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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005
COMMISSION FILE NUMBER 0-19771
   
DATA SYSTEMS & SOFTWARE INC.
(Exact name of registrant as specified in charter)
 


 Delaware
  
 22-2786081
 (State or other jurisdiction incorporation or organization) 
  
  (I.R.S. employer identification no.)
     
 200 Route 17, Mahwah, New Jersey 
  
 07430
 (Address of principal executive offices) 
  
  (Zip code)
     
     
 
 (201) 529-2026
  
 Registrant’s telephone number, including area code 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
 x| Yes 
  
 oNo
     
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). 
 
oYes 
  
 xNo
 
Number of shares outstanding of the registrant’s common stock, as of May 10, 2005: 8,116,691


 
DATA SYSTEMS & SOFTWARE INC.
Quaterly Report on Form 10-Q
for the Quaterly Period Ended March 31, 2005


TABLE OF CONTENTS

 
PART I. Financial Information
 
Item 1. Financial Statements
 
 
  
  Unaudited Consolidated Financial Statements:  
     
 
Consolidated Balance Sheets as of December 31, 2004 and March 31, 2005
1
 
 
  
 
Consolidated Statements of Operations and Comprehensive Loss for the three month periods ended March 31, 2004 and 2005
2
 
 
  
 
Consolidated Statement of Changes in Shareholders’ Equity for the three month period ended March 31, 2005
3
 
 
  
 
Consolidated Statements of Cash Flows for the three month periods ended March 31, 2004 and 2005
4
     
 
Notes to Consolidated Financial Statements
5
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
9
   
Item 3. Quantitative and Qualitative Disclosures about Market Risk
13
   
Item 4. Controls and Procedures
13
     
PART II. Other Information
   
Item 1. Legal Proceedings
14
   
Item 6. Exhibits
 14
     
Signatures 
 
15
 
Certain statements contained in this report are forward-looking in nature. These statements are generally identified by the inclusion of phrases such as “we expect”, “we anticipate”, “we believe”, “we estimate” and other phrases of similar meaning. Whether such statements ultimately prove to be accurate depends upon a variety of factors that may affect our business and operations. Many of these factors are described in our most recent Annual Report on Form 10-K as filed with Securities and Exchange Commission.

 

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

-1-

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

-2-
 
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders’ Equity (unaudited)
(in thousands)

                                     
     
Number of Shares
 
 Common Stock
 
  
Additional
Paid-In
Capital
 
  
Warrants
 
  
Stock-Based Deferred Compensation
 
  
Accumulated Deficit
 
  
Treasury Stock
 
  
Accumulated Other Comprehensive Loss
 
  
Total
  
                                       
Balances as of December 31, 2004
    
8,937
  
 
$88
  
 
$39,733
  
 
$461
  
 
$(59
)
 
$(34,290
)
 
$(3,791
)
 
$(17
)
 
$2,125
  
                                                         
Amortization of stock-based deferred compensation
    
— 
   
— 
   
— 
   
— 
   
6
    
— 
   
— 
   
— 
   
6
  
                                                         
Net loss
    
— 
   
— 
   
— 
   
— 
   
— 
   
(439
)
  
— 
   
— 
   
(439
)
                                                         
Differences from translation of financial statements of subsidiaries
    
— 
   
— 
   
— 
   
— 
   
— 
   
— 
   
— 
   
(41
)
  
(41
)
                                                         
Balances as of March 31, 2005
    
8,937
  
 
$88
  
 
$39,733
  
 
$461
  
 
$(53
)
 
$(34,729
)
 
$(3,791
)
 
$(58
)
 
$1,651
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
-3-
 
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
(dollars in thousands)
   
Three months ended March 31,
  
   
2004
  
2005
  
Cash flows provided by (used in) operating activities:
          
