e10vq

As filed with the Securities and Exchange Commission on November 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 September 30, 2007


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

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES þ NO 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 November 6, 2007 was 19,208,219.

PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

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


	September 30,			June 30,
	2007			2007
	(Unaudited)
Assets

Current assets:
Cash and cash equivalents	$	1,284		$	2,622
Restricted cash		349			349
Accounts receivable, net		4,117			3,831
Inventories, net		760			769
Deferred contract costs		41			—
Prepaid expenses and other		775			688

Total current assets		7,326			8,259
Property and equipment, net		787			749
Goodwill		386			386
Acquired intangibles, net		405			512
Other non-current assets, net		489			597

Total assets	$	9,393		$	10,503


Liabilities and Stockholders’ Equity

Current liabilities:
Accounts payable	$	971		$	880
Accrued expenses		1,348			1,758
Accrued compensation		845			878
Deferred revenue		3,621			3,798

Total current liabilities		6,785			7,314
Series A Senior Convertible Note, net of a debt discount of $1,613 and $1,780		2,587			2,420

Total liabilities		9,372			9,734


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, 19,106,513 and 18,647,962 shares issued and outstanding		191			186
Additional paid-in capital		39,532			39,320
Other accumulated comprehensive loss		(29	)		(28	)
Accumulated deficit		(39,673	)		(38,709	)

Total stockholders’ equity		21			769


Total liabilities and stockholders’ equity	$	9,393		$	10,503

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

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


	For the three months ended
	September 30,
	2007			2006
	(Unaudited)			(Unaudited)
Cash flows from operating activities:
Net income (loss)	$	(964	)	$	(2,745	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		379			401
Amortization of debt discount		167			—
Provision for doubtful accounts and inventory reserves		19			49
Restricted stock compensation expense		29			25
Stock option and employee stock purchase plan compensation expense		59			34
Issuance of common stock as payment of interest		121			—

Changes in operating assets and liabilities:
Accounts receivable		(286	)		1,183
Inventories, net		(10	)		20
Prepaid expenses and other assets		(87	)		(45	)
Deferred contract costs		(41	)		(67	)
Accounts payable		91			(165	)
Accrued liabilities		(443	)		13
Deferred revenue		(177	)		(352	)

Net cash used in operating activities		(1,143	)		(1,649	)


Cash flows from investing activities:
Purchases of property and equipment		(126	)		(75	)
Proceeds from other non-current assets		—			12
Purchase of software license		(76	)		(86	)

Net cash used in investing activities		(202	)		(149	)

Cash flows from financing activities:
Net borrowings on line of credit		—			(124	)
Other notes payable		—			(5	)
Proceeds from exercise of stock warrants		—			1,599
Proceeds from employee stock purchase plan and exercise of stock options		8			32

Net cash provided by financing activities		8			1,502

Net decrease in cash and cash equivalents		(1,337	)		(296	)
Effect of exchange rate change on cash		(1	)		49
Cash and cash equivalents at beginning of period		2,622			946

Cash and cash equivalents at end of period	$	1,284		$	699


Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	6		$	73
Cash paid during the period for income taxes	$	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	$	—		$	—

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

ACE*COMM CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)


						Additional		Other
	Common Stock					Paid-In		Comprehensive			Accumulated
	Shares			Par Value		Capital		Loss			Deficit			Total
Balance, June 30, 2006		17,788			178		35,257		(91	)		(29,247	)		6,097
Exercise of common stock options		14			—		18		—			—			18
Employee stock purchase plan		37			—		69		—			—			69
2helix notes payable settlement		139			1		287		—			—			288
Exercise of warrants		688			7		1,591		—			—			1,598
Payment of interest from financing		27			—		26		—			—			26
Restricted stock grants, net of forfeitures		(45	)		—		82		—			—			82
Warrants granted in connection with the sale of Series A Senior Secured Convertible Notes		—			—		1,814		—			—			1,814
Stock option compensation expense		—			—		176		—			—			176
Foreign currency translation		—			—		—		63			—			63
Net loss		—			—		—		—			(9,462	)		(9,462	)

Balance, June 30, 2007		18,648			186		39,320		(28	)		(38,709	)		769
Employee stock purchase plan		11			—		8		—			—			8
Payment of interest from financing		174			2		119		—			—			121
Restricted stock grants, net of forfeitures		274			3		26		—			—			29
Stock option compensation expense		—			—		59		—			—			59
Foreign currency translation		—			—		—		(1	)		—			(1	)
Net loss		—			—		—		—			(964	)		(964	)

Balance, September 30, 2007		19,107			191		39,532		(29	)		(39,673	)		21

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

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared by management of ACE*COMM Corporation 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, 2007.

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 25% and 13% of our revenues were calculated under this method for the three months ended September 30, 2007 and 2006, respectively. 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 at each month end the cumulative progress on each contract matches the then 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 costs of $41 thousand as of September 30, 2007 and no deferred contract costs as of June 30, 2007.

