e10vq

As filed with the Securities and Exchange Commission on February 14, 2007

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2006


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-21059

ACE*COMM CORPORATION

(Exact name of registrant as specified in its charter)


Maryland (State or Other Jurisdiction of Incorporation or Organization)		52-1283030 (IRS Employer ID Number)


704 Quince Orchard Road, Gaithersburg, MD (Address of Principal Executive Offices)		20878 (Zip Code)

301-721-3000
(Registrant’s telephone number, including area code)

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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES o NO þ

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 þ NO o

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

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. (Check one):

Large accelerated filer o Accelerated filer o Non-accelerated filer þ

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): YES o NO þ

The number of shares of Common Stock outstanding as of February 12, 2007 was 18,615,350.

PART I. FINANCIAL INFORMATION


Item 1.		CONSOLIDATED FINANCIAL STATEMENTS

ACE*COMM CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands except share and per share amounts)


	December 31,			June 30,
	2006			2006
	(Unaudited)
Assets

Current assets:
Cash and cash equivalents	$	1,170		$	946
Accounts receivable, net		4,730			10,981
Inventories, net		811			838
Deferred contract costs		7			18
Prepaid expenses and other		653			571

Total current assets		7,371			13,354
Property and equipment, net		777			787
Goodwill		386			522
Acquired intangibles, net		727			1,041
Other non-current assets, net		501			657

Total assets	$	9,762		$	16,361


Liabilities and Stockholders’ Equity

Current liabilities:
Borrowings	$	—		$	2,970
Accounts payable		800			1,114
Accrued expenses		1,271			1,661
Accrued compensation		594			885
Deferred revenue		4,169			3,617

Total current liabilities		6,834			10,247
Long-term notes payable		—			17

Total liabilities		6,834			10,264


Commitments and contingencies

Stockholders’ equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized, none issued and outstanding		—			—
Common stock, $.01 par value, 45,000,000 shares authorized, 18,601,529 and 17,788,032 shares issued and outstanding		186			178
Additional paid-in capital		37,301			35,257
Other accumulated comprehensive loss		(29	)		(91	)
Accumulated deficit		(34,530	)		(29,247	)

Total stockholders’ equity		2,928			6,097


Total liabilities and stockholders’ equity	$	9,762		$	16,361

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

ACE*COMM CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)


	For the six months ended December 31,
	2006			2005
	(Unaudited)			(Unaudited)
Cash flows from operating activities:
Net income (loss)	$	(5,283	)	$	446
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		756			676
Provision for doubtful accounts		60			107
Restricted stock compensation expense		47			18
Stock option and employee stock purchase plan compensation expense		71			58
Changes in operating assets and liabilities:
Accounts receivable		6,191			(2,006	)
Inventories, net		27			(3	)
Prepaid expenses and other assets		(82	)		(154	)
Deferred contract costs		11			60
Accounts payable		(314	)		(395	)
Accrued liabilities		(636	)		(628	)
Deferred revenue		552			(425	)

Net cash provided by (used in) operating activities		1,400			(2,246	)

Cash flows from investing activities:
Purchases of property and equipment		(196	)		(271	)
Proceeds from other non-current assets		12			—
Purchase of software license		(94	)		(203	)

Net cash used in investing activities		(278	)		(474	)

Cash flows from financing activities:
Net borrowings on line of credit		(2,607	)		908
Other notes payable		(17	)		(38	)
Proceeds from exercise of stock warrants		1,599			—
Proceeds from employee stock purchase plan and exercise of stock options		48			275

Net cash (used in) provided by financing activities		(977	)		1,145

Net increase (decrease) in cash and cash equivalents		145			(1,575	)
Effect of exchange rate change on cash		79			(117	)
Cash and cash equivalents at beginning of period		946			2,683

Cash and cash equivalents at end of period	$	1,170		$	991

Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	130		$	92
Cash paid during the period for income taxes	$	2		$	(1	)
Supplemental disclosure of non-cash investing and financing activities:
Settlement of 2helix notes payable	$	289		$	—
Issuance of common stock in connection with software purchase	$	—		$	791
Return of common stock in connection with the 2helix re-negotiation	$	—		$	1,519
Reduction of notes payable and accrued interest in connection with the 2helix Re-negotiation	$	—		$	356
Issuance of common stock related to the grant of restricted stock	$	—		$	374

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

ACE*COMM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE 1 — ORGANIZATION

ACE*COMM Corporation (the “Company”), incorporated in Maryland in 1983, delivers enterprise telemanagement applications and advanced Convergent Mediation™ solutions to wired and wireless voice, data, and Internet communications providers. ACE*COMM’s technology enables the capture, security, validation, correlation, augmentation, and warehousing of data from network elements and distributes it in appropriate formats to OSS (“Operations Support Systems”) and BSS (“Business Support Systems”) operations. ACE*COMM’s products are tailored to each customer’s needs, providing the capabilities to extract knowledge from their networks-knowledge they use to reduce costs, accelerate time-to-market for new products and services, generate new sources of revenue, and push forward with next-generation initiatives.

ACE*COMM Corporation, and its wholly owned subsidiaries, Solutions ACE*COMM Corporation, incorporated in Quebec in 1996, ACE*COMM Solutions UK Limited, incorporated in the United Kingdom in 2003, ACE*COMM Solutions Australia Pty Limited, incorporated in Australia in 2004, i3 Mobile, acquired in December 2003, and Double Helix Solutions Limited, acquired in March 2005, are referred to in this document collectively as ACE*COMM, unless otherwise noted or the context indicates otherwise. All inter-company transactions have been eliminated.

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Liquidity and Capital Resources

The Company incurred a net loss during the six months ended December 31, 2006 of $5.3 million and had net cash provided by operations of $1.4 million. The Company had cash and cash equivalents available at December 31, 2006, totaling $1.2 million.

Management believes that the downturn in operations was due primarily to the delays in receipt of additional work on various large contracts and market conditions which has slowed the receipt on new orders. During the six months ended December 31, 2006, we experienced a significant decrease in revenues when compared to the fourth fiscal quarter of last year and to the comparable quarter of last year. This decrease resulted in a loss for the quarter, compared to net income in the same quarter last year.

On going projects with Telecom Egypt and the U.S. Air Force continued to experience delays. These delays were not due to any performance issues on the part of the Company but will delay the revenue associated with these contracts contained in the backlog of the Company.

The Company has reduced operating expenses and, if necessary, the Company will reduce variable operating and other expenses, curtail certain of its operations and take other actions it believes will preserve cash. Management believes that it has sufficient cash on hand and available funds from the collection of outstanding accounts receivable, receipt of new contracts, and the availability of credit under our agreement with the Bank to support our working capital requirements for the next twelve months, based on current expectations as to anticipated revenue, expenses and cash flows.

However, because of the shortfalls in revenue, we have experienced increased liquidity demands, and we expect to have continuing pressure on our liquidity unless and until we can increase revenues significantly. In addition to managing our costs, we are devoting significant effort to increase our revenues by selling our Patrol Suite of products to carriers on a global basis. We also may pursue additional financing, which may or may not be available on terms acceptable to us. Any such financing could result in increased leverage (if a debt financing) or equity liquidation (if an equity financing). This financing likely would be in addition to any borrowing under our line of credit against outstanding eligible accounts receivable.

For the quarter ending December 31, 2006, we were not in compliance with the minimum tangible net worth covenant. The Bank has waived this covenant violation and established new minimum tangible net worth and quick ratio covenants. See Lines of Credit in Management’s discussion and Analysis for additional details concerning our lines of credit and amounts available to us under these lines.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared by the management of ACE*COMM Corporation (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission for Quarterly Reports on Form 10-Q. Accordingly, certain information and footnotes required by accounting principles generally accepted in the United States of America (“US GAAP”) for complete financial statements of the type included in the Annual Report on Form 10-K are not required to be included in and have been omitted from this report. It is the opinion of management that all adjustments considered necessary for a fair presentation have been included, and that all such adjustments are of a normal and recurring nature. Operating results for the periods presented are not necessarily indicative of the results that may be expected for any future periods. For further information, refer to the audited financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2006.