Net loss 
  
$
(595
)
$
(439
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
              
Depreciation and amortization 
    
62
    
52
  
Minority interests 
    
15
    
42
  
Share in losses of Comverge 
    
353
    
201
  
Deferred taxes 
    
24
    
11
  
Increase in liability for employee termination benefits 
    
136
    
105
  
Loss (gain) on disposition of property and equipment 
    
(5
)
  
2
  
Amortization of deferred compensation 
    
—
    
6
  
Other 
    
(40
)
  
(7
)
Change in operating assets and liabilities:
              
Decrease (increase) in accounts receivable, unbilled work-in-process and other current and other assets 
    
971
    
(1,817
)
Decrease (increase) in inventory 
    
46
    
(53
)
Increase (decrease) in accounts payable and other liabilities 
    
(879
)
  
1,397
  
Net cash provided by (used in) operating activities 
    
88
    
(500
)
 
Cash flows provided by (used in) investing activities:
              
Amounts funded for employee termination benefits 
    
(106
)
  
(6
)
Utilization of employee termination benefits 
    
(12
)
  
(18
)
Maturity of short-term deposits 
    
—
    
72
  
Acquisitions of property and equipment 
    
(22
)
  
(98
)
Proceeds from sale of property and equipment 
    
30
    
19
  
Net cash used in investing activities 
    
(110
)
  
(31
)
 
Cash flows provided by (used in) financing activities:
              
Short-term debt borrowings (repayments), net 
    
39
    
(70
)
Proceeds from note payable to a related party 
    
— 
   
250
  
Proceeds from long-term debt 
    
— 
   
76
  
Repayments of long-term debt 
    
(164
)
  
(83
)
Proceeds from employee stock option exercises 
    
35
    
— 
 
Net cash provided by (used in) financing activities 
    
(90
)
  
173
  
Net decrease in cash and cash equivalents 
    
(112
)
  
(358
)
Cash and cash equivalents at beginning of period 
    
1,213
    
685
  
Cash and cash equivalents at end of period 
  
$
1,101
  
$
327
  
Supplemental cash flow information:
             
Cash paid during the period for:
              
Interest 
  
$
48
  
$
32
  
Income taxes 
  
$
8
  
$
3
  
Non-cash investing and financing activities:
              
Adjustment of treasury stock and additional paid-in capital with respect to options exercised 
  
$
83
        


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

-4-

DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(dollars in thousands)
 
Note 1: Basis of Presentation
 
The accompanying unaudited consolidated financial statements of Data Systems & Software Inc. (“DSSI”) and subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. Certain reclassifications have been made to the Company’s prior period’s consolidated financial statements to conform to the current period’s consolidated financial statement presentation. 
 
Note 2: Financing of Operations 
 
As of March 31, 2005, the Company had working capital of $814, including $327 in non-restricted cash and cash equivalents. Net cash used in the first quarter of 2005 was $358. Net cash of $500 was used in operating activities during the first quarter of 2005. The net loss for the three-month period ended March 31, 2005 of $439 was primarily due to the Company’s share of unconsolidated losses of Comverge of $201 and corporate expenses of $445. The Company's use of cash in operating activities during the first quarter of 2005 was primarily due to increases in accounts receivables, unbilled work-in-process and other current assets in excess of reductions in accounts payable and other liabilities of $420, net. Net cash of $173 provided by financing activities was primarily from the proceeds of a note payable to a related party of $250.
 
Of the total working capital at March 31, 2005, approximately $678 was in the Company’s majority owned dsIT Technologies Ltd. subsidiary (dsIT). Due to Israeli tax and company law constraints, as well as the significant minority interest in dsIT, such working capital and cash flows from dsIT’s operations are not readily available to finance U.S. activities.
 
dsIT is utilizing approximately $647 of its $1,150 lines of credit as of March 31, 2005. dsIT's lines of credit are denominated in NIS and bear an average interest rate of the Israeli prime rate plus 2.8% per annum. The Israeli prime rate fluctuates and as of March 31, 2005 is 5.0%.
 
