As filed with the Securities and Exchange Commission on January 27, 2005

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended December 31, 2004

OR

For the transition period from __________ to _________

Commission file number 0-21059

ACE*COMM CORPORATION

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 registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act. Yes o  No  þ

The number of shares of Common Stock outstanding as of January 25, 2005 was 13,805,629.

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ACE*COMM CORPORATION
INDEX

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PART I. FINANCIAL INFORMATION

Item 1. CONSOLIDATED FINANCIAL STATEMENTS

ACE*COMM CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands)

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

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

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

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

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

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ACE*COMM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared by ACE*COMM Corporation and its consolidated subsidiaries (the “Company”) in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) 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 US GAAP 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, 2004.

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; and tax valuation allowances.

Recently Issued Accounting Prouncements

In November 2004, the FASB issued SFAS No. 151 “Inventory Costs, an amendment of ARB No. 43, Chapter 4. The amendments made by Statement 151 clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges and require the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. The guidance is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory costs incurred during fiscal years beginning after November 23, 2004. The Company is currently evaluating the financial statement impact of the adoption of SFAS 151.

In December 2004, the FASB issued SFAS No.123 (revised 2004), “Share-Based Payment” Statement. SFAS 123(R) will provide investors and other users of financial statements with more complete and neutral financial information by requiring that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. Statement 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Statement 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. Statement 123, as originally issued in 1995, established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair-value-based method been used. Public entities (other than those filing as small business issuers) will be required to apply Statement 123(R) as of the first interim or annual reporting period that begins after June 15, 2005. The Company is currently evaluating the financial statement impact of the adoption of SFAS 123(R).

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) were exercised and

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converted to common stock. Because of the reported net losses for the six months ended December 31, 2004, , the effect of including potentially dilutive securities is anti-dilutive and therefore they have been excluded. If stock options had been included, shares used in the diluted loss per share calculation for the six months would have increased by 202,881 shares.

Reclassifications

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

Foreign Currency

The Company’s functional currency for all operations and foreign transactions is the local currency. Gains and losses from the translation of foreign currency into U.S. dollars are included in equity. Gains and losses resulting from foreign currency transactions are included in current results of operations.

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

Stock Based Compensation

The Company generally applies Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations in accounting for stock options and presents pro forma net income and earnings per share data as if the accounting prescribed by Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation” had been applied. The Company also applies the provisions of FIN 44, “Accounting for Certain Transactions Involving Stock Compensation”, as required when modifications and other provisions cause the application of variable accounting which calls for the periodic measurement of compensation expense based on the difference in the exercise price and the underlying value of the related stock.

Had compensation cost been recognized based on the fair values of options at the grant dates consistent with the provisions of SFAS No. 123, the Company’s net (loss) income and basic and diluted net (loss) income per common share would have been changed to pro forma amounts in the following table. The assumptions included in the fair value calculations for the current quarter are expected life of 3 years, interest rate of 3%, expected volatility of 110% and dividend yield of 0%.

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NOTE 2 – ACCOUNTS RECEIVABLE

Accounts receivable consists 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. At December 31, 2004, approximately 23% of the Company’s billed accounts receivable was older than ninety days. Two international customers comprised 30% of our billed accounts receivable at December 31, 2004 and 69% 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. The Company recorded a provision for doubtful accounts of $163 thousand and $90 thousand during the six months ending December 31, 2004 and 2003, respectively. At December 31, 2004, billed receivables due from one customer comprised 21% of the billed accounts receivable balance and billed accounts receivable from four additional customers comprised 29% of the balance.

In the quarter ended March 31, 2004, we delivered products pursuant to a contract with a customer in the Middle East. The contract provides for aggregate installment payments totaling $4.2 million to be made over 5 quarters. Installments totaling $3.7 million were due on or before December 31, 2004 and as of December 31, 2004, $2.8 million of these amounts had been collected and the remainder was included in accounts receivable. In accordance with Statement of Position 97-2, “Software Revenue Recognition,” we will recognize revenue only as amounts become due given the contract’s extended payment terms. Future installments due will be recognized as they become due, assuming no issues related to their collectibility are present.