Use of estimates

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates. Significant estimates inherent in the preparation of the accompanying financial statements include: management’s forecasts of contract costs and progress toward completion, which are used to determine revenue recognition under the percentage-of-completion method; estimates of allowances for doubtful accounts receivable and inventory obsolescence; impairment of long-lived assets; and tax valuation allowances.

Earnings (Loss) per Share

The basic net earnings (loss) per share presented in the accompanying financial statements is computed using weighted average common shares outstanding. Diluted net earnings per share generally includes the effect, if dilutive, of potential dilution that could occur if securities or other contracts to issue common stock (e.g. stock options and warrants) were exercised and converted to common stock.

Revenue Recognition

ACE*COMM derives revenues primarily from contracts with telecommunication carriers and large enterprises for hardware, software license fees, professional services, and maintenance and support fees. These products and services are formalized in a multiple element arrangement involving application of existing software capabilities or modification of the underlying software and implementation services. Our software licenses to end-users generally provide for an initial license fee to use the product in perpetuity. Under certain contracts, ACE*COMM licenses its software to resellers for subsequent modification and resale. Our customers, including resellers, do not possess the right to return or exchange products. Subscription revenue, included in Operational Support Systems revenue, is recognized on a monthly basis based upon the number of telephone subscribers of our customers.

We often enter into multiple element arrangements that do not involve significant modification or customization of the related software. In these instances, ACE*COMM recognizes revenue in accordance with AICPA Statement of Position 97-2, “Software Revenue Recognition,” and allocates revenue to each element of the arrangement based on vendor specific objective evidence of the element’s fair value. Revenue for software licenses in these instances is recognized upon delivery (i.e. transfer of title), when a signed agreement exists, the fee is fixed and determinable, and collection of the resulting receivable is probable. If vendor specific objective evidence does not exist, we defer the related revenue. Maintenance revenue is recognized ratably over the term of the respective maintenance period.

In situations when our products involve significant modification or customization of software, or when our systems integration and product development are essential to the functionality of the software, revenues relating to the software licenses and services are aggregated and the combined revenues are recognized on a percentage-of-completion basis. Approximately 12% of our revenues were calculated under this method for the three and six months ended December 31, 2006. The hardware revenue on these contracts is recognized upon transfer of title, which generally occurs at the same time the licensed software is delivered as the majority of the hardware is from third parties and the hardware is rarely modified.

Revenue recognized using the percentage-of-completion method is based on the estimated stage of completion of individual contracts determined on a cost or level of efforts basis. We compare the budgeted level of effort to actual level of effort incurred each month. The estimated level of effort to complete an individual contract is adjusted accordingly. Also, at each month end the cumulative progress is measured and adjusted so that the cumulative progress on each contract matches the current view of the percentage completed. If the actual level of effort incurred plus the estimated level of effort to complete exceeds the level of effort consistent with making a profit on a contract, then the loss on the contract would be recognized in the month that the loss becomes evident.

When our contracts contain extended payment terms, we defer recognition of revenue until amounts become due pursuant to payment schedules and no other uncertainties exist. We correspondingly defer a proportionate amount of contract cost which will be matched against the deferred revenue when recognized. Should management make the determination that previously deferred revenue will not be recognized, the corresponding amount of deferred contract cost will be charged to expense at that time. In accordance with this policy we have deferred contract costs of $7 thousand and $18 thousand as of December 31, 2006 and June 30, 2006, respectively.

Our revenue recognition policy takes into consideration the creditworthiness of the customer in determining the probability of collection as a criterion for revenue recognition. The determination of creditworthiness requires the exercise of judgment, which affects our revenue recognition. If a customer is deemed to be not creditworthy, all revenue under arrangements with that customer is recognized only upon receipt of cash. The creditworthiness of such customers is re-assessed on a regular basis and revenue is deferred until cash is received. In addition, when our contracts contain customer acceptance provisions, management assesses whether uncertainty exists about such acceptance in determining when to record revenue.

Cash and cash equivalents

ACE*COMM considers all investments with an original maturity of three months or less to be cash equivalents. Cash held in foreign bank accounts was $389 thousand and $440 thousand at December 31, 2006 and 2005, respectively.

Impairment of Long-Lived Assets

We evaluate the carrying value of long-lived assets and intangible assets whenever certain events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When indicators of impairment exist, the estimated future net undiscounted cash flows associated with the asset are compared to the asset’s carrying amount to determine if impairment has occurred. If such assets are deemed impaired, an impairment loss equal to the amount by which the carrying amount exceeds the fair value of the assets is recognized. If quoted market prices for the assets are not available, the fair value is calculated using the present value of estimated net cash flows. We did not record an impairment during the six months ended December 31, 2006 and 2005, respectively. If we were to adjust our estimate of future cash flows downward in the future, we may be required to record an impairment charge to reduce the carrying value of long-lived and intangible assets.

Inventories

Inventories consist principally of purchased materials to be used in the production of finished goods and are stated at the lower of cost, determined on the first-in, first-out (FIFO) method, or market. We periodically review our inventories against future estimated demand and usage and either write down or reserve against inventory carrying values.

Reclassifications

Certain prior year information has been reclassified to conform to the current year’s presentation.

Foreign Currency

The Company considers the functional currency of its foreign subsidiaries to be the local currency. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date and revenue, costs and expenses are translated at average rates of exchange in effect during the relevant period. Translation gains and losses are reported within accumulated other comprehensive income (loss).

Total comprehensive income (loss) consists of the following (in thousands):


	For the three months ended						For the six months ended
	December 31,						December 31,
	2006			2005			2006			2005
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)

Net income (loss)	$	(2,538	)	$	347		$	(5,283	)	$	446
Other comprehensive income (foreign currency translation)		30			(69	)		62			(105	)

Total other comprehensive income (loss)	$	(2,508	)	$	278		$	(5,221	)	$	341

Recently Issued Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty of Income Taxes,” which is an interpretation of FAS 109, “Accounting for Income Taxes” (FIN 48). FIN 48 prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods, and income tax disclosures. For the Company, this Interpretation is effective as of July 1, 2007 and the cumulative effects, if any, of applying this Interpretation will be recorded as an adjustment to retained earnings as of July 1, 2007. We are currently evaluating the impact of FIN 48 on our financial statements.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (SAB 108), which becomes effective the first fiscal year ending after November 15, 2006. SAB 108 provides guidance for SEC registrants on how the effects of uncorrected errors originating in previous years should be considered when quantifying errors in the current year. SAB 108 was issued to eliminate diversity in practice for quantifying uncorrected prior year misstatements (including prior year unadjusted audit differences) and to address weaknesses in methods commonly used to quantify such misstatements. SAB 108 does not amend the SEC’s existing guidance for evaluating the materiality of errors included in SAB 99. SAB 108 provides transitional guidance that allows registrants to report the effect of adoption as a cumulative effect adjustment to beginning of year retained earnings. We are currently evaluating the effect that the adoption of SAB 108 will have on our financial position, results of operations and cash flows.

NOTE 3 — ACCOUNTS RECEIVABLE

Accounts receivable consists of the following (in thousands):


	December 31,			June 30,
	2006			2006

Billed receivables	$	3,426		$	8,517
Unbilled and other receivables		1,532			2,697
Allowance for doubtful accounts		(228	)		(233	)

	$	4,730		$	10,981

Billed

At December 31, 2006, five of our customers, including three international customers, comprised $1.6 million or 47% of the total billed receivables. Two of these five customers have billed receivables totaling $325 thousand that have been outstanding for longer than ninety days. We have total billed receivables of $870 thousand outstanding for longer than ninety days. Management believes the outstanding amounts will be collected. International customers have traditionally taken longer to pay than domestic customers.

Unbilled

Unbilled receivables include costs and estimated profit on contracts in progress that have been recognized as revenue but not yet billed to customers under the provisions of specific contracts. Substantially all unbilled receivables are expected to be billed and collected within one year.