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 $186 thousand and $354 thousand at September 30, 2007 and 2006, respectively.

Restricted Cash

The Company maintains a cash deposit of $349 thousand used as collateral for letters of credit issued as security deposits on office leases and contract deposits.

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 three months ended September 30, 2007 or 2006.

Intangibles and Goodwill

Intangibles and goodwill acquired in connection with business acquisitions are stated at their fair value on the date of purchase. The cost of intangibles which are subject to amortization are amortized on a straight-line basis over their expected lives of two to five years. The recoverability of carrying values of amortizable intangible assets is evaluated on a recurring basis whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. Recovery of assets to be held and used is measured by comparing the carrying value of these assets with the expected future cash flows generated by the assets. If the assets are considered to be impaired, the impairment is recognized by the amount which the carrying amount of the assets exceeds their fair value. Goodwill and intangibles with indefinite lives are not amortized, but are subject to an annual impairment test, pursuant to the provision of FAS No. 142: Goodwill and Other Intangible Assets. The primary indicators are current and forecasted profitability and cash flow of the related business. There have been no adjustments to the carrying values of goodwill or intangible assets resulting from these impairment tests during 2007.

Amortization expense for identified intangibles acquired were $107 thousand for the three months ended September 30, 2007 and 2006. Estimated future aggregate annual amortization expense for intangible assets is as follows (in thousands):


Year Ended June 30,	Amount

2008	$	376
2009	$	136

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.

Property and Equipment

Property and equipment are recorded at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets as follows: equipment and vehicles over five to seven years; computer equipment over three to seven years. Leasehold improvements are amortized on a straight-line basis over the shorter of the improvements’ estimated useful lives or related remaining lease terms. Maintenance and repair costs are charged to current earnings.

Income Taxes

ACE*COMM accounts for income taxes under Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes”. Deferred income tax assets and liabilities are determined based upon differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance reduces deferred tax assets when it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Fair Value of Financial Instruments

The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses approximate fair value because of the short maturity of these items. The carrying amounts of debt issued pursuant to our bank credit agreements approximate fair value because the interest rates on these instruments change with market interest rates.

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
	September 30,
	2007			2006
	(Unaudited)			(Unaudited)

Net (loss) income	$	(964	)	$	(2,745	)
Other comprehensive income (foreign currency translation)		(1	)		32

Total comprehensive (loss) income	$	(965	)	$	(2,713	)

Recently Issued Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” which is effective for fiscal years beginning after November 15, 2007. This statement permits an entity to choose to measure many financial instruments and certain other items at fair value at specified election dates. Subsequent unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. The Company is currently evaluating the potential impact of SFAS No. 159 on its consolidated results of operations and financial position.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact of SFAS No. 157 on its consolidated results of operations and financial position.

NOTE 3 — ACCOUNTS RECEIVABLE

Accounts receivable consists of the following (in thousands):


	September 30,			June 30,
	2007			2007

Billed receivables	$	2,721		$	2,380
Unbilled and other receivables		1,561			1,616
Allowance for doubtful accounts		(165	)		(165	)

	$	4,117		$	3,831

Billed

At September 30, 2007, five of our customers, including three international customers, comprised $1.6 million or 58% of the total billed receivables. One of these five customers has billed receivables totaling $201 thousand that have been outstanding for longer than ninety days. We have total billed receivables of $574 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 — INVENTORIES

Inventories consist of the following (in thousands):


	September 30,			June 30,
	2007			2007

Inventories	$	1,213		$	1,203
Allowance for obsolescence		(453	)		(434	)

	$	760		$	769

Inventory write-offs were $19 thousand for the three months ended September 30, 2007 and 2006. 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 $480 thousand is included in inventory with the balance of the license included in other assets.

NOTE 5 — STOCKHOLDERS’ EQUITY

During the three months ended September 30, 2007, the Company issued 11,045 shares of common stock under the Employee Stock Purchase Plan. The Company also issued 275,000 shares as restricted stock grants which vest over three years and cancelled 1,125 shares of previously granted restricted stock due to employee terminations. The Company recognized a $29 thousand expense during the three months ended September 30, 2007 related to these restricted stock grants.

In addition, 173,631 shares were issued during the first quarter of fiscal year 2008 for the payment of interest from the Series A note.

Warrants

At September 30, 2007, there are 500,000 stock warrants outstanding from the March 31, 2005 private placement at an exercise price of $3.53 per share, which expire April 1, 2010. Also, there are warrants to purchase 1,860,760 shares of common stock outstanding issued in connection with the sale of Series A Senior Convertible debt on June 8, 2007 at an exercise price of $0.84 per share which expire June 8, 2014.

NOTE 6 — BORROWINGS

Series A Senior Secured Convertible Note

The stock portion of any repayment may not exceed 100% of the daily trading volume of the Company’s common stock without consent of the investors. The Company has a limited right to defer a specified number of monthly installments.