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NOTE 3 – INVENTORY

Inventory consists of the following (in thousands):

Inventory write-off’s during the six months ended December 31, 2004 and 2003 were $0 and $60 thousand, respectively.

NOTE 4 – DEFERRED CONTRACT COSTS

As discussed in Note 2, during the third quarter of fiscal 2004, we delivered a large order to a customer in the Middle East that has payment terms that extend beyond one year. During the first quarter of 2005, we delivered a large order to an Asian customer under an arrangement with deferred payment terms. We are deferring the recognition of revenue until the due date of the installment payments in accordance with Statement of Position 97-2. Accordingly we have deferred the related costs associated with the future installment payments on both contracts ($258,000 at December 31, 2004) and we will recognize revenue and the related costs on the due date of the payment.

NOTE 5 – STOCKHOLDERS’ EQUITY

During the six months ended December 31, 2004, the Company issued 21,104 shares of common stock under the Employee Stock Purchase Plan.

Other accumulated comprehensive loss comprises foreign currency translation charges associated with operations in the United Kingdom, Australia and Canada.

NOTE 6 – MERGERS AND ACQUISITIONS

On December 5, 2003, ACE*COMM consummated its acquisition of i3 Mobile, Inc. under a merger agreement executed in September 2003. The acquisition was effected through the issuance of approximately 3.8 million shares of our common stock. ACE*COMM accounted for the Merger as a financing transaction and recorded the issuance of its common stock at the negotiated value and i3 Mobile’s cash on hand net of liabilities assumed. Because i3 Mobile ceased all revenue producing operations in March 2003 and we have no intention to revive i3 Mobile’s business subsequent to the Merger, the Merger does not possess the characteristics of a business combination found in Regulation S-X and Financial Accounting Standard No. 141, Business Combinations, and EITF Issue 98-3 Determining Whether a Non-monetary Transaction Involves Receipt of Productive Assets of a Business. As such, no goodwill resulted from this transaction.

During the second quarter of fiscal year 2005, we negotiated a settlement with a former i3 Mobile vendor. The settlement resulted in a reduction of a liability by $228 thousand which the Company recorded as a reduction of current liabilities and a gain which comprises other income. The remaining balance of $163,000 will be paid over a twelve month period.

On February 12, 2004, ACE*COMM completed its previously announced purchase of certain operations support systems solutions assets of Intasys from Mamma.com, Inc. This was accounted for as a purchase and the accompanying financial statements include the results of operations from the purchase date forward. We paid cash of $2.0 million for the purchase of the intellectual property (including in process research and development), customers, fixed assets and transaction related expenses. There was an additional $250 thousand of consideration to be paid based upon certain earn out provisions of the asset purchase agreement. At December 31, 2004, $100 thousand was earned, $40 thousand has been paid and the remaining $60 thousand has been accrued and will be paid in January 2005. The remaining $150 thousand was not earned since the earn out provisions were not met.

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In accordance with FAS 141, the Company allocated the purchase price of the Intasys assets as follows (in thousands):

Contract rights and technology will be amortized over sixty months. Through December 31, 2004, amortization expense totaled $176,000.

The tax benefits associated with the future tax deductions associated with this acquisition have been fully reserved due to doubt as to whether they will be realized. Upon release of the valuation allowance associated with these tax benefits in the future, the related tax benefit will be applied first against recorded intangible assets.

NOTE 7 – INCOME TAXES

The Company is in a net operating loss carry forward position. A valuation allowance offsets all net deferred tax assets.