The Company intends to fund its US activities with the cash available and anticipated profits from its US operations. The Company continues to consider various restructuring, merger or acquisition and/or additional financing transactions. As described below in Note 8, the Company and the other shareholders of dsIT have entered into an agreement in principal for the sale of dsIT. The Company’s share of the proceeds of such sale, if and when consummated, would provide additional liquidity. If the contemplated sale is not consummated and if the Company should need additional liquidity to finance its US activities, the Company would sell a portion of its Comverge shares.

-5-

DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(dollars in thousands)
 
Note 3: Investment in Comverge
 
Comverge’s summary results of operations for the three months ended March 31, 2004 and 2005, is as follows:
 
   
Three months ended March 31,
  
   
2004
  
2005
  
Sales
  
$
4,892
  
$
3,901
  
Gross profit
  
$
1,854
  
$
1,636
  
Net loss
  
$
(2,084
)
$
(2,970
)
 
The change in the Company’s Comverge investment, during the three months ended March 31, 2005 is as follows:
 
   
Common
stock
  
Preferred
stock
  
Net investment
in Comverge
  
Balances as of December 31, 2004
  
$
(1,824
)
$
380
  
$
(1,444
)
Equity loss in Comverge
    
—
   
(201
)
  
(201
)
Balances as of March 31, 2005
  
$
(1,824
)
$
179
  
$
(1,645
)
 
Note 4—  Goodwill and Other Intangible Assets
 
The entire balance of goodwill was in the software consulting and development segment. There were no acquisitions or impairments of goodwill recorded during the three-month period ended March 31, 2005.
 
The Company’s amortizable intangible assets consisted of software licenses, with a gross carrying amount of $260 and accumulated amortization of $179 and $188, as of December 31, 2004 and March 31, 2005, respectively. All intangibles assets are being amortized over their estimated useful lives, which averaged five years and the amortization expense for each of the three months ended March 31, 2004 and 2005 amounted to $8. Amortization expense of the remaining balance of these assets, for the years ending March 31, 2006, 2007 and 2008, is estimated to be $32, $32 and $8, respectively.
 
Note 5: Warranty Provision
 
The Company grants its customers one-year product warranty. No provision was made in respect of warranties based on the Company’s previous history.
 
Note 6: Stock-Based Compensation
 
The Company applies Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” and the related interpretations in accounting for its stock option grants to employees and directors, with the disclosure provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”. Under APB No. 25, compensation expense is computed under the intrinsic value method of accounting to the extent that the fair value of the underlying shares on the date of the grant exceed the exercise price of the share option, and thereafter amortized on a straight-line basis against income over the expected service period.
 
Had compensation cost for the Company’s option plans been determined based on the fair value at the grant dates of awards, consistent with the method prescribed in SFAS No. 123, the Company’s net loss and loss per share would have been changed to the pro forma amounts indicated below:
 
-6-
 
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(dollars in thousands)
 
   
Three Months Ended March 31, 
  
   
2004
  
2005
  
Net loss as reported 
$
(595
)
$
(439
)
Plus: Stock-based employee and director compensation expense included in reported net loss 
  
—
   
6
  
Less: Total stock-based employee compensation expense determined under fair value based method for all awards 
  
15
    
81
  
Pro forma net loss 
$
(610
)
$
(514
)
 
Net loss per share:
            
Basic and diluted - as reported 
$
(0.08
)
$
(0.05
)
Basic and diluted - pro forma 
$
(0.08
)
$
(0.06
)
 
The pro forma information in the above table also gives effect to the application of SFAS No. 123 on the share option plans of the Company’s subsidiaries.
 
The Company accounts for stock-based compensation issued to non-employees on a fair value basis in accordance with SFAS No. 123 and EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services” and related interpretations.
 
