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**UNITED      STATES**

**SECURITIES      AND EXCHANGE COMMISSION**

**WASHINGTON,      D.C. 20549**

**FORM      10-Q**

| QUARTERLY                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE          |
|---------------------------------------------------------------------------------|
| SECURITIES                EXCHANGE ACT OF 1934                                  |
|                                                                            |
| For                the quarterly period ended **March                31, 2006** |
|                                                                            |

**0-19771**

**DATA      SYSTEMS & SOFTWARE INC.**

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

**(201)      529-2026**

|   | Yes                x | No                 ̈ |
|--------|----------------------|--------------------------|

| Large accelerated filer  ̈ | Accelerated filer  ̈ | 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                   ̈ | No                  x |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------|-----------------------|

| Class                                                  |   | Outstanding                at May 15, 2006 |
|--------------------------------------------------------|--------|--------------------------------------------|
| Common                Stock, $0.01 par value per share |   | 8,160,024                shares            |

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**DATA      SYSTEMS & SOFTWARE INC. **

**Quarterly      Report on Form 10-Q**

**for      the Quarterly Period Ended March 31, 2006**

**TABLE      OF CONTENTS**

| **PART                I. Financial Information** |                                                                               |
|--------------------------------------------------|------------------------------------------------------------------------------------|
|                                             |                                                                               |   |
| Item                  1.                         | Financial                  Statements                                              |   |
|                                             |                                                                               |   |
|                                             | Unaudited                  Consolidated Financial Statements:                      |   |
|                                             |                                                                               |   |
|                                             | Consolidated                  Balance Sheets                                       |   |
|                                             | of                  December 31, 2005 and March 31, 2006                           | 1 |
|                                             |                                                                               |   |
|                                             | Consolidated                  Statements of Operations                             |   |
|                                             | for                  the three month periods ended March 31, 2005 and 2006         | 2 |
|                                             |                                                                               |   |
|                                             | Consolidated                  Statement of Changes in Shareholders’ Equity   |   |
|                                             | for                  the three month period ended March 31, 2006                   | 3 |
|                                             |                                                                               |   |
|                                             | Consolidated                  Statements of Cash Flows                             |   |
|                                             | for                  the three month periods ended March 31, 2005 and 2006         | 4 |
|                                             |                                                                               |   |
|                                             | Notes                  to Consolidated Financial Statements                        | 6 |
|                                             |                                                                               |   |
| Item                  2.                         | Management’s                  Discussion and Analysis of Financial Condition |   |
|                                             | and                  Results of Operations                                         | 14 |
|                                             |                                                                               |   |
| Item                  3.                         | Quantitative                  and Qualitative Disclosures about Market Risk        | 19 |
|                                             |                                                                               |   |
| Item                  4.                         | Controls                  and Procedures                                           | 19 |
|                                             |                                                                               |   |
| **PART                  II. Other Information**  |                                                                               |
|                                             |                                                                               |   |
| Item                  1.                         | Legal                  Proceedings                                                 | 20 |
|                                             |                                                                               |   |
| Item                  1A.                        | Risk                  Factors                                                      | 21 |
|                                             |                                                                               |   |
| Item                  2.                         | Unregistered                  Sales of Equity Securities and Use of Proceeds       | 21 |
|                                             |                                                                               |   |
| Item                  6.                         | Exhibits                                                                           | 21 |
|                                             |                                                                               |   |
| **Signatures**                              | 22                                                                                 |