The interest rate of 11.25% per annum will be reduced by 1% for every 25% increase in the share price over the life of the loan, but will be readjusted in the event of a subsequent share price reduction. The notes are convertible, from time to time, into shares of the Company’s common stock at a fixed conversion price of $0.80 per share, subject to certain adjustments. These adjustments will include an adjustment provision commonly known as a “ratchet,” which automatically lowers the conversion price if subsequent issuances of equity occur at a price below the conversion price, although the agreements prohibit the Company from making such issuances of equity and thereby lowering the conversion price until all necessary shareholder approvals have been obtained. The notes also include standard anti-dilution provisions, which adjust the conversion rate in the event of a stock split, stock dividend, combination or similar corporate transaction.

The notes are guaranteed by the Company’s subsidiaries and secured by a pledge of substantially all assets of the Company and its subsidiaries. Proceeds from these notes replace the Company’s outstanding lines of credit with Silicon Valley Bank. The notes contain various financial covenants, including requirements to maintain specified minimum tangible net worth, cash, quarterly revenues, EBITDA and eligible working capital. Events of default include the failure to pay principal, interest or other payments when due, material breaches of the investment documents, certain change of control events and specified bankruptcy events. Upon an event of default, the principal and all accrued interest may be accelerated at the option of the holders and become immediately due and payable, and the holders have the right to require the Company to repurchase the notes at a price equal to 125% of the outstanding principal amount plus accrued interest.

The investment documents contain various limitations on other debt and equity financings during the three years in which the notes are outstanding, and require the proceeds of any such financings to be used to make an offer to pay down the notes. Those limitations include prohibitions on the incurrence of other senior or secured debt and rights of first refusal in the event of other debt and equity financings. The investors also have rights of approval over proposed sales of assets and rights of first refusal in the event of sales of any business line. At September 30, 2007, the Company was in compliance with all covenants.

In connection with the issuance of these notes, the Company issued stock purchase warrants for the purchase of up to 1,860,760 shares of the Company’s common stock at $0.84 per share. This stock purchase warrant expires on June 8, 2014. Based on the relative fair value of the note and stock purchase warrants, the stock purchase warrant has been assigned a value of $933 thousand, which represents a note discount. The Company also calculated the value of beneficial conversion feature associated with these notes of $880 thousand. The discount related to the warrants and beneficial conversion feature will be amortized to interest expense over the life of the notes. The Company has a best efforts obligation to register the shares and has filed a registration statement, which is presently in review by the SEC.

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.

Effective July 1, 2007, we adopted the provisions of the Financial Accounting Standards Board (“FASB”) Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 prescribes a more-likely-than-not threshold of 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 derecognition of income tax assets and liabilities, classification of current and deferred tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods and income tax disclosures. The cumulative effects of applying this interpretation did not have a significant impact on either our net deferred tax assets or valuation allowance.

We have made no adjustments to the classification of assets or liabilities, or recognized any income tax related liability for unrecognized tax benefits, in connection with the adoption of FIN 48.

The Company is subject to income taxes in the U.S federal jurisdiction, and various states and foreign jurisdictions. Tax regulations within each jurisdiction are subject to interpretation of the related tax laws and regulations and require significant judgment to apply. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for the years before 1998.

In adopting FIN 48, the Company changed its previous method of classifying interest and penalties related to unrecognized tax benefits as income tax expense to classifying interest accrued as interest expense and penalties as operating expenses.

Subsequently, in May 2007, the FASB published FSP FIN 48-1. FSP FIN 48-1 is an amendment to FIN 48. It clarifies how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. As of our adoption of FIN 48, our accounting is consistent with the guidance in FSP FIN 48-1.

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
	September 30,
	2007			2006
	(Unaudited)			(Unaudited)
Basic EPS:
Net income (loss) — numerator
Net income (loss) available to common shareholders	$	(964	)	$	(2,745	)
Shares — denominator
Weighted average common shares		18,250			17,441

Basic EPS	$	(0.05	)	$	(0.16	)


Diluted EPS:
Net income (loss) — numerator
Net income (loss) available to common shareholders	$	(964	)	$	(2,745	)
Shares — denominator
Weighted average common shares		18,250			17,441
Stock options		—			—
Restricted stock		—			—

Total weighted shares and equivalents		18,250			17,441

Diluted EPS	$	(0.05	)	$	(0.16	)

Diluted EPS

Due to the loss incurred during the three months ended September 30, 2007, no incremental shares related to stock options are included in the calculation of Diluted EPS because the effect would be anti-dilutive. A total of 4,810,447 potentially dilutive shares related to outstanding stock options and warrants were not included in the EPS calculation at September 30, 2007 since their effect would be anti-dilutive. The impact of the conversion of the Series A Senior Convertible Notes has been excluded at September 30, 2007 since the conversion into the maximum of 5,250,000 shares would have been anti-dilutive.

