**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 **June
        30, 2006**






Commission
      file number: **0-19771**





**DATA
      SYSTEMS & SOFTWARE INC.**


(Exact
      name of registrant as specified in its charter)





**Delaware**
            
            **22-2786081**(State
                or other jurisdiction of
            
            (I.R.S.
                Employerincorporation
                or organization)
            
            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.


Yes x    No  ̈





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


accelerated
      filer  ̈    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





Indicate
      the number of shares outstanding of each of the issuer's classes of common
      stock, as of the latest practicable date.





Class
            
            Outstanding
                at August 10, 2006Common
                Stock, $0.01 par value per share
            
            9,362,024
                shares




















**DATA
      SYSTEMS & SOFTWARE INC.**


**Quarterly
      Report on Form 10-Q**


**for
      the Quarterly Period Ended June 30, 2006**





**TABLE
      OF CONTENTS**




**PART
              I.  Financial Information**Item 1.
            
            Financial StatementsUnaudited Consolidated Financial
              Statements:Consolidated Balance Sheets
              as
                  of December 31, 2005 and June 30, 2006
            
            1Consolidated
                Statements of Operations
              for
                the six and three month periods ended June 30, 2005 and 2006
            
            2Consolidated
                Statement of Changes in Shareholders’ Equity
              for
                the six month period ended June 30, 2006
            
            3Consolidated
                Statements of Cash Flows
              for
                the six month periods ended June 30, 2005 and 2006
            
            4Notes to Consolidated Financial
              Statements
            
            6Item 2.
            
            Management’s Discussion and Analysis of
              Financial Condition
              and
                Results of Operations
            
            16Item 3.
            
            Quantitative
              and Qualitative Disclosures about Market Risk
            
            22Item 4.
            
            Controls and Procedures
            
            22**PART II. Other
              Information**Item 1.
            
            Legal Proceedings
            
            23Item 6.
            
            Exhibits
            
            23**Signatures**
            
            24







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,
                2005**
            
            **As
                of**
              **June****30,**
              **2006**Current
                assets:Cash
                and cash equivalents
            
            $
            913
            
            $
            170Restricted
                cash
            
            
            247
            
            
            --Restricted
                cash (under agreement with a related party)
            
            
            300
            
            
            --Accounts
                receivable, net
            
            
            4,096
            
            
            1,272Unbilled
                work-in-process
            
            
            348
            
            
            400Inventory
            
            
            25
            
            
            --Other
                current assets
            
            
            709
            
            
            653Total
                current assets
            
            
            6,638
            
            
            2,495Property
                and equipment, net
            
            
            500
            
            
            428Other
                assets
            
            
            334
            
            
            324Funds
                in respect of employee termination benefits
            
            
            1,441
            
            
            1,426Restricted
                cash - non-current (under agreement with a related party)
            
            
            1,050
            
            
            --Goodwill
            
            
            129
            
            
            128Other
                intangible assets, net
            
            
            81
            
            
            65Total
                assets
            
            $
            10,173
            
            $
            4,866LIABILITIES
                AND SHAREHOLDERS’ EQUITYCurrent
                liabilities:Short-term
                bank credit
            
            $
            130
            
            $
            152Current
                maturities of long-term debt
            
            
            160
            
            
            100Trade
                accounts payable
            
            
            1,950
            
            
            316Accrued
                payroll, payroll taxes and social benefits
            
            
            740
            
            
            426Other
                current liabilities
            
            
            2,200
            
            
            1,697Total
                current liabilities
            
            
            5,180
            
            
            2,691Long-term
                liabilities:Investment
                in Comverge, net
            
            
            1,824
            
            
            1,824Long-term
                debt
            
            
            75
            
            
            --Liability
                for employee termination benefits
            
            
            2,264
            
            
            2,239Other
                liabilities
            
            
            10
            
            
            52Total
                long-term liabilities
            
            
            4,173
            
            
            4,115Shareholders’
                equity:Common
                stock - $0.01 par value per share:Authorized
                - 20,000,000 shares; Issued -8,939,395 shares
              at
                December 31, 2005 and June 30, 2006
            
            
            88
            
            
            89Additional
                paid-in capital
            
            
            40,011
            
            
            40,756Warrants
            
            
            183
            
            
            183Deferred
                stock-based compensation
            
            
            (36
            )
            
            --Accumulated
                deficit
            
            
            (35,608
            )
            
            (39,370
            )Treasury
                stock, at cost - 820,704 and 777,371 shares for December 31, 2005
                and June
                30, 2006, respectively
            
            
            (3,791
            )
            
            (3,592
            )Accumulated
                other comprehensive loss
            
            
            (27
            )
            
            (6
            )Total
                shareholders’ equity
            
            
            820
            
            
            (1,940
            )Total
                liabilities and shareholders’ equity
            
            $
            10,173
            
            $
            4,866




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






-1-





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


**Consolidated
      Statements of Operations** (unaudited)


(in
      thousands, except per share data)




**Six
                months ended**
              **June
                30,**
            
            **Three
                months ended**
              **June
                30,****2005**
            
            **2006**
            
            **2005**
            
            **2006**Sales:Projects
            
            $
            1,657
            
            $
            1,521
            
            $
            814
            
            $
            791Services
                and other
            
            
            551
            
            
            442
            
            
            235
            
            
            199Total
                sales
            
            
            2,208
            
            
            1,963
            
            
            1,049
            
            
            990Cost
                of sales:Projects
            
            
            1,127
            
            
            1,021
            
            
            590
            
            
            482Services
                and other
            
            
            451
            
            
            369
            
            
            190
            
            
            163Total
                cost of sales
            
            
            1,578
            
            
            1,390
            
            
            780
            
            
            645Gross
                profit
            
            
            630
            
            
            573
            
            
            269
            
            
            345Operating
                expenses:Research
                and development expenses
            
            
            26
            
            
            97
            
            
            17
            
            
            71Selling,
                marketing, general and administrative
              expenses
            
            
            1,945
            
            
            1,966
            
            
            915
            
            
            1,044Total
                operating expenses
            
            
            1,971
            
            
            2,063
            
            
            932
            
            
            1,115Operating
                loss
            
            
            (1,341
            )
            
            (1,490
            )
            
            (663
            )
            
            (770
            )Interest
                income
            
            
            3
            
            
            25
            
            
            2
            
            
            --Interest
                expense
            
            
            (50
            )
            
            (16
            )
            
            (27
            )
            
            (6
            )Other
                income (expense), net
            
            
            59
            
            
            315
            
            
            49
            
            
            (14
            )Loss
                before taxes on income
            
            
            (1,329
            )
            
            (1,166
            )
            
            (639
            )
            
            (790
            )Taxes
                on income
            
            
            6
            
            
            (6
            )
            
            4
            
            
            (4
            )Loss
                from operations of the Company and its
              consolidated
                subsidiaries
            
            
            (1,323
            )
            
            (1,172
            )
            
            (635
            )
            
            (794
            )Share
                of losses in Comverge
            
            
            (380
            )
            
            (210
            )
            
            (179
            )
            
            --Minority
                interests
            
            
            (59
            )
            
            --
            
            
            (17
            )
            
            --Net
                loss from continuing operations
            
            
            (1,762
            )
            
            (1,382
            )
            
            (831
            )
            
            (794
            )Net
                income from discontinued operations,
              net
                of tax
            
            
            749
            
            
            78
            
            
            257
            
            
            --Loss
                on sale of discontinued operations and contract
              settlement,
                net of tax
            
            
            --
            
            
            (2,298
            )
            
            --
            
            
            --Net
                loss
            
            $
            (1,013
            )
            $
            (3,602
            )
            $
            (574
            )
            $
            (794
            )Basic
                and diluted net income (loss) per share:Loss
                per share from continuing operations
            