NOTE 4 — INVENTORY

Inventory consists of the following (in thousands):


	December 31,			June 30,
	2006			2006

Inventory	$	1,207		$	1,196
Allowance for obsolescence		(396	)		(358	)

	$	811		$	838

Inventory write-offs were $38 thousand and $0 during the six months ended December 31, 2006 and 2005, respectively. In September 2005, we purchased a non-exclusive perpetual software license valued at $1.3 million. The cost of the license is being amortized over 36 months beginning in October 2005. The current portion of the license of $490 thousand is included in inventory with the balance of the license included in other assets.

NOTE 5 — STOCKHOLDERS’ EQUITY

During the six months ended December 31, 2006, the Company issued 16,557 shares of common stock under the Employee Stock Purchase Plan and issued 42,500 shares as restricted stock grants which vest over four years of which 2,500 shares were canceled during the current quarter. The Company recognized a $9 thousand expense during the period related to these stock grants. The Company issued 148,667 shares of restricted stock in fiscal year 2006, of which 91,792 shares were canceled including 79,792 shares canceled during the period. These grants vest over four years and the Company recognized $38 thousand in expense during the period.

During the three months ended December 31, 2006, the Company granted 469,000 stock options, including 21,000 stock options under the 2000 Stock Options Plan for Directors and 448,000 stock options under the Amended and Restated Omnibus Stock Plan. The stock options have a fair value of $325 thousand and we recognized an expense of $15 thousand related to these options during the period. The assumptions included in the fair value calculations for the quarter ended December 31, 2006, are expected life of 4.8 years, interest rate of 4.625%, expected volatility of 95% and dividend yield of 0%.

On September 26, 2006, we issued 138,704 shares to settle notes payable to the former 2helix owners that were due on September 30, 2006.

Exercise of Stock Warrants

During the six months ended December 31, 2006, 687,653 shares of our common stock were purchased for net proceeds of $1.6 million on the exercise of previously issued stock warrants. Stock warrants for the purchase of 1,060,347 shares of our common stock expired on September 2, 2006. At December 31, 2006, there were 500,000 stock warrants outstanding at an exercise price of $3.53 per share which expire April 1, 2010.

NOTE 6 — MERGERS AND ACQUISITIONS

Fiscal 2005

Double Helix Solutions Limited

On March 24, 2005, we acquired Double Helix Solutions Limited, a company based in London that operates under the name 2helix, a provider of network asset assurance, revenue optimization, and business intelligence solutions to Tier 1 carriers, primarily in Europe.

The total purchase price for the acquisition was £4.4 million, or approximately $8.3 million, plus additional consideration under an earn-out equal to the excess of 2helix revenues during the next 12 months over £3.5 million. The purchase price consisted of 1,740,294 shares of ACE*COMM common stock valued at a per share price of $3.1648, the 10 day volume weighted average price of ACE*COMM common stock, and notes with a six month maturity in the aggregate principal amount of approximately $2.8 million. On April 8, 2005, $2.1 million of the notes were paid.

On October 28, 2005 the Company and the former owners of 2helix entered into a Deed of Variation and settlement amendment relating to the sale and purchase of the entire issued share capital of Double Helix Solutions Limited. Under the terms of the agreement, 500,000 shares of ACE*COMM stock issued in the original transaction were returned to the Company, the remaining notes and accrued interest of $745 thousand were reduced to $373 thousand and the maturity dates were extended to September 30, 2006. This was in exchange for a new earn-out of 618,084 ACE*COMM shares with a graduated payment schedule based upon the revenues generated from the sales of Network Business Intelligence products and services over the next two fiscal years ending on June 30, 2007.

On September 26, 2006, the notes and interest payable to the former 2helix owners of $424 thousand less a potential tax liability of $136 thousand, which was indemnified by the former owners, were paid through the issuance of ACE*COMM stock. The net liability of $288 thousand was settled by issuing 138,704 shares based on a 10 day weighted average share price. The balance of $136 thousand was accounted for as a reduction of goodwill.

NOTE 7 — INCOME TAXES

The Company is in a net operating loss carry forward position. In the event we experience a change in control as defined by the Internal Revenue Service, use of some or all of our net operating loss carry forwards may be limited. The Company has established a valuation allowance to offset its net deferred tax asset balance.

NOTE 9 — EARNINGS PER SHARE (in thousands, except per share amounts)

The following is a reconciliation of the numerators and denominators of basic net income (loss) per common share (“Basic EPS”) and diluted net income (loss) per common share (“Diluted EPS”):


	For the three months ended					For the six months ended
	December 31,					December 31,
	2006			2005		2006			2005
	(Unaudited)			(Unaudited)		(Unaudited)			(Unaudited)
Basic EPS:
Net income (loss) — numerator
Net income (loss) available to common shareholders	$	(2,538	)	$	347	$	(5,283	)	$	446
Shares — denominator
Weighted average common shares		18,006			16,886		17,724			16,814

Basic EPS	$	(0.14	)	$	0.02	$	(0.30	)	$	0.03


Diluted EPS:
Net income (loss) — numerator
Net income (loss) available to common shareholders	$	(2,538	)	$	347	$	(5,283	)	$	446
Shares — denominator
Weighted average common shares		18,006			16,886		17,724			16,814
Stock options		—			462		—			414
Restricted stock		—			92		—			45

Total weighted shares and equivalents		18,006			17,440		17,724			17,273

Diluted EPS	$	(0.14	)	$	0.02	$	(0.30	)	$	0.03

Due to the loss incurred during the three and six months ended December 31, 2006, zero incremental shares related to stock options are included in the calculation of Diluted EPS because the effect would be anti-dilutive. The total number of potentially dilutive shares not included in the EPS calculation for the three months ended December 31, 2006, due to anti-dilution was 153,078 including 70,956 for stock options and 82,122 for restricted stock. The total number of potentially dilutive shares not included in the EPS calculation for the six months ended December 31, 2006 due to anti-dilution was 249,671 including 179,506 for stock options and 70,165 for restricted stock.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

This Report contains certain statements of a forward-looking nature relating to future events or the future financial performance of the Company, some or all of which may involve risk and uncertainty. ACE*COMM often introduces a forward-looking statement by such words as “anticipate,” “plan,” “projects,” “continuing,” “ongoing,” “expects,” “management (or the Company) believes,” or “intend.” Investors should not place undue reliance on these forward-looking statements, which involve estimates, assumptions, risks and uncertainties that could cause actual results to vary materially from those expressed in this Report or from those indicated by one or more forward-looking statements. The forward-looking statements speak only as of the date on which they were made, and the Company undertakes no obligation to update any of the forward-looking statements. In evaluating forward-looking statements, the risks and uncertainties investors should specifically consider include, but are not limited to, demand levels in the relevant markets for the Company’s products, the ability of the Company’s customers to make timely payment for purchases of its products and services, the risk of additional losses on accounts receivable, success in marketing the Company’s products and services internationally, the effectiveness of cost containment strategies, as well as the various factors contained in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2006, and in subsequent reports filed with the Securities and Exchange Commission, including the matters set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Additional Factors Affecting Future Operating Results,” as well as other matters presented in this Report.

Overview

Sources of Revenue

ACE*COMM delivers enterprise telemanagement applications and advanced Convergent Mediation™ and Operations Support Systems solutions to wireline and wireless voice, data, and Internet communications providers. Our solutions typically consist of hardware, software and related services that enable the capture, security, validation, correlation, augmentation, and warehousing of data from network elements and the distribution of this data in appropriate formats to OSS (“Operations Support Systems”) and BSS (“Business Support Systems”) operations. Our solutions also provide for centralized management and security of enterprise networks.

ACE*COMM derives revenues primarily from the sale of our products, including hardware and software, and related services. ACE*COMM enters into formal arrangements that provide for single or multiple deliverables of hardware, software and services. These arrangements are formalized by either a simple purchase order or by more complex contracts such as development, reseller or master agreements. These arrangements are generally U.S. dollar denominated, but as we have increased the percentage of international sales these arrangements are also denominated in local currencies such as the British Pound, and typically have an aggregate value of several thousand to several million dollars and vary in length from 30 days to several years, as in the case of master agreements. Agreements spanning several years are normally implemented in smaller statements of work or orders that are typically deliverable within three to twelve months. Our customers, including resellers, do not possess the right of return or exchange.