NOTE 8 – SEGMENT INFORMATION

The Company is managed as one segment and results are measured based on revenue type and not business unit. However, we do not measure operating profit by revenue source. The following table reflects revenues by type and geographic location:

We purchased the OSS assets of Intasys in February 2004, accordingly, the results of Intasys’s OSS revenues are included in our results of operations for the six months ended December 31, 2004. Previous periods do not include the revenue of Intasys.

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

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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, 2004, 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 Report.

Overview

ACE*COMM delivers enterprise telemanagement applications and advanced Convergent Mediation™ and Operations Support Systems solutions to wired and wireless voice, data, and Internet communications providers. Our 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. Our solutions also provide for centralized management and security of enterprise networks. After completing the acquisition of the assets of Intasys Billing Technologies in the quarter ending March 31, 2004, ACE*COMM now offers Intasys’ line of wireless OSS products and has commenced integrating the Intasys technologies into our convergent mediation products.

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 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.

More frequently, we are entering into multiple element arrangements that do not involve significant modification or customization of the related software. In these instances, ACE*COMM allocates revenue to each element of the arrangement based on objective evidence of the element’s fair value.

When an agreement provides for significant modification or customization of software, or when our system integration and product development are essential to the functionality of the software, revenues related to the software licenses and services are aggregated and the combined revenues 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 effort basis. Any hardware or post-contract customer support provided for under the terms of the agreement is unbundled. Hardware revenue is recognized upon delivery, which usually occurs upon transfer of title, and post-contract customer support is recognized ratably over the term of the arrangement.

Most of our professional services are delivered in conjunction with our solutions and are sometimes essential to the functionality of other elements of the arrangement. However, ACE*COMM does sell unbundled services; and, in these instances, ACE*COMM generally recognizes revenue as the services are performed.

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, 2004, we had nine customers generating $150,000 or more in revenue during the period (“Major Customers”) representing approximately 57% of total revenue. Our largest three customers during the three months ended December 31, 2004 were an international systems integrator whose purchases represented approximately 15% of revenue, a reseller in the Middle East whose purchases represented approximately 12% of total revenue and a wireless service provider in the UK, whose purchases represented approximately 9% of total revenue. During the three months ended December 31, 2003, we had three Major

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Customers representing approximately 31% of total revenue. Our largest customer during the three months ended December 31, 2003 was an international systems integrator whose purchases represented approximately 9% of revenue. The average revenue earned per Major Customer was $302 thousand and $253 thousand, respectively, for the three months ended December 31, 2004 and 2003.

To counteract the pressure on revenues from the prolonged downturn in demand in the telecommunications industry, we have been pursuing a growth strategy designed to expand our product line and areas of distribution. The acquisition of i3 Mobile and the purchase of the assets of Intasys during fiscal year 2004 are results of this strategy. During the past three fiscal years and first quarter of fiscal year 2005, we experienced significant net losses from operations, primarily due to reduced demand from our North American telecommunications customers. During the second quarter of 2005, we reported a net loss from operations of $43 thousand. The improvement in results is primarily the result of sales under a large contract with a customer in the Middle East, sales under a large contract with a customer in Asia and revenues from the Intasys OSS business. To offset the effects of the current lower North American demand, we continue to target sales efforts toward what we believe to be a growing market for our Convergent Mediation™ solutions outside of North America and to acquire revenues by expanding our customer base and product offerings through acquisition. During the past fiscal year and current quarter, we increased our revenues from outside of North America, in particular from the Middle East, Asia and Europe as a result of a previously announced order from Telecom Egypt, a new order from an Asian carrier during the current quarter and the new products added through our purchase of the assets of Intasys.

On February 12, 2004, we completed our previously announced acquisition of OSS solutions assets of Intasys from Mamma.com, Inc. We paid $2.0 million for the purchase of the intellectual property, customers, fixed assets and transaction related expenses. The terms provided for an additional $250 thousand of consideration to be paid based upon certain earn out provisions of the asset purchase agreement. At December 31, 2004, $100 thousand was earned, $40 thousand has been paid and the remaining $60 thousand has been accrued and will be paid in January 2005. The remaining $150 thousand will not be earned since the earn out provisions were not met.