            $
            (0.22
            )
            $
            (0.17
            )
            $
            (0.10
            )
            $
            (0.10
            )Discontinued
                operations
            
            
            0.10
            
            
            (0.27
            )
            
            0.03
            
            
            --Net
                loss per share - basic and diluted
            
            $
            (0.12
            )
            $
            (0.44
            )
            $
            (0.07
            )
            $
            (0.10
            )Weighted
                average number of shares outstanding -
              basic
                and diluted
            
            
            8,117
            
            
            8,152
            
            
            8,117
            
            
            8,161






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
                31,2005
            
            
            8,937
            
            $
            88
            
            $
            40,011
            
            $
            183
            
            $
            (36
            )
            $
            (35,608
            )
            $
            (3,791
            )
            $
            (27
            )
            $
            820Net
                loss
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            (3,602
            )
            
            --
            
            
            --
            
            
            (3,602
            )Differences
                fromtranslation
                of financial statements of subsidiaries
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            21
            
            
            21Comprehensive
                loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (3,581
            )Reclassification
                of stock-based deferred compensation
            
            
            --
            
            
            --
            
            
            (36
            )
            
            --
            
            
            36
            
            
            --
            
            
            --
            
            
            --
            
            
            --Exercise
                of options
            
            
            2
            
            
            1
            
            
            4
            
            
            --
            
            
            --
            
            
            (160
            )
            
            199
            
            
            --
            
            
            44Stock
                option compensation
            
            
            --
            
            
            --
            
            
            777
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            777Balances
                as ofJune
                30, 2006
            
            
            8,939
            
            $
            89
            
            $
            40,756
            
            $
            183
            
            $
            -
            
            $
            (39,370
            )
            $
            (3,592
            )
            $
            (6
            )
            $
            (1,940
            )







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)




**Six
                  months ended June 30,****2005**
              
              **2006**Cash
                  flows provided by (used in) operating activities:Net
                  loss
              
              $
              (1,013
              )
              $
              (3,602
              )Adjustments
                  to reconcile net loss to net cash
                provided
                  by (used in) operating activities:Depreciation
                  and amortization
              
              
              128
              
              
              112Change
                  in minority interests
              
              
              59
              
              
              --Share
                  in losses of Comverge
              
              
              380
              
              
              210Change
                  in deferred taxes
              
              
              7
              
              
              --Increase
                  (decrease) in liability for employee termination benefits
              
              
              (9
              )
              
              (25
              )Gain
                  on disposition of property and equipment
              
              
              (2
              )
              
              --Amortization
                  of stock-based deferred compensation
              
              
              12
              
              
              462Loss
                  on sale of Databit and contract settlement
              
              
              --
              
              
              2,298Other
              
              
              (31
              )
              
              3Change
                  in operating assets and liabilities:Decrease
                  (increase) in accounts receivable, unbilled work-in process and
                  other
                  current and other assets
              
              
              (77
              )
              
              68Increase
                  in inventory
              
              
              (2
              )
              
              (18
              )Increase
                  (decrease) in accounts payable and other liabilities
              
              
              (101
              )
              
              (656
              )Net
                  cash used in operating activities
              
              
              (649
              )
              
              (1,148
              )Cash
                  flows provided by (used in) investing activities:Release
                  of restricted cash
              
              
              --
              
              
              247Release
                  of restricted cash (under agreement with a related party)
              
              
              --
              
              
              1,350Change
                  in restricted cash
              
              
              2
              
              
              --Investment
                  in Comverge
              
              
              --
              
              
              (210
              )Amounts
                  funded for employee termination benefits
              
              
              (69
              )
              
              (82
              )Utilization
                  of employee termination benefits
              
              
              157
              
              
              97Maturity
                  of short-term deposits
              
              
              72
              
              
              --Acquisitions
                  of property and equipment
              
              
              (117
              )
              
              (78
              )Proceeds
                  from sale of property and equipment
              
              
              23
              
              
              --Sale
                  of Databit Inc. - Appendix A
              
              
              --
              
              
              (911
              )Net
                  cash provided by investing activities
              
              
              68
              
              
              413Cash
                  flows provided by (used in) financing activities:Short-term
                  debt borrowings (repayments), net
              
              
              129
              
              
              22Proceeds
                  from note payable to related party
              
              
              350
              
              
              --Repayment
                  of note payable to a related party
              
              
              (250
              )Proceeds
                  from long-term debt
              
              
              90
              
              
              --Repayments
                  of long-term debt
              
              
              (158
              )
              
              (74
              )Proceeds
                  from employee stock option exercises
              
              
              --
              
              
              44Net
                  cash provided by (used in) financing activities
              
              
              161
              
              
              (8
              )Net
                  decrease in cash and cash equivalents
              
              
              (420
              )
              
              (743
              )Cash
                  and cash equivalents at beginning of period
              
              
              685
              
              
              913Cash
                  and cash equivalents at end of period
              
              $
              265
              
              $
              170Supplemental
                  cash flow information:Cash
                  paid during the period for:Interest
              
              $
              64
              
              $
              14Income
                  taxes
              
              $
              17
              
              $
              6


are
      an
      integral part of these consolidated financial statements.








-4-






**Appendix
                A****Six
                months**
              **ended
                June 30,****2006**Assets/liabilities
                disposed of in disposition of Databit Inc. and contract
                settlement:Current
                assets
            
            $
            2,815Non-current
                assets
            
            
            40Debt
            
            
            (20
            )Current
                liabilities
            
            
            (1,816
            )Stock
                compensation costs
            
            
            315Unpaid
                transaction costs in disposition of Databit and contract
                settlement
            
            
            63Other
            
            
            (10
            )Loss
                on the sale of Databit and contract settlement
            
            $
            (2,298
            )Net
                cash used in business disposition
            
            $
            (911
            )








-5-






**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 six-month period ended June 30, 2006
      are not necessarily indicative of the results that may be expected for the
      year
      ending December 31, 2006. 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, 2005. **** 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. ****




As
      further described in Note 4, in March 2006, the Company completed the sale
      of
      its subsidiary, Databit Inc. The transferred operation is reflected as a
      discontinued operation for all periods presented in the Consolidated Statements
      of Operations.




**Note
      2: Financing of Operations**




As
      more
      fully described in Note 11, in July 2006, the Company completed a private
      placement of its Common Stock and warrants which resulted in gross proceeds
      to
      the Company of $3,180 and net proceeds of approximately $2,700 after deducting
      commissions and other transaction costs.




The
      $196
      of negative working capital at June 30, 2006, included approximately $542 of
      positive working capital in the Company’s 80% owned dsIT Solutions Ltd.
      subsidiary (“dsIT”). Due to Israeli tax and company law constraints, as well as
      dsIT’s own cash flow requirements, such working capital and cash flows from
      dsIT’s operations are not readily available to finance US based corporate
      activities.




dsIT
      was
      utilizing $152 of its $349 lines of credit as of June 30, 2006. dsIT's lines
      of
      credit are denominated in NIS and bear a weighted average interest rate of
      the
      Israeli prime rate
      plus
      2.45% per annum.
      The Israeli prime rate fluctuates and as of June 30, 2006 was 6.75%.