Note 7: Segment Information
 
   
Software Consulting and Development
  
 
Computer Hardware
  
Other (*)
  
 
Total
  
Three months ended March 31, 2005:
                  
Revenues from external customers
  
$
3,374
  
$
5,181
  
$
4
  
$
8,559
  
Intersegment revenues
    
—
   
10
    
—
   
10
  
Segment gross profit
    
873
    
973
    
4
    
1,850
  
Segment income
    
67
    
138
    
2
    
207
  
 
Three months ended March 31, 2004:
                          
Revenues from external customers
  
$
2,910
  
$
4,339
  
$
6
  
$
7,255
  
Intersegment revenues
    
—
   
—
   
—
   
—
 
Segment gross profit
    
594
    
950
    
6
    
1,550
  
Segment income (loss)
    
63
    
198
    
(3
)
  
258
  
_______________
(*) Represents VAR software operations in Israel that did not meet the quantitative thresholds of SFAS No. 131.
 
Reconciliation of Segment Loss to Consolidated Net Loss
 
   
Three months ended March 31,
  
   
2004
  
2005
  
Total income for reportable segments
  
$
261
  
$
205
  
Other operational segment income (loss)
    
(3
)
  
2
  
Total operating income
    
258
    
207
  
Share of losses in Comverge
    
(353
)
  
(201
)
Net loss of corporate headquarters
    
(500
)
  
(445
)
Total consolidated net loss
  
$
(595
)
$
(439
)
 
 
-7-

DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(dollars in thousands)
 
Note 8: Sale of dsIT
 
In March 2005, the Company and the other shareholders of dsIT entered into an agreement in principle for the sale of all the outstanding shares of dsIT to Matrix IT Ltd. (“Matrix”). dsIT constitutes virtually the entire software consulting and development segment. Under the terms of the agreement in principle, the total consideration to be paid for the shares would be $9 million, to be paid in cash and in Matrix ordinary shares. A portion of the consideration is subject to adjustment based on dsIT’s performance against certain operating goals to be set forth in the definitive agreement.
 
 
-8-
DATA SYSTEMS & SOFTWARE INC.
Management’s Discussion and Analysis of
Financial Condition and Results of Operations

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion includes statements that are forward-looking in nature. Whether such statements ultimately prove to be accurate depends upon a variety of factors that may affect our business and operations. Certain of these factors are discussed in this report and in “Item 1. Description of Business-Factors That May Influence Future Results” in our Annual Report on Form 10-K for the year ended December 31, 2004.
 
Overview and Trend Information
 
During the periods included in this report, we operated in two reportable segments: software consulting and development and computer hardware. The following analysis should be read together with the segment information provided in Note 7 to the interim unaudited consolidated financial statements included in this quarterly report, which information is hereby incorporated by reference into this Item 2.
 
Software Consulting and Development
 
Segment revenues continued to increase in the first quarter of 2005, primarily due to increases in the consulting business as well as increased revenues from fixed price development projects, particularly our sonar technology solutions. We have been successful in maintaining this segment’s higher gross profit margin, due to the improved cost structure. We believe sonar technology solutions will be the primary source of future segment growth and profitability.
 
In March 2005, we, together with the other shareholders of dsIT, entered into an agreement in principle for the sale of all the outstanding shares of dsIT to Matrix IT Ltd. If the sale is consummated, we would no longer have any continuing operations in this segment.
 
Computer Hardware Sales
 
Sales in the first quarter of 2005 were higher than those in the immediately preceding quarter and those of the first quarter of 2004. The segment’s dependency on sales to a particular customer has remained high, however we continue to invest significant efforts to diversify our sales base.
 
To offset the concentration and volatility in the hardware resale market, we continue to seek to diversify our revenue base and have initiated efforts to augment with more value added software products and services. We currently expect sales to increase in the coming quarters of 2005, primarily due to new VAR activity in the area of integrated hardware/software security solutions for computer LAN and WAN networks and related services, leveraging our existing VAR customer base.
 