Revenue for a given period typically reflects products delivered or services performed during the period with respect to relatively large financial commitments from a small number of customers. During the three months ended December 31, 2006, we had six customers generating $150,000 or more in revenue during the period (“Major Customers”) representing approximately 52% of total revenue. One customer, Impressive Communications, accounted for 11% of reported revenue. During the three months ended December 31, 2005, we had nine Major Customers representing approximately 73% of total revenue. However, only one such customer, Giza Systems (27% of revenue), had revenue greater than 10% of reported revenue. The average revenue earned per Major Customer was $270 thousand and $547 thousand, respectively, for the three months ended December 31, 2006 and 2005.

Trends and Strategy

Revenue growth depends, in part, on the overall demand for our product-based solutions and on sales to large customers. Because our sales are primarily to telecommunication and Internet service providers and large enterprises, our ability to generate revenue also depends on specific conditions affecting those providers and on general economic conditions.

We have been pursuing a growth strategy designed to expand our product line and areas of distribution to counteract reductions in demand for our traditional products and services. We are continuing to target sales efforts for our Convergent Mediation™ solutions outside of North America. A substantial percentage of our sales over the past several quarters have been to overseas customers.

During the past year we have put more focus on our Patrol Suite of products marketed to carriers on a global basis. The sales cycle for these type sales are longer than our other products and services and range from twelve to twenty four months. We recently announced our first sale to a carrier in North America and have entered into partnership arrangements with Lucent and Verisign to resell our Patrol Suite of products.

This past year we have introduced our next generation convergent mediations product NV2. NV2 uses advanced technologies and techniques to control, moderate, and facilitate the interactive communication between multiple network technologies and software support systems, without sacrificing support for critical legacy network and infrastructure investments.

Over the last year, we have focused our sales resources on opportunities for our newest generation of NetPlus EOSS products. In addition to pursuing our traditional government markets, sales activities have been increased to large commercial enterprises to expand our NetPlus customer base.

Even as our newer technologies have been gaining market acceptance, we have experienced some reductions in demand for some of our traditional products due to the continuing changes in the telecommunications industry. We experienced a decline in the number of potential customers for our OSS products and services and a reduction in our existing customer base in the UK as a result of consolidation within the UK service provider market by network providers. Our largest customer in this group completed their service contract with us in the first quarter. This customer accounted for 2% of our consolidated revenues for the six months ended December 31, 2006 and 5% of our consolidated revenues in fiscal 2006.

During the most recent two quarters we have experienced increased competition and a general delay associated with purchase decisions for our products and services. These factors, coupled with delays in existing contracts, have significantly reduced revenues in the past two quarters. We are continuing to manage our costs and have maintained numerous cost reduction measures which have reduced operating expenses. In the past two quarters total expenses have decreased $1.5 million or 12% over the same two quarters last year. Because of the shortfalls in revenue, we have experienced increased liquidity demands and incurred large losses over the past two quarters. In addition to managing our costs, we are devoting significant effort to increase our revenues by selling our Patrol Suite of products to carriers on a global basis. We also may pursue additional financing, which may or may not be available on terms acceptable to us. Any such financing could result in increased leverage (if a debt financing) or equity dilution (if an equity financing). This financing likely would be in addition to any borrowings under our line of credit against outstanding eligible accounts receivable. We had no outstanding borrowings as of December 31, 2006, and as of January 31, 2007, we had $790 thousand of available borrowing capacity based on then-outstanding accounts receivable.

Recent Developments

2helix

On September 26, 2006, the notes and interest payable to the former 2helix owners of $424 thousand less a potential tax liability of $136 thousand, which is indemnified by the former owners, were paid through the issuance of ACE*COMM stock. The net liability of $288 thousand was settled by issuing 138,704 shares based on a 10 day weighted average share price. The balance of $136 thousand was accounted for as a reduction of goodwill.

Warrant Exercises Under Revised Private Placement

As a result of our private placement in March 2005, as re-negotiated in October 2005, we had outstanding warrants to purchase 1.9 million shares at an exercise price of $2.50 per share with a term of six months commencing with effectiveness of the registration statement relating to the share underlying those warrants. The registration statement covering the stock issued to the investors and the shares underlying the warrants was declared effective on March 3, 2006. The warrant holders exercised warrants to purchase 839,653 shares of the 1.9 million shares available at an exercise price of $2.50 per share, and the unexercised warrants expired on September 2, 2006.

Critical Accounting Policies

Our significant accounting policies are more fully described in the notes to the financial statements included in our most recent Form 10-K filing. However, certain of our accounting policies are particularly important to the portrayal of our financial position and results of operations or require the application of significant estimates, judgment or assumptions by our management. We believe that the estimates, judgments and assumptions upon which we rely are reasonably based upon information available to us at the time that the estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenue and expenses during the periods presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. The following is a brief discussion of these critical accounting policies:

Revenue Recognition

ACE*COMM derives revenues primarily from products, where a combination of hardware, proprietary licensed software, and services are offered to customers. These products are typically formalized in a multiple element arrangement involving application of existing software capabilities or modification of the underlying software, implementation and support services. Our software licenses to end-users generally provide for an initial license fee to use the product in perpetuity. Subscription revenue, included in Operational Support Systems revenue, is recognized on a monthly basis based upon the number of telephone subscribers of our customers.

We recognize revenue in accordance with current generally accepted accounting principles. ACE*COMM follows specific and detailed guidelines in measuring revenue; however, certain judgments and current interpretations of rules and guidelines affect the application of our revenue recognition policy. Revenue from license fees is recognized when persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is fixed or determinable and collectibility is considered “probable” under applicable accounting tests. One of the critical judgments we make is our assessment of the probability of collecting the related accounts receivable balance on a customer-by-customer basis. As a result, the timing or amount of revenue recognition may have been different if different assessments of the probability of collection had been made at the time the transactions were recorded in revenue. In cases where collectibility is not deemed probable, revenue is recognized upon receipt of cash, assuming all other criteria have been met. We are also required to exercise judgment in determining whether the fixed and determinable fee criteria have been met by evaluating the risk of our granting a concession to our customers, particularly when payment terms are beyond our normal credit period of sixty to ninety days. In addition, when our contracts contain customer acceptance provisions, management assesses whether uncertainty exists about such acceptance in determining when to record revenue.

For multiple element arrangements that include software products, we allocate and defer revenue for the undelivered elements based on their vendor-specific objective evidence of fair value, which is generally the price charged when that element is sold separately. We are required to exercise judgment in determining whether sufficient evidence exists for each undelivered element and to determine whether and when each element has been delivered. If we were to change any of these assumptions or judgments, it could cause a material increase or decrease in the amount of revenue that we report in a particular period.

In situations when our products involve significant modification or customization of software, or when our systems integration and services are essential to the functionality of the software, revenues relating to the software licenses and services are aggregated and the combined revenues are recognized on a percentage-of-completion basis. The hardware revenue on these contracts is recognized upon transfer of title, which generally occurs at the same time the licensed software is delivered. Revenue recognized using the percentage-of-completion method is based on the estimated stage of completion of individual contracts determined on a cost or level of efforts basis. Approximately 12% of our revenue for the three and six months ended December 31, 2006 and 2005, respectively, was derived from contracts accounted for under the percentage of completion method.

Allowance for Bad Debts

The allowance for doubtful accounts is established through a charge to general and administrative expenses. This allowance is for estimated losses resulting from the inability of our customers to make required payments. It is an estimate and is regularly evaluated by us for adequacy by taking into consideration factors such as past experience, credit quality of the customer, age of the receivable balance, individually and in aggregate, and current economic conditions that may affect a customer’s ability to pay. The use of different estimates or assumptions could produce different allowance balances. Our customer base is highly concentrated in the telecommunications and Internet service provider industries. Several of the leading companies in these industries have filed for bankruptcy. In addition, we have experienced delays in receiving payment from certain of our international customers and certain of these customers have negotiated longer payment terms. If collection is not probable at the time the transaction is consummated, we do not recognize revenue until cash collection. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Impairment of Long-Lived Assets

value is calculated using the present value of estimated net cash flows. We did not record an impairment charge during the six months ended December 31, 2006 and 2005.