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




Prior
      to
      January 1, 2006, the Company accounted for share-based compensation in
      accordance with Accounting Principles Board Opinion No. 25, (“APB 25”)
“Accounting for Stock Issued to Employees,” and related interpretations. The
      Company also followed the disclosure requirements of SFAS No. 123, “Accounting
      for Stock-Based Compensation”, as amended by SFAS 148, “Accounting for
      Stock-Based Compensation - Transition and Disclosure”. As a result, no expense
      was recognized for options to purchase the Company’s common stock that were
      granted with an exercise price equal to fair market value at the day of the
      grant. Effective January 1, 2006, the Company adopted the provisions of
      Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based
      Payment,” (“SFAS 123R”) which establishes accounting for equity instruments
      exchanged for services. Under the provisions of SFAS 123R, share-based
      compensation cost is measured at the grant date, based on the fair value of
      the
      award, and is recognized as expense on a straight-line basis over the employee’s
      requisite service period (generally the vesting period of the equity grant).
      The
      Company elected to adopt the modified prospective transition method as provided
      by SFAS 123R and, accordingly, financial statement amounts for the prior periods
      presented in this Form 10-Q have not been restated to reflect the fair value
      method of expensing share-based compensation. The Company has applied the
      provisions of SAB 107 in its adoption of SFAS 123R. See Note 7 to the condensed
      consolidated interim financial statements for information on the impact of
      the
      Company’s adoption of SFAS 123R and the assumptions used to calculate the fair
      value of share-based employee compensation.







-6-






The
      Company recognizes no income tax benefit on its stock compensation expense
      as it
      is not “more likely than not” that it will be able to utilize them to offset
      future income taxes.




The
      following table illustrates the effect on net income and net income per share
      if
      the Company had applied the fair value recognition provisions of SFAS 123R
      for
      periods prior to January 1, 2006:





Six
                months
              ended
                June 30,
              2005
            
            Three
                months
              ended
                June
              30,
                2005Net
                loss as reported
            
            $
            (1,013
            )
            $
            (574
            )Plus:
                Stock-based employee and director compensation expense included in
                reported net loss
            
            
            12
            
            
            6Less:
                Total stock-based employee compensation expense determined under
                fair
                value based method for all awards
            
            
            162
            
            
            81Pro
                forma net loss
            
            $
            (1,163
            )
            $
            (649
            )Net
                loss per share:Basic
                and diluted - as reportedFrom
                continuing operations
            
            $
            (0.22
            )
            $
            (0.10
            )From
                discontinued operations
            
            
            0.10
            
            
            0.03Basic
                and diluted loss per share as reported
            
            $
            (0.12
            )
            $
            (0.07
            )Basic
                and diluted - pro formaFrom
                continuing operations
            
            $
            (0.22
            )
            $
            (0.10
            )From
                discontinued operations
            
            
            0.08
            
            
            0.02Basic
                and diluted loss per share - pro forma
            
            $
            (0.14
            )
            $
            (0.08
            )







The
      historical pro forma impact of applying the fair value method prescribed by
      SFAS
      123R is not representative of the impact that may be expected in the future
      due
      to changes resulting from additional grants in future years and changes in
      assumptions such as volatility, interest rates and expected life used to
      estimate fair value of the grants in future years.







Stock-based
      compensation expense included in the Company’s statements of operations was:





Six
                months
              ended
                June
              30,
                2006
            
            Three
                months
              ended
                June
              30,
                2006Cost
                of sales
            
            $
            21
            
            $
            2Selling,
                marketing, general and administrative expenses
            
            
            441
            
            
            325Loss
                on sale of discontinued operations and contract settlement
            
            
            315
            
            
            --Total
                stock based compensation expense
            
            $
            777
            
            $
            327







For
      restricted common stock, we recognize compensation expense over the vesting
      period for the difference between the exercise price or purchase price and
      the
      fair market value on the measurement date.







-7-






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




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




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




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




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




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




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




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




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




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




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






-8-






As
      a
      result of the transaction, the Company transferred the following assets and
      liabilities:




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




The
      excess of assets over liabilities transferred was treated as part of the loss
      on
      the sale of Databit.








Profit
      and loss of the discontinued operations of Databit were as follows:





Period
              ended
              March
                9, 2006
            
            Six
                months
              ended
                June
              30,
                2005
            
            Three
                months
              ended
                June
              30,
                2005Sales
            
            $
            2,949
            
            $
            9,146
            
            $
            3,965Cost
                of sales
            
            
            2,316
            
            
            7,470
            
            
            3,262Gross
                profit
            
            
            633
            
            
            1,676
            
            
            703Selling,
                marketing, general and administrative expenses
            
            
            558
            
            
            1,573
            
            
            753Income
                from operations
            
            
            75
            
            
            103
            
            
            (50
            )Other
                income, net
            
            
            3
            
            
            --
            
            
            --Finance
                expense, net
            
            
            --
            
            
            (3
            )
            
            (3
            )Net
                income before income taxes
            
            
            78
            
            
            100
            
            
            (53
            )Income
                taxes
            
            
            --
            
            
            15
            
            
            --Net
                income from discontinued operations
            
            $
            78
            
            $
            85
            
            $
            (53
            )






As
      a
      result of the transaction, the Company recorded a loss of $2,298. In addition,
      cash, which had previously been restricted with respect to the GM Employment
      Agreement, was no longer restricted. Subsequent to the first quarter of 2006,
      the Company no longer has any activity in its Computer Hardware
      segment.






-9-






The
      loss
      of the sale of Databit and contract settlement is comprised of the
      following:







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




**Note
      5: Investment in Comverge**




The
      change in the Company’s Comverge investment, during the six months ended June
      30, 2006 is as follows:




Common
              stock
            
            Preferred
              stock
            
            Provision
                for
              unrecognized
              losses
            
            Net
              investment
              in
              ComvergeBalances
                as of December 31, 2005
            
            $
            (1,824
            )
            $
            (64
            )
            $
            64
            
            $
            (1,824
            )Additional
                investment in Preferred stock
            
            
            --
            
            
            210
            
            
            --
            
            
            210Equity
                loss in Comverge
            
            
            --
            
            
            (528
            )
            
            318
            
            
            (210
            )Balances
                as of June 30, 2006
            
            $
            (1,824
            )
            $
            (382
            )
            $
            382
            
            $
            (1,824
            )





In
      the
      first quarter of 2006, the Company recorded an additional $210 investment in
      Comverge’s Series C Preferred Stock. As result of the investment, the Company
      maintained its preferred stock holdings at approximately 7%. In addition, the
      Company also owns approximately 76% of Comverge’s common shares. As a result of
      the investment, the Company immediately recognized a loss equal to (i) its
      provision for unrecognized losses in Comverge of $64 as of December 31, 2005
      and
      (ii) an additional $146 representing its 7% equity share of Comverge’s losses
      for the first quarter of 2006.




As
      of
      June 30, 2006, the Company’s share of losses attributable to its Comverge
      preferred stock was once again equal to its investment in Comverge’s preferred
      stock. As a result, the Company has ceased recording losses against in preferred
      stock investment. In the future, equity income will be recorded to the Company’s
      preferred stock investment only once Comverge’s equity reaches the level it was
      when the Company ceased recording equity losses. As at June 30, 2006, the
      Company had a provision for unrecognized losses in Comverge of $382 and the
      Company will record equity income from its preferred investment in Comverge,
      if
      and when Comverge’s records net income in excess of approximately $5,670. Equity
      income from the Company’s preferred investment may be recorded up to the
      Company’s original $3,854 preferred
      share investment in Comverge, and thereafter to its investment in Comverge’s
      common shares, of which the Company currently owns approximately
      76%.





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




There
      were no acquisitions or impairments of goodwill recorded during the six month
      period ended June 30, 2006.




The
      Company’s amortizable intangible assets consisted of software licenses, with a
      nominal gross carrying amount of $224 and nominal accumulated amortization
      of
      $143 and $159, as of December 31, 2005 and June 30, 2006, respectively. All
      intangibles assets are being amortized over their estimated useful lives, which
      averaged five years and the nominal a mortization
      expense for each of the six months ended June 30, 2005 and 2006 amounted to
      $16
      and $19, respectively. Nominal amortization expense of the remaining balance
      of
      these assets, for the years ending June 30, 2007, 2008, 2009 and 2010, is
      estimated to be $32, $17 $7, $7 and $2, respectively.






