**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,
      2005
    COMMISSION FILE NUMBER
0-19771


**DATA
SYSTEMS & SOFTWARE INC.**


(Exact
name of registrant as specified in charter)











**Delaware**
    
    **22-2786081**(State or other jurisdiction incorporation
      or organization)
    
    (I.R.S. employer identification
      no.)**200 Route 17, Mahwah, New
      Jersey**
    
    **07430**(Address of principal executive
      offices)
    
    (Zip code)**(201)
      529-2026**Registrant’s telephone number, including
      area code****




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.




x|
      Yes
    
    oNo





Indicate
by check mark whether the registrant is an accelerated filer (as defined in
Rule 12b-2 of the Act).




oYes
    
    xNo




Number
of shares outstanding of the registrant’s common stock, as of May 10, 2005:
8,116,691













**DATA
SYSTEMS & SOFTWARE INC.**


Quaterly Report on Form
10-Q


for the Quaterly Period Ended March 31,
2005








**TABLE
OF CONTENTS**


******PART I.**Financial
      Information****Item
      1. Financial StatementsUnaudited
      Consolidated Financial Statements:Consolidated
      Balance Sheetsas of December 31, 2004 and March 31,
      2005
    1Consolidated
      Statements of Operations and Comprehensive Lossfor the three month
      periods ended March 31, 2004 and 2005
    2Consolidated
      Statement of Changes in Shareholders’ Equityfor the three month
      period ended March 31, 2005
    3Consolidated
      Statements of Cash Flowsfor the three month periods ended March
      31, 2004 and 2005
    4Notes
      to Consolidated Financial Statements
    5Item
      2. Management’s Discussion and Analysis of Financial Conditionand
      Results of Operations
    9Item
      3.Quantitative
      and Qualitative Disclosures about Market Risk
    13Item
      4.Controls
      and Procedures
    13**PART
      II. Other Information**Item
      1.Legal
      Proceedings
    14Item
      6. Exhibits
    14**Signatures**
    
    15


Certain
statements contained in this report are forward-looking in nature. These
statements are generally identified by the inclusion of phrases such as “we
expect”, “we anticipate”, “we believe”, “we estimate” and other phrases of
similar meaning. Whether such statements ultimately prove to be accurate depends
upon a variety of factors that may affect our business and operations. Many of
these factors are described in our most recent Annual Report on Form 10-K as
filed with Securities and Exchange Commission.











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


**Consolidated
Balance Sheets**


(in
thousands, except share and per share data)




**ASSETS**
    
    **As
      of**
      **December
      31, 2004**
    
    
    **As
      of**
      **March
      31,**
      **2005**Current
      assets:
    
    
    
    
    (unaudited)Cash
      and cash equivalents
    $
    685
    
    $
    327Short-term
      bank deposits
    
    72
    
    
    —Restricted
      cash
    
    354
    
    
    354Accounts
      receivable, net
    
    6,069
    
    
    6,985Unbilled
      work-in-process
    
    533
    
    
    1,036Inventory
    
    61
    
    
    114Other
      current assets
    
    540
    
    
    1,002Total
      current assets
    
    8,314
    
    
    9,818Property
      and equipment, net
    
    649
    
    
    677Other
      assets
    
    737
    
    
    662Funds
      in respect of employee termination benefits
    
    2,836
    
    
    2,860Goodwill
    
    4,408
    
    
    4,354Other
      intangible assets, net
    
    81
    
    
    72Total
      assets
    $
    17,025
    
    $
    18,443**LIABILITIES
      AND SHAREHOLDERS’ EQUITY**Current
      liabilities:Short-term
      bank credit
    $
    729
    
    $
    647Current
      maturities of long-term debt
    
    466
    
    
    445Related
      Party - Note payable
    
    —
    
    
    250Trade
      accounts payable
    
    2,283
    
    
    3,575Accrued
      payroll, payroll taxes and social benefits
    
    1,735
    
    
    1,810Other
      current liabilities
    
    2,227
    
    
    2,277Total
      current liabilities
    
    7,440
    
    
    9,004Long-term
      liabilities:Investment
      in Comverge, net
    
    1,444
    
    
    1,645Long-term
      debt
    
    201
    
    
    220Liability
      for employee termination benefits
    
    4,279
    
    
    4,384Other
      liabilities
    
    65
    
    
    45Total
      long-term liabilities
    
    5,989
    
    
    6,294Minority
      interests
    
    1,471
    
    
    1,494Shareholders’
      equity:Common
      stock - $0.01 par value per share:Authorized
      - 20,000,000 shares; Issued - 8,937,395 shares atDecember
      31, 2004 and March 31, 2005
    