Results of Operations

The following table shows the percentage of revenue of certain items from ACE*COMM’s statements of operations:


	For the three months ended						For the six months ended
	December 31,						December 31,
	2006			2005			2006			2005

Revenue		100.0	%		100.0	%		100.0	%		100.0	%

Costs and expenses:
Cost of revenue		70.9	%		31.2	%		69.8	%		35.7	%
Selling, general and administrative expenses		86.8	%		49.6	%		90.2	%		45.9	%
Research and development		21.5	%		13.5	%		23.6	%		14.5	%

Income (loss) from operations		(79.2	)%		5.7	%		(83.6	)%		3.9	%
Interest expense		1.5	%		0.5	%		2.0	%		0.6	%

Income (loss) before income taxes		(80.7	)%		5.2	%		(85.6	)%		3.3	%
Income tax expense		0.0	%		0.0	%		0.0	%		0.0	%

Net income (loss)		(80.7	)%		5.2	%		(85.6	)%		3.3	%

Revenues

The following summarizes revenue for the three and six months ended December 31, 2006 and 2005 (in thousands):


	For the three months ended				For the six months ended
	December 31,				December 31,
	2006		2005		2006		2005
	(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)

Revenue
Licenses and hardware	$	1,005	$	3,196	$	1,463	$	6,651
Services		2,141		3,541		4,705		6,771

Total revenue	$	3,146	$	6,737	$	6,168	$	13,422

Total revenues for the three months ended December 31, 2006 were $3.1 million compared to $6.7 million in 2005, reflecting a decrease of $3.6 million or 54%. Total revenues for the six months ended December 31, 2006 were $6.2 million compared to $13.4 million in 2005 reflecting a decrease of $7.2 million or 54%. Our revenues continue to be significantly affected by the number of large contracts we have at any particular time, and the customer’s schedule for receiving our products and services. In the most recent quarter, we were not able to book new orders on contracts we were pursuing during the quarter, and customer schedules under a few large existing contracts did not allow us to deliver products and record the revenue. Our results from operations were adversely affected, and in this most recent quarter the effects were significant. This affected our license and hardware revenue and our services revenue, including revenue from sales to enterprises, revenue from sales to network service providers and revenue from sales of Operations Support Systems.

License and hardware revenue decreased by $2.2 million to $1.0 million for the three months ended December 31, 2006 compared to 2005 and by $5.2 million to $1.5 million for the six months ended December 31, 2006 compared to 2005. The decrease included revenues of $1.3 million from a customer in the Middle East, $1.5 million for a software license related to the Air Force contract, one-time revenue from three customers for software licenses totaling $0.8 million, hardware sales from one customer of $0.4 million and a reduction in revenues related to a contract from the Middle East as it nears completion of $0.5 million.

Services revenue decreased by $1.4 million from $3.5 million for the three months ended December 31, 2005 to $2.1 million in 2006 and by $2.1 million from $6.8 million for the six months ended December 31, 2005 to $4.7 million for the six months ended December 31, 2006. The majority of this decrease was principally the result of a billing customer in the UK that completed their service contract during the first quarter of fiscal year 2007, which decreased by $0.6 million and to decreased revenues from four additional OSS customers. Also services decreased due to completion of contract and maintenance from one Enterprise customer of $0.7 million. These decreases were not offset by new orders.


	For the three months ended				For the six months ended
	December 31,				December 31,
	2006		2005		2006		2005
	(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)

Revenue by Type
Enterprise	$	935	$	2,941	$	1,899	$	4,279
Network Service Provider (NSP)		1,451		2,169		2,526		5,906
Operations Support Systems (OSS)		760		1,627		1,743		3,237

Total Revenue	$	3,146	$	6,737	$	6,168	$	13,422

Revenue from sales to enterprises decreased 69% from $2.9 million for the three months ended December 31, 2005, to $0.9 million for the three months ended December 31, 2006 and 56% from $4.3 million to $1.9 million for the six months ended December 31, 2006. The decrease includes $0.7 million related to a maintenance and services contract from one customer and $1.5 million from a software license related to the Air Force contract that were not replaced.

Revenue from sales to network service providers decreased 32% from $2.2 million to $1.5 million for the three months ended December 31, 2006, and represented 46% of total revenue and 58% from $5.9 million to $2.5 million for the six months ended December 31, 2006. The decrease included revenues of $1.3 million from a customer in the Middle East, one-time revenue from three customers for software licenses totaling $0.8 million, hardware sales from one customer of $0.4 million and a reduction in revenues related to a contract from the Middle East as it nears completion of $0.5 million.

Revenue from sales of Operations Support Systems decreased 50% from $1.6 million to $0.8 million for the three months ended December 31, 2006, compared to 2005 and 47% from $3.2 million to $1.7 million for the six months ended December 31, 2006. The decrease in OSS revenue is primarily due to one customer in the UK that completed their service contract during the first quarter of fiscal year 2007 which decreased by $0.6 million and to decreased revenues from four additional OSS customers.

Backlog was $14.9million as of December 31, 2006 compared to $15.8 million at June 30, 2006. We define backlog as future revenue from signed contracts or purchase orders for delivery of hardware and software products and services to be provided to customers generally within one year. We have experienced fluctuations in our backlog at various times. We anticipate that $5.6 million of the backlog will be recognized during the remainder of fiscal year 2007. Although we believe that our entire backlog consists of firm orders, our backlog as of any particular date may not be indicative of actual revenue for any future period because of the possibility of customer changes in delivery schedules and delays inherent in the contracting process.

Cost of Revenues

Our cost of revenue consists primarily of direct labor costs, direct material costs, and allocable indirect costs. The expenses for services provided by certain alliance partners in connection with the installation and integration of our products may also be included.

Cost of revenues has fixed and variable components and includes expenses that are directly related to the generation of operating revenues. Several cost categories are specifically identifiable as relating to products versus services including material costs and direct labor charged to a product job. In many instances, certain expenses related to infrastructure and personnel are often utilized to generate revenues from the various product and service categories, making it difficult to determine cost of revenue by product. We developed a methodology for segregating the product and service components of cost of revenues. Costs directly related to hardware or software that are identifiable by cost type, such as materials, freight, direct labor and travel charges were assigned to cost of licenses and hardware. Other charges including warranty, maintenance and re-work costs were allocated based upon warranty incident reports. Employee benefits are allocated based on total burden rate and other overhead costs are allocated on a pro-rata basis.

Our method of allocating these costs may or may not be comparable to approaches of other companies. Use of a different method of allocation could change the costs of revenues and margin associated with products and services. Our overall cost of revenue and gross margin is not affected by this allocation method.

Cost of revenue was $2.2 million and $2.1 million for the three months ended December 31, 2006 and 2005, respectively, representing 71% and 31% of revenues, respectively. Cost of revenue was $4.3 million and $4.8 million for the six months ended December 31, 2006 and 2005, respectively, representing 70% and 36% of revenues, respectively. Because revenues decreased significantly and most of our costs are relatively fixed, cost of revenue as a percentage of revenue increased significantly.

Cost of licenses and hardware revenue was $503 thousand and $413 thousand for the three months ended December 31, 2006 and 2005, respectively, representing 50% and 13% of licenses and hardware revenue, respectively. Cost of licenses and hardware revenue was $806 thousand and $1.5 million for the six months ended December 31, 2006 and 2005, respectively, representing 55% and 22% of revenues, respectively. The percentage of revenues increased because fixed costs are being spread over lower revenues.

Cost of services revenue was $1.7 million for the three months ended December 31, 2006 and 2005, representing 81% and 48% of services revenue for those periods, respectively. Cost of services revenue was $3.5 million and $3.3 million for the six months ended December 31, 2006 and 2005, respectively, representing 74% and 49% of revenues, respectively. The increase includes $112 thousand related to labor based on the allocation of resources and to an increase in amortization expense of $110 thousand for intangibles and software licenses. Cost of services revenue as a percentage of revenue increased due to the decrease in revenues.

Selling, General and Administrative Expenses

Selling, general and administrative (SG&A) expenses consist of costs to support our sales and administrative functions. Sales expenses consist primarily of salary, commission, travel, trade show, bid and proposal, and other related selling and marketing expenses required to sell our products to target markets. General and administrative expenses consist of provision for doubtful accounts and unallocated costs related to our information systems infrastructure, facilities, finance and accounting, legal, human resources and corporate management.