-10-






**Note
      7: Stock Based Compensation**




(a)
            Stock
                Option Plans




The
      Company’s stock option plans provide for the grant to officers, directors and
      other key employees of options to purchase shares of common stock at not less
      than 85% of the market value of the Company’s common stock on the date of grant.
      The purchase price must be paid in cash. Each option is exercisable for one
      share of the Company’s common stock. All options expire within five to ten years
      from the date of the grant, and generally vest over a three year period from
      the
      date of the grant. At June 30, 2006, no options or other equity instruments
      were
      available for grant under the various plans as the plans have expired, other
      than 335,000 shares available for grant under the 1994 Outside Director Stock
      plan .





A
      summary
      of stock option activity for the six months ended June 30, 2006 is as
      follows:





Number
                of
              Options
              (in
                shares)
            
            Weighted
              Average
              Exercise
              Price
            
            Weighted
              Average
              Remaining
              Contractual
              Life
            
            Aggregate
              Intrinsic
              ValueOutstanding
                at December 31, 2005
            
            
            1,575,355
            
            $
            2.48Granted
                at market price
            
            
            75,000
            
            $
            2.65Granted
                at discount to market price
            
            
            400,000
            
            $
            2.13Exercised
            
            
            (45,333
            )
            $
            0.96
            
            
            
            
            $
            49Forfeited
                or expired
            
            
            (148,337
            )
            $
            5.05Outstanding
                at June 30, 2006
            
            
            1,856,665
            
            $
            2.36
            
            
            2.9
                years
            
            $
            2,109Exercisable
                at June 30, 2006
            
            
            1,334,152
            
            $
            2.55
            
            
            2.3
                years
            
            $
            1,519





The
      weighted average grant date fair value of stock options granted during the
      first
      six months of 2006 was $2.11 per share based on the assumptions
      below.




The
      fair
      value options granted during the six months ended June 30, 2006 periods was
      estimated on the grant date using the Black-Scholes option-pricing model with
      the following weighted average assumptions:





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





The
      Company estimated volatility by considering historical stock volatility. The
      expected term of options granted is based on management’s estimate since the
      Company’s history of option exercises is too brief to have established
      historical rates. The risk-free interest rates are based on the U.S. Treasury
      yields for a period consistent with the expected term. Additionally, the Company
      expects no dividends to be paid. The Company believes that the valuation
      technique and the approach utilized to develop the underlying assumptions are
      appropriate in determining the estimated fair value of the Company’s stock
      options granted in the three months ended June 30, 2006. Estimates of fair
      value
      are not intended to predict actual future events or the value ultimately
      realized by persons who receive equity awards .




In
      connection with the stock option exercises during the six months ended June
      30,
      2006, the Company received proceeds of $44. Of the 45,333 shares issued as
      a
      result of stock option exercises in the six months ended June 30, 2006, 43,333
      were issued from treasury stock and 2,000 were newly issued shares. During
      the
      six months ended June 30, 2006, the Company recorded an increase of $160 to
      its
      accumulated deficit with respect to the treasury shares issued from option
      exercises.






-11-






(b)
      Restricted Stock




In
      August
      2004, the CEO of Databit received
      a restricted stock grant of 95,000 shares of common stock of the Company, which
      were to vest one third on each of the second, third and fourth anniversaries
      of
      the grant. The Company recognized deferred compensation of $68 with respect
      to
      the restricted stock grant which was to be amortized as
      compensation expense on a straight-line basis over the vesting period of the
      grant. At January 1, 2006, $36 of deferred compensation remained to be
      amortized. As a result of the sale of Databit, all the restricted shares
      immediately vested and all remaining deferred compensation was recognized as
      expense. During the three months ended June 30, 2006, the Company recognized
      $5
      of deferred compensation expense in selling, marketing, general and
      administrative expenses and $31 as part of the loss on the sale of discontinued
      operations and contract settlement.





As
      of
      June 30, 2006, the Company had no remaining unrecognized compensation costs
      related to non-vested restricted stock.




**Note
      8: 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
      9: Bank Settlement Agreement**




In
      March
      2006, the Company reached a settlement agreement with an Israeli Bank (the
      “Bank”)with respect to its claims against the Bank and the Bank’s counterclaims.
      The Bank agreed to return to the Company approximately $94, plus interest and
      CPI adjustments, of attorney fees and court costs. As a result of the settlement
      agreement, the accrued loss for contingent performance of bank guarantees of
      $410 was reversed and the $247 collateralized portion of these guarantees (shown
      as restricted cash at December 31, 2005) are no longer classified as restricted
      cash. The Company recorded other income of $330 in the first quarter of 2006
      as
      a result of the settlement agreement.







**Note
      10: Segment Information**




As
      a
      result of the sale of Databit and the change in management in the Company,
      the
      Company has redefined its reported operating segments. The Company’s current
      operations are based upon two operating segments, which operate in the Company’s
      dsIT subsidiary:





·
            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.





-12-






Prior
      year segment disclosures have been conformed to the new segment
      presentation.







**RT
                Solutions**
            
            **IT
                Solutions**
            
            **Other****(*)**
            
            **Total**Six
                months ended June 30, 2006:Revenues
                from external customers
            
            $
            1,334
            
            $
            515
            
            $
            114
            
            $
            1,963Intersegment
                revenues
            
            
            --
            
            
            --
            
            
            --
            
            
            --Segment
                gross profit
            
            
            497
            
            
            57
            
            
            19
            
            
            573Segment
                loss
            
            
            (45
            )
            
            (169
            )
            
            (4
            )
            
            (218
            )Six
                months ended June 30, 2005:Revenues
                from external customers
            
            $
            1,558
            
            $
            629
            
            $
            21
            
            $
            2,208Intersegment
                revenues
            
            
            --
            
            
            --
            
            
            --
            
            
            --Segment
                gross profit
            
            
            501
            
            
            108
            
            
            21
            
            
            630Segment
                income (loss)
            
            
            71
            
            
            (94
            )
            
            16
            
            
            (7
            )Three
                months ended June 30, 2006:Revenues
                from external customers
            
            $
            702
            
            $
            230
            
            $
            58
            
            $
            990Intersegment
                revenues
            
            
            --
            
            
            --
            
            
            --
            
            
            --Segment
                gross profit
            
            
            327
            
            
            10
            
            
            8
            
            
            345Segment
                income (loss)
            
            
            12
            
            
            (111
            )
            
            (2
            )
            
            (101
            )Three
                months ended June 30, 2005:Revenues
                from external customers
            
            $
            728
            
            $
            304
            
            $
            17
            
            $
            1,049Intersegment
                revenues
            
            
            --
            
            
            --
            
            
            --
            
            
            --Segment
                gross profit
            
            
            211
            
            
            41
            
            
            17
            
            
            269Segment
                income (loss)
            
            
            (2
            )
            
            (49
            )
            
            13
            
            
            (38
            )


_______________


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






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





Six
                months ended June 30,
            
            Three
                months ended June 30,2005
            
            2006
            
            2005
            
            2006Total
                loss for reportable segments
            
            $
            (23
            )
            $
            (214
            )
            $
            (51
            )
            $
            (99
            )Other
                operational segment income (loss)
            
            
            16
            
            
            (4
            )
            
            13
            
            
            (2
            )Total
                operating income (loss)
            
            
            (7
            )
            
            (218
            )
            
            (38
            )
            
            (101
            )Minority
                interests
            
            
            (59
            )
            
            --
            
            
            (17
            )
            