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, 2007, 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 September 30, 2007, we had five customers generating $150,000 or more in revenue during the period (“Major Customers”) representing approximately 69% of total revenue. Our three largest customers during the three months ended September 30, 2007 were Giza Systems, whose purchases represented approximately 22% of total revenue, mBlox, Inc. accounted for 19% of total revenues and Northrop Grumman accounted for 18% of reported revenue. During the three months ended September 30, 2006, we had five Major Customers representing approximately 41% of total revenue. However, only one such customer, General Dynamics (11% of revenue), had revenue greater than 10% of reported revenue. The average revenue earned per Major Customer was $574 thousand and $247 thousand, respectively, for the three months ended September 30, 2007 and 2006.

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.

We incurred significant losses in fiscal 2007, and in April 2007 we began reducing expenses to more closely align anticipated future revenues with expenses. During the past year, we have put more focus on our Patrol Suite of products marketed to carriers on a global basis. The sales cycles for these types of sales are longer than our other products and services and range from twelve to twenty-four months. We recently announced our first sales to carriers in North America and have entered into partnership arrangement with Alcatel-Lucent and VeriSign to resell our Patrol Suite of products.

In fiscal 2007, we introduced our next generation convergent mediation product OpenARMS™, an Advanced Revenue Management solution for telecommunications service providers. OpenARMS™ uses open source components that complement open orchestration and processing products from ACE*COMM’s current portfolio and are integrated using a fully extensible service oriented architecture (SOA). The solution is designed to satisfy a new breed of multi-media service providers with diverse order, product, contract and customer relationship management needs as well as billing, invoicing, and settlement needs, at a fraction of the price of traditional proprietary solutions. OpenARMS™ can be retrofitted into traditional carrier environments as the carriers reach out to customers with multi services offerings.

Over the last year, we have focused our sales resources on opportunities for our newest generation of NetPlus^® EOSS products. We are focusing our sales activities on pursuing our traditional government markets and are being selective in pursuing 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 of fiscal 2007. This customer accounted for 1% of our consolidated revenue for the year ended June 30, 2007, and 5% of our consolidated revenues in fiscal year 2006.

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. We have implemented additional cost reduction measures, which have reduced operating expenses. In the past fiscal year, total expenses have decreased $3.7 million or 14% over the prior year. In April 2007, the Company reduced operating expenses further by approximately $3.0 million per annum primarily through a reduction in personnel and personnel related costs. Because of the shortfalls in revenue, we have experienced severe liquidity demands and incurred large losses over the past fiscal year and in this first quarter of fiscal 2008.

We are continuing to manage our costs and have implemented numerous cost reduction measures to keep operating expenses lower than prior years and at a level which addresses our liquidity issues. We believe that these cost reduction measures do not affect our operational capabilities. We have also carried over these cost reduction measures to our acquisitions as part of the continued integration of the acquired companies. We are continuing to look for additional areas where we can decrease expenses.

Recent Developments

Delisting from Nasdaq Capital Market

The company’s common stock ceased trading on the Nasdaq Capital Market at the opening of business on September 17, 2007. The company’s common stock is trading on the OTC “Pink Sheets” but is expected to become eligible for trading on the OTC Bulletin Board if a market maker makes application to register in and quote the security in accordance with SEC Rule 15c2-11 and such application is cleared. Until such time trading in the common stock may be conducted in the “Pink Sheets.” Effective November 2, 2007, the common stock was trading on the Over the Counter Bulletin Board (OTCBB) under the symbol ACEC.OB.

The delisting followed a series of letters from Nasdaq regarding non-compliance. These included a letter on March 28, 2007 relating to the failure to meet the minimum $1.00 per share requirement for 30 consecutive trading days and a letter received on May 23, 2007 indicating that the company failed to comply with the requirements to have a minimum shareholders’ equity of $2.5 million or $35 million market value of listed securities. We regained compliance with Nasdaq’s minimum bid price requirement, but were out of compliance again by August 10, 2007. The Nasdaq Listing Qualifications staff also agreed to grant us an extension through September 5, 2007 to regain compliance with the minimum shareholders’ equity requirement. On September 6, 2007, we received a delisting letter for failure to come into compliance with that requirement. After discussions with Nasdaq and investors, we did not appeal the Nasdaq Stock Market’s determination to delist the company’s stock from the Nasdaq Capital Market.

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 25% and 13% of our revenue for the three months ended September 30, 2007 and 2006, respectively, was derived from contracts accounted for under the percentage of completion method.

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.

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

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 charge during the three months ended September 30, 2007 and 2006.