    88
    
    
    88Additional
      paid-in capital
    
    39,733
    
    
    39,733Warrants
    
    461
    
    
    461Deferred
      compensation
    
    (59
    )
    
    (53
    )Accumulated
      deficit
    
    (34,290
    )
    
    (34,729
    )Treasury
      stock, at cost -820,704 shares at December 31, 2004 and March 31,
      2005
    
    (3,791
    )
    
    (3,791
    )Accumulated
      other comprehensive loss
    
    (17
    )
    
    (58
    )Total
      shareholders’ equity
    
    2,125
    
    
    1,651Total
      liabilities and shareholders’ equity
    $
    17,025
    
    $
    18,443




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







-1-





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


**Consolidated
Statements of Operations and Comprehensive Loss** (unaudited)


(in
thousands, except net loss per share data)




**Three
      months ended March 31,****2004**
    
    **2005**Sales:Products
    
    $
    4,269
    
    $
    5,128Services
    
    
    2,308
    
    
    2,588Projects
    
    
    678
    
    
    843Total
      sales
    
    
    7,255
    
    
    8,559Cost
      of sales:Products
    
    
    3,365
    
    
    4,185Services
    
    
    1,767
    
    
    1,984Projects
    
    
    573
    
    
    540Total
      cost of sales
    
    
    5,705
    
    
    6,709Gross
      profit
    
    
    1,550
    
    
    1,850Operating
      expenses:Research
      and development expenses
    
    
    --
    
    
    9Selling,
      marketing, general and administrative expenses
    
    
    1,830
    
    
    1,892Total
      operating expenses
    
    
    1,830
    
    
    1,901Operating
      loss
    
    
    (280
    )
    
    (51
    )Interest
      income
    
    
    2
    
    
    2Interest
      expense
    
    
    (57
    )
    
    (55
    )Other
      income, net
    
    
    101
    
    
    5Loss
      before taxes on income
    
    
    (234
    )
    
    (99
    )Taxes
      on income
    
    
    7
    
    
    (97
    )Loss
      from operations of the Company and its consolidated
      subsidiaries
    
    
    (227
    )
    
    (196
    )Share
      in losses of Comverge
    
    
    (353
    )
    
    (201
    )Minority
      interests
    
    
    (15
    )
    
    (42
    )Net
      loss
    
    $
    (595
    )
    $
    (439
    )Other
      comprehensive loss, net of tax:Differences
      from translation of financial statements of subsidiaries
    
    
    (196
    )
    
    (41
    )Comprehensive
      loss
    
    $
    (791
    )
    $
    (480
    )Basic
      and diluted loss per share:Net
      loss per share - basic and diluted
    
    $
    (0.08
    )
    $
    (0.05
    )Weighted
      average number of shares outstanding - basic and diluted
    
    
    7,920
    
    
    8,117




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








-2-


DATA SYSTEMS & SOFTWARE INC. AND
SUBSIDIARIES




**Consolidated
Statement of Changes in Shareholders’ Equity** (unaudited)


(in
thousands)


Number of Shares
    
    Common
      Stock
    
    Additional
      Paid-In
      Capital
    
    Warrants
    
    Stock-Based Deferred Compensation
    
    Accumulated Deficit
    
    Treasury Stock
    
    Accumulated Other Comprehensive Loss
    
    TotalBalances
      as ofDecember 31, 2004
    
    
    8,937
    
    
    $88
    
    
    $39,733
    
    
    $461
    
    
    $(59
    )
    
    $(34,290
    )
    
    $(3,791
    )
    
    $(17
    )
    
    $2,125Amortization
      of stock-based deferred compensation
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    6
    
    
    —
    
    
    —
    
    
    —
    
    
    6Net
      loss
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    (439
    )
    
    —
    
    
    —
    
    
    (439
    )Differences
      from translation of financial statements of subsidiaries
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    (41
    )
    
    (41
    )Balances
      as ofMarch 31, 2005
    
    
    8,937
    
    
    $88
    
    
    $39,733
    
    
    $461
    
    
    $(53
    )
    
    $(34,729
    )
    
    $(3,791
    )
    
    $(58
    )
    
