UNITED
STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

---

FORM 10-Q

(Mark one)

|[X] | QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934
|--- | ----------------------------------------------------------------------------------------

For the quarterly
period ended April 30, 2005

OR

|[  ] | TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|---- | ----------------------------------------------------------------------------------------

For the transition
period from __________ to ________

Commission File No.
0-24015

STEELCLOUD, INC(Exact name of registrant as specified in its charter)

|VIRGINIA
(State or other jurisdiction of
incorporation or organization) | 54-1890464
(I.R.S. Employer Identification No.)
|----------------------------------------------------------------------- | -----------------------------------------------

|14040 Park Center Road, Herndon, VA
(Address of principal executive offices) | 20171
(Zip code)
|---------------------------------------------------------------------------- | ----------------

(703) 674-5500
(Registrant's telephone number, including area code)

1306 Squire Court
Dulles, VA   20166(Former name, former address and former fiscal year, if changed since
last report)

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 |_|

Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule  12b-2
of the Exchange Act).

Yes |_|   No |X|

As of June 10, 2005 there
were 13,946,862 shares of the registrants common stock outstanding.

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SteelCloud, Inc.
Form 10-Q IndexFor the Quarterly period ended April 30, 2005

|Description |  |                                                                                                           |  | Page | 
|----------- |  | --------------------------------------------------------------------------------------------------------- |  | ---- | 
|            | 
|Part I.     |  | Financial Information                                                                                     |  |      | 
|            | 
|Item 1.     |  | Financial Statements                                                                                      |  | 3    | 
|            | 
|            |  | Consolidated Balance Sheets as of October 31, 2004 and April 30, 2005                                     |  | 3    | 
|            | 
|            |  | Consolidated Statements of Operations for the three month periods ended April 30, 2004 and 2005           |  | 4    | 
|            | 
|            |  | Consolidated Statements of Cash Flows for the three month periods ended April 30, 2004 and 2005           |  | 5    | 
|            | 
|            |  | Consolidated Statements of Stockholders Equity for the three month periods ended April 30, 2004 and 2005 |  | 6    | 
|            | 
|            |  | Notes to the Consolidated Financial Statements                                                            |  | 7    | 
|            | 
|Item 2.     |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                     |  | 10   | 
|            | 
|Item 3.     |  | Quantitative and Qualitative Disclosures About Market Risks                                               |  | 17   | 
|            | 
|Item 4.     |  | Controls and Procedures                                                                                   |  | 17   | 
|            | 
|Part II.    |  | Other Information                                                                                         |  | 19   | 
|            | 
|Item 1.     |  | Legal Proceedings                                                                                         |  | 19   | 
|            | 
|Item 2.     |  | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities                          |  | 19   | 
|            | 
|Item 3.     |  | Defaults Upon Senior Securities                                                                           |  | 19   | 
|            | 
|Item 4.     |  | Submission of Matters to a Vote of Security Holders                                                       |  | 19   | 
|            | 
|Item 5.     |  | Other Information                                                                                         |  | 19   | 
|            | 
|Item 6.     |  | Exhibits and Reports on Form 8-K                                                                          |  | 20   | 

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PART I. FINANCIAL
INFORMATION