SG&A expenses were $2.7 million and $3.3 million for the three months ended December 31, 2006 and 2005, respectively, representing 87% and 50% of total revenues in each period, respectively. SG&A expenses were $5.6 million and $6.1 million for the six months ended December 31, 2006 and 2005, respectively, representing 90% and 46% of revenues, respectively. Expenses decreased as a result of cost containment measures in our foreign subsidiaries and the percentage increase is due to the decrease in revenues.

Research and Development Expenses

Research and development (R&D) expenses consist of personnel costs and the associated infrastructure costs required to support the design and development of our products such as JBill Global and NetPlus and our convergent mediation service delivery platform.

Research and development expenses were $676 thousand and $914 thousand for the three months ended December 31, 2006 and 2005, respectively, and represented 21% and 14% of revenues for the three months ended December 31, 2006 and 2005, respectively. Research and development expenses were $1.5 million and $2.0 million for the six months ended December 31, 2006 and 2005, respectively, and represented 24% and 15% of revenues, respectively. The decrease in research and development during the period relates to the reduction in the UK headcount for personnel working on R&D projects associated with JBill and Network Business Intelligence (NBI). These expenses are expected to continue at or above the current levels for the remainder of fiscal year 2007 as we continue to develop and expand our Patrol Suite, NetPlus and convergent mediation products.

Although research and development expenses are expected to continue at or above the current level, we are pursuing several strategies to control costs in this area. We have been selective in approving new projects and in some instances discontinued projects that were not related to the development of Convergent Mediation solutions. We are also pursuing alternative development opportunities such as outsourcing and we are consolidating development activities to continue to manage our expenses. In instances where we charge our customers for custom development we include the costs associated with the development in the cost of revenues. Finally, we have acquired market-ready new technology from third parties as part of our strategy for expanding our product offerings.

Liquidity and Capital Resources

Asset and Cash Flow Analysis

We had cash and cash equivalents of $1.2 million and $946 thousand at December 31, 2006 and June 30, 2006, respectively. Cash and cash equivalents increased by $224 thousand from June 30, 2006, to December 31, 2006, and comprised 12% and 6% of total assets as of December 31, 2006 and June 30, 2006, respectively. The decrease in accounts receivable from $11.0 million at June 30, 2006 to $4.7 million at December 31, 2006 relates primarily to the receipt of $4.7 million from Northrop Grumman and receipts of approximately $1.6 million from other customers. We had borrowings outstanding under our lines of credit of $-0- at December 31, 2006 and $2.6 million at June 30, 2006. The cash received was used to pay off our borrowings and fund operations. As a result, working capital decreased $2.6 million from $3.1 million at June 30, 2006 to $537 thousand at December 31, 2006.

Our cash flow is dependent upon numerous factors, including the timing of customer orders and engagements, and related obligations and payments, market acceptance of our products, the resources we devote to developing, marketing, selling and supporting our products, the timing and extent of changes in the size of our operations and other factors.

Five customers represent 40% of our gross trade receivables balances as of December 31, 2006 and two of these customers are international. At December 31, 2006, approximately 25% of the Company’s billed accounts receivable was older than ninety days compared to 16% at June 30, 2006 and of the 25% over ninety days at December 31, 2006, 80% are comprised of international customers. We expect that international telecommunication and internet service providers will continue to take longer to make payments than domestic customers. Five customers comprised 47% of our billed accounts receivable at December 31, 2006, and 80 % of this balance is current.

Operating activities provided $1.4 million and used $2.3 million in cash during the six months ended December 31, 2006 and 2005, respectively. The change between periods in cash flows from operating activities is principally due to changes in accounts receivable netted with the change in net loss.

Net cash used for investing activities was $278 thousand and $474 thousand, respectively. Financing activities used cash of $977 thousand and generated cash of $1.1 million during the six months ended December 31, 2006 and 2005, respectively. The cash used during the six months ended December 31, 2006 included $2.6 million used to pay off the borrowings on the line of credit, offset by $1.6 million provided by the proceeds from exercise of stock warrants.

Cost Containment Program

We have continued to manage our expenses based on expectations as to anticipated revenues and expenses. We have reduced the number of full time employees during the past three fiscal years and we have carried over these cost reduction measures to our 2helix acquisition as part of the integration of that company. We expect to have continuing liquidity demands unless and until we can increase revenues significantly. If necessary, we will reduce operating expenses further and curtail certain of our operations and take other actions we believe will reduce expenses and preserve cash. These actions, if taken, might affect the cost associated with cost of revenues, selling, general and administrative expenses and research and development expense but at this time the effects on expense levels cannot be determined.

Contractual Obligations and Commitments

The following table summarizes contractual obligations and commitments as of December 31, 2006:


Contractual Obligation	Payments Due by Period
	(amounts in thousands)
	Total		Less than 1 year		1-3 years		4-5 years		After 5 years
Operating leases	$	2,477	$	957	$	1,171	$	323	$	26
Other commitments		31		31		—		—		—

Total commitments	$	2,508	$	988	$	1,171	$	323	$	26

We have commercial commitments of two accounts receivable backed lines of credit. Both were renewed simultaneously via separate amended and restated loan and security agreements with the Bank on November 14, 2006. There were no outstanding amounts due on either line of credit at December 31, 2006.

We also have issued standby letters of credit for security deposits for office space and to guarantee service contracts as summarized in the following table. The standby letters of credit have a one-year term and renew annually.


Other Commercial Commitments	Commitment Expiration Per Period (in thousands)
	Total
	Amounts		Less than						Over
	Committed		1 year		1-3 years		4-5 years		5 years
Standby Letters of Credit	$	344	$	256	$	88	$	—	$	—

Under the terms of our corporate headquarters office lease, we maintain a letter of credit under our line of credit with our bank, which names the landlord as the sole beneficiary and which may be drawn on by the landlord in the event of a monetary default by us under the lease. The letter of credit currently required under the lease is $103 thousand, and will decrease annually each November through fiscal year 2008. Additionally, under the terms of our Canadian office lease, we maintain another letter of credit under our line of credit with our bank, which also names the landlord as the sole beneficiary and which may be drawn on by the landlord in the event of a monetary default by us under the lease. The letter of credit currently required under the Canadian lease is $88 thousand and will decrease annually beginning in March 2009 and continue through March 2010. We also maintain other customer related letters of credit issued by the Bank and secured under our line of credit to support specific terms and conditions of customer orders.

Lines of Credit

On November 14, 2006, we renewed our loan and security agreement and entered into an amended and restated loan and security agreement with Silicon Valley Bank. This amended agreement expires and is subject to renewal on November 13, 2007. Under this agreement, we may borrow based upon the amount of our approved borrowing base of eligible accounts receivable, up to a maximum of $3.5 million. The line of credit has sub limits of $500 thousand for cash secured letters of credit and $1.75 million for U.S. Export Import Bank usage. We can draw up to 70% of our eligible accounts receivable under the master line and 70% of our eligible foreign accounts receivable under the U.S. Export Import Bank sub limit line. Inclusive to the U.S. Export Import Bank sub limit is a $250 thousand sub limit for 50% of the UK eligible accounts receivable.

Amounts borrowed bear interest at a rate equal to the bank’s prime rate plus 1.75% per annum, charged on the average daily balance of advances outstanding, payable monthly and calculated on a 360 days per year basis. We also pay certain costs and expenses of the bank in administering the line. The receivables comprising the borrowing base must not be more than 90 days aged, must not be in dispute, and must conform to other eligibility requirements. The agreement has a monthly quick ratio covenant which must be complied with on an intra-quarterly basis, and a minimum tangible net worth covenant which must be complied with on a quarterly basis. The agreement also subjects the Company to non-financial covenants, including restrictions over dividends and certain reporting requirements. For the quarter ending December 31, 2006, we were not in compliance with the minimum tangible net worth covenant. The Bank has waived this covenant violation and established new minimum tangible net worth and quick ratio covenants.