In accordance with FAS 142, we allocated the purchase price based on an economic valuation of the purchased assets. Based upon this valuation, we recorded an intangible asset of $845 thousand which is being amortized over sixty months related to the purchased customers and technology of Intasys. Additionally, we recorded a charge of $1.2 million in the third quarter of 2004 associated with the purchase of in process research and development.

We have also focused our sales resources on opportunities for our NetPlus EOSS products. In addition to pursuing our traditional government markets, sales activities have been increased to large commercial enterprises to expand our NetPlus customer base.

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 judgment by our management. 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 and implementation services. Our software licenses to end-users generally provide for an initial license fee to use the product in perpetuity. Operational Support Systems revenue is recognized on a monthly basis based upon the number of telephone subscribers of our customers.

More frequently, we are entering 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 objective evidence of the element’s fair value based on internal price listings developed by ACE*COMM. Revenue for software licenses in these instances is recognized upon delivery (i.e., transfer of title), when a signed agreement exists, the fee

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is fixed and determinable, and collection of the resulting receivable is probable. The amount allocated to ACE*COMM’s maintenance contracts 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. 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.

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.

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 reassessed on a regular basis and revenue is deferred until cash is received.

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.

Results of Operations

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

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Three and Six months ended December 31, 2004 compared to Three and Six Months ended December 31, 2003. The above reflects the results of operations from the purchase of the Intasys OSS assets in February 2004. Previous periods do not include the revenue of Intasys.

Revenue

Revenue for the three months ended December 31, 2004 (“second quarter of fiscal year 2005”) and December 31, 2003, was $4.8 million and $2.4 million, respectively, reflecting an increase of $2.4 million or 100%. Revenue for the six months ended December 31, 2004 and December 31, 2003 was $9.4 million and $4.9 million, respectively, reflecting an increase of $4.5 million or 92%.

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 enterprises, our ability to generate revenue also depends on specific conditions affecting those providers and on general economic conditions. The increase in revenue during the three months and six months ended December 31, 2004 as compared to the corresponding period last year reflects sales under a large contract with a customer in the Middle East of $556 thousand for the quarter and $1.1 million year to date, sales under a large contract with a customer in Asia of $166 thousand for the quarter and $755 thousand year to date and revenues from the Intasys OSS business of $1.3 million for the quarter and $2.6 million year to date.

Revenue from sales to network service providers increased 38% from $1.3 million to $1.8 million for the three months ended December 31, 2004, and represented 38% of total revenue. Revenue from sales to network service providers increased 75% from $2.4 million to $4.2 million for the six months ended December 31, 2004 and represented 45% of total revenue. The increase in revenue during the six months ended December 31, 2004 results from the large contracts from the Middle East and Asia.

Revenue from sales to enterprises increased 45% from $1.1 million to $1.6 million for the three months ended December 31, 2004 and represented approximately 33% of total revenue. Revenue from sales to enterprises increased 9% from $2.5 million to $2.7 million for the six months ended December 31, 2004 and represented 28% of total revenue. Revenues increased during the quarter primarily due to a new customer order, a follow-on order from an existing customer and a maintenance contract.

Revenue from sales of Operations Support Systems was $1.3 million and $2.6 million for the three months and six months ended December 31, 2004, respectively. The Operations Support Systems products were acquired with the purchase of the assets from Intasys in February 2004, and represented 27% of total revenue for the quarter and 28% of total revenue year to date. Periods prior to March 31, 2004, did not include the revenue of the Operations Support Systems products.

Backlog was $9.8 million, including $2.8 million related to the Operations Support Systems products, as of December 31, 2004, compared to $12.1 million as of June 30, 2004. 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 $6.2 million of the backlog at December 31, 2004, will be recognized during fiscal year 2005. 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.

