivable from these customers were $325, $1,443 and $261,
            respectively at December 31, 2005. During the year ended December 31,
            2004, the
            Company had two customers which accounted for 15.4% and 10.7% of the
            Company’s
            total revenue. The total accounts receivable from these customers were
            $256 and
            $129, respectively, at December 31, 2004. During the year ended December
            31,
            2003, the Company had one customer which accounted for 18.5% of the Company’s
            total revenue. No other customer accounted for more than 10 percent of
            the
            Company’s total revenue in 2005, 2004, or 2003.
  **16.**
                  **Related
                      Party Transactions and
                      Balances**
  An
            affiliate of DSSI charged the Company’s Israeli subsidiary, Comverge Control
            Systems, $138 in each of 2005, 2004, and 2003 in consideration of it
            providing
            office space and certain accounting and administrative services which
            amounts
            are included in general and administrative expense.
  Prior
            to
            2002, the Company extended loans of $10 each to both the Chief Executive
            Officer
            and Chief Financial Officer of DSSI. The loans had an initial maturity
            date of
            January 3, 2002, and were extended at that time to mature on January
            3, 2004.
            The loans bore interest at 4.25 percent per annum. The balance of the
            loans and
            accrued interest totaling $37 was repaid in 2004.
  The
            lender of the Subordinated Debt became a shareholder of the Company in
            February
            2006 by investing in the Series C preferred stock. During 2005, the Company
            made
            interest payments on the Subordinated Debt of $130 in addition to paying
            the
            Lender an $80 placement fee related to the Subordinated Debt.
  C-22
 
 **Comverge,
                    Inc. and Subsidiaries**
 **Notes
                    to Consolidated Financial Statements**
 
 ***(All
                    notes in thousands of dollars, except share and per share
                    data)***
 **17.**
                  **Subsequent
                      Events**
  **Series
            C Convertible Preferred Stock**
 In
            March
            2006, the Company completed the sale of 1,100,000 shares of Series C
            Convertible
            Preferred Stock (“Series C Preferred”) for $5,500. The rights, preferences and
            privileges attached to the Series C Preferred are identical to those
            of holders
            of the Company’s Series A and Series B Preferred Stock.
  **Stock
            Warrant**
 In
            February 2006, a significant investor in the Series C Preferred entered
            into a
            strategic marketing and development agreement with the Company (“Agreement”). As
            part of the Agreement, the investor was given a warrant to purchase 500,000
            shares of Series C Preferred for $7.50 per share. The warrant is exercisable
            only if the investor meets certain defined performance milestones under
            the
            Agreement as specified in the warrant. The warrant expires in August
            2008.
  C-23