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

**Consolidated      Balance Sheets**

| ASSETS                                                                                                                                                   |   | **As                of****December                31,****2005** |    | **As                of****March                31,****2006** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------|---------|--------------------------------------------------------------|--------|
|                                                                                                                                                     |   |                                                            |    | (unaudited)                                                  |   |
| Current                assets:                                                                                                                           |   |                                                            |    |                                                         |   |
| Cash                and cash equivalents                                                                                                                 |   | $                                                               | 913     |                                                         | $      | 834 |   |
| Restricted                cash                                                                                                                      |   |                                                            | 247     |                                                         |   | -- |   |
| Restricted                cash (under agreement with a related party)                                                                               |   |                                                            | 300     |                                                         |   | -- |   |
| Accounts                receivable, net                                                                                                             |   |                                                            | 4,096   |                                                         |   | 898 |   |
| Unbilled                work-in-process                                                                                                             |   |                                                            | 348     |                                                         |   | 580 |   |
| Inventory                                                                                                                                           |   |                                                            | 25      |                                                         |   | -- |   |
| Other                current assets                                                                                                                 |   |                                                            | 709     |                                                         |   | 487 |   |
| Total                current assets                                                                                                                 |   |                                                            | 6,638   |                                                         |   | 2,799 |   |
| Property                and equipment, net                                                                                                               |   |                                                            | 500     |                                                         |   | 413 |   |
| Other                assets                                                                                                                              |   |                                                            | 334     |                                                         |   | 327 |   |
| Funds                in respect of employee termination benefits                                                                                         |   |                                                            | 1,441   |                                                         |   | 1,356 |   |
| Restricted                cash - non-current (under agreement with a related party)                                                                      |   |                                                            | 1,050   |                                                         |   | -- |   |
| Goodwill                                                                                                                                                 |   |                                                            | 129     |                                                         |   | 122 |   |
| Other                intangible assets, net                                                                                                              |   |                                                            | 81      |                                                         |   | 71 |   |
| Total                assets                                                                                                                              |   | $                                                               | 10,173  |                                                         | $      | 5,088 |   |
| LIABILITIES                AND SHAREHOLDERS’ EQUITY                                                                                                |   |                                                            |    |                                                         |   |   |   |
| Current                liabilities:                                                                                                                      |   |                                                            |    |                                                         |   |   |   |
| Short-term                bank credit                                                                                                               |   | $                                                               | 130     |                                                         | $      | 78 |   |
| Current                maturities of long-term debt                                                                                                 |   |                                                            | 160     |                                                         |   | 131 |   |
| Trade                accounts payable                                                                                                                    |   |                                                            | 1,950   |                                                         |   | 294 |   |
| Accrued                payroll, payroll taxes and social benefits                                                                                   |   |                                                            | 740     |                                                         |   | 411 |   |
| Other                current liabilities                                                                                                            |   |                                                            | 2,200   |                                                         |   | 1,617 |   |
| Total                current liabilities                                                                                                            |   |                                                            | 5,180   |                                                         |   | 2,531 |   |
| Long-term                liabilities:                                                                                                                    |   |                                                            |    |                                                         |   |   |   |
| Investment                in Comverge, net                                                                                                               |   |                                                            | 1,824   |                                                         |   | 1,824 |   |
| Long-term                debt                                                                                                                       |   |                                                            | 75      |                                                         |   | -- |   |
| Liability                for employee termination benefits                                                                                          |   |                                                            | 2,264   |                                                         |   | 2,136 |   |
| Other                liabilities                                                                                                                    |   |                                                            | 10      |                                                         |   | 106 |   |
| Total                long-term liabilities                                                                                                          |   |                                                            | 4,173   |                                                         |   | 4,066 |   |
| Shareholders’                equity:                                                                                                               |   |                                                            |    |                                                         |   |   |   |
| Common                stock - $0.01 par value per share:                                                                                                 |   |                                                            |    |                                                         |   |   |   |
| Authorized                - 20,000,000 shares; Issued -8,937,395 shares at                December 31, 2005 and March 31, 2006                      |   |                                                            | 88      |                                                         |   | 89 |   |
| Additional                paid-in capital                                                                                                           |   |                                                            | 40,011  |                                                         |   | 40,425 |   |
| Warrants                                                                                                                                            |   |                                                            | 183     |                                                         |   | 183 |   |
| Deferred                stock-based compensation                                                                                                    |   |                                                            | (36     | )                                                            |   | -- |   |
| Accumulated                deficit                                                                                                                  |   |                                                            | (35,608 | )                                                            |   | (38,                576 | ) |
| Treasury                stock, at cost - 820,704 and 777,371 shares for December 31, 2005                and                March 31, 2006, respectively |   |                                                            | (3,791  | )                                                            |   | (3,592 | ) |
| Accumulated                other comprehensive loss                                                                                                      |   |                                                            | (27     | )                                                            |   | (38 | ) |
| Total                shareholders’ equity                                                                                                     |   |                                                            | 820     |                                                         |   | (1,509 | ) |
| Total                liabilities and shareholders’ equity                                                                                     |   | $                                                               | 10,173  |                                                         | $      | 5,088 |   |