Energy Intelligence Solutions
 
Although we no longer control Comverge, we have invested in it significantly and it continues to have a material effect on our consolidated results.
 
During the first quarter of 2005 Comverge continues to strengthen its strategic alliances and broadened the spectrum of solutions offered, while continuing to perform under its Virtual Peaking CapacityTM (“VPC”) contracts. Comverge currently has in its VPC programs more than 190 Megawatts under contract.
 
Due to the structure of its largest VPC contract, Comverge’s results continue to suffer from revenue recognition constraints. Due to the conditions of that contract, recognition of revenues is dependent on the results of certain tests, which can only be performed in the summer months. Accordingly Comverge’s revenues from this contract are expected to be seasonal.
 
-9-
 
Corporate
 
Over the past year we have been in the process of evaluating and exploring different possibilities of restructuring, acquisitions or mergers and/or other strategic alternatives. This process has required the devotion of significant time and resources by our management as well as by our legal and accounting advisors. As mentioned above, we have entered into an agreement in principal for the sale of dsIT. We expect to complete a definitive contract for the sale of dsIT by June 2005. If and when we complete this sale, management will consider the alternatives then available for DSSI’s continued growth.
 
Results of Operations
 
The following table sets forth certain information with respect to the consolidated results of operations of the Company for the three months ended March 31, 2004 and 2005, including the percentage of total revenues during each period attributable to selected components of the operations statement data and for the period to period percentage changes in such components.
 

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

Sales. The increase in sales in the first quarter of 2005, as compared to the first quarter of 2004, was primarily due to a $0.8 million, or 19%, increase in computer hardware sales. This increase was due to a particular sale to an existing customer. Sales in our software consulting and development segment also increased by $0.5 million, or 16%, primarily due to increased consulting revenues.
 
Gross profit. The increase in gross profits in the first quarter of 2005, as compared to the first quarter of 2004, was primarily attributable to the increase in software consulting and development sales, as well as improved gross profit margins in that segment, from 20% in the first quarter of 2004 to almost 26% in the first quarter of 2005. Gross profit in the computer hardware segment remained relatively stable with the increase in sales being offset by a decrease in gross profit margin from 22% in the first quarter of 2004 to almost 19% in the first quarter of 2005, due to the inclusion of a particularly profitable sale in the 2004 period.
 
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Share of Losses in Comverge. Our share of Comverge's net loss of $3.0 million and $2.1 million in the first quarter of 2005 and 2004, was $0.2 million and $0.4 million, respectively. Our share of Comverge losses decreased, despite the increase in their losses, due to the decrease in our percentage holdings of Comverge’s preferred share equity.
 
Liquidity and Capital Resources 
 
As of March 31, 2005, we had working capital of $0.8 million, including $0.3 million in non-restricted cash and cash equivalents. Net cash used in the first quarter of 2005 was $0.4 million. Net cash of $0.5 million was used in operating activities during the first quarter of 2005. The net loss for the three-month period ended March 31, 2005 of $0.4 million was primarily due to our share of unconsolidated losses of Comverge of $0.2 million and corporate expenses of $0.4 million. The primary use of cash in operating activities during the first quarter of 2005 was primarily increases in accounts receivables, unbilled work-in-process and other current and non-current assets in excess of reductions in accounts payable and other liabilities of $0.4 million. Net cash of $0.2 million provided by financing activities was primarily from the proceeds of a note payable to Shlomie Morgenstern of $0.3 million. Mr. Morgenstern has agreed to make available to Databit a line of credit of up to $0.5 million, at an interest rate of prime plus 3%, the utilization of which would be at Databit’s discretion. The line could be utilized through May 15, 2006 unless Mr. Morgenstern were involuntarily terminated as President of Databit, in which event no additional drawdowns could be made.
 
