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As filed with the Securities and Exchange Commission on February 14, 2002

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the transition period from                to               

Commission file number 0-21059

ACE*COMM CORPORATION

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

     Indicate by check mark whether registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act. Yes o No x

The number of shares of Common Stock outstanding as of December 31, 2002 was 9,781,220

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ACE*COMM CORPORATION
INDEX
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2002

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PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

ACE*COMM CORPORATION
BALANCE SHEETS
(in thousands)

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

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ACE*COMM CORPORATION
STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)

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

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

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

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ACE*COMM CORPORATION
NOTES TO FINANCIAL STATEMENTS

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited financial statements have been prepared by ACE*COMM Corporation (the “Company”) in accordance with generally accepted accounting principles for interim financial statements and pursuant to the rules of the Securities and Exchange Commission for Quarterly Reports on Form 10-Q. Accordingly, certain information and footnotes required by generally accepted accounting principles for complete financial statements have been omitted. 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, 2002.

Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates.

Reclassifications

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

NOTE 2 – ACCOUNTS RECEIVABLE

Accounts receivable consist of the following (in thousands):

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. The Company recorded a provision for doubtful accounts of $60,000 and wrote-off $521,000, of which $512,000 related to one customer was included in the allowance for the six months ended December 31, 2002. In addition, the Company recovered $9,000 to the allowance for the six months ended December 31, 2002. The Company increased its allowance for doubtful accounts to $209,000 and wrote-off $85,000 in uncollectable accounts for the six months ended December 31, 2001. During the six months ended December 31, 2002, gross receivables increased by $925,000, largely reflecting the lengthening of the payment terms for some of the Company’s international customers and the timing of shipments during the quarter.

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NOTE 3 – STOCKHOLDERS’ EQUITY

During the six months ended December 31, 2002, the Company issued 23,048 shares of common stock under the Employee Stock Purchase Plan and there were no exercises of stock options issued under the Omnibus Stock Plan. For the six months ended December 31, 2001, the Company issued 36,064 shares of common stock under the Employee Stock Purchase Plan and there were no exercises of stock options under the Omnibus Stock Plan.

In December 2002, a new strategic partner, Westlake Development Company, Inc., acquired 475,000 or 4.86% shares of the Company’s common stock at an aggregate purchase price of $475,000.

Stock Repurchases

During the twelve months ended September 16, 2002, the Company repurchased a total of 48,872 shares of common stock at an average per share price of $0.84. During the six months ended December 31, 2002, the Company repurchased 44,872 shares of common stock at an average per share price of $0.82. The Stock Repurchase program expired on September 16, 2002.

NOTE 4 – INCOME TAXES

Net operating loss carry forwards are available to offset the tax liability related to income earned during the six months ended December 31, 2002. Accordingly, no provision for income taxes was recorded.

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ITEM 2. Management’s Discussion and Analysis of Results of Operations And Financial Condition

Cautionary Note Regarding Forward-Looking Statements

     This Quarterly Report and the information incorporated by reference in it include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We intend the forwarding-looking statements to be covered by the safe harbor provisions for forward-looking statements in these sections. These forward-looking statements relate to future events or the future financial performance of the Company, some or all of which may involve risk and uncertainty. The Company 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, 2002, 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 others matters presented in this Quarterly Report.

     The following discussion and analysis should be read in conjunction with our financial statements and related notes included elsewhere in the Report on Form 10-Q and our Annual Report on Form 10-K filed with the SEC on June 30, 2002.

Overview   The Company delivers enterprise telemanagement applications and advanced Convergent Mediation™ solutions to wired and wireless voice, data, and Internet communications providers. The Company’s solutions are tailored to each customer’s needs and 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. The Company’s solutions also provide for centralized management and security of enterprise networks.

     The Company enters into formal arrangements that provide for single or multiple deliverables of hardware, software and related 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 primarily U.S. dollar denominated typically have an aggregate value of several thousand to several million dollars and vary in length from 30 days to several years (e.g., master agreements). Agreements spanning several years are typically implemented in smaller statements of work or orders that are typically deliverable within three to twelve months.

     The Company derives revenue primarily from the sale of its product-based solutions, where a combination of hardware, proprietary software and related services are offered to customers. When an agreement provides for significant modification or customization of software, or when the Company’s system integration and product development are essential to the functionality of the software, revenue related to the software licenses and services are aggregated and the combined revenue are recognized on a percentage-of-completion basis. 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. Any hardware or post contract customer support provided for under the terms of the agreement is unbundled. Hardware revenue is recognized upon delivery (e.g., transfer of title) and post contract customer support is recognized ratably over the term of the arrangement.