ITEM 1. FINANCIAL
STATEMENTS

STEELCLOUD, INC.
CONSOLIDATED BALANCE SHEET

|                                                               | October 31,2004 |  | April 30,2005 |            
|-------------------------------------------------------------- | --------------- |  | ------------- | -----------
|                                                               |                 |  |               |            
|ASSETS                                                         |                 |  |               |            
|Current assets                                                 |                 |  |               |            
|Cash and cash equivalents                                      |                 |  | $             | 3,108,941  
|Accounts receivable, net                                       |                 |  |               | 9,532,770  
|Inventory, net                                                 |                 |  |               | 3,629,685  
|Prepaid expenses and other current assets                      |                 |  |               | 307,427    
|Deferred contract cost                                         |                 |  |               | 40,085     
|                                                               |                 |  |               |            
|Total current assets                                           |                 |  |               | 16,618,908 
|                                                              
|Property and equipment, net                                    |                 |  |               | 454,928    
|Equipment on lease, net                                        |                 |  |               | 373,590    
|Goodwill and other intangible assets, net                      |                 |  |               | 4,687,105  
|Deferred tax asset                                             |                 |  |               | 400,000    
|Other assets                                                   |                 |  |               | 196,244    
|                                                               |                 |  |               |            
|Total assets                                                   |                 |  | $             | 22,730,775 
|                                                               |                 |  |               |            
|LIABILITIES AND STOCKHOLDERS EQUITY                           |                 |  |               |            
|Current liabilities                                            |                 |  |               |            
|Accounts payable                                               |                 |  | $             | 4,866,079  
|Accrued expenses                                               |                 |  |               | 1,441,350  
|Notes payable, current                                         |                 |  |               | 71,176     
|Unearned revenue                                               |                 |  |               | 373,017    
|                                                               |                 |  |               |            
|Total current liabilities                                      |                 |  |               | 6,751,622  
|                                                              
|Notes payable, long-term                                       |                 |  |               | 120,660    
|Other                                                          |                 |  |               | 20,083     
|                                                               |                 |  |               |            
|Total long-term liabilities                                    |                 |  |               | 140,743    
|                                                              
|Stockholders equity                                           |                 |  |               |            
|Preferred stock, $.001 par value: 2,000,000 shares authorized, |                 |  |               |            
|no shares issued and outstanding at October 31, 2004 and       |                 |  |               |            
|April 30, 2005                                                 |                 |  |               |           
|Common stock, $.001 par value: 50,000,000 shares authorized,   |                 |  |               |            
|14,213,514 and 14,346,862 shares issued at October 31, 2004    |                 |  |               |            
|and April 30, 2005, respectively                               |                 |  |               | 14,214     
|Additional paid in capital                                     |                 |  |               | 50,934,453 
|Treasury stock, 400,000 shares at October 31, 2004 and         |                 |  |               |            
|April 30, 2005, respectively                                   |                 |  |               | (3,432,500 
|Accumulated deficit                                            |                 |  |               | (31,677,757
|                                                               |                 |  |               |            
|Total stockholders equity                                     |                 |  |               | 15,838,410 
|                                                               |                 |  |               |            
|Total liabilities and stockholders equity                     |                 |  | $             | 22,730,775 
|                                                               |                 |  |               |            

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

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STEELCLOUD,
INC.CONSOLIDATED STATEMENTS OF OPERATIONS(unaudited)

|                                             | Three Months EndedApril 30, |  | Six Months EndedApril 30, |           
|-------------------------------------------- | --------------------------- |  | ------------------------- | ----------
|
|Revenues                                     |                             |  |                           |           
|Products                                     |                             |  | $                         | 4,636,361 
|Services                                     |                             |  |                           | 1,155,403 
|                                             |                             |  |                           |           
|Total revenues                               |                             |  |                           | 5,791,764 
|                                             |                             |  |                           |           
|Cost of revenues                             |                             |  |                           |           
|Products                                     |                             |  |                           | 3,338,071 
|Services                                     |                             |  |                           | 716,861   
|                                             |                             |  |                           |           
|Total cost of revenues                       |                             |  |                           | 4,054,932 
|                                             |                             |  |                           |           
|Gross profit                                 |                             |  |                           | 1,736,832 
|                                            
|Selling and marketing                        |                             |  |                           | 514,530   
|Research and product development             |                             |  |                           | 124,973   
|General and administrative                   |                             |  |                           | 1,411,661 
|Amortization of other intangible assets      |                             |  |                           |          
|                                             |                             |  |                           |           
|(Loss) income                                |                             |  |                           | (314,332  
|                                            
|Interest expense (income), net               |                             |  |                           | 1,597     
|                                             |                             |  |                           |           
|Net (loss) income                            |                             |  |                           | (315,929  
|                                            
|(Loss) earnings per share:                   |                             |  |                           |           
|                                            
|Basic (loss) earnings per share              |                             |  | $                         | (0.02     
|Diluted (loss) earnings per share            |                             |  | $                         | (0.02     
|                                            
|Weighted-average shares outstanding, basic   |                             |  |                           | 13,431,893
|Weighted-average shares outstanding, diluted |                             |  |                           | 13,431,893