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

**Consolidated      Statements of Operations **

|                                                                                                                                                                                      |   | **Three                months ended March 31,** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------|--------|
|                                                                                                                                                                                      |   | **2005**                                        |   | **2006** |   |
| Sales                                                                                                                                                                                     |   |                                            |   |   |   |
| Projects                                                                                                                                                                             |   | $                                               | 844    |   | $ | 730 |   |
| Services                and other                                                                                                                                                    |   |                                            | 315    |   |   | 243 |   |
|                                                                                                                                                                                      |   |                                            | 1,159  |   |   | 973 |   |
| Cost                of sales                                                                                                                                                              |   |                                            |   |   |   |   |   |
| Projects                (including $19 of stock compensation expense in 2006)                                                                                                        |   |                                            | 537    |   |   | 539 |   |
| Services                and other                                                                                                                                                    |   |                                            | 253    |   |   | 206 |   |
|                                                                                                                                                                                      |   |                                            | 790    |   |   | 745 |   |
| Gross                profit                                                                                                                                                          |   |                                            | 369    |   |   | 228 |   |
| Operating                expenses:                                                                                                                                                        |   |                                            |   |   |   |   |   |
| Research                and development expenses                                                                                                                                     |   |                                            | 9      |   |   | 26 |   |
| Selling,                marketing, general and administrative expenses (including $6 and                $116 of                stock compensation expense in 2005 and 2006, respectively) |   |                                            | 1,038  |   |   | 922 |   |
| Total                operating expenses                                                                                                                                              |   |                                            | 1,047  |   |   | 948 |   |
| Operating                loss                                                                                                                                                        |   |                                            | (678   | ) |   | (720 | ) |
| Interest                income                                                                                                                                                       |   |                                            | 1      |   |   | 25 |   |
| Interest                expense                                                                                                                                                      |   |                                            | (23    | ) |   | (10 | ) |
| Other                income, net                                                                                                                                                     |   |                                            | 10     |   |   | 329 |   |
| Loss                before taxes on income                                                                                                                                      |   |                                            | (690   | ) |   | (376 | ) |
| Taxes                on income                                                                                                                                                       |   |                                            | (2     | ) |   | (2 | ) |
| Loss                from operations of the Company and its consolidated                subsidiaries                                                                                  |   |                                            | (688   | ) |   | (378 | ) |
| Share                in losses of Comverge                                                                                                                                           |   |                                            | (201   | ) |   | (210 | ) |
| Minority                interests                                                                                                                                                    |   |                                            | (42    | ) |   | -- |   |
| Net                loss from continuing operations                                                                                                                                   |   |                                            | (931   | ) |   | (588 | ) |
| Net                income from discontinued operations, net of tax                                                                                                                   |   |                                            | 492    |   |   | 78 |   |
| Loss                on sale of discontinued operations and contract settlement, net of                tax                (including $315 of stock compensation expense in 2006)           |   |                                            | --     |   |   | (2,298 | ) |
| Net                loss                                                                                                                                                              |   | $                                               | (439   | ) | $ | (2,808 | ) |
| Basic                and diluted income (loss) per share:                                                                                                                                 |   |                                            |   |   |   |   |   |
| Loss                per share from continuing operations                                                                                                                             |   | $                                               | (0.11  | ) | $ | (0.07 | ) |
| Discontinued                operations                                                                                                                                               |   |                                            | 0.06   |   |   | (0.27 | ) |
| Net                loss per share - basic and diluted                                                                                                                                |   | $                                               | (0.05  | ) | $ | (0.34 | ) |
| Weighted                average number of shares outstanding - basic and diluted                                                                                                |   |                                            | 8,117  |   |   | 8,160 |   |

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

**Consolidated      Statement of Changes in Shareholders’ Equity **

|                                                                                |   | Number                of Shares |   | Common                Stock |   | AdditionalPaid-InCapital |   | Warrants |   | Stock-Based                Deferred Compensation |   | Accumulated                Deficit |   | Treasury                Stock |   | Accumulated                Other Comprehensive Loss |   | Total   |   |
|-------------------------------------------------------------------------------------|--------|---------------------------------|--------|-----------------------------|--------|--------------------------|--------|----------|--------|--------------------------------------------------|--------|------------------------------------|--------|-------------------------------|--------|-----------------------------------------------------|--------|---------|--------|
|                                                                                |   |                            |   |                        |   |                     |   |     |   |                                             |   |                               |   |                          |   |                                                |   |    |   |
| Balances                as of December                31, 2005                      |   |                            | 8,937  |                        | $      | 88                       |   | $        | 40,011 |                                             | $      | 183                                |   | $                             | (36    | )                                                   | $      | (35,608 | )      | $ | (3,791 | ) | $ | (27 | ) | $ | 820 |   |
|                                                                                |   |                            |   |                        |   |                     |   |     |   |                                             |   |                               |   |                          |   |                                                |   |    |   |   |   |   |   |   |   |   |   |   |
| Net                loss                                                             |   |                            | -      |                        |   | -                        |   |     | -      |                                             |   | -                                  |   |                          | -      |                                                |   | (2,808  | )      |   | - |   |   | - |   |   | (2,808 | ) |
|                                                                                |   |                            |   |                        |   |                     |   |     |   |                                             |   |                               |   |                          |   |                                                |   |    |   |   |   |   |   |   |   |   |   |   |
| Differences                from translation of financial statements of subsidiaries |   |                            | -      |                        |   | -                        |   |     | -      |                                             |   | -                                  |   |                          | -      |                                                |   | -       |   |   | - |   |   | (11 | ) |   | (11 | ) |
| Comprehensive                loss                                                   |   |                            |   |                        |   |                     |   |     |   |                                             |   |                               |   |                          |   |                                                |   |    |   |   |   |   |   |   |   |   | (2,819 | ) |
|                                                                                |   |                            |   |                        |   |                     |   |     |   |                                             |   |                               |   |                          |   |                                                |   |    |   |   |   |   |   |   |   |   |   |   |
| Reclassification                of stock-based deferred compensation                |   |                            | -      |                        |   | -                        |   |     | (36    | )                                                |   | -                                  |   |                          | 36     |                                                |   | -       |   |   | - |   |   | - |   |   | - |   |
|                                                                                |   |                            |   |                        |   |                     |   |     |   |                                             |   |                               |   |                          |   |                                                |   |    |   |   |   |   |   |   |   |   |   |   |
| Exercise                of options                                                  |   |                            |   |                        |   | 1                        |   |     |   |                                             |   |                               |   |                          |   |                                                |   | (160    | )      |   | 199 |   |   |   |   |   | 40 |   |
|                                                                                |   |                            |   |                        |   |                     |   |     |   |                                             |   |                               |   |                          |   |                                                |   |    |   |   |   |   |   |   |   |   |   |   |
| Stock                option compensation                                            |   |                            |   |                        |   |                     |   |     | 450    |                                             |   |                               |   |                          |   |                                                |   |    |   |   |   |   |   |   |   |   | 450 |   |
| Balances                as ofMarch                31, 2006                          |   |                            | 8,937  |                        | $      | 89                       |   | $        | 40,425 |                                             | $      | 183                                |   | $                             | 0      |                                                | $      | (38,576 | )      | $ | (3,592 | ) | $ | (38 | ) | $ | (1,509 | ) |