We believe that as a result of the inclusion of the revenues from the asset purchase of Intasys for a full year, the revenues generated from backlog and sales efforts that revenues will increase in fiscal 2005 as compared to fiscal 2004. At this time, we cannot predict whether the increase in revenues will enable us to make a profit for fiscal 2005.

Cost of Revenue

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 revenue was $2.0 million and $1.7 million, respectively, for the three months ended December 31, 2004 and 2003, representing 42% and 71% of total revenue for each period, respectively. Cost of revenue was $4.1 million and $3.3 million,

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respectively, for the six months ended December 31, 2004 and 2003, representing 44% and 67% of total revenue for each period, respectively. Cost of revenue increased $254 thousand, or 15%, during the three months ended December 31, 2004, as compared to the prior corresponding period. Cost of revenue increased $830 thousand, or 25%, during the six months ended December 31, 2004, as compared to the prior corresponding period. The decrease in the cost of sales as a percentage of revenue is primarily the result of fixed costs being spread out over a higher level of sales during the most recent two quarters. Cost of sales of Operations Support Systems was $270 thousand and $550 thousand for the three and six months ended December 31, 2004, respectively, due to the purchase of the assets from Intasys. Periods prior to March 31, 2004, did not include the costs of Intasys. The remaining increase is primarily due to increased materials expense related to the two large contracts in the Middle East and Asia.

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 information systems infrastructure, facilities, finance and accounting, legal, human resources and corporate management.

SG&A expenses were $2.3 million and $2.1 million, respectively, during the three months ended December 31, 2004 and 2003, representing 48% and 87% of total revenue for each period. SG&A expenses were $4.6 and $3.9 million, respectively, for the six months ended December 31, 2004 as compared to the prior year. The decrease as a percentage of revenue results from fixed costs being spread out over a higher level of sales during the most recent quarter. The increase in the level of expenses results from the additional selling, general and administrative costs associated with the Operations Support Systems products acquired from Intasys and in increase in selling expenses for our existing product lines.

Research and Development Expenses

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

Research and development expenses were $570 thousand and $92 thousand during the three months ended December 31, 2004 and 2003, respectively, and represented 12% and 4% of total revenue for each period, respectively. Research and development expenses were $1.1 million and $222 thousand during the six months ended December 31, 2004 and 2003, respectively, and represented 12% and 4% of total revenue for each period, respectively. Research and development expenses increased $478 thousand or 520% during the three months ended December 31, 2004, as compared to the prior corresponding period. Research and development expenses increased $892 thousand or 402% during the six months ended December 31, 2004, as compared to the prior corresponding period. The increase in research and development expenses is primarily due to the inclusion of the research and development expenses associated with the acquisition of the assets of Intasys which amounted to approximately $487 thousand during the current quarter and $938 thousand during the six months ended December 31, 2004. These expenses are expected to continue at or above the current levels for the remainder of fiscal year 2005 as we complete the development of new versions of the Intasys product, expand development of ACE*COMM products and make the technical changes necessary to integrate the new products into our product lines.

Although research and development expenses have increased, we are pursuing several strategies to keep up with market demands for new technology while controlling costs. We have been selective in approving new projects and in some instances discontinued projects that were not related to the development of our core Convergent Mediation™ solutions. In some instances, we charge our customers for development which we include in cost of revenues. Finally, we have been pursuing opportunities to license or acquire new technology from third parties as a strategy for expanding our product offerings. The purchase of the assets of Intasys is an example of this strategy.

Liquidity and Capital Resources

As of December 31, 2004 and June 30, 2004, our primary sources of liquidity were cash and cash equivalents of $2.2 million and $2.9 million, respectively. Cash and cash equivalents decreased by 23% from June 30, 2004 to December 31, 2004, and comprised 23% and 28% of total assets as of December 31, 2004 and June 30, 2004, respectively. The net decrease of $755 thousand is due to cash used in operating activities of $1.1 million offset by borrowings on line of credit of $478 thousand.