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
	September 30,
	2007			2006

Revenue		100.0	%		100.0	%
Costs and expenses:
Cost of revenue		46.8	%		68.7	%
Selling, general and administrative expenses		61.7	%		93.7	%
Research and development		8.1	%		25.8	%

Income (loss) from operations		(16.6	)%		(88.2	)%
Interest expense		6.7	%		2.6	%

Income (loss) before income taxes		(23.3	)%		(90.8	)%
Income tax expense		0.0	%		0.0	%

Net income (loss)		(23.3	)%		(90.8	)%

Revenues

The following summarizes revenue for the three months ended September 30, (in thousands):


	For the three months ended
	September 30,
	2007		2006
	(Unaudited)		(Unaudited)

Revenue
Licenses and hardware	$	1,099	$	458
Services		3,042		2,564

Total revenue	$	4,141	$	3,022

Total revenues for the three months ended September 30, 2007 were $4.1 million compared to $3.0 million in 2006, reflecting an increase of $1.1 million or 37%. During this quarter our revenues increased as we were able to book additional business on existing contracts, increase deliveries on existing contracts and deliver on new customer contracts.

License and hardware revenue increased by $0.6 million to $1.1 million for the three months ended September 30, 2007 compared to 2006. The increase during three months ended September 30, 2007, included increased revenues of $0.4 million from the U.S. Air Force and $0.1 million from a new customer in the U.K.

Services revenue increased by $0.4 million from $2.6 million for the three months ended September 30, 2006 to $3.0 million in 2007. The majority of this increase was principally the result of a new customer in the U.K. for our Advanced Operations Support Systems, which increased revenue by $0.7 million offset by completion of two service contracts in fiscal year 2007 for $0.3 million.


	For the three months ended
	September 30,
	2007		2006
	(Unaudited)		(Unaudited)

Revenue by Type
Enterprise	$	1,417	$	964
Advanced Operations Support Systems (AOSS)		2,637		2,058
Value Added Services (VAS)		87		—

Total Revenue	$	4,141	$	3,022

Revenue from sales to enterprises increased 40% from $1.0 million for the three months ended September 30, 2006, to $1.4 million for the three months ended September 30, 2007. The increase is primarily as a result of an increase in revenues of $0.5 million from the U.S. Air Force.

Revenue from sales of Advanced Operations Support Systems increased 24% from $2.1 million to $2.6 million for the three months ended September 30, 2007, and represented 64% of total revenue. The increase during the three months ended September 30, 2007, included revenues of $0.8 million from a customer in the Middle East offset by completion of two service contracts in the U.K. in fiscal year 2007 for $0.3 million.

Revenue from sales of Value added Services increased 100% to $0.1 million for the three months ended September 30, 2007, compared to 2006. The increase is due to revenues from two contracts received in the third quarter of fiscal year 2007.

Backlog was $14.4 million as of September 30, 2007 compared to $12.9 million at June 30, 2007. 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 $8.6 million of the backlog will be recognized during the remainder of fiscal year 2008. 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 $1.9 million and $2.1 million for the three months ended September 30, 2007 and 2006, respectively, representing 47% and 69% of revenues, respectively. The decrease relates to hardware costs of approximately $118 thousand for two contracts incurred in 2007 that were not incurred in the current quarter and our cost reduction measures. Because revenues increased significantly and most of our costs are relatively fixed, cost of revenue as a percentage of revenue decreased significantly.

Cost of licenses and hardware revenue was $308 thousand and $303 million for the three months ended September 30, 2007 and 2006, respectively, representing 28% and 66% of licenses and hardware revenue, respectively. The percentage of revenues decreased because fixed costs are being spread over higher revenues.

Cost of services revenue was $1.6 million and $1.8 million for the three months ended September 30, 2007 and 2006, respectively, representing 54% and 69% of services revenue for those periods, respectively. Cost of services revenue as a percentage of revenue decreased due to the increase 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 $2.6 million and $2.8 million for the three months ended September 30, 2007 and 2006, representing 62% and 94% of total revenues in each period, respectively. The percentage decrease is primarily due to the increase in revenues. Additionally, the cost reductions implemented last fiscal year have reduced SG&A expenses. We plan to continue to monitor our general and administrative expenses and further reduce costs as appropriate.

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 OpenARMS and NetPlus and our convergent mediation service delivery platform.

Research and development expenses were $337 thousand and $780 thousand for the three months ended September 30, 2007 and 2006, respectively, and represented 8% and 26% of revenues for the three months ended September 30, 2007 and 2006, 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 were reduced as part of our cost reduction effort.

In 2007, we decreased our expenditures on research and development as part of our cost containment plans. Our revenues declined during the year, we reduced expenses in all areas, and we have been selective in approving new projects and in some instances deferred projects that were not related to the development of Parent Patrol^® or Open ARMS™ solutions. We are also evaluating alternative development opportunities such as outsourcing or 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 been pursuing opportunities to license or acquire market-ready new technology from third parties as part of our strategy for expanding our product offerings while reducing expenses and bringing products to market faster.