Of the total working capital at March 31, 2005, $0.6 million was in our majority owned dsIT subsidiary. Due to Israeli tax and company law constraints as well as the significant minority interest in dsIT, such working capital and cash flows from dsIT’s operations are not readily available to finance U.S. activities.
 
As of April 30, 2005 the Company’s wholly owned US operations (i.e., excluding dsIT and Comverge) had an aggregate of $0.2 million in unrestricted cash and cash equivalents, reflecting a $0.5 million decrease from the balance as of December 31, 2004.
 
We intend to fund our US activities with the cash available and anticipated profits from our US operations. DSSI continues to consider various restructuring, merger or acquisition and/or additional financing transactions. In March 2005, we entered into an agreement in principle for the sale of dsIT to Matrix IT Ltd. Under the terms of this agreement in principle, assuming an agreed upon net asset value, the total consideration to be paid for the shares would be approximately $9 million, to be paid in cash and in Matrix ordinary shares. A portion of the consideration is subject to adjustment based on dsIT’s performance against certain operating goals to be set forth in the definitive agreement. Our share of the proceeds of such sale, if and when consummated, would provide additional liquidity. Consummation of this transaction is subject to (i) satisfactory completion by Matrix of its due diligence investigation of dsIT, (ii) negotiation and execution of a definitive agreement, and (iii) the receipt of all necessary corporate and other approvals. The actual consideration to be paid by Matrix for the dsIT shares, and the amount that we may receive in connection with the transaction, is subject to adjustment. There is no assurance that the transaction will be consummated on the terms described above or at all.
 
Should we not consummate the sale of dsIT, we expect dsIT to continue generating profits at a level similar to that of the last quarter of 2004. Although dsIT will need to utilize its profits to fund its growth, we expect dsIT to repay a portion of its loan from DSSI, beginning in August 2005, providing additional liquidity to the US operations.
 
In addition, we believe that should we need additional liquidity, we will be able to sell a portion of our Comverge Preferred shares, as we did in September 2004.
 
Based on our expectations and contingency plans described above, all of the above are expected to provide more than sufficient liquidity for DSSI’s foreseeable future and the next 12 months in particular.
 

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Contractual Obligations and Commitments
 
Our contractual obligations and commitments at March 31, 2005, excluding certain severance arrangements described below, principally include obligations associated with our outstanding indebtedness, future minimum operating lease obligations and contractual obligations to our CEO for payments for his post-retirement consulting services to us, are as set forth in the table below.
 
    Cash Payments Due During Year Ending March 31,   
   
(amounts in thousands) 
  
Contractual Obligations
  
Total
  
2006
  
2007-2008
  
2009-2010
  
2011 and thereafter
  
Long-term debt
 
$
665
  
$
445
  
$
187
  
$
33
  
$
—
  
Contingent performance of bank guarantees (1)
    
410
    
410
    
—
   
—
   
—
 
Operating leases
    
3,289
    
1,187
    
1,600
    
502
    
—
 
Potential severance obligations to Israeli employees (2)
    
4,384
    
2
    
70
    
29
    
4,283
  
Consulting agreement with CEO (3)
    
1,575
    
300
    
600
    
413
    
262
  
Purchase commitments
    
—
   
—
   
—
   
—
   
—
 
Other long-term liabilities reflected on the balance sheet in accordance with GAAP
    
—
   
—
   
—
   
—
   
—
 
Total contractual cash obligations
  
$
10,323
  
$
2,344
  
$
2,457
  
$
977
  
$
4,545
  
 
We expect to finance these contractual commitments from cash on hand and cash generated from operations.
 
(1) Previously, we accrued a loss for contingent performance of bank guarantees. Our remaining commitment under these guarantees is $0.4 million at March 31 2005. We have collateralized a portion of these guarantees by means of a deposit of $0.2 million as of March 31, 2005. The obligation is presented as a current liability, though it is uncertain as to when actual payment may be made.
 