    $1,651


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






-3-


DATA SYSTEMS & SOFTWARE INC. AND
SUBSIDIARIES




**Consolidated
Statements of Cash Flows** (unaudited)


(dollars
in thousands)


**Three
      months ended March 31,****2004**
    
    **2005**Cash
      flows provided by (used in) operating activities:Net
      loss
    
    $
    (595
    )
    $
    (439
    )Adjustments
      to reconcile net loss to net cashprovided
      by (used in) operating activities:Depreciation
      and amortization
    
    
    62
    
    
    52Minority
      interests
    
    
    15
    
    
    42Share
      in losses of Comverge
    
    
    353
    
    
    201Deferred
      taxes
    
    
    24
    
    
    11Increase
      in liability for employee termination benefits
    
    
    136
    
    
    105Loss
      (gain) on disposition of property and equipment
    
    
    (5
    )
    
    2Amortization
      of deferred compensation
    
    
    —
    
    
    6Other
    
    
    (40
    )
    
    (7
    )Change
      in operating assets and liabilities:Decrease
      (increase) in accounts receivable, unbilled work-in-process and other
      current and other assets
    
    
    971
    
    
    (1,817
    )Decrease
      (increase) in inventory
    
    
    46
    
    
    (53
    )Increase
      (decrease) in accounts payable and other liabilities
    
    
    (879
    )
    
    1,397Net
      cash provided by (used in) operating activities
    
    
    88
    
    
    (500
    )Cash
      flows provided by (used in) investing activities:Amounts
      funded for employee termination benefits
    
    
    (106
    )
    
    (6
    )Utilization
      of employee termination benefits
    
    
    (12
    )
    
    (18
    )Maturity
      of short-term deposits
    
    
    —
    
    
    72Acquisitions
      of property and equipment
    
    
    (22
    )
    
    (98
    )Proceeds
      from sale of property and equipment
    
    
    30
    
    
    19Net
      cash used in investing activities
    
    
    (110
    )
    
    (31
    )Cash
      flows provided by (used in) financing activities:Short-term
      debt borrowings (repayments), net
    
    
    39
    
    
    (70
    )Proceeds
      from note payable to a related party
    
    
    —
    
    
    250Proceeds
      from long-term debt
    
    
    —
    
    
    76Repayments
      of long-term debt
    
    
    (164
    )
    
    (83
    )Proceeds
      from employee stock option exercises
    
    
    35
    
    
    —Net
      cash provided by (used in) financing activities
    
    
    (90
    )
    
    173Net
      decrease in cash and cash equivalents
    
    
    (112
    )
    
    (358
    )Cash
      and cash equivalents at beginning of period
    
    
    1,213
    
    
    685Cash
      and cash equivalents at end of period
    
    $
    1,101
    
    $
    327Supplemental
      cash flow information:Cash
      paid during the period for:Interest
    
    $
    48
    
    $
    32Income
      taxes
    
    $
    8
    
    $
    3Non-cash
      investing and financing activities:Adjustment
      of treasury stock and additional paid-in capital with respect to options
      exercised
    
    $
    83








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





-4-





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


**Notes
to Consolidated Financial Statements** (unaudited)


(dollars
in thousands)




**Note
1: Basis of Presentation**




The
accompanying unaudited consolidated financial statements of Data Systems &
Software Inc. (“DSSI”) and subsidiaries (the “Company”) have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by accounting principles generally accepted in the United
States of America for complete consolidated financial statements. In the opinion
of management, all adjustments considered necessary for a fair presentation have
been included. Operating results for the three-month period ended March 31, 2005
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2005. These unaudited consolidated financial statements
should be read in conjunction with the consolidated financial statements and
footnotes thereto included in the Company’s Annual Report on Form 10-K for the
year ended December 31, 2004. **** Certain
reclassifications have been made to the Company’s prior period’s consolidated
financial statements to conform to the current period’s consolidated financial
statement presentation. ****




**Note
2: Financing of Operations** ****




As of
March 31, 2005, the Company had working capital of $814, including $327 in
non-restricted cash and cash equivalents. Net cash used in the first quarter of
2005 was $358. Net cash
of $500 was used in operating activities during the first quarter of 2005. The
net loss for the three-month period ended March 31, 2005 of $439 was primarily
due to the Company’s share of unconsolidated losses of Comverge of $201 and
corporate expenses of $445. The Company's use of cash in operating activities
during the first quarter of 2005 was primarily due to increases in accounts
receivables, unbilled work-in-process and other current assets in excess of
reductions in accounts payable and other liabilities of $420, net. Net cash of
$173 provided by financing activities was primarily from the proceeds of a note
payable to a related party of $250.