Liquidity and Capital Resources

Asset and Cash Flow Analysis

We had cash and cash equivalents of $1.3 million and $2.6 million at September 30, 2007 and June 30, 2007, respectively. The Company also has $349 thousand of restricted cash that can only be used as collateral for letters of credit. Cash and cash equivalents decreased by $1.3 million from June 30, 2007 to September 30, 2007, and comprised 14% and 25% of total assets as of September 30, 2007 and June 30, 2007, respectively. The increase in accounts receivable from $3.8 million at June 30, 2007 to $4.1 million at September 30, 2007 relates primarily to the increase in revenues. Working capital decreased $0.4 million from $0.9 million at June 30, 2007 to $0.5 million at September 30, 2007.

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 62% of our gross trade receivables balances as of September 30, 2007 and three of these customers are international. At September 30, 2007, approximately 21% of the Company’s billed accounts receivable was older than ninety days compared to 16% at June 30, 2007. Five customers comprised 58% of our billed accounts receivable at September 30, 2007, and 87% of this balance is current. We expect that international telecommunication and internet service providers will continue to take longer to make payments than domestic customers.

Our operating activities used $1.1 million and $1.6 million in cash during the three months ended September 30, 2007 and 2006, respectively. The change between periods in cash flows from operating activities is principally due to changes in net loss after adjustments for non-cash charges such as depreciation and amortization.

Net cash used for investing activities was $202 thousand and $149 thousand, respectively. Financing activities generated cash of $8 thousand and $1.5 million during the three months ended September 30, 2007 and 2006, respectively. The cash generated during the three months ended September 30, 2006, was primarily from the exercise of stock warrants by investors.

Cost Containment Program

Although revenues increased during the first quarter of fiscal 2008 and in the fourth quarter of 2007, we have continued to manage our expenses based on expectations as to anticipated revenues and expenses. In April 2007, the Company reduced operating expenses by approximately $3.0 million per annum primarily through a reduction in personnel and personnel related costs. We expect to have increased costs and continuing liquidity demands in the future as we devote significant efforts to delivering products and services, supporting our customers under existing contracts and investing in new products. 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. In the first quarter of 2008, we began to see the benefits of these actions as our cash loss declined somewhat reducing our liquidity demands.

The following table summarizes contractual obligations and commitments as of September 30, 2007:


	Payments Due by Period
	(amounts in thousands)

Contractual Obligation	Total		Less than 1 year		1-3 years		4-5 years		After 5 years

Operating leases	$	1,840	$	988	$	620	$	232	$	—
Other commitments		17		14		3		—		—

Total commitments	$	1,857	$	1,002	$	623	$	232	$	—

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.


	Commitment Expiration Per Period (in thousands)

	Total Amounts		Less than 1
Other Commercial Commitments	Committed		year		1-3 years		4-5 years		Over 5 years

Standby Letters of Credit	$	349	$	349	$	—	$	—	$	—

Series A Senior Secured Convertible Note

On June 8, 2007, ACE*COMM Corporation completed a private placement of $4.2 million of senior secured convertible notes, yielding net proceeds to the Company of $3.6 million. The notes are to be repaid over a 3-year period ending June 2010, in equal monthly installments beginning December 30, 2008, 18 months into the term of the notes. Repayment must be in cash or, if the Company’s market price is 10% or more above the conversion price, in shares of the Company’s common stock, valued at the conversion price (or at the market price, in the event of payment of interest in stock). The stock portion of any repayment may not exceed 100% of the daily trading volume of the Company’s common stock without consent of the investors. The Company has a limited right to defer a specified number of monthly installments. A fuller description of these notes is set forth in Note 6 — Borrowings.

Liquidity Analysis

At September 30, 2007, we had cash and cash equivalents and restricted cash of $1.6 million. We expect to continue to have liquidity demands during the current fiscal year as we devote significant effort to delivering products and services and supporting our customers under the contracts resulting in our backlog at September 30, 2007.

We are continuing to manage our expenses to conserve cash and maintain adequate liquidity. In the fourth quarter of 2007, we reduced annual expenses by approximately $3.0 million annually and we were able to increase revenues in the quarter, but not to the level to reach break even. In the first quarter of 2008, we increased revenues slightly over the previous quarter and reduced our loss significantly, reducing our liquidity demand from previous levels. We have no significant commitments for capital expenditures at September 30, 2007. We believe that cash flows from operations, particularly collection of outstanding accounts receivable, receipt of new contracts, and our current cash will support our working capital requirements for the next twelve months, based on our current expectations as to anticipated revenue, expenses and cash flow.

In June of 2007 we raised $4.2 million of convertible debt financing that provided working capital and in conjunction with the April 2007 reduction in operating expenses by approximately $3.0 million per annum achieved primarily through a reduction in personnel and personnel related costs, we have reduced our liquidity demands. To avoid future liquidity problems we must increase revenues or we will have to raise additional capital. This financing, or any other financing that may be available to us, is likely to be more expensive than previous financings and there is no assurance that future financings can be closed.