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

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STEELCLOUD, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited)

|                                                                   | Six Months EndedApril 30, | 
|------------------------------------------------------------------ | ------------------------- | 
|
|                                                                   |                           | 
|Operating activities                                               |                           | 
|Net (loss) income                                                  |                           | 
|                                                                  
|Adjustments to reconcile net (loss) income to net cash (used in)   |                           | 
|provided by operating activities:                                  |                           | 
|                                                                  
|Depreciation and amortization                                      |                           | 
|                                                                  
|Changes in operating assets and liabilities, net of effects of     |                           | 
|acquisition:                                                       |                           | 
|Accounts receivable                                                |                           | 
|Inventory                                                          |                           | 
|Prepaid expenses and other assets                                  |                           | 
|Deferred contract costs                                            |                           | 
|Accounts payable                                                   |                           | 
|Accrued expenses                                                   |                           | 
|Unearned revenue and other liabilities                             |                           | 
|                                                                   |                           | 
|Net cash (used in) provided by operating activities                |                           | 
|                                                                  
|Investing activities                                               |                           | 
|Purchase of property and equipment                                 |                           | 
|Cash paid in acquisition                                           |                           | 
|                                                                   |                           | 
|Net cash used by investing activities                              |                           | 
|                                                                  
|Financing activities                                               |                           | 
|Proceeds from issuance of common stock                             |                           | 
|Proceeds from exercise of common stock options                     |                           | 
|Payments on notes payable                                          |                           | 
|Proceeds on line of credit                                         |                           | 
|                                                                   |                           | 
|Net cash provided by financing activities                          |                           | 
|Net (decrease) increase in cash and cash equivalents of operations |                           | 
|Cash and cash equivalents at beginning of period                   |                           | 
|                                                                   |                           | 
|Cash and cash equivalents at end of period                         |                           | 
|                                                                   |                           | 
|Supplemental cash flow information                                 |                           | 
|Common stock issued in acquisition                                 |                           | 
|Interest paid                                                      |                           | 
|Income taxes paid                                                  |                           | 

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

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STEELCLOUD, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY(unaudited)