Of the
total working capital at March 31, 2005, approximately $678 was in the Company’s
majority owned dsIT Technologies Ltd. subsidiary (dsIT). Due to Israeli tax and
company law constraints, as well as the significant minority interest in dsIT,
such working capital and cash flows from dsIT’s operations are not readily
available to finance U.S. activities.




dsIT is
utilizing approximately $647 of its $1,150 lines of credit as of March 31, 2005.
dsIT's lines of credit are denominated in NIS and bear an average interest rate
of the Israeli prime rate plus
2.8% per annum.
The Israeli prime rate fluctuates and as of March 31, 2005 is 5.0%.




The
Company intends to fund its US activities with the cash available and
anticipated profits from its US operations. The Company continues to consider
various restructuring, merger or acquisition and/or additional financing
transactions. As described below in Note 8, the Company and the other
shareholders of dsIT have entered into an agreement in principal for the sale of
dsIT. The Company’s share of the proceeds of such sale, if and when consummated,
would provide additional liquidity. If the contemplated sale is not consummated
and if the Company should need additional liquidity to finance its US
activities, the Company would sell a portion of its Comverge
shares.





-5-





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


**Notes
to Consolidated Financial Statements** (unaudited)


(dollars
in thousands)




**Note
3: Investment in Comverge**




Comverge’s
summary results of operations for the three months ended March 31, 2004 and
2005, is as follows:





Three
      months ended March 31,2004
    
    2005Sales
    
    $
    4,892
    
    $
    3,901Gross
      profit
    
    $
    1,854
    
    $
    1,636Net
      loss
    
    $
    (2,084
    )
    $
    (2,970
    )




The
change in the Company’s Comverge investment, during the three months ended March
31, 2005 is as follows:





Common
      stock
    
    Preferred
      stock
    
    Net
      investment
      in
      ComvergeBalances
      as of December 31, 2004
    
    $
    (1,824
    )
    $
    380
    
    $
    (1,444
    )Equity
      loss in Comverge
    
    
    —
    
    
    (201
    )
    
    (201
    )Balances
      as of March 31, 2005
    
    $
    (1,824
    )
    $
    179
    
    $
    (1,645
    )




**Note
4—  Goodwill and Other Intangible Assets**




The
entire balance of goodwill was in the software consulting and development
segment. There were no acquisitions or impairments of goodwill recorded during
the three-month period ended March 31, 2005.




The
Company’s amortizable intangible assets consisted of software licenses, with a
gross carrying amount of $260 and accumulated amortization of $179 and $188, as
of December 31, 2004 and March 31, 2005, respectively. All intangibles assets
are being amortized over their estimated useful lives, which averaged five years
and the a mortization
expense for each of the three months ended March 31, 2004 and 2005 amounted to
$8. Amortization expense of the remaining balance of these assets, for the years
ending March 31, 2006, 2007 and 2008, is estimated to be $32, $32 and $8,
respectively.




**Note
5: 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.




**Note
6:** **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
changed to the pro forma amounts indicated below:




-6-




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


**Notes
to Consolidated Financial Statements** (unaudited)


(dollars
in thousands)




Three
      Months Ended March 31,2004
    
    2005Net
      loss as reported
    $
    (595
    )
    $
    (439
    )Plus:
      Stock-based employee and director compensation expense included in
      reported net loss
    
    —
    
    
    6Less:
      Total stock-based employee compensation expense determined under fair
      value based method for all awards
    
    15
    
    
    81Pro
      forma net loss
    $
    (610
    )
    $
    (514
    )Net
      loss per share:Basic
      and diluted - as reported
    $
    (0.08
    )
    $
    (0.05
    )Basic
      and diluted - pro forma
    $
    (0.08
    )
    $
    (0.06
    )




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.