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

**Consolidated      Statements of Cash Flows **

|                                                                                                                                        |   | **Three                months ended****March                31,** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------|--------|
|                                                                                                                                        |   | **2005**                                                          |   | **2006** |   |
| Cash                flows provided by (used in) operating activities:                                                                       |   |                                                              |   |   |   |
| Net                loss                                                                                                                |   | $                                                                 | (439   | ) | $ | (2,808 | ) |
| Adjustments                to reconcile net loss to net cash provided                by (used in) operating activities:                     |   |                                                              |   |   |   |   |   |
| Depreciation                and amortization                                                                                           |   |                                                              | 52     |   |   | 59 |   |
| Minority                interests                                                                                                      |   |                                                              | 42     |   |   | -- |   |
| Share                in losses of Comverge                                                                                             |   |                                                              | 201    |   |   | 210 |   |
| Deferred                taxes                                                                                                          |   |                                                              | 11     |   |   | -- |   |
| Increase                (decrease) in liability for employee termination benefits                                                      |   |                                                              | 105    |   |   | (128 | ) |
| Loss                on disposition of property and equipment                                                                           |   |                                                              | 2      |   |   | -- |   |
| Amortization                of stock-based deferred compensation                                                                       |   |                                                              | 6      |   |   | 136 |   |
| Loss                on sale of Databit and contract settlement                                                                         |   |                                                              | --     |   |   | 2,298 |   |
| Other                                                                                                                                  |   |                                                              | (7     | ) |   | (3 | ) |
| Change                in operating assets and liabilities:                                                                                  |   |                                                              |   |   |   |   |   |
| Decrease                (increase) in accounts receivable, unbilled work-in process and other                current and other assets  |   |                                                              | (1,817 | ) |   | 425 |   |
| Increase                in inventory                                                                                                   |   |                                                              | (53    | ) |   | (18 | ) |
| Increase                (decrease) in accounts payable and other liabilities                                                           |   |                                                              | 1,397  |   |   | (719 | ) |
| Net                cash used in operating activities                                                                                   |   |                                                              | (500   | ) |   | (548 | ) |
| Cash                flows provided by (used in) investing activities:                                                                       |   |                                                              |   |   |   |   |   |
| Release                of restricted cash                                                                                              |   |                                                              | --     |   |   | 247 |   |
| Release                of restricted cash (under agreement with a related party)                                                       |   |                                                              | --     |   |   | 1,350 |   |
| Investment                in Comverge                                                                                                  |   |                                                              | --     |   |   | (210 | ) |
| Amounts                funded for employee termination benefits                                                                        |   |                                                              | (6     | ) |   | 123 |   |
| Utilization                of employee termination benefits                                                                            |   |                                                              | (18    | ) |   | (38 | ) |
| Maturity                of short-term deposits                                                                                         |   |                                                              | 72     |   |   | -- |   |
| Acquisitions                of property and equipment                                                                                  |   |                                                              | (98    | ) |   | (42 | ) |
| Proceeds                from sale of property and equipment                                                                            |   |                                                              | 19     |   |   | -- |   |
| Sale                of Databit Inc. - Appendix A                                                                                       |   |                                                              | --     |   |   | (911 | ) |
| Net                cash provided by (used in) investing activities                                                                     |   |                                                              | (31    | ) |   | 519 |   |
| Cash                flows provided by (used in) financing activities:                                                                       |   |                                                              |   |   |   |   |   |
| Short-term                debt borrowings (repayments), net                                                                            |   |                                                              | (70    | ) |   | (52 | ) |
| Proceeds                from note payable to related party                                                                             |   |                                                              | 250    |   |   | -- |   |
| Proceeds                from long-term debt                                                                                            |   |                                                              | 76     |   |   | -- |   |
| Repayments                of long-term debt                                                                                            |   |                                                              | (83    | ) |   | (38 | ) |
| Proceeds                from employee stock option exercises                                                                           |   |                                                              | --     |   |   | 40 |   |
| Net                cash provided by (used in) financing activities                                                                     |   |                                                              | 173    |   |   | (50 | ) |
| Net                decrease in cash and cash equivalents                                                                               |   |                                                              | (358   | ) |   | (79 | ) |
| Cash                and cash equivalents at beginning of period                                                                        |   |                                                              | 685    |   |   | 913 |   |
| Cash                and cash equivalents at end of period                                                                              |   | $                                                                 | 327    |   | $ | 834 |   |
| Supplemental                cash flow information:                                                                                          |   |                                                              |   |   |   |   |   |
| Cash                paid during the period for:                                                                                             |   |                                                              |   |   |   |   |   |
| Interest                                                                                                                               |   | $                                                                 | 32     |   | $ | 7 |   |
| Income                taxes                                                                                                            |   | $                                                                 | 3      |   | $ | 2 |   |