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Working capital was $3.7 million at December 31, 2004 and at June 30, 2004. The Company is pursuing a growth strategy that involves acquisitions and additional financing may be required for future acquisitions.

At December 31, 2004, approximately 23% of the Company’s billed accounts receivable was older than ninety days. Two international customers comprised 30% of our billed accounts receivable at December 31, 2004 and 69% 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.

Operating activities used $1.1 million and $1.4 million in cash during the six months ended December 31, 2004 and 2003, respectively. Net cash used for investing activities was $164 thousand and $10 thousand, respectively, during the six months ended December 31, 2004 and 2003, and primarily relates to the addition of leasehold improvements and computer equipment.

Financing activities generated cash of $516 thousand during the six months ended December 31, 2004, primarily from borrowings under our bank line and generated $6.4 million during the six months ended December 31, 2003, resulting from the merger with i3 Mobile, Inc..

Our loan and security agreement with Silicon Valley Bank was renewed effective December 31, 2004. Under the new agreement, we may borrow based upon the amount of our approved borrowing base of eligible accounts receivable, up to a maximum of $3.5 million. The line of credit has sub-limits of $500,000 for letters of credit and $1.25 million for U.S. Export Import Bank usage. We can draw up to 70% of our eligible accounts receivable under the master line and up to 70% of our eligible foreign accounts receivable under the U.S. Export Import Bank sub-limit line. Amounts borrowed bear interest at a rate equal to the bank’s prime rate plus 200 basis points per annum, charged on the average daily balance of advances outstanding, payable monthly and calculated on a 360-day year basis. The receivables comprising the borrowing base must not be more than 90 days aged (unless approved by the bank), must not be in dispute, and must conform to other eligibility requirements. As of December 31, 2004, $674 thousand was available under the line of credit. Our obligations under the Agreement are secured by a security interest in all of our assets and intellectual property. Advances made to us are payable in full upon demand in the event of default under the agreement. Financial covenants under the loan and security agreement require us to maintain certain tangible net worth figures at quarter end, certain quick ratios on a monthly basis and to also maintain a $750 thousand unrestricted cash and borrowing capability requirement per week. At December 31, 2004, we were in compliance with the financial covenants.

ACE*COMM has issued standby letters of credit for security deposits for office space and to guarantee service contracts as summarized in the following table. The letters of credit total approximately $350 thousand at December 31, 2004 , which are fully secured under our line of credit with the Bank.

Under the terms of our corporate headquarters’ office lease, we maintain a letter of credit under our line of credit with our bank, which names the landlord as the sole beneficiary and which may be drawn on by the landlord in the event of a monetary default by us under the lease. The letter of credit required under the lease through November 2004 is $135,000. For the remainder of fiscal year 2005, the letter of credit will decrease to $124 thousand and will continue to decrease annually thereafter through fiscal year 2008. As of the date of this filing, we were not subject to any draw against this letter of credit by the landlord.

We have incurred significant net losses from operations during the past three fiscal years and first quarter of fiscal year 2005, primarily due to reduced demand from our North American telecommunications customers. During the second quarter of 2005 we reported a net loss from operations of $43 thousand. The improvement in results is primarily the result of increased revenues related to sales under a large contract with a customer in the Middle East, sales under a large contract with a customer in Asia and revenues from the Intasys OSS business. To offset the effects of the current lower North American demand, we continue to target sales efforts toward what we believe to be a growing market for our Convergent Mediation™ solutions outside of North America and to acquire revenues by expanding our customer base and product offerings through acquisition.

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As a result of previous losses, we have maintained numerous cost reduction measures which have kept operating expenses low. Additionally, we have developed contingency plans to reduce expenses further, should revenues decline below projected levels.