We have an additional loan and security agreement which provides a second line of credit for the financing of non-standard accounts receivable. We renewed our additional loan and security agreement on November 14, 2006 and entered into an amended and restated loan and security agreement with Silicon Valley Bank. This amended agreement expires and is subject to renewal on November 13, 2007. Under this second line, we may borrow based upon a borrowing base of specifically-approved accounts receivable not part of the borrowing base for our other line of credit, up to a maximum of $1.5 million. The line is administered under the specialty finance division of the Bank and its primary purpose is to allow financing for specific receivables with extended terms. We can draw up to 70% of approved accounts receivable under this additional line. Amounts borrowed bear interest at a rate equal to the bank’s prime rate plus 2% per annum, charged on the outstanding financed gross receivable balance, calculated on a 360 day year basis, and payable upon the earlier of when the payment is received for the financed receivable or when the financed receivable is no longer an eligible receivable. We also pay certain costs and expenses of the bank in administering the line. The receivables comprising the borrowing base must not be more than 90 days aged, but financing for accounts receivable up to 180 days is available to the extent approved on a case-by-case basis by the Bank. All such receivables must not be in dispute, and must conform to other eligibility requirements. The agreement has no financial covenants, but does subject the Company to non-financial maintenance covenants, including restrictions over dividends.

ACE*COMM’s obligations under both agreements are secured by a security interest in all of our assets and intellectual property. Advances made to ACE*COMM are payable in full upon demand in the event of default under the agreement. As of December 31, 2006, we had no borrowings on the $3.5 million line of credit or the $1.5 million line of credit and there was $1.1 million available for additional borrowing based on then-outstanding accounts receivable.

Liquidity Analysis

At December 31, 2006, we had cash and cash equivalents of $1.2 million. We had no outstanding borrowings as of December 31, 2006, and we had $1.1 million of available borrowing capacity under the line of credit based on the then-outstanding accounts receivable.

We are continuing to manage our expenses to conserve cash and maintain adequate liquidity. We have no significant commitments for capital expenditures at December 31, 2006. We believe that cash flows from operations, particularly collection of outstanding accounts receivable, receipt of new contracts, and the availability of credit under our agreement with the Bank will support our working capital requirements for the next twelve months, based on our current expectations as to anticipated revenue, expenses and cash flow.

Risk Factors Affecting Future Operating Results

This quarterly report on Form 10-Q and the other documents we file with the SEC contain forward looking statements that are based on current expectations, estimates, forecasts and projections about the industries to which we supply solutions and in which we operate, our beliefs and our management’s assumptions. In addition, other written or oral statements that constitute forward-looking statements may be made by or on behalf of us. Words such as ‘expects,’ ‘anticipates,’ ‘targets,’ ‘goals,’ ‘projects,’ ‘intends,’ ‘believes,’ ‘seeks,’ ‘estimates,’ or variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecast in such forward-looking statements. Except as required under the federal securities laws and the rules and regulations of the SEC, we do not have the intention or obligation to update publicly any forward-looking statements after the distribution of this Report on Form 10-Q, whether as a result of new information, future events, changes in assumptions, or otherwise.

The following items are representative of the risks, uncertainties and assumptions that could affect the outcome of the forward-looking statements.

Because of our reliance on significant customers and large orders, failures to obtain a sufficient number of large contracts has had and could continue to have a material adverse effect on our revenues for one or more periods

A significant portion of our revenue comes from large financial commitments by a small number of customers, including both telecommunications carriers and large enterprises. We expect to continue to depend on a limited number of customers in any given period for a significant portion of our revenue and, in turn, to be dependent on their continuing success and positive financial results and condition. These large customers may result from one-time competitive procurements or from repeat purchases from distributors, OEMs or other strategic partners. We may not prevail in one or more of the procurements, and our distributors may increase or suspend purchases of our products and services at any time. If we fail to continue to receive orders from such customers, or if any one or more of these customers suffers a downturn, our financial results will suffer. Our revenues and liquidity also may vary significantly from quarter to quarter based upon the delivery schedules of our large contracts, particularly extensions or delays in the delivery schedule arising from customer decisions or requirements. In the most recent two quarters, we were not able to book some of the larger contracts we were pursuing during the quarter, and customer schedules under large existing contracts did not allow us to deliver products and record the revenue. Our results from operations were adversely affected, and in this most recent six months, the effects were significant resulting in our having large losses for those quarters.

We have experienced liquidity demands as a result of revenue shortfalls and delays in customer schedules under large contracts

We have been experiencing increased costs and liquidity demands during the past six months arising from revenue shortfalls and our inability to recognize revenues under certain large existing contracts where customer schedules did not allow us to deliver products sand record the revenue. This increased pressure on our liquidity may continue unless and until we can increase revenues significantly.

We are dependent on our ability to borrow

We are dependent on our ability to borrow funds under our lines of credit. Any inability to borrow could have a material adverse effect on the Company. Additionally, our borrowings under our lines of credit are dependent upon our eligible and approved accounts receivable. In the event of an inability to borrow, we would require additional financing and the additional financing may not be available or may not be available on terms acceptable to us. We had no outstanding borrowings as of December 31, 2006. However, because of the shortfalls in revenue and increased liquidity demands, we are managing our costs and may also pursue additional financing, which may or may not be available on terms acceptable to us.

Our products must be continuously updated to work with changing technology and demand for our products could be impacted by any competitors introducing more advanced technology

To maintain and improve demand for our products, we must continue to develop and introduce value-added, timely and cost effective new products, features and services that keep pace with technological developments and emerging industry standards. Any failure to do this will limit the market into which we can sell our products and services. We have recently

introduced new software products such as Parent Patrol™ and are pursuing the development of others. These products have not yet achieved market acceptance, and the sales cycle for these products are longer than our other products and services, ranging from 12 to 24 months. With our increasing focus on sales of our Patrol Suite of products to carriers, our ability to achieve significant revenue growth may depend increasingly on the acceptance of these products and related services. Further, customers are always looking for the most advanced technology available, within certain price ranges. To the extent that competitors can offer more advanced technology within a given price range our sales would be adversely affected. Further, customer technology upgrades can lead to sometimes lengthy delays in orders for our products until their system upgrades are complete and they are in a position to have our products installed as part of their new systems.

The adverse conditions in the telecommunications industry continue despite improvements in the economy and may continue to do so

Our business and financial results are highly dependent on the telecommunications industry and the capital spending of our customers. Over the past four or five years capital spending by telecommunication companies has been at reduced levels. Telecommunications products and services have increasingly become commodities that cannot easily be distinguished, leading to lower margins and reduced spending on costly software. The reduction of spending by companies in the telecommunication industries has caused, and may continue to cause, a significant reduction in our revenues. Although over the past fiscal year we experienced an increase in demand from certain types of customers, other areas of our business have experienced continued weakness in demand and unwillingness of customers to spend significant sums on procuring new Convergent Mediation™ or OSS solutions products or services.

Unless we continue to maintain existing strategic alliances and develop new ones, our sales will suffer

Our results could suffer further if we are unable to maintain existing and develop additional strategic alliances with leading providers of telecommunications services and network equipment who serve as distributors for our products. If we are not able to maintain these strategic alliances, we will not be able to expand our distribution channels and provide additional exposure for our product offerings. These relationships can take significant periods of time and work to develop, and may require the development of additional products or features or the offering of support services we do not presently offer. Failure to maintain particular relationships may limit our access to certain countries or geographic areas unless we are able to enter into new relationships with companies that can offer improved access.

Many of our telecommunications customers involve credit risks for us

Many of our customers present potential credit risks, and we are dependent on a small number of major customers. The majority of our customers are in the telecommunication services industry and government sector, or are in the early stages of development when financial resources may be limited. Five customers represented 40% of our gross trade receivables balance as of December 31, 2006. Because we depend on a small number of major customers, and many of our customers present potential credit risks for different reasons, our results of operations could be adversely affected by non-payment or slow-payment of receivables. For a more detailed discussion of doubtful accounts please read the section labeled “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Allowance for Bad Debts.” Several of our international customers have negotiated extended payment terms, further separating the time payment is received from when costs are incurred.