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| **Appendix                A**                                                                                        |   |   |   |
|----------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| Assets/liabilities                disposed of in disposition of Databit Inc. and contract                settlement: |   |   |   |
| Current                assets                                                                                   |   | $      | 2,815  |   |
| Non-current                assets                                                                               |   |   | 40     |   |
| Debt                                                                                                            |   |   | (20    | ) |
| Current                liabilities                                                                              |   |   | (1,816 | ) |
| Stock                compensation costs                                                                         |   |   | 315    |   |
| Unpaid                transaction costs in disposition of Databit and contract                settlement        |   |   | 63     |   |
| Other                                                                                                           |   |   | (10    | ) |
| Loss                on the sale of Databit and contract settlement                                              |   | $      | (2,298 | ) |
| Net                cash used in business disposition                                                            |   | $      | (911   | ) |

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

**Notes      to Consolidated Financial Statements **

**Note      1: Basis of Presentation**

** **
** **

**Note      2: Financing of Operations **

**Note      3: Accounting Policies - Stock Based Compensation**

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

**Notes        to Consolidated Financial Statements **

|                                                                                                                                                             |   | Three                months ended March 31, 2005 |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------|--------|
| Net                loss as reported                                                                                                                         |   | $                                                | (439   | ) |
| Plus:                Stock-based employee and director compensation expense included in                reported net loss                                    |   |                                             | 6      |   |
| Less:                Total stock-based employee compensation expense determined under                fair                value based method for all awards  |   |                                             | 81     |   |
| Pro                forma net loss                                                                                                                           |   | $                                                | (514   | ) |
| Net                loss per share:                                                                                                                               |   |                                             |   |   |
| Basic                and diluted - as reported                                                                                                              |   |                                             |   |   |
| From                continuing operations                                                                                                                   |   | $                                                | (0.11  | ) |
| From                discontinued operations                                                                                                                 |   |                                             | 0.06   |   |
| Basic                and diluted loss per share as reported                                                                                                 |   | $                                                | (0.05  | ) |
|                                                                                                                                                             |   |                                             |   |   |
| Basic                and diluted - pro forma                                                                                                                |   |                                             |   |   |
| From                continuing operations                                                                                                                   |   | $                                                | (0.12  | ) |
| From                discontinued operations                                                                                                                 |   |                                             | 0.06   |   |
| Basic                and diluted loss per share - pro forma                                                                                                 |   | $                                                | (0.06  | ) |

|                                                                           |   | Three                months ended March 31, 2006 |   |
|--------------------------------------------------------------------------------|--------|--------------------------------------------------|--------|
| Cost                of sales                                                   |   | $                                                | 19     |   |
| Selling,                marketing, general and administrative expenses         |   |                                             | 116    |   |
| Loss                on sale of discontinued operations and contract settlement |   |                                             | 315    |   |
| Total                stock based compensation expense                          |   | $                                                | 450    |   |

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

**Notes          to Consolidated Financial Statements **

**Note      4: Sale of Databit and Contract Settlement**

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

**Notes          to Consolidated Financial Statements **

| **Assets**                                                                                                                                    |   |   |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| Cash                                                                                                                                          |   | $      | 185    |   |
| Accounts                receivable, net                                                                                                       |   |   | 2,696  |   |
| Inventory                and other current assets                                                                                             |   |   | 119    |   |
| Property                and equipment, net                                                                                                    |   |   | 35     |   |
| Other                assets                                                                                                                   |   |   | 5      |   |
| ** **Reduction                in total assets                                                                                            |   | $      | 3,040  |   |
| **Liabilities**                                                                                                                               |   |   |   |   |
| Trade                payables, accrued payroll, payroll taxes and social benefits and                other                current liabilities |   |   | 1,816  |   |
| Long-term                debt                                                                                                                 |   |   | 20     |   |
| Reduction                in total liabilities                                                                                                 |   | $      | 1,836  |   |
| Excess                of assets over liabilities                                                                                              |   | $      | 1,204  |   |

|                                                                         |   | Three                months ended March 31, 2005 |   | Period                ended March                9, 2006 |   |
|------------------------------------------------------------------------------|--------|--------------------------------------------------|--------|----------------------------------------------------------|--------|
|                                                                         |   |                                             |   |                                                     |   |
| Sales                                                                   |   | $                                                | 5,181  |                                                     | $      | 2,949 |   |
| Cost                of sales                                            |   |                                             | 4,208  |                                                     |   | 2,316 |   |
| Gross                profit                                             |   |                                             | 973    |                                                     |   | 633 |   |
| Selling,                marketing, general and administrative expenses  |   |                                             | 820    |                                                     |   | 558 |   |
| Income                from operations                                   |   |                                             | 153    |                                                     |   | 75 |   |
| Other                income                                             |   |                                             | --     |                                                     |   | 3 |   |
| Net                income before income taxes                           |   |                                             | 153    |                                                     |   | 78 |   |
| Income                taxes                                             |   |                                             | 15     |                                                     |   | -- |   |
| Net                income from discontinued operations                  |   | $                                                | 138    |                                                     | $      | 78 |   |