**Note
7: Segment Information**





**Software
      Consulting and****Development**
    
    **Computer****Hardware**
    
    **Other****(*)**
    
    **Total**Three
      months ended March 31, 2005:Revenues
      from external customers
    
    $
    3,374
    
    $
    5,181
    
    $
    4
    
    $
    8,559Intersegment
      revenues
    
    
    —
    
    
    10
    
    
    —
    
    
    10Segment
      gross profit
    
    
    873
    
    
    973
    
    
    4
    
    
    1,850Segment
      income
    
    
    67
    
    
    138
    
    
    2
    
    
    207Three
      months ended March 31, 2004:Revenues
      from external customers
    
    $
    2,910
    
    $
    4,339
    
    $
    6
    
    $
    7,255Intersegment
      revenues
    
    
    —
    
    
    —
    
    
    —
    
    
    —Segment
      gross profit
    
    
    594
    
    
    950
    
    
    6
    
    
    1,550Segment
      income (loss)
    
    
    63
    
    
    198
    
    
    (3
    )
    
    258


_______________


(*)  Represents
VAR software operations in Israel that did not meet the quantitative thresholds
of SFAS No. 131.




**Reconciliation
of Segment Loss to Consolidated Net Loss**





Three
      months ended March 31,2004
    
    2005Total
      income for reportable segments
    
    $
    261
    
    $
    205Other
      operational segment income (loss)
    
    
    (3
    )
    
    2Total
      operating income
    
    
    258
    
    
    207Share
      of losses in Comverge
    
    
    (353
    )
    
    (201
    )Net
      loss of corporate headquarters
    
    
    (500
    )
    
    (445
    )Total
      consolidated net loss
    
    $
    (595
    )
    $
    (439
    )






-7-





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


**Notes
to Consolidated Financial Statements** (unaudited)


(dollars
in thousands)




**Note
8: Sale of dsIT**




In March
2005, the Company and the other shareholders of dsIT entered into an agreement
in principle for the sale of all the outstanding shares of dsIT to Matrix IT
Ltd. (“Matrix”). dsIT constitutes virtually the entire software consulting and
development segment. Under the terms of the agreement in principle, the total
consideration to be paid for the shares would be $9 million, to be paid in cash
and in Matrix ordinary shares. A portion of the consideration is subject to
adjustment based on dsIT’s performance against certain operating goals to be set
forth in the definitive agreement.






-8-


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**




The
following discussion includes statements that are forward-looking in nature.
Whether such statements ultimately prove to be accurate depends upon a variety
of factors that may affect our business and operations. Certain of these factors
are discussed in this report and in “Item 1. Description of Business-Factors
That May Influence Future Results” in our Annual Report on Form 10-K for the
year ended December 31, 2004.




**Overview
and Trend Information**




During
the periods included in this report, we operated in two reportable segments:
software consulting and development and computer hardware. The following
analysis should be read together with the segment information provided in Note 7
to the interim unaudited consolidated financial statements included in this
quarterly report, which information is hereby incorporated by reference into
this Item 2.




*Software
Consulting and Development*




Segment
revenues continued to increase in the first quarter of 2005, primarily due to
increases in the consulting business as well as increased revenues from fixed
price development projects, particularly our sonar technology solutions. We have
been successful in maintaining this segment’s higher gross profit margin, due to
the improved cost structure. We believe sonar technology solutions will be the
primary source of future segment growth and profitability.




In March
2005, we, together with the other shareholders of dsIT, entered into an
agreement in principle for the sale of all the outstanding shares of dsIT to
Matrix IT Ltd. If the sale is consummated, we would no longer have any
continuing operations in this segment.




*Computer
Hardware Sales*




Sales in
the first quarter of 2005 were higher than those in the immediately preceding
quarter and those of the first quarter of 2004. The segment’s dependency on
sales to a particular customer has remained high, however we continue to invest
significant efforts to diversify our sales base.




To offset
the concentration and volatility in the hardware resale market, we continue to
seek to diversify our revenue base and have initiated efforts to augment with
more value added software products and services. We currently expect sales to
increase in the coming quarters of 2005, primarily due to new VAR activity in
the area of integrated hardware/software security solutions for computer LAN and
WAN networks and related services, leveraging our existing VAR customer
base.




*Energy
Intelligence Solutions*




Although
we no longer control Comverge, we have invested in it significantly and it
continues to have a material effect on our consolidated results.




During
the first quarter of 2005 Comverge continues to strengthen its strategic
alliances and broadened the spectrum of solutions offered, while continuing to
perform under its Virtual
Peaking Capacity TM (“VPC”) contracts.
Comverge currently has in its VPC
programs more than 190 Megawatts under contract .




Due to
the structure of its largest VPC contract, Comverge’s results continue to suffer
from revenue recognition constraints. Due to the conditions of that contract,
recognition of revenues is dependent on the results of certain tests, which can
only be performed in the summer months. Accordingly Comverge’s revenues from
this contract are expected to be seasonal.