            --Share
                of losses in Comverge
            
            
            (380
            )
            
            (210
            )
            
            (179
            )
            
            --Net
                loss of corporate headquarters and other unallocated costs
            
            
            (1,316
            )
            
            (954
            )
            
            (595
            )
            
            (703
            )Net
                loss from continuing operations
            
            
            (1,762
            )
            
            (1,382
            )
            
            (829
            )
            
            (794
            )Discontinued
                operations
            
            
            749
            
            
            78
            
            
            257
            
            
            --Loss
                on sale of discontinued operations and contract settlement
            
            
            --
            
            
            (2,298
            )
            
            --
            
            
            --Total
                consolidated net loss
            
            $
            (1,013
            )
            $
            (3,602
            )
            $
            (572
            )
            $
            (794
            )







-13-






**Note
      11: Subsequent Event**





(a)
      Private Placement





In
      July
      2006, the Company completed a private placement of its Common Stock, par value
      $.01 per share, resulting in the issuance of 1,200,003 shares of Common Stock.
      In connection with the placement, the Company entered into subscription
      agreements with certain accredited investors for the purchase of the shares
      at a
      purchase price of $2.65 per share, resulting in gross proceeds to the Company
      of
      $3,180. By the terms of the subscription agreements, each subscriber, in
      addition to the Common Stock purchased, received a warrant exercisable for
      the
      purchase of 25% of the number of shares purchased, resulting in the issuance
      of
      warrants to purchase 300,005 shares. The warrants are exercisable for shares
      of
      the Company’s Common Stock for a period of five years at an exercise price of
      $2.78 per share and are redeemable by the Company in certain circumstances.





The
      Company used the Black-Scholes valuation method to estimate the fair value
      of
      the warrants to purchase 300,005 shares of common stock of the Company, using
      a
      risk free interest rate of 5.1%, its contractual life of five years, an annual
      volatility of 102% and no expected dividends. The Company estimated the fair
      value of the warrants to be approximately $493.





In
      connection with the offering, the Company retained a registered broker-dealer
      to
      serve as placement agent. In accordance with the terms of the agreement, the
      placement agent received a 7% selling commission, 3% management fee, and 1%
      advisory fee of the gross proceeds of the offering. In addition, the placement
      agent received warrants with the same terms as those issued to the subscribers
      exercisable for the purchase of 10% of the number of shares purchased in the
      offering.





Out
      of
      the gross proceeds received at the closings, the Company paid the placement
      agent commissions and expenses of approximately $351 and incurred legal and
      other costs of approximately $133. In addition, the Company issued to the
      placement agent warrants to purchase 120,001 shares of Common Stock on the
      same
      terms as those issued to the subscribers.





The
      Company used the Black-Scholes valuation method to estimate the fair value
      of
      the warrants to purchase 120,001 shares of common stock of the Company, using
      a
      risk free interest rate of 5.1%, its contractual life of five years, an annual
      volatility of 102% and no expected dividends. The Company estimated the fair
      value of the warrants to be approximately $202.








(b)
      Investment in Paketeria




On
      August
      7, 2006 the Company entered into a Common Stock Purchase Agrement with Paketeria
      GmbH, a limited liability company incorporated under the laws of Germany, and
      certain Paketeria shareholders, for the purchase by the Company of an
      approximately 23% interest in Paketeria for a purchase price of approximately
      €600 (equivalent to approximately $776) Paketeria is a provider of eBay drop
      shop, post and parcels, office supplies, photo processing, photocopy and printer
      cartridge refilling services in Germany.





In
      addition to the Common Stock Purchase Agreement, the Company also entered into
      a
      Note Purchase Agreement with Paketeria’s founder and managing director. Under
      the Note Purchase Agrement, the Company would be obligated to purchase from
      the
      founder and managing director all or a portion of the €210 Promissory Note
      issued by Paketeria and payable to him. The Promissory Note is convertible
      into
      shares of Paketeria at a conversion price of €50.70 per share, accrues interest
      at a rate of 8% per annum, and may be redeemed by the Company in whole or in
      part at any time prior to its maturity or conversion. Under the terms of the
      Note Purchase Agreement, the Company would be required to purchase one third
      of
      the principal amount of the Note upon Paketeria’s achieving each of three
      frachise licensing milestones.






-14-





The
      Company also entered into a Stock Purchase Agreement with two shareholders
      of
      Paketeria—one of whom is the Company’s President and Chief Executive Officer and
      the other who has been named by the Company’s Board of directors as a nominee
      for director at the Company’s upcoming annual meeting. Pursuant to that
      agreement, the Company is entitled through August 2007 to purchase the shares
      of
      Paketeria held by the two Paketeria shareholders for an aggregate purchase
      price
      of the US dollar equivalent on the date of purchase of €600 (approximately $773
      at the current exchange rate), payable in Company Common Stock and warrants
      on
      the same terms as the Company’s recently completed private placement. At the
      current exchange rate this would result in the issuance of approximately 292,000
      shares of Common Stock and warrants exercisable for 73,000 shares of Common
      Stock. Th warrants would have an exercise price of $2.78 per share and be
      exercisable though July 31, 2011.





The
      closing of the Company’s purchase of its 23% stake in Paketeria occurred on
      August 9, 2006. At the closing, the Company granted to Paketeria’s founder and
      managing director an option to purchase 150,000 shares of the Company’s Common
      Stock at an exercise price of $2.80 The option vests as to one-third on the
      occurrence of each of the three franchising milestones referred to above and
      expires in August 2011.





In
      connection with its investment in Paketeria, the Company also entered into
      an
      Investors’ Rights Agreement with Paketeria and it shareholders, whereby it was
      given certain rights including a right of first offer, with respect to any
      future issuance of Paketeria securities, and tag-along rights, with respect
      to
      any future sale by an existing shareholder. The Company was also given certain
      blocking rights with respect to decisions of the shareholders and management
      of
      Paketeria.







-15-






**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 our Annual Report on Form 10-K for the
      year
      ended December 31, 2005.




**Overview
      and Trend Information**




In
      August
      2006, using a portion of the proceeds of our private placement which was
      completed in July 2006 (see below), we entered into and consummated a definitive
      agreement for the purchase of an approximately 23% interest in Paketeria GmbH
      for approximately € 600,000.
      Paketeria is a company registered in Germany that owns and franchises stores
      which provide a variety of services, including eBay drop shop, post and parcels,
      office supplies, photo processing, photocopy and printer cartridge refilling
      services in Germany. In addition to the agreement for the purchase of our
      current 23% interest in Paketeria we entered into an agreement which
      gives us the right, for one year, to purchase a controlling
      interest.





In
      July
      2006, we completed a private placement of our Common Stock, par value $.01
      per
      share, resulting in the issuance of 1,200,003 shares of Common Stock. In
      connection with the closing, we entered into subscription agreements with
      certain accredited investors for the purchase of the shares at a purchase price
      of $2.65 per share, resulting in gross proceeds $3,180,000. By the terms of
      the
      subscription agreements, each subscriber, in addition to the Common Stock
      purchased, received a warrant exercisable for the purchase of 25% of the number
      of shares purchased, resulting in the issuance of warrants to purchase 300,005
      shares. The warrants are exercisable for shares of our Common Stock for a period
      of five years at an exercise price of $2.78 per share and are redeemable by
      us
      in certain circumstances.





In
      connection with the offering, we retained a registered broker-dealer to serve
      as
      placement agent. In accordance with the terms of the agreement, the placement
      agent received a 7% selling commission, 3% management fee, and 1% advisory
      fee
      of the gross proceeds of the offering. In addition, the placement agent received
      warrants with the same terms as those issued to the subscribers exercisable
      for
      the purchase of 10% of the number of shares purchased in the offering.