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

**Notes          to Consolidated Financial Statements **

| Excess                of assets over liabilities transferred                       |   | $      | 1,204 |   |
|------------------------------------------------------------------------------------|--------|--------|-------|--------|
| Contract                settlement costs                                           |   |   | 600   |   |
| Stock                compensation expense                                          |   |   | 315   |   |
| Professional                fees and other transaction costs                       |   |   | 179   |   |
| ** **Total                loss on the sale of Databit and contract settlement |   | $      | 2,298 |   |

**Note      5: Investment in Comverge**

|                                                    |   | Common                stock |   | Preferred                stock |   | Provision                for unrecognized                losses |   | Net                investment in Comverge |   |
|---------------------------------------------------------|--------|-----------------------------|--------|--------------------------------|--------|-----------------------------------------------------------------|--------|-------------------------------------------|--------|
| Balances                as of December 31, 2005         |   | $                           | (1,824 | )                              | $      | (64                                                             | )      | $                                         | 64     |   | $ | (1,824 | ) |
| Additional                investment in Preferred stock |   |                        | --     |                           |   | 210                                                             |   |                                      | --     |   |   | 210 |   |
| Equity                loss in Comverge                  |   |                        | --     |                           |   | (187                                                            | )      |                                      | (13    | ) |   | (210 | ) |
| Balances                as of March 31, 2005            |   | $                           | (1,824 | )                              | $      | (41                                                             | )      | $                                         | 41     |   | $ | (1,824 | ) |

**Note      6: Goodwill and Other Intangible Assets**

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

**Notes          to Consolidated Financial Statements **

**Note      7: Stock Based Compensation**

| (a)   | Stock                Option Plans |
|-----------------|-----------------------------------|

|                                               |   | Number                of Options (in shares) |      | Weighted                Average Exercise Price |   | Weighted                Average Remaining Contractual Life |   | Aggregate                Intrinsic Value |                     |
|----------------------------------------------------|--------|----------------------------------------------|-----------|------------------------------------------------|--------|------------------------------------------------------------|--------|------------------------------------------|--------------------------|
| Outstanding                at December 31, 2005    |   |                                         | 1,575,355 |                                           | $      | 2.48                                                       |   |                                     |                     |   |   |   |   |
| Granted                at market price             |   |                                         | 75,000    |                                           | $      | 2.65                                                       |   |                                     |                     |   |   |   |   |
| Granted                at discount to market price |   |                                         | 400,000   |                                           | $      | 2.13                                                       |   |                                     |                     |   |   |   |   |
| Exercised                                          |   |                                         | (43,333   | )                                              | $      | 0.91                                                       |   |                                     |                     |   | $ | 47 |   |
| Forfeited                or expired                |   |                                         | (18,337   | )                                              | $      | 5.81                                                       |   |                                     |                     |   |   |   |   |
| Outstanding                at March 31, 2006       |   |                                         | 1,988,665 |                                           | $      | 2.46                                                       |   |                                     | 3.0                years |   | $ | 1,870 |   |
| Exercisable                at March 31, 2006       |   |                                         | 1,387,818 |                                           | $      | 2.68                                                       |   |                                     | 2.3                years |   | $ | 1,366 |   |

| Volatility                             |   |   | 106%                     |
|----------------------------------------|--------|--------|--------------------------|
| Expected                term (years)   |   |   | 3.5                years |
| Risk                free interest rate |   |   | 4.7%                     |
| Expected                dividend yield |   |   | 0.0%                     |

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

**Notes          to Consolidated Financial Statements **

**Note      8: Warranty Provision**

**Note      9: Bank Settlement Agreement **

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

**Notes          to Consolidated Financial Statements **

**Note      10: Segment Information**

| ·   | RT                Solutions whose activities are focused on two areas - naval solutions                and                other real-time and embedded hardware & software                development. |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | IT                Solutions whose activities are comprised of the Company’s OncoProTM                solution state of the art chemotherapy package for oncology and hematology                departments and EasyBillTM, 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. |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|                                              |   | **RT                Solutions** |   | **IT                Solutions** |   | **Other****(*)** |   |  **Total** |   |
|---------------------------------------------------|--------|---------------------------------|--------|---------------------------------|--------|------------------|--------|-----------------|--------|
| Three                months ended March 31, 2006: |   |                            |   |                            |   |             |   |            |   |
| Revenues                from external customers   |   | $                               | 633    |                            | $      | 285              |   | $               | 55     |   | $ | 973 |   |
| Intersegment                revenues              |   |                            | --     |                            |   | --               |   |            | --     |   |   | -- |   |
| Segment                gross profit               |   |                            | 170    |                            |   | 47               |   |            | 11     |   |   | 228 |   |
| Segment                loss                       |   |                            | (57    | )                               |   | (58              | )      |            | (2     | ) |   | (117 | ) |
| Three                months ended March 31, 2005: |   |                            |   |                            |   |             |   |            |   |   |   |   |   |
| Revenues                from external customers   |   | $                               | 830    |                            | $      | 325              |   | $               | 4      |   | $ | 1,159 |   |
| Intersegment                revenues              |   |                            | --     |                            |   | --               |   |            | --     |   |   | -- |   |
| Segment                gross profit               |   |                            | 291    |                            |   | 74               |   |            | 4      |   |   | 369 |   |
| Segment                income (loss)              |   |                            | 73     |                            |   | (37              | )      |            | 3      |   |   | 39 |   |