We are continuing to manage our expenses to conserve cash and maintain adequate liquidity. We have no significant commitments for capital expenditures at December 31, 2004. We believe that existing consolidated cash balances reflecting completion of the i3 Mobile merger, cash flow from operations, and the availability of credit under our agreement with the Bank will support our working capital requirements for the next twelve months, based on our current expectations as to anticipated revenue, expenses and cash flow.

The following table summarizes contractual obligations and commitments as of December 31, 2004 which includes the commitments associated with the asset purchase of Intasys:

Additional 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,’ 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, any failure to obtain a sufficient number of large contracts could 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 of 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.

Unless economic conditions improve, our results of operations may not return to prior levels

The current economic environment remains volatile. If the current uncertainty and negativity in the economic climate in the U.S. and the rest of the world continues, our customers — and our business and financial results — will continue to be adversely affected.

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The adverse conditions in the telecommunications industry are materially and adversely affecting us 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 three or four years capital spending by telecommunication companies has been at reduced levels and may continue to be at such levels or decrease further. Various commentators have attributed the decrease in spending to the decline in the telecommunications industry in particular and economic conditions in general. Telecommunications products and services have increasingly become commodities that cannot easily be distinguished with intense competition in the development of new technology or other features and increasing competition from smaller but rapidly developing alternative carriers. The reduction of spending by companies in the telecommunication industries has caused, and may continue to cause, a significant reduction in our revenues. Although we recently noted 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 software or OSS solutions products or services.

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.

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 companies that provide telecommunications services or that manufacture and market network equipment. If we are not able to maintain or develop 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 and until 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 52% of our gross trade receivables balance as of December 31, 2004. 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. We have also experienced significant losses for doubtful accounts. For a more detailed discussion of doubtful accounts please read the section labeled “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Allowance for Bad Debts”. Several of our international customers have negotiated extended payment terms.

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

Our OSS solutions must be compatible with and add value to our customer’s existing systems and networks, and that compatibility and value-add must be maintained as these systems and networks change over time. 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. Further, customers are always looking for the most

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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.

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, and longer payment cycles. We derived approximately $3.0 million, or 63% of our total revenue and $760 thousand or 31% from customers outside of the United States for the three months ended December 31, 2004 and 2003, respectively. We derived $6.1 million, or 64% of total revenue and $1.4 million or 28.7% of total revenue from customers outside of the United States for the six months ended December 31, 2004 and 2003, respectively. To the extent that we have increased our international revenue sources over the last three years, the impact of the risks related to international sales could have an increasingly larger effect on our financial condition as a whole.

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

We intend to investigate and pursue potential business combinations as one of the ways of growing our business during a difficult period. However, acquisitions must be conducted very carefully or there can be adverse consequences. In particular, failure to identify risks of potential acquisition targets or inability to correctly evaluate costs of combining business or technologies could cost us significant resources, dilution to our stockholders or loss of valuable time. Acquisitions may require additional financing and the additional financing may not be available or may not be available on terms acceptable to the Company.

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 typically formalized in agreements that 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 are exposed to interest rate risk related to any borrowings under our line of credit. As of December 31, 2004, borrowings outstanding under our line of credit were approximately $1.0 million. Our market risk sensitive instruments do not expose us to material market risk exposures.

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

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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 in timely alerting them to any material information relating to us and our subsidiaries required to be included in our Exchange Act filings.

There were no significant changes in our internal controls over financial reporting 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

On December 3, 2004, the Registrant held its 2004 Annual Meeting of Stockholders. A vote was held for the election of Directors and the stockholders re-elected Directors Paul Casner, Jr. and Matthew Stover, both Class II directors, whose terms expire at the 2007 Annual Meeting, and J. William Grimes, Class III director, whose term expires at the 2005 Annual Meeting.

The stockholders also took the following action at the 2004 Annual Meeting:

To approve the proposal to ratify the selection of Grant Thornton LLP as the Company’s independent auditors for the fiscal year ending June 30, 2005.

(b) Reports on Form 8-K

     During the period covered by this report, ACE*COMM filed the following reports on Form 8-K:

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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