(2) Under Israeli law and labor agreements, dsIT is required to make severance payments to dismissed employees and to employees leaving employment under certain other circumstances. The obligation for severance pay benefits, as determined by the Israeli Severance Pay Law, is based upon length of service and last salary. These obligations are substantially covered by regular deposits with recognized severance pay and pension funds and by the purchase of insurance policies. As of March 31, 2005, we accrued a total of $4.4 million for potential severance obligations which is included in long term liabilities, of which approximately $2.9 million was funded with cash to insurance companies.
 
(3) Under the terms of his employment agreement with us, as amended, we have an obligation to continue to pay our Chief Executive Officer consulting fees over a seven-year period starting January 1, 2005. As a result, during the coming four years, through 2008, we have to pay our CEO $240,000 per year, equal to 50% of his salary in effect as of December 31, 2003. From 2009 through 2011, we must pay $120,000 per year, equal to 25% of that salary. In addition, we must pay contributions to a non-qualified defined contribution retirement plan equal to 25% of the consulting fee. In accordance with the employment contract, we are obliged to fund amounts payable for the term of the consulting period by the purchase of an annuity or similar investment product at the beginning of the consulting period. The CEO has agreed to allow us not to so fund such amounts until the earlier of (i) March 31, 2006, (ii) his termination as CEO, or (ii) the closing of a transaction with gross proceeds to us of at least $1.5 million.
 

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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 $0.6 million. Additionally, our monetary assets and liabilities (net liability of approximately $0.3 million) in Israel are exposed to fluctuations in exchange rates. We do not employ specific strategies, such as the use of derivative instruments or hedging, to manage our interest rate or foreign currency exchange rate exposures.
 
Item 4.  Controls and Procedures
 
Evaluation of Controls and Procedures
 
Within 90 days prior to the date of filing of this report, we carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective for gathering, analyzing and disclosing the information we are required to disclose in the reports we file under the Securities Exchange Act of 1934, within the time periods specified in the SEC's rules and forms.
 
Changes in Controls and Procedures
 
There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation.
 

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PART II - Other information
 
 
Item 1. Legal Proceedings
 
IDB Litigation
 
In March 2005, a Jerusalem District Court rendered a decision in our favor in our suit against Israel Discount Bank (“IDB”) and has awarded us damages, legal fees and other costs of approximately $2.2 million.
 
Our case against IDB was commenced in March 1999 and had alleged that IDB had wrongfully retained control of our shares in Decision System Israel Ltd. (now known as dsIT Technologies Ltd.). Our action also sought a declaratory judgment that we were not liable to IDB on a guarantee made on behalf of a former equity affiliate. In September 2001 the District Court decided against us on all claims. We appealed the decision to the Israel Supreme Court, which in June 2004 upheld the decision of the District Court on the guarantee but reversed the District Court on the shares and held that IDB had wrongfully retained the shares. The Supreme Court remanded the case to the District Court to determine the damages payable to us by IDB. The decision in March 2005 was rendered on the remand from the Israel Supreme Court. The District Court decision is subject to appeal by IDB, which we understand it intends to file. There is no assurance that the decision in our favor will be upheld on appeal.
 
In accordance with generally accepted accounting principles, any gain contingency associated with the decision in our favor will not be recognized as income until the earlier of the exhaustion of all appeals or settlement of the action.
 
Item 6. Exhibits
 
 
 
10.1
Loan Agreement between Databit, Inc. and Shlomie Morgenstern (and forms of Note, Security Agreement and Guarantee of Registrant), dated as of March 22, 2005.
 
  10.2  Letter Agreement between the Registrant and George Morgenstern, dated as of May 5, 2005.
     
 
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
  32.1
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
  32.2 
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
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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: May 11, 2005		  
 		  
 
By:   /s/ Yacov Kaufman 
 
Yacov Kaufman
  Vice President and Chief Financial Officer

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