     Most of the Company’s professional services are delivered in conjunction with the Company’s solutions and are essential to the functionality of other elements of the arrangement, and are therefore bundled with software licenses as

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described above. However, the Company occasionally sells unbundled services; in these instances, the Company generally recognizes revenue as the services are performed.

     In some instances, the Company enters into a multiple element arrangement that does not involve significant modification or customization of the related software. In these limited instances, the Company allocates revenue to each element of the arrangement based on objective evidence of the element’s fair value based on internal price listings developed by the Company. Revenue 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.

     Revenue for a given period typically reflects products delivered or services performed during the period with respect to relatively large financial commitments from a small number of customers. During the three months ended December 31, 2002, the Company had six customers generating $150,000 or more in revenue during the period (“Major Customers”) representing approximately 70% of total revenue. The Company’s largest customer during the three months ended December 31, 2002, was a supplier who delivers advanced U.S. technologies to the communication sectors of China and represented approximately 24% of total revenue. During the three months ended December 31, 2001, the Company had twelve Major Customers representing approximately 77% of total revenue. The average revenue earned per Major Customer was $475 thousand and $296 thousand, for the three months ended December 31, 2002 and 2001, respectively.

     During fiscal years 2001 and 2002, the Company experienced significant net losses from operations, primarily due to lower demand from its North American telecommunications customers. Management expects this lower demand to continue in the foreseeable future. To offset the effects of the current lower North American demand, the Company continues to target sales efforts in what it believes to be a growing market for its Convergent Mediation™ solutions outside of North America.

     The Company plans to continue pursuing new business opportunities in partnerships and alliances with other companies, although there can be no assurances as to the timing or effectiveness of any partnering arrangements. These arrangements could include technology and marketing alliances driven by product development requirements and sales opportunities, as well as other business combinations that would strengthen the Company’s product offerings and market potential.

Critical Accounting Policies

     In December 2001, the SEC requested that all registrants include a discussion of its critical accounting policies. The Company’s significant accounting policies are more fully described in Note 2 included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2002. However, certain number of our accounting policies are particularly important to the portrayal of our financial position and results of operations and require the application of significant judgment by our management. The following is a brief discussion of the Company’s critical accounting policies:

Allowance for Doubtful Accounts

     The allowance for doubtful accounts is an estimate of losses resulting from the inability of our customers to make required payments. We evaluate the adequacy of the allowance regularly, 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. If our assessment indicates that collection is not probable at the time the transaction is consummated, we do not recognize revenue until cash collection.

     However, analysis of the ability of our customers to make required payments is subject to substantial uncertainty. In general, historical data and recent experience both indicate that in the absence of the bankruptcy of a customer, almost all accounts receivable are paid in due course, despite an increase in the number of days to collect over the past several years. However, the current economic conditions and our customer base, which is highly concentrated in the telecommunications and Internet service provider industries where several of the leading companies have filed for bankruptcy, has made analysis of collectibility of accounts increasingly difficult. Normal indicators used in customer creditworthiness evaluation have not adequately predicted the sudden decline in financial condition experienced by some of our customers. Our growing number of international customers has posed additional challenges regarding collections.

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In addition, the data on which we base our assessments may not be completely current or reliable, and receipt of new data can result in large adjustments to the allowance for doubtful accounts. One example of this type of adjustment is the recent $512,000 write off related to a single customer, where we concluded based on new data that the customer likely would not be able to make payment.

While we have attempted to reflect these factors in the estimates and assumptions used to arrive at the allowance, the use of different estimates or assumptions could produce significantly different allowances

  Revenue Recognition

     The Company derives revenues primarily from product-based solutions, where a combination of hardware, proprietary software, and services are offered to customers. These product-based solutions are typically formalized in a multiple element arrangement involving significant modification or customization of the underlying software and services related to implementation and integration. The Company’s software licenses to end-users generally provide for an initial license fee to use the product in perpetuity. Under certain contracts, the Company licenses its software to resellers for subsequent modification and resale. In situations when the Company’s product-based solutions involve significant modification or customization of software, or when the Company’s 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. The hardware revenue on these contracts is recognized upon transfer of title. 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.

     The Company also enters into a multiple element arrangements that do not involve significant modification or customization of the related software. In these limited instances, the Company recognizes revenue in accordance with the American Institute of Certified Public Accountants (AICPA) Statement of Position 97-2, “Software Revenue Recognition,” and allocates revenue to each element of the arrangement based on objective evidence of the element’s fair value based on internal price listings developed by the Company. Revenue 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.

     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 customers is re-assessed on a regular basis and revenue is deferred until cash is received.

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Results of Operations

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