-9-




*Corporate*




Over the
past year we have been in the process of evaluating and exploring different
possibilities of restructuring, acquisitions or mergers and/or other strategic
alternatives. This process has required the devotion of significant time and
resources by our management as well as by our legal and accounting advisors. As
mentioned above, we have entered into an agreement in principal for the sale of
dsIT. We expect to complete a definitive contract for the sale of dsIT by June
2005. If and when we complete this sale, management will consider the
alternatives then available for DSSI’s continued growth.




**Results
of Operations**




The
following table sets forth certain information with respect to the consolidated
results of operations of the Company for the three months ended March 31, 2004
and 2005, including the percentage of total revenues during each period
attributable to selected components of the operations statement data and for the
period to period percentage changes in such components.




Three
      months ended March 31,
    
    Change
      from2004
    
    2005
    
    2004
      to
      2005($,000)
    
    %
      of sales
    
    ($,000)
    
    %
      of sales
    
    %Sales
    
    $
    7,255
    
    
    *100*
    *%*
    $
    8,559
    
    
    *100*
    *%*
    
    *18*Cost
      of sales
    
    
    5,705
    
    
    *79*
    
    
    6,709
    
    
    *78*
    
    
    *18*Gross
      profit
    
    
    1,550
    
    
    *21*
    
    
    1,850
    
    
    *22*
    
    
    *19*R&D
      expenses
    
    
    —
    
    
    *—*
    
    
    9
    
    
    *0*SMG&A
      expenses
    
    
    1,830
    
    
    *25*
    
    
    1,892
    
    
    *22*
    
    
    *3*Operating
      loss
    
    
    (280
    )
    
    *(4*
    *)*
    
    (51
    )
    
    *(1*
    *)*
    
    *(82*
    *)*Interest
      expense, net
    
    
    (55
    )
    
    *(1*
    *)*
    
    (53
    )
    
    *(1*
    *)*
    
    *(4*
    *)*Other
      income (expense), net
    
    
    101
    
    
    *1*
    
    
    5
    
    
    *0*
    
    
    *(95*
    *)*Loss
      before taxes on income
    
    
    (234
    )
    
    *(3*
    *)*
    
    (99
    )
    
    *(1*
    *)*
    
    *(58*
    *)*Taxes
      on income
    
    
    7
    
    
    *0*
    
    
    (97
    )
    
    *1*
    
    
    *(1486*
    *)*Loss
      from operations of the Company and its consolidated
      subsidiaries
    
    
    (227
    )
    
    *(3*
    *)*
    
    (196
    )
    
    *(2*
    *)*
    
    *(14*
    *)*Share
      in losses of Comverge
    
    
    (353
    )
    
    *(5*
    *)*
    
    (201
    )
    
    *(2*
    *)*
    
    *(43*
    *)*Minority
      interest
    
    
    (15
    )
    
    *0*
    
    
    (42
    )
    
    *0*
    
    
    *180*Net
      loss
    
    $
    (595
    )
    
    *(8*
    *)%*
    $
    (439
    )
    
    *(5*
    *)%*
    
    *(26*
    *)*





*Sales.* The
increase in sales in the first quarter of 2005, as compared to the first quarter
of 2004, was primarily due to a $0.8 million, or 19%, increase in computer
hardware sales. This increase was due to a particular sale to an existing
customer. Sales in our software consulting and development segment also
increased by $0.5 million, or 16%, primarily due to increased consulting
revenues.




*Gross
profit.* The
increase in gross profits in the first quarter of 2005, as compared to the first
quarter of 2004, was primarily attributable to the increase in software
consulting and development sales, as well as improved gross profit margins in
that segment, from 20% in the first quarter of 2004 to almost 26% in the first
quarter of 2005. Gross profit in the computer hardware segment remained
relatively stable with the increase in sales being offset by a decrease in gross
profit margin from 22% in the first quarter of 2004 to almost 19% in the first
quarter of 2005, due to the inclusion of a particularly profitable sale in the
2004 period.




-10-





*Share
of Losses in Comverge.* Our
share of Comverge's net loss of $3.0 million and $2.1 million in the first
quarter of 2005 and 2004, was $0.2 million and $0.4 million,
respectively. Our share of Comverge losses decreased, despite the increase in
their losses, due to the decrease in our percentage holdings of Comverge’s
preferred share equity.