The $4.2 million of senior secured convertible notes issued to the selling stockholders in our recent private placement must be repaid in cash unless certain conditions exist that allow us to repay such notes in shares of common stock, including that the market price of our common stock is 10% or more above the conversion price and that the stock portion of any repayment not exceed 100% of the daily trading volume of our common stock without consent of the investors. We have only a limited right to defer a specified number of monthly installments. Since the daily trading volume of our common stock has been well below the amount needed to allow us to pay in stock, and since the recent market price of our common stock has been well below the conversion price, our ability to repay the notes will depend upon the willingness of the investors to accept repayment in stock or on our having or raising the cash needed to repay. Principal is to be repaid in eighteen equal payments beginning in December 2008.

Certain provisions from our recent private placement could make it more difficult for us to raise financing in the future, including an antidilution right known as a ratchet under which the note conversion price and warrant exercise price would decrease, and accordingly the number of shares issuable under the notes and warrants would increase, in the event we make subsequent issuances of equity at a price less than the note conversion price and warrant exercise price, unless the anti-dilution provision is waived or modified by the note holders. If the subsequent issuance is at a significantly lower price, the increase in the number of shares could be substantial, causing existing stockholders to suffer significant dilution in ownership interests and voting rights. These provisions also may inhibit our ability to raise additional equity capital while the notes and warrants are outstanding. We also agreed not to incur any senior debt and not to incur more than $2.5 million of subordinated debt, and substantially all of our assets have been pledged to secure certain indebtedness under the notes and we have agreed not to pledge any assets to support other indebtedness. With respect to equity offerings, we have granted the investors a right of first refusal, for as long as the notes are outstanding, to participate in any subsequent equity financing that we conduct. Further, we have agreed to use all proceeds of any equity or debt financing to fund an offering to repurchase the notes plus a 25% premium. These provisions may hamper our ability to raise additional capital while the notes are outstanding.

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 2007, we were not able to book some of the larger contracts we were pursuing 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 twelve months, the effects were significant resulting in our having large losses for the year.

We have experienced severe liquidity demands as a result of revenue shortfalls.

The cumulative losses in the previous year created a significant liquidity problem for the Company. In June of 2007 we raised $4.2 million of convertible debt financing that provided working capital and in conjunction with the April 2007 reduction in operating expenses by approximately $3.0 million per annum achieved primarily through a reduction in personnel and personnel related costs, we have reduced our liquidity demands. To avoid future liquidity problems we must increase revenues or we will have to raise additional capital. This financing, or any other financing that may be available to us, is likely to be more expensive than previous financings and there is no assurance that future financings can be closed.

We may be unable to repay the notes issued in our recent private placement unless we raise additional funds or satisfy those notes in shares of common stock.

The $4.2 million of senior secured convertible notes issued to the selling stockholders in our recent private placement must be repaid in cash unless certain conditions exist that allow us to repay such notes in shares of common stock, including that the market price of our common stock is 10% or more above the conversion price and that the stock portion of any repayment not exceed 100% of the daily trading volume of our common stock without consent of the investors. We have only a limited right to defer a specified number of monthly installments. Since the daily trading volume of our common stock has been well below the amount needed to allow us to pay in stock, and since the recent market price of our common stock has been well below the conversion price, our ability to repay the notes will depend upon the willingness of the investors to accept repayment in stock or on our having or raising the cash needed to repay. We cannot assure you that we will have sufficient funds to repay these notes and meet our operating needs.

We may cease to comply with the restrictive financial covenants in our recent private placement.

The notes issued in our recent private placement contain restrictive financial covenants, including requirements to maintain:

	•		certain levels of tangible net worth (as described on Schedule 3 to the Notes),

	•		certain levels of cash (as described on Schedule 3 to the Notes),

	•		certain levels of EBITDA (as described on Schedule 3 to the Notes)

	•		quarterly revenues of not less than $3,000,0000 and

	•		eligible working capital of not less than $4,200,000.

These financial covenants are more extensive than those in the lines of credit we had in place before this financing, and in the past we have had to request waivers from our lenders to avoid default because of our non-compliance with financial covenants. Any future default, if not cured or waived, could result in the acceleration of all indebtedness outstanding under the notes, and we do not expect to have sufficient funds to make full payment of the principal amount of the notes in the event of acceleration. In addition, our ability to obtain future financing may depend upon our ability to show at that time pro forma compliance with the covenants through the maturity date of the notes. We cannot assure you that we will remain in compliance with the financial covenants.

The anti-dilution rights in our recent private placement may make it difficult for us to raise funds and may result in a significant increase in the number of shares issuable under the notes and warrants.