Out
      of
      the gross proceeds received at the closings, we paid the placement agent
      commissions and expenses of approximately $350,000 and incurred legal and other
      costs of approximately $133,000 . In
      addition, we issued to the placement agent warrants to purchase 120,001 shares
      of Common Stock on the same terms as those issued to the
      subscribers.





In
      March
      2006, we sold our Databit computer hardware sales company to Shlomie
      Morgenstern, President of Databit and our former Vice President, in exchange
      for
      the release of DSSI from obligations relating to our former CEO’s consulting
      agreement and various lease obligations. As part of the agreement, we agreed
      to
      pay our former CEO $600,000 at closing and pay certain costs for Databit. In
      addition, cash, which had previously been restricted with respect to our former
      CEO’s employment agreement, is no longer restricted. As a result of the
      transaction, we recorded a loss of approximately $2.3 million. Subsequent to
      the
      first quarter of 2006, we no longer have any activity in our computer hardware
      segment.




During
      the periods included in this report, we operated in two reportable segments:
      RT
      Solutions and IT Solutions. The following analysis should be read together
      with
      the segment information provided in Note 10 to the interim unaudited
      consolidated financial statements included in this quarterly report, which
      information is hereby incorporated by reference into this Item 2.






-16-






*RT
      Solutions*




Segment
      revenues increased in the second quarter of 2006 as compared to the first
      quarter of 2006. The increase was concentrated in our non-sonar technology
      solutions projects. The increase in revenues was combined with an increase
      in
      our gross profit margin, which was the result of a number of high margin
      projects in progress during the quarter. We do not expect to maintain these
      high
      margins during the coming quarters as these projects near completion. We are
      continuing our discussions for strategic alliances for marketing our sonar
      solutions. We believe that sonar technology solutions, and our Port Security
      Solutions in particular will be the primary source of this segment’s future
      growth and profitability although we do not believe we will see significant
      revenues from a new sonar technology solutions project prior to fourth quarter
      of 2006 or early 2007.




*IT
      Solutions*




Segment
      revenues and gross profit margins decreased in the second quarter of 2006 as
      compared to the first quarter of 2006. Both our OncoProTM and EasyBillTM solutions
      had decreased revenues in the second quarter of 2006 as compared to the first
      quarter of 2006. The decreased revenues are the result of the continued
      slow-down in the progress of an EasyBillTM project and the delayed approval of
      billing for certain development work already performed by our OncoProTM solutions
      team. We expect second half revenues in our OncoProTM solutions to increase in
      the second half of 2006. We expect to conclude an agreement for an OncoProTM
beta-site in the US in the near future. In addition, we are continuing our
      discussions to establish strategic alliances for marketing and to obtain
      additional investment for our OncoProTM solutions. We believe that our OncoProTM
solutions will be the primary source of this segment’s future growth and
      profitability.




*Comverge*




Although
      we no longer control Comverge, we have invested in it significantly and it
      continues to have a material effect on our strategic planning. During the first
      quarter of 2006, Comverge completed an additional round of private equity
      financing. As a result of the most recent financing round, in which we
      participated at a cost of $210,000, we currently own approximately 7% of
      Comverge’s preferred shares and 76% of its common shares, representing
      approximately 24% of its total equity.




Comverge’s
      Demand Response solutions are installed at residential, small commercial and
      large commercial/industrial facilities to reduce and shift energy usage from
      higher peak hours to times of lower energy use, such as night time hours.
      Ultimately, these systems are used to increase the reliability of the electrical
      grid and to prevent interruptions in service like blackouts, brownouts, and
      localized service interruptions.




As
      much
      of the United States remains in the grip of a sweltering heat wave, Comverge’s
      Demand Response systems, including its proprietary Virtual Peaking CapacityTM
programs, are providing an unprecedented amount of electricity capacity as
      well
      as transmission and distribution relief, helping to ensure the continued
      reliability of the nation’s electric grid.




Over
      one
      gigawatt of electric capacity, including over 100 megawatts of capacity provided
      by Comverge to its utility customers under its Virtual Peaking CapacityTM
programs, is being called on to provide demand relief in operating regions
      stretching from New England to California - enough energy to power approximately
      one million homes on an average day.







*Corporate*




During
      the first quarter of 2006, we sold our Databit computer hardware company,
      settled our long-term employment contract with our former CEO by making a
      one-time settlement payment and appointed a new CEO. As such, we anticipate
      having significantly reduced corporate expenses in our current corporate
      structure.




In
      July
      2006, we concluded a private placement of our Common Stock, which raised
      approximately $2.7 million, net of transaction costs. We expect to use the
      proceeds of our private placement to finance our corporate expenses and to
      allow
      us to explore possible acquisitions or other strategic
      transactions.




In
      August
      2006, using a portion of the proceeds of our private placement, we entered
      into
      and consummated a definitive agreement for the purchase of approximately 23%
      of
      Paketeria GmbH for approximately €600,000. Paketeria is a company registered in
      Germany that owns and franchises stores which provide a supermarket of services.
      Their services include eBay drop shop, package shipping services, photo
      printing, office supplies, copying services and refilling printer cartridges.
      The agreement for the purchase of our current 23% share of Paketeria includes
      various options which, if effected, would result in our owning a controlling
      interest in Paketeria within one year.






-17-







**New
      Accounting Standards**




On
      January 1, 2006, the we adopted SFAS No.123 (revised 2004), Share-Based
      Payment (“SFAS 123R”), which requires the measurement and recognition of
      compensation expense for all share-based payment awards made to employees and
      directors, including employee stock options and employee stock purchases under
      the Employee Stock Purchase Plan, based on estimated fair values. We elected
      to
      use the modified prospective transition method; therefore prior periods have
      not
      been restated to reflect, and do not include, the impact of SFAS 123R. In March
      2005, the Securities and Exchange Commission issued Staff Accounting Bulletin
      No. 107 (“SAB 107”), which provides supplemental implementation guidance
      for SFAS 123R. The Company has applied the provisions of SAB 107 in its adoption
      of SFAS 123R.




As
      a
      result of adopting SFAS 123R on January 1, 2006, our net loss for the six and
      three month periods ended June 30, 2006, is $740,000 and $327,000, respectively,
      greater than had we continued to account for stock-based compensation under
      APB
      No. 25.




The
      following table sets forth a comparison of the per share effect of our adoption
      of SFAS 123R for the six and three month periods ended June 30, 2005 and
      2006.







**Six
                months ended**
              **June
                30,**
            
            **Three
                months ended**
              **June
                30,****2005**
            
            **2006**
            
            **2005**
            
            **2006**Basic
                and diluted net income (loss) per share as reported:Loss
                per share from continuing operations
            
            $
            (0.22
            )
            $
            (0.17
            )
            $
            (0.10
            )
            $
            (0.10
            )Discontinued
                operations
            
            
            0.10
            
            
            (0.27
            )
            
            0.03
            
            
            --Net
                income (loss) per share - basic and diluted
            
            $
            (0.12
            )
            $
            (0.44
            )
            $
            (0.07
            )
            $
            (0.10
            )Basic
                and diluted net income (loss) per share had we not adopted SFAS
                123R:Loss
                per share from continuing operations
            
            $
            (0.22
            )
            $
            (0.11
            )
            $
            (0.10
            )
            $
            (0.06
            )Discontinued
                operations
            
            
            0.10
            
            
            (0.24
            )
            
            0.03
            
            
            --Net
                income (loss) per share - basic and diluted
            
            $
            (0.12
            )
            $
            (0.35
            )
            $
            (0.07
            )
            $
            (0.06
            )




See
      Note
      7 to the condensed consolidated interim financial statements for information
      on
      the impact of our adoption of SFAS 123R and the assumptions used to calculate
      the fair value of share-based employee compensation.