**Reconciliation      of Segment Income (Loss) to Consolidated Net Loss**

|                                                                           |   | Three                months ended March 31, |   |
|--------------------------------------------------------------------------------|--------|---------------------------------------------|--------|
|                                                                           |   | 2005                                        |   | 2006 |   |
| Total                loss for reportable segments                              |   | $                                           | 36     |   | $ | (115 | ) |
| Other                operational segment income (loss)                         |   |                                        | 3      |   |   | (2 | ) |
| Total                operating income (loss)                                   |   |                                        | 39     |   |   | (117 | ) |
| Minority                interests                                              |   |                                        | (42    | ) |   | -- |   |
| Share                of losses in Comverge                                     |   |                                        | (201   | ) |   | (210 | ) |
| Net                loss of corporate headquarters and other unallocated costs  |   |                                        | (727   | ) |   | (261 | ) |
| Net                loss from continuing operations                             |   |                                        | (931   | ) |   | (588 | ) |
| Discontinued                operations                                         |   |                                        | 492    |   |   | 78 |   |
| Loss                on sale of discontinued operations and contract settlement |   |                                        | --     |   |   | (2,298 | ) |
| Total                consolidated net loss                                     |   | $                                           | (439   | ) | $ | (2,808 | ) |

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**DATA      SYSTEMS & SOFTWARE INC.**

**Management’s      Discussion and Analysis of **

**Financial      Condition and Results of Operations**

**Item      2.**
**Management’s      Discussion and Analysis of Financial Condition and Results of      Operations**

**Overview      and Trend Information**

*RT      Solutions*

*IT      Solutions*

*Comverge*

----

*Corporate*

**New      Accounting Standards**

----

**Results      of Operations**

|                                                                                                |   | Three                months ended March 31, |   | Change                from |   |
|-----------------------------------------------------------------------------------------------------|--------|---------------------------------------------|--------|----------------------------|--------|
|                                                                                                |   | 2005                                        |   | 2006                       |   | 2005                to2006 |   |
|                                                                                                |   | ($,000)                                     |   | %                of sales  |   | ($,000) |   | %                of sales |   | %  |   |
| Sales                                                                                               |   | $                                           | 1,159  |                       |   | 100 | % | $ | 973 |   |   | 100 | % |   | (16 | )% |
| Cost                of sales                                                                        |   |                                        | 790    |                       |   | *68* |   |   | 745 |   |   | *77* |   |   | (6 | ) |
| Gross                profit                                                                         |   |                                        | 369    |                       |   | *32* |   |   | 228 |   |   | *23* |   |   | (38 | ) |
| R&D                expenses                                                                     |   |                                        | 9      |                       |   | *1* |   |   | 26 |   |   | *3* |   |   | *189* |   |
| SMG&A                expenses                                                                   |   |                                        | 1,038  |                       |   | *90* |   |   | 922 |   |   | *95* |   |   | (11 | ) |
| Operating                loss                                                                       |   |                                        | (678   | )                          |   | (58 | ) |   | (720 | ) |   | (74 | ) |   | *6* |   |
| Interest                income (expense), net                                                       |   |                                        | (22    | )                          |   | (2 | ) |   | 15 |   |   | (2 | ) |   | (168 | ) |
| Other                income , net                                                                   |   |                                        | 10     |                       |   | *1* |   |   | 329 |   |   | *34* |   |   | *3170* |   |
| Loss                before taxes on income                                                          |   |                                        | (690   | )                          |   | (60 | ) |   | (376 | ) |   | (39 | ) |   | (45 | ) |
| Taxes                on income                                                                      |   |                                        | (2     | )                          |   | *0* |   |   | 2 |   |   | *0* |   |   | (200 | ) |
| Loss                from operations of the Company and its consolidated                subsidiaries |   |                                        | (688   | )                          |   | (59 | ) |   | (378 | ) |   | (39 | ) |   | (45 | ) |
| Share                in losses of Comverge                                                          |   |                                        | (201   | )                          |   | (17 | ) |   | (210 | ) |   | (22 | ) |   | *5* |   |
| Minority                interest                                                                    |   |                                        | (42    | )                          |   | (4 | ) |   | -- |   |   | *--* |   |   | (100 | ) |
| Net                loss from continuing operations                                                  |   |                                        | (931   | )                          |   | (80 | ) |   | (588 | ) |   | (61 | ) |   | (37 | ) |
| Net                income from discontinued operations, net of tax                                  |   |                                        | 492    |                       |   | *42* |   |   | 78 |   |   | *8* |   |   | (84 | ) |
| Loss                on sale of discontinued operations and contract settlement                      |   |                                        | --     |                       |   | *--* |   |   | (2,298 | ) |   | (236 | ) |   |   |   |
| Net                loss                                                                             |   | $                                           | (439   | )                          |   | (38 | ) | $ | (2,808 | ) |   | (289 | ) |   | 540 | % |

*Sales.*

*Gross      profit. *

*Selling,      marketing, general and administrative expenses (“SMG&A”). *

----

*Other      income (expense), net. *

*Share      of losses in Comverge. *
* *

*Net      income from discontinued operations, net of tax. *

*Loss      on sale of discontinued operations and contract settlement, net of tax.*

**Liquidity      and Capital Resources**
** **

----

**Contractual      Obligations and Commitments**

|                                                                    |   | Cash                Payments Due During Year Ending March 31, |   |
|-------------------------------------------------------------------------|--------|---------------------------------------------------------------|--------|
|                                                                    |   | (amounts                in thousands)                         |   |
| Contractual                Obligations                                  |   | Total                                                         |   | 2007 |   | 2008-2009 |   | 2010-2011 |   | 2012                and thereafter |   |
| Long-term                debt                                           |   | $                                                             | 133    |   | $ | 133 |   | $ | -- |   | $ | -- |   | $ | -- |   |
| Operating                leases (1)                                     |   |                                                          | 1,701  |   |   | 660 |   |   | 917 |   |   | 124 |   |   | -- |   |
| Potential                severance obligations to Israeli employees (2) |   |                                                          | 2,137  |   |   | -- |   |   | -- |   |   | -- |   |   | 2,137 |   |
| Purchase                commitments                                     |   |                                                          | --     |   |   | -- |   |   | -- |   |   | -- |   |   | -- |   |
| Total                contractual cash obligations                       |   | $                                                             | 3,971  |   | $ | 793 |   | $ | 917 |   | $ | 124 |   | $ | 2,137 |   |

----

**Item      3.**
**      Quantitative and Qualitative Disclosures About Market Risk**

**Item      4.**
**      Controls and Procedures**

**Evaluation      of Controls and Procedures **

**Changes      in Controls and Procedures**

----

**PART      II - OTHER INFORMATION**

**Item      1.**
**Legal      Proceedings**

**Item      1A. Risk Factors**

**Item      2. Unregistered Sales of Equity Securities and Use of      Proceeds**

**Item      6.**
**Exhibits.**

| 10.1  |   | 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 to the                Registrant’s Current Report on Form 8-K dated March 16, 2006 (the “2006                8-K”)). |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2  |   | Termination                and Release Agreement dated as of March 9, 2006 by and between Shlomie                Morgenstern and Data Systems & Software Inc. (incorporated herein by                reference to Exhibit A to Exhibit 10.1 to the 2006                8-K).                                                                                                |
| 10.3  |   | 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).                                                      |
| 10.4  |   | 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 & Software Inc. (incorporated herein by reference to                Exhibit C to Exhibit 10.1 to the 2006 8-K).                    |
| 10.5  |   | 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).                                  |
| 10.6  |   | Consulting                Agreement dated as of March 9, 2006 by and between George Morgenstern                and                Data Systems & Software Inc. (incorporated herein by reference to                Exhibit E to Exhibit 10.1 to the 2006 8-K).                                                                                                              |
| 10.7  |   | Form                of Consent Agreement (incorporated herein by reference to Exhibit                F to                Exhibit 10.1 to the 2006 8-K.).                                                                                                                                                                                                                        |
| 10.8  |   | Form                of Indemnification Agreement (incorporated herein by reference to                the                Registrant’s Current Report on Form 8-K dated March 14,                2006).                                                                                                                                                                     |
| 10.9  |   | Assignment                and Assumption of Office Lease dated as of March 10, 2006 by and                between                Databit Inc. and Data Systems & Software Inc.                                                                                                                                                                                              |
| 10.10 |   | Non-Plan                Stock Option Agreement dated as of March 27, 2006 by and between                Elihu                Levine and Data Systems & Software Inc.                                                                                                                                                                                                        |
| 10.11 |   | Non-Plan                Stock Option Agreement dated as of March 27, 2006 by and between                Samuel                Zentman and Data Systems & Software                Inc.                                                                                                                                                                                       |

----

| 10.12 |   | Non-Plan                Stock Option Agreement dated as of March 27, 2006 by and between                Shane                Yurman and Data Systems & Software Inc. |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1  |   | Certification                of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley                Act of 2002.                                        |
| 31.2  |   | Certification                of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley                Act of 2002.                                        |
| 32.1  |   | Certification                of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley                Act of 2002.                                        |
| 32.2  |   | Certification                of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley                Act of 2002.                                        |

----

**SIGNATURES**

|                                              |                                              |                                |
|---------------------------------------------------|---------------------------------------------------|-------------------------------------|
|                                              | **DATA              SYSTEMS & SOFTWARE INC.** |
|                                         |                                         |                           |
| Date: May              19,              2006 | By:                                     | /s/ Michael              Barth |
|                                              | Michael              Barth                        |
|                                              | Chief              Financial Officer              |

----