|                            | Preferred Stock |  | Common Stock |   | AdditionalPaid-In |  | Treasury |  | Accumulated |            | 
|--------------------------- | --------------- |  | ------------ | - | ----------------- |  | -------- |  | ----------- | ---------- | 
|
|                            |                 | 
|Balance at November 1, 2003 |                 |  |              |  |                   |  |         |  |             | 13,008,553 | 
|                            |                 | 
|Issuance of common stock    |                 |  |              |   |                   |  |          |  |             |            | 
|in connection with          |                 |  |              |   |                   |  |          |  |             |            | 
|exercise of employee        |                 |  |              |   |                   |  |          |  |             |            | 
|incentive stock option      |                 |  |              |   |                   |  |          |  |             |            | 
|plan                        |                 |  |              |  |                   |  |         |  |             | 97,496     | 
|                           
|Issuance of common stock    |                 |  |              |   |                   |  |          |  |             |            | 
|in connection with          |                 |  |              |   |                   |  |          |  |             |            | 
|exercise of                 |                 |  |              |   |                   |  |          |  |             |            | 
|warrants                    |                 |  |              |  |                   |  |         |  |             | 247,525    | 
|                           
|Issuance of common stock    |                 |  |              |   |                   |  |          |  |             |            | 
|in connection with          |                 |  |              |   |                   |  |          |  |             |            | 
|employee stock purchase     |                 |  |              |   |                   |  |          |  |             |            | 
|plan                        |                 |  |              |  |                   |  |         |  |             | 24,846     | 
|                           
|Issuance of common stock    |                 |  |              |   |                   |  |          |  |             |            | 
|in connection with          |                 |  |              |   |                   |  |          |  |             |            | 
|acquisition                 |                 |  |              |  |                   |  |         |  |             | 575,000    | 
|                           
|Net loss                    |                 |  |              |  |                   |  |         |  |             |           | 
|                            |                 | 
|Balance at April 30, 2004   |                 |  |              |  |                   |  |         |  |             | 13,953,420 | 
|                            |                 | 
|                           
|                            |                 | 
|Balance at November 1, 2004 |                 |  |              |  |                   |  |         |  |             | 14,213,514 | 
|                            |                 | 
|Issuance of common stock    |                 |  |              |   |                   |  |          |  |             |            | 
|in connection with          |                 |  |              |   |                   |  |          |  |             |            | 
|exercise of employee        |                 |  |              |   |                   |  |          |  |             |            | 
|incentive stock option      |                 |  |              |   |                   |  |          |  |             |            | 
|plan                        |                 |  |              |  |                   |  |         |  |             | 100,625    | 
|                           
|Issuance of common stock    |                 |  |              |   |                   |  |          |  |             |            | 
|in connection with          |                 |  |              |   |                   |  |          |  |             |            | 
|employee stock purchase     |                 |  |              |   |                   |  |          |  |             |            | 
|plan                        |                 |  |              |  |                   |  |         |  |             | 32,723     | 
|                           
|Net income                  |                 |  |              |  |                   |  |         |  |             |           | 
|                            |                 | 
|Balance at  April 30, 2005  |                 |  |              |  |                   |  |         |  |             | 14,346,862 | 
|                            |                 | 

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

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STEELCLOUD, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|1. | Nature of Business and Basis of Presentation
|-- | --------------------------------------------

Founded in 1987,
SteelCloud, Inc, (the Company) based in Herndon, Virginia, designs
and manufactures ready-to-deploy server appliances through strategic
relationships with software and technology companies. The Companys server
appliances are designed to meet the precise needs of volume customers.
SteelClouds consulting services organization provides clients with
technical services, including network analysis and design; security audits and
assessments and managed security services. The Company also resells the software
products of its strategic partners and certain other software providers. In
addition, the Company is making research and development investments to develop
intellectual property in the form of SteelCloud branded software and server
appliances that will help organizations be compliant with federal and state
legislative acts such as Sarbanes-Oxley, Gramm-Leach-Bliely and Health Insurance
Portability and Accountability Act (HIPAA).

The consolidated
financial statements for the three and six month periods ended April 30, 2005
and 2004 are unaudited and include all adjustments which, in the opinion of
management, are necessary to present fairly the results of operations for the
periods then ended. All such adjustments are of a normal and recurring nature.
These consolidated financial statements should be read in conjunction with the
Annual Report on Form 10-K of the Company, which includes consolidated financial
statements and notes thereto for the years ended October 31, 2004 and 2003.

|2. | Employee Stock Options
|-- | ----------------------

The Company accounts for
employee stock option grants using the intrinsic method in accordance with
Accounting Principles Board (APB) Opinion No. 25 Accounting for Stock
Issued to Employees and accordingly associated compensation expense, if
any, is measured as the excess of the underlying stock price over the exercise
price on the date of grant. The Company complies with the disclosure option of
Statement of Financial Accounting Standards (SFAS) No. 123 Accounting for
Stock Based Compensation, and SFAS No. 148 Accounting for
Stock-Based CompensationTransition and Disclosure which requires
pro-forma disclosure of compensation expense associated with stock options under
the fair value method.