**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 June 30, 2005
      and 2006, 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. Since we sold our
      Databit business in March 2006, the activity in this business has been
      reclassified and consolidated on one line as net income from discontinued
      operations, after tax.





-18-






Six
                months ended June 30,
            
            Three
                months ended June 30,2005
            
            2006
            
            Change
            
            2005
            
            2006
            
            Change($,000)
            
            %
                of
                sales
            
            ($,000)
            
            %
                of
                sales
            
            %
                of
                2005
            
            ($,000)
            
            %
                of
                sales
            
            ($,000)
            
            %
                of
                sales
            
            %
                of
                2005Sales
            
            $
            2,208
            
            
            *100*
            *%*
            $
            1,963
            
            
            *100*
            *%*
            
            *(11*
            *)*
            $
            1,049
            
            
            *100*
            *%*
            
            990
            
            
            *100*
            *%*
            
            *(6*
            *)*Cost
                of sales
            
            
            1,578
            
            
            *71*
            
            
            1,390
            
            
            *71*
            
            
            *(12*
            *)*
            
            780
            
            
            *74*
            
            
            645
            
            
            *65*
            
            
            *(17*
            *)*Gross
                profit
            
            
            630
            
            
            *29*
            
            
            573
            
            
            *29*
            
            
            *(19*
            *)*
            
            269
            
            
            *26*
            
            
            345
            
            
            *35*
            
            
            *28*R&D
                expenses
            
            
            26
            
            
            *1*
            
            
            97
            
            
            *4*
            
            
            *273*
            
            
            17
            
            
            *2*
            
            
            71
            
            
            *7*
            
            
            *318*SMG&A
                expenses
            
            
            1,945
            
            
            *88*
            
            
            1,966
            
            
            *100*
            
            
            *1*
            
            
            915
            
            
            *87*
            
            
            1,044
            
            
            *105*
            
            
            *14*Operating
                income (loss)
            
            
            (1,341
            )
            
            *(61*
            *)*
            
            (1,490
            )
            
            *(76*
            *)*
            
            *11*
            
            
            (663
            )
            
            *(63*
            *)*
            
            (770
            )
            
            *(78*
            *)*
            
            *16*Interest
                income (expense), net
            
            
            (47
            )
            
            *(2*
            *)*
            
            9
            
            
            *0*
            
            
            *(119*
            *)*
            
            (25
            )
            
            *(2*
            *)*
            
            (6
            )
            
            *(1*
            *)*
            
            *(76*
            *)*Other
                income, net
            
            
            59
            
            
            *3*
            
            
            315
            
            
            *16*
            
            
            *434*
            
            
            49
            
            
            *5*
            
            
            (14
            )
            
            *(1*
            *)*
            
            *(129*
            *)*Income
                (loss) before taxes on income
            
            
            (1,329
            )
            
            *(60*
            *)*
            
            (1,166
            )
            
            *(59*
            *)*
            
            *(12*
            *)*
            
            (639
            )
            
            *(61*
            *)*
            
            (790
            )
            
            *(77*
            *)*
            
            *24*Taxes
                on income
            
            
            6
            
            
            *0*
            
            
            (6
            )
            
            *0*
            
            
            *(200*
            *)*
            
            4
            
            
            *0*
            
            
            (4
            )
            
            *0*
            
            
            *(200*
            *)*Income
                (loss) from operations of the Company and its consolidated
                subsidiaries
            
            
            (1,323
            )
            
            *(60*
            *)*
            
            (1,172
            )
            
            *(60*
            *)*
            
            *(11*
            *)*
            
            (635
            )
            
            *(61*
            *)*
            
            (794
            )
            
            *(80*
            *)*
            
            *25*Share
                in losses of Comverge
            
            
            (380
            )
            
            *(17*
            *)*
            
            (210
            )
            
            *(11*
            *)*
            
            *(45*
            *)*
            
            (179
            )
            
            *(17*
            *)*
            
            --
            
            
            *--*
            
            
            *(100*
            *)*Minority
                interests
            
            
            (59
            )
            
            *(3*
            *)*
            
            --
            
            
            *--*
            
            
            *(100*
            *)*
            
            (17
            )
            
            *(2*
            *)*
            
            --
            
            
            *--*
            
            
            *(100*
            *)*Net
                loss from continuing operations
            
            
            (1,762
            )
            
            *(80*
            *)*
            
            (1,382
            )
            
            *(70*
            *)*
            
            *(22*
            *)*
            
            (831
            )
            
            *(79*
            *)*
            
            (794
            )
            
            *(80*
            *)*
            
            *(4*
            *)*Net
                income from discontinued operations, net of tax
            
            
            749
            
            
            *34*
            
            
            78
            
            
            *4*
            
            
            *(90*
            *)*
            
            257
            
            
            *24*
            
            
            --
            
            
            *--*
            
            
            *(100*
            *)*Loss
                on sale of discontinued operations and contract settlement
            
            
            --
            
            
            *--*
            
            
            (2,298
            )
            
            *(117*
            *)*
            
            
            
            
            --
            
            
            *--*
            
            
            --
            
            
            *--*
            
            
            *--*Net
                income (loss)
            
            $
            (1,013
            )
            
            *(46*
            *)*
            $
            (3,602
            )
            
            *(183*
            *)*
            
            *256*
            
            $
            (574
            )
            
            *(55*
            *)*
            $
            (794
            )
            
            *(80*
            *)*
            
            *38*







*Sales.* Sales in
      the first six months of 2006 decreased by $0.2 million or 11% from $2.2 million
      in the first six months of 2005 to $2.0 million in 2006. The decrease was
      attributable to decreases in RT Solutions segment sales due to the substantial
      completion in fiscal year 2005 of a significant naval sonar project as well
      as
      decreases in IT Solutions segment sales due in part to a diversion of resources
      to adapt our OncoPro software product to the US market.


*Gross
      profit.* Gross
      profit in the
      first six months of 2006 decreased by $0.1 million, compared to the first six
      months of 2005. The decrease was primarily attributable to decreased gross
      profits in our IT Solutions segment due to a delay in OncoProTM billing combined
      with a continued slowdown in an EasyBillTM project. Gross profit in the second
      quarter of 2006 increased by $0.1 million, in comparison to the second quarter
      of 2005, due primarily to an increase in RT Solutions projects sales with
      relatively high gross profit margins.




*Selling,
      marketing, general and administrative expenses (“SMG&A”).* SMG&A
      in the first six months
      of
      2006 increased slightly compared to the first six months of 2005 and increased
      by $0.1 million in the second quarter of 2006 as compared to the second quarter
      of 2005. SMG&A expenses have decreased in our dsIT subsidiary, however this
      decrease has been offset by increases in corporate SMG&A expense, which
      arose from stock option compensation recorded in 2006. Corporate SMG&A
      expense in 2006 includes $0.4 million of stock option compensation expense
      ($0.3
      million recorded in the second quarter) with respect to SFAS 123R stock
      compensation expense. In 2005, we did not record any stock option compensation
      expense with respect to SFAS 123R.




*Other
      income (expense), net.* In
      the
      first quarter of 2006, we reached a settlement agreement with an Israeli bank
      with respect to our claims against the bank and the bank’s counterclaim against
      us. As a result of the settlement agreement, we recorded income of $0.3 million,
      net of legal expenses.




*Share
      of losses in Comverge.* In
      the
      first quarter of 2006, the carrying value of our investment in Comverge's common
      stock and preferred stock was reduced to zero. As such, Comverge had no effect
      on our results in the second quarter of 2006. ** Our
      share
      of Comverge's of net losses in the first six months of 2006 was $0.2 million.
      In
      the future, when Comverge begins to show profit, after it has reached the level
      of equity at which we ceased recording equity losses, we will record 7% of
      that
      income as equity income to our preferred investment up to our original $3.9
      million preferred share investment in Comverge, and thereafter to our investment
      in Comverge’s common shares, of which we currently own approximately
      76%.