We are increasingly subject to the risks and costs of international sales, and failure to manage these risks would have an adverse effect on us

A substantial portion of our revenues are derived from international sales and are therefore subject to the risks of conducting business overseas, including the general economic conditions in each country, the overlap of different tax structures, the difficulty in managing resources in various countries, changes in regulatory requirements, compliance with a variety of foreign laws and regulations, foreign currency translations and longer payment cycles. We derived approximately $1.7 million, or 55% of our total revenue and $3.0 million, or 45% from customers outside of the United States for the three months ended December 31, 2006 and 2005, respectively. We derived $3.6 million or 58% of total revenue and $8.2 million or 61% of total revenue from customers outside of the United States for the six months ended December 31, 2006 and 2005, respectively. To the extent that we have increased our international revenue sources over the last three years, the impact of the risks related to international sales could have an increasingly larger effect on our financial condition as a whole.

Failure to manage risks of potential acquisitions would have an adverse effect on us

We have completed three significant acquisitions over the past three years and pursuing additional acquisitions to expand our product line remains part of our growth plan. However, acquisitions involve a number of potential adverse consequences. In particular, failure to identify or evaluate risks such as possible loss of major customers, or inability to correctly evaluate costs of combining businesses or technologies have in the past and could cost us in the future significant resources, dilution to our stockholders or loss of valuable time. In addition, recent acquisitions have included expenses associated with in process research and development and require us to absorb the cost of completion of ongoing product development. Failure to complete product development on time and within projected cost estimates would have an adverse affect on operating results and potentially decrease the value of the acquisition. Acquisitions may require additional financing and the additional financing may not be available or may not be available on terms acceptable to us.

Continuing market consolidation may reduce the number of potential customers for our products

The North American communications industry has experienced significant consolidation. In the future, there may be fewer potential customers requiring operations support systems and related services, increasing the level of competition in the industry. In addition, larger, consolidated communication companies have strengthened their purchasing power, which could create a decline in our pricing structure and a decrease of the margins we can realize. These larger consolidated companies are also striving to streamline their operations by combining different communications systems and the related operations support systems into one system, reducing the number of vendors needed. The continuing industry consolidation may cause us to lose more customers, which would have a material adverse effect on our business, financial condition and results of

operations. Market consolidation within the UK service provider market has reduced the number of customers for our products and has begun to erode our existing customer base within this group. Failure to replace these customers will have a negative impact upon future operating results.

Failure to estimate accurately the resources necessary to complete fixed-price contracts would have an adverse effect on our bottom line

Our failure to accurately estimate the resources required for a project or a failure to complete contractual obligations in a manner consistent with the projected plan may result in lower than expected project margins or project losses, which would negatively impact operating results. Our sales are formalized in agreements that may include customization of the underlying software and services. These agreements require projections related to allocation of employees and other resources. Additionally, we may fix the price of an arrangement before the final requirements are finalized. On occasion, we have and may be required in the future to commit unanticipated additional resources to complete projects, and the estimated fixed price may not include this unanticipated increase of resources. If our original projections are not met, project losses may occur that would have a negative impact on our operating results.

Inability to forecast revenue accurately may result in costs that are out of line with revenues, leading either to additional losses or downsizing that may not have been necessary

We may not be able to accurately forecast the timing of our revenue recognition due to the difficulty of anticipating compliance with the accounting requirements for revenue recognition and to the fact that we historically have generated a disproportionate amount of our operating revenues toward the end of each quarter. Our operating results historically have varied from fiscal period to fiscal period. Accordingly, our financial results in any particular fiscal period are not necessarily indicative of results for future periods.

ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to interest rate risk related to any borrowings under our line of credit. As of December 31, 2006, borrowings outstanding under our line of credit were zero. Our market risk sensitive instruments do not expose us to material market risk exposures. An increase or decrease of 1% would not impact our interest expense based on our borrowings as of December 31, 2006.

ITEM 4 CONTROLS AND PROCEDURES

Our management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) (the “Exchange Act”) as of the end of the period covered by this report. Based upon that evaluation, our management, including the Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures are effective.

There was no change in our internal controls over financial reporting that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II: OTHER INFORMATION

ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On December 1, 2006, the Registrant held it 2006 Annual Meeting of Stockholders. A vote was held for the election of Directors and the stockholders re-elected Directors Harry M. Linowes and Gilbert A. Wetzel. Both are Class I directors and their terms will expire at the 2009 Annual meeting. The stockholders also took the following action at the 2006 Annual Meeting:

To approve the proposal to ratify the selection of Grant Thornton LLP as the Company’s independent auditors for the fiscal year ending June 30, 2007.


Votes For: 14,639,103		Votes Against: 749,222		Abstain: 68,861		Broker Non-Votes: 0

ITEM 6 EXHIBITS

(a) Exhibits


Exhibit 10.1*		2007 Incentive Compensation Plan †
Exhibit 10.2*		Employment Agreement, dated as of the 1st day of December 2006, by and between ACE*COMM Corporation and George T. Jimenez †
Exhibit 10.3*		Employment Agreement, dated as of the 1st day of December 2006, by and between ACE*COMM Corporation and Steven R. Delmar †
Exhibit 10.4*		Employment Agreement, dated as of the 1st day of December 2006, by and between ACE*COMM Corporation and Christopher C. Couch †
Exhibit 31.1		Certification of Chief Executive Officer
Exhibit 31.2		Certification of Chief Financial Officer
Exhibit 32		Certifications Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


*		Identifies exhibit that consists of or includes a management contract or compensatory plan or arrangement.

†		Filed herewith.


Part I — Financial Information

Item 1.	Consolidated Financial Statements

	Consolidated Balance Sheets as of December 31, 2006 and June 30, 2006 (Unaudited)	3

	Consolidated Statements of Operations (Unaudited) for the three and six months ended December 31, 2006 and 2005	4

	Consolidated Statements of Cash Flows (Unaudited) for the six months ended December 31, 2006 and 2005	5

	Consolidated Statements of Stockholders’ Equity for the six months ended December 31, 2006 and the year ended June 30, 2006	6

	Notes to Consolidated Financial Statements (Unaudited)	7

Item 2	Management’s Discussion and Analysis of Results of Operations and Financial Condition	12

Item 3	Quantitative and Qualitative Disclosures about Market Risk	21

Item 4	Controls and Procedures	21

Part II — Other Information

Item 4	Submission of Matters to a Vote of Security Holders	21

Item 6	Exhibits	21

Signatures

2007 Incentive Compensation Plan

Employment Agreements

Certifications


							Additional			Other
	Common Stock						Paid-In			Comprehensive			Accumulated
	Shares			Par Value			Capital			Loss			Deficit			Total

Balance, June 30, 2005		16,694		$	167 92		$	34,808		$	(32	)	$	(29,566	)	$	5,377
Exercise of common stock options		331			3			585			—			—			588
Employee stock purchase plan		30			—			64			—			—			64
Stock option compensation expense		—			—			99			—			—			99
Foreign currency translation		—			—			—			(59	)		—			(59	)
Exercise of warrants		152			2			352			—			—			354
Purchase of software license		326			3			787			—			—			790
Issuance of restricted stock		137			2			82			—			—			84
2helix re-negotiation		118			1			(1,520	)		—			—			(1,519	)
Net income		—			—			—			—			319			319

Balance, June 30, 2006		17,788			178			35,257			(91	)		(29,247	)		6,097
Exercise of common stock options		10			—			16			—			—			16
Employee stock purchase plan		17			—			47			—			—			47
Stock option compensation expense		—			—			54			—			—			54
Foreign currency translation		—			—			—			62			—			62
Exercise of warrants		688			7			1,592			—			—			1,599
2helix notes payable settlement		139			2			287			—			—			289
Issuance of restricted stock		(40	)		(1	)		48			—			—			47
Net loss		—			—			—			—			(5,283	)		(5,283	)

Balance, December 31, 2006		18,602		$	186		$	37,301		$	(29	)	$	(34,530	)	$	2,928


	ACE*COMM CORPORATION
February 14, 2007	By	/s/ George T. Jimenez
		George T. Jimenez
		Chief Executive Officer


		/s/ Steven R. Delmar
		Steven R. Delmar
		Chief Financial Officer (Principal Financial Officer)