The Companys pro
forma information follows:

|                                                     | Three Months EndedApril 30, |  | Six Months EndedApril 30, |         
|---------------------------------------------------- | --------------------------- |  | ------------------------- | --------
|
|                                                     |                             |  |                           |         
|Net (loss) earnings, as reported                     |                             |  | $                         | (315,929
|Less: Total stock based employee compensation        |                             |  |                           |         
|expense determined under the fair-value based method |                             |  |                           | 59,251  
|                                                     |                             |  |                           |         
|Pro-Forma net (loss) earnings                        |                             |  | $                         | (375,180
|                                                     |                             |  |                           |         
|Basic (loss) earnings per share as reported          |                             |  | $                         | (0.02   
|                                                     |                             |  |                           |         
|Basic pro-forma net (loss) earnings per share        |                             |  | $                         | (0.03   
|                                                     |                             |  |                           |         
|Diluted earnings (loss) per share as reported        |                             |  | $                         | (0.02   
|                                                     |                             |  |                           |         
|Diluted pro-forma net earnings (loss) per share      |                             |  | $                         | (0.03   
|                                                     |                             |  |                           |         

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|3. | Operating Leases
|-- | ----------------

The Company moved its
headquarters and operations facilities in April 2005. As such, the Company has
executed non-cancelable leases for these new facilities. The leases expire in
August 2009 and August 2014. Rent expense under these leases, which is recorded
on a straight-line basis over the life of each lease, is approximately $44,000
per month. This expense includes certain costs associated with the operations
and maintenance of the new facilities.

|4. | Debt
|-- | ----

On March 21, 2005, the
Company renewed its bank line of credit that allows the Company to borrow an
amount to the lesser of its collateralized cash on hand or $3.5 million. The
line of credit bears interest at the LIBOR Market Index rate plus 1.25%. The
line of credit is secured by all assets of the Companyand expires on
March 31, 2006. The outstanding borrowings on the line of credit at October 31,
2004 and April 30, 2005 were $0 and $2.0 million, respectively.

On February 17, 2004, the
Company executed two three-year promissory notes in conjunction with the
purchase of the assets of Asgard for an aggregate principal amount of $170,138.
The promissory notes each bear interest at 4% and mature in February 2007. The
Company makes monthly aggregate payments of $4,726 plus accrued interest. The
outstanding balance on the two notes at October 31, 2004 and April 30, 2005 was
$132,330 and $103,973, respectively.

|5. | Deferred Contract Revenue
|-- | -------------------------

As of April 30, 2005, the
Company had deferred contract revenue of approximately $351,000 related to a
Lockheed Martin contract, which was awarded in fiscal year 2005. The deferred
revenue represents payments received for milestones achieved prior to
recognition of revenue. This revenue will be recognized over the remaining life
of the contract as products are shipped under the contract, which is scheduled
for completion in August of 2005. As of April 30, 2005, the deferred costs
associated with this contract were approximately $267,000. Other deferred
revenue consists of warranties, OEM releases and consulting services.

|6. | Earnings Per Share
|-- | ------------------

Basic earnings per share
is based on the weighted average number of common shares outstanding during the
period and is calculated by dividing the net earnings (loss) by the weighted
average number of common shares outstanding. Diluted earnings per share is based
on the weighted average number of common shares outstanding plus common stock
equivalents associated with stock options and warrants and is calculated by
dividing net earnings by the weighted average number of common shares
outstanding used in the basic earnings per share calculation plus the common
stock equivalent of stock options and warrants.

|7. | Segment Reporting
|-- | -----------------

FASB Statement No. 131,
Disclosures about Segments of an Enterprise and Related Information,
establishes standards for reporting information about operating segments.
Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker, or decision making group, in deciding how to
allocate resources and in assessing performance. The Companys chief
operating decision maker is the Companys President. While the President is
apprised of a variety of financial metrics and information, the President makes
decisions regarding how to allocate resources and assess performance