-19-






*Net
      income from discontinued operations, net of tax.*  Under
      applicable accounting principles, as a result of our sale of Databit in the
      first quarter of 2006, the results of Databit have been reclassified in the
      current period and for all prior periods as a discontinued operation. The
      condensed results of this business are presented in each of the current and
      comparative period as net income from discontinued operations.




The
      results for the first quarter of 2005 include the condensed results of Databit
      as well as the condensed results of the Company’s outsourcing consulting
      services business in Israel, which was sold in August 2005. The decrease in
      net
      income from discontinued operations in the 2006 period as compared to the 2005
      period was primarily due to the inclusion in the 2005 period of the results
      of
      the outsourcing consulting services business.




*Loss
      on sale of discontinued operations and contract settlement, net of tax.* This
      loss
      resulted from the sale of our Databit computer hardware company and contract
      settlement with our former CEO during the first quarter of 2006.




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




As
      of
      June 30, 2006, we had negative working capital of $0.2 million, including $0.2
      million of cash and cash equivalents. Net cash used in the first six months
      of
      2006 was $0.7 million. Net cash of $1.1 million was used in operating activities
      during the first six months of 2006. The net loss for the six-month period
      ended
      June 30, 2006 of $3.6 million was primarily due to the $2.3 million loss on
      our
      sale of our Databit computer hardware company, the contract settlement with
      our
      former CEO, and corporate expenses of $1.0 million of which $0.5 million was
      related to stock option compensation. The primary use of cash in operating
      activities during the first quarter of 2006 was $0.2 million of cash used by
      Databit in the period up to its sale and reductions in accounts payable and
      other liabilities in excess of the decrease in accounts receivables, unbilled
      work-in-process and other current and non-current assets of $0.6 million. Net
      cash of $0.4 million was provided by investing activities primarily from the
      release of previously restricted cash balances of $1.6 million, less cash used
      in the sale of our Databit computer hardware company and contract settlement
      with our former CEO totaling $0.9 million and our additional investment in
      Comverge of $0.2 million.




Of
      our
      $0.2 million of negative working capital, on June 30, 2006, $0.5 million of
      positive working capital was in our majority owned dsIT subsidiary. Due to
      Israeli tax and company law constraints as well as dsIT’s own working capital
      requirements, such working capital and cash flows from dsIT’s operations are not
      readily available to finance U.S. corporate activities.





As
      of
      June 30, 2006, our dsIT subsidiary is in technical violation of its covenant
      with one of its banks. dsIT is working towards remedying the technical
      violation.





In
      July
      2006, we concluded a private placement of our Common Stock, which raised
      approximately $2.7 million, net of transaction costs. We have significantly
      reduced our corporate overhead costs as a result of the sale of Databit and
      the
      contract settlement with our former CEO. We believe that as a result of the
      private placement, our available cash is sufficient to fund our US based
      corporate activities for the next 12 months.





As
      of
      August 1, 2006 our wholly owned US operations (i.e., excluding dsIT and
      Comverge) had an aggregate of $2.9 million in cash and cash equivalents,
      reflecting a $2.0 million increase from the balance as of December 31, 2005.
      Of
      this balance, approximately $770 was utilized in the previously mentioned
      acquisition of 23% of Paketeria in August 2006.






-20-






**Contractual
      Obligations and Commitments**




Our
      contractual obligations and commitments at June 30, 2006, excluding certain
      severance arrangements described below, principally include obligations
      associated with our outstanding indebtedness, future minimum operating lease
      obligations and potential severance obligations to Israeli employees and are
      set
      forth in the table below.




Cash
                Payments Due During Year Ending June 30,(amounts
                in thousands)Contractual
                Obligations
            
            Total
            
            2007
            
            2008-2009
            
            2010-2011
            
            2012
                and thereafterLong-term
                debt
            
            $
            100
            
            $
            100
            
            $
            --
            
            $
            --
            
            $
            --Operating
                leases (1)
            
            
            1,546
            
            
            663
            
            
            833
            
            
            50
            
            
            --Potential
                severance obligations to Israeli employees (2)
            
            
            2,239
            
            
            --
            
            
            --
            
            
            --
            
            
            2,239Total
                contractual cash obligations
            
            $
            3,885
            
            $
            763
            
            $
            833
            
            $
            50
            
            $
            2,239




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




(1)
      As
      part of the sale of our Databit computer hardware subsidiary, we assigned all
      of
      the US leases to Databit and after the first quarter of 2006 will no longer
      have
      rental expense for facilities in the US. However, the landlords of the
      properties have not yet consented to the assignments and we therefore continue
      to be contingently liable on these leases, which have an annual cost of
      approximately $120,000 until November 2008. Such costs are included in the
      table
      above. Databit has agreed to indemnify us for any liability in connection with
      these leases. Under the terms of the sale agreement with Databit, we continue
      to
      house certain corporate headquarter functions in Mahwah, New Jersey. Under
      a
      transition services arrangement, we have agreed to pay Databit $20,000 per
      year
      for the continued use of the Mahwah premises and various administrative
      services.


(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 ending 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
      June 30, 2006, we accrued a total of $2.2 million for potential severance
      obligations of which approximately $1.4 million was funded with cash to
      insurance companies.




In
      addition, as a result of our agreement to purchase 23% of Paketeria, we have
      agreed to buy-out the €210,000 loan principal made by the Paketeria CEO to
      Paketeria. Under the terms of the agreement, we must purchase one-third of
      the
      loan principal from the Paketeria CEO for a cash payment equal to one-third
      of
      the principal amount upon Paketeria meeting three milestones with respect to
      the
      signing of license agreements for the opening of Paketeria stores. We expect
      Paketeria to meet all these milestones within the next year. The obligation
      to
      buy-out these loans is not reflected in the contractual obligations and
      commitments table above.






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**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
      $152,000. Additionally, our monetary assets and liabilities (net asset of
      approximately $0.1 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**




As
      of the
      end of the period covered by 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 (as such term is defined
      in
      Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the
“Exchange Act’)). Based on this evaluation, our Chief Executive Officer and
      Chief Financial Officer concluded that our disclosure controls and procedures
      were effective at the reasonable assurance level at end of the period covered
      by
      this report to ensure that the information required to be disclosed by us in
      the
      reports we file or submit under the Exchange Act is (i) accumulated and
      communicated to our management (including our Chief Executive Officer and Chief
      Financial Officer) in a timely manner, and (ii) recorded, processed, summarized
      and reported within the time periods specified in the SEC’s rules and
      forms.




**Changes
      in Controls and Procedures**




There
      was
      no change in our internal controls over financial reporting (as such term is
      defined in Rule 13a-15(f) under the Exchange Act) during the period covered
      by
      this report that has materially affected, or is reasonably likely to materially
      affect, internal controls over financial reporting.





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**PART
      II - OTHER INFORMATION**




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


None.




Item
        5.Other
        Information
 
 We
        refer
        you to the discussion beginning on page 14 under the heading “Investment in
        Paketeria,” which discussion is incorporated herein by
        reference.




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


4.1
            
            Form
                of Warrant10.1
            
            Form
                of Subscription Agreement10.2
            
            Placement
                Agent Agreement between the Company and First Montauk Securities
                Corp.
                dated June 13, 2006.31.1
            
            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.






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**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:
              August 11, 2006
            By:
            /s/ Michael
              BarthMichael
                Barth
              Chief Financial
                Officer


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