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




As of
March 31, 2005, we had working capital of $0.8 million, including $0.3 million
in non-restricted cash and cash equivalents. Net cash used in the first quarter
of 2005 was $0.4 million. Net cash
of $0.5 million was used in operating activities during the first quarter of
2005. The net loss for the three-month period ended March 31, 2005 of $0.4
million was primarily due to our share of unconsolidated losses of Comverge of
$0.2 million and corporate expenses of $0.4 million. The primary use of cash in
operating activities during the first quarter of 2005 was primarily increases in
accounts receivables, unbilled work-in-process and other current and non-current
assets in excess of reductions in accounts payable and other liabilities of $0.4
million. Net cash of $0.2 million provided by financing activities was primarily
from the proceeds of a note payable to Shlomie Morgenstern of $0.3 million. Mr.
Morgenstern has agreed to make available to Databit a line of credit of up to
$0.5 million, at an interest rate of prime plus 3%, the utilization of which
would be at Databit’s discretion. The line could be utilized through May 15,
2006 unless Mr. Morgenstern were involuntarily terminated as President of
Databit, in which event no additional drawdowns could be made.




Of the
total working capital at March 31, 2005, $0.6 million was in our majority owned
dsIT subsidiary. Due to Israeli tax and company law constraints as well as the
significant minority interest in dsIT, such working capital and cash flows from
dsIT’s operations are not readily available to finance U.S.
activities.




As of
April 30, 2005 the Company’s wholly owned US operations (i.e., excluding dsIT
and Comverge) had an aggregate of $0.2 million in unrestricted cash and cash
equivalents, reflecting a $0.5 million decrease from the balance as of December
31, 2004.




We intend
to fund our US activities with the cash available and anticipated profits from
our US operations. DSSI continues to consider various restructuring, merger or
acquisition and/or additional financing transactions. In March 2005, we entered
into an agreement in principle for the sale of dsIT to Matrix IT Ltd. Under the
terms of this agreement in principle, assuming an agreed upon net asset value,
the total consideration to be paid for the shares would be approximately $9
million, to be paid in cash and in Matrix ordinary shares. A portion of the
consideration is subject to adjustment based on dsIT’s performance against
certain operating goals to be set forth in the definitive agreement. Our share
of the proceeds of such sale, if and when consummated, would provide additional
liquidity. Consummation of this transaction is subject to (i) satisfactory
completion by Matrix of its due diligence investigation of dsIT, (ii)
negotiation and execution of a definitive agreement, and (iii) the receipt of
all necessary corporate and other approvals. The actual consideration to be paid
by Matrix for the dsIT shares, and the amount that we may receive in connection
with the transaction, is subject to adjustment. There is no assurance that the
transaction will be consummated on the terms described above or at all.




Should we
not consummate the sale of dsIT, we expect dsIT to continue generating profits
at a level similar to that of the last quarter of 2004. Although dsIT will need
to utilize its profits to fund its growth, we expect dsIT to repay a portion of
its loan from DSSI, beginning in August 2005, providing additional liquidity to
the US operations.




In
addition, we believe that should we need additional liquidity, we will be able
to sell a portion of our Comverge Preferred shares, as we did in September
2004.




Based on
our expectations and contingency plans described above, all of the above are
expected to provide more than sufficient liquidity for DSSI’s foreseeable future
and the next 12 months in particular.







-11-







**Contractual
Obligations and Commitments**




Our
contractual obligations and commitments at March 31, 2005, excluding certain
severance arrangements described below, principally include obligations
associated with our outstanding indebtedness, future minimum operating lease
obligations and contractual obligations to our CEO for payments for his
post-retirement consulting services to us, are as set forth in the table
below.




Cash Payments Due During Year Ending
      March 31,(amounts
      in thousands)Contractual
      Obligations
    
    Total
    
    2006
    
    2007-2008
    
    2009-2010
    
    2011
      and thereafterLong-term
      debt
    
    $
    665
    
    $
    445
    
    $
    187
    
    $
    33
    
    $
    —Contingent
      performance of bank guarantees (1)
    
    
    410
    
    
    410
    
    
    —
    
    
    —
    
    
    —Operating
      leases
    
    
    3,289
    
    
    1,187
    
    
    1,600
    
    
    502
    
    
    —Potential
      severance obligations to Israeli employees (2)
    
    
    4,384
    
    
    2
    
    
    70
    
    
    29
    
    
    4,283Consulting
      agreement with CEO (3)
    