In the recent private placement we granted the investors an anti-dilution right known as a “ratchet,” under which the note conversion price and warrant exercise price would decrease, and accordingly the number of shares issuable under the notes and warrants would increase, in the event we make subsequent issuances of equity at a price less than the note conversion price and warrant exercise price, unless the anti-dilution provision is waived or modified by the note holders. If the subsequent issuance is at a significantly lower price, the increase in the number of shares could be substantial, causing existing stockholders to suffer significant dilution in ownership interests and voting rights. These provisions also may inhibit our ability to raise additional equity capital while the notes and warrants are outstanding.

Other provisions from our recent private placement could make it more difficult for us to raise financing in the future.

We also agreed in the documents for the recent private placement not to incur any senior debt and not to incur more than $2.5 million of subordinated debt. Further, substantially all of our assets have been pledged to secure certain indebtedness under the notes and we have agreed not to pledge any assets to support other indebtedness. With respect to equity offerings, we have granted the investors a right of first refusal, for as long as the notes are outstanding, to participate in any subsequent equity financing that we conduct. We also have granted an anti-dilution right known as a ratchet, described more fully in the preceding paragraph. Further, we have agreed to use all proceeds of any equity or debt financing to fund an offering to repurchase the notes plus a 25% premium. These provisions may hamper our ability to raise additional capital while the notes are outstanding.

Demand for our Parent Patrol^® product has not developed as rapidly as expected and overall demand is still uncertain.

We have been projecting for a couple of years a strong growth in the demand for the technology underlying our Parent Patrol^® and related products, based upon market research and other factors. However, while the number of contracts for these products is growing, and reports on consumer desires for this capability still show that demand should be increasing, we have not yet seen the revenue growth that we have been expecting. Carriers have been slower to embrace and implement this technology than anticipated, and the increase in interest following AT&T’s introduction of a product in this space may not continue. Since we are continuing to invest in this product line, the demand for this technology is expected to have a significant impact on our results of operations and ability to return to profitability.

Our delisting from the Nasdaq Capital Market and recent listing on the over-the-counter bulletin board could reduce the marketability of our shares and our ability to raise equity capital could be harmed.

Our common stock was delisted from the Nasdaq Capital Market and we are currently trading on the over-the-counter bulletin board. This could make it more difficult for investors to sell our shares, may cause the price of our common stock to decline to reflect this and may make it more difficult or expensive for us to raise additional equity capital in the future. In addition, since our common stock has been delisted, it comes within the definition of “penny stock” as defined in the Securities Exchange Act of 1934 and is covered by Rule 15g-9 of the Securities Exchange Act of 1934. That rule imposes additional sales practice requirements on broker-dealers who sell securities to persons other than established customers and accredited investors. For transactions covered by Rule 15g-9, the broker-dealer must make a special suitability determination for the purchaser and receive the purchaser’s written agreement to the transaction prior to the sale. Consequently, Rule 15g-9’s applicability affects the ability or willingness of broker-dealers to sell our securities, and accordingly affects the ability of stockholders to sell their securities in a public market and limits our ability to raise additional equity capital in the future.

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 wide spread market acceptance, and the sales cycle for these products is 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 62% of our gross trade receivables balance as of September 30, 2007. 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 Results of Operations and Financial Condition — 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 61% and 60% of our revenue from customers outside of the United States for the three months ended September 30, 2007 and 2006 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.

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.

We may be subject to additional risks

The risks and uncertainties described above are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also adversely affect our business operations.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to interest rate risk related to our Series A Senior Secured Convertible Notes. As of September 30, 2007, we owed $4.2 million on these notes. Our market risk sensitive instruments do not expose us to material market risk exposures. Should interest rates increase or decrease 1%, interest expense would increase or decrease $42 thousand per year based on our borrowings as of September 30, 2007. We are exposed to foreign currency risks related to our foreign operations. Principal currencies we have exposure to include the British pound and Canadian dollar. We do not hedge these exposures and fluctuations could impact our results of operations, financial position, and cash flows.

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 6. EXHIBITS

(a) Exhibits


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


Part I — Financial Information

Item 1	Consolidated Financial Statements

	Consolidated Balance Sheets as of September 30, 2007 (Unaudited) and June 30, 2007	3

	Consolidated Statements of Operations (Unaudited) for the three months ended September 30, 2007 and 2006	4

	Consolidated Statements of Cash Flows (Unaudited) for the three months ended September 30, 2007 and 2006	5

	Consolidated Statements of Stockholders’ Equity for the three months ended September 30, 2007 and the year ended June 30, 2007	6

	Notes to Consolidated Financial Statements (Unaudited)	7

Item 2	Management’s Discussion and Analysis of Results of Operations and Financial Condition	14

Item 3	Quantitative and Qualitative Disclosures about Market Risk	27

Item 4	Controls and Procedures	27

Part II — Other Information

Item 6	Exhibits	27

Signatures

Certifications


	ACE*COMM CORPORATION
November 14, 2007	By:	/s/ James W. Greenwell
		James W. Greenwell
		Chief Executive Officer



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