    
    1,575
    
    
    300
    
    
    600
    
    
    413
    
    
    262Purchase
      commitments
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —Other
      long-term liabilities reflected on the balance sheet in accordance with
      GAAP
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —Total
      contractual cash obligations
    
    $
    10,323
    
    $
    2,344
    
    $
    2,457
    
    $
    977
    
    $
    4,545




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




(1)
Previously, we accrued a loss for contingent performance of bank guarantees. Our
remaining commitment under these guarantees is $0.4 million at March 31 2005. We
have collateralized a portion of these guarantees by means of a deposit of $0.2
million as of March 31, 2005. The obligation is presented as a current
liability, though it is uncertain as to when actual payment may be made.




(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
March 31, 2005, we accrued a total of $4.4 million for potential severance
obligations which is included in long term liabilities, of which approximately
$2.9 million was funded with cash to insurance companies.




(3) Under
the terms of his employment agreement with us, as amended, we have an obligation
to continue to pay our Chief Executive Officer consulting fees over a seven-year
period starting January 1, 2005. As a result, during the coming four years,
through 2008, we have to pay our CEO $240,000 per year, equal to 50% of his
salary in effect as of December 31, 2003. From 2009 through 2011, we must pay
$120,000 per year, equal to 25% of that salary. In addition, we must pay
contributions to a non-qualified defined contribution retirement plan equal to
25% of the consulting fee. In accordance with the employment contract, we are
obliged to fund amounts payable for the term of the consulting period by the
purchase of an annuity or similar investment product at the beginning of the
consulting period. The CEO has agreed to allow us not to so fund such amounts
until the earlier of (i) March 31, 2006, (ii) his termination as CEO, or (ii)
the closing of a transaction with gross proceeds to us of at least $1.5 million.









-12-


****


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




In the
normal course of business, we are exposed to fluctuations in interest rates on
lines-of-credit incurred to finance our operations in Israel, currently $0.6
million. Additionally, our monetary assets and liabilities (net liability of
approximately $0.3 million) in Israel are exposed to fluctuations in exchange
rates. We do not employ specific strategies, such as the use of derivative
instruments or hedging, to manage our interest rate or foreign currency exchange
rate exposures.




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




**Evaluation
of Controls and Procedures**




Within 90
days prior to the date of filing of this report, 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 our
disclosure controls and procedures are effective for gathering, analyzing and
disclosing the information we are required to disclose in the reports we file
under the Securities Exchange Act of 1934, within the time periods specified in
the SEC's rules and forms.




**Changes
in Controls and Procedures**




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







-13-




**PART
II - Other information**






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




***IDB
Litigation***




In March
2005, a Jerusalem District Court rendered a decision in our favor in our suit
against Israel Discount Bank (“IDB”) and has awarded us damages, legal fees and
other costs of approximately $2.2 million.




Our case
against IDB was commenced in March 1999 and had alleged that IDB had wrongfully
retained control of our shares in Decision System Israel Ltd. (now known as dsIT
Technologies Ltd.). Our action also sought a declaratory judgment that we were
not liable to IDB on a guarantee made on behalf of a former equity affiliate. In
September 2001 the District Court decided against us on all claims. We appealed
the decision to the Israel Supreme Court, which in June 2004 upheld the decision
of the District Court on the guarantee but reversed the District Court on the
shares and held that IDB had wrongfully retained the shares. The Supreme Court
remanded the case to the District Court to determine the damages payable to us
by IDB. The decision in March 2005 was rendered on the remand from the Israel
Supreme Court. The District Court decision is subject to appeal by IDB, which we
understand it intends to file. There is no assurance that the decision in our
favor will be upheld on appeal.




In
accordance with generally accepted accounting principles, any gain contingency
associated with the decision in our favor will not be recognized as income until
the earlier of the exhaustion of all appeals or settlement of the
action.




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






10.1
    Loan
      Agreement between Databit, Inc. and Shlomie Morgenstern (and forms of
      Note, Security Agreement and Guarantee of Registrant), dated as of March
      22, 2005.




10.2
    Letter Agreement between the Registrant and George
      Morgenstern, dated as of May 5, 2005.
 
 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.




-14-


**SIGNATURES**




Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by its Principal Financial
Officer thereunto duly authorized.


**DATA SYSTEMS
      & SOFTWARE INC.**Dated: May 11,
      2005By:
    /s/ Yacov KaufmanYacov KaufmanVice President and Chief Financial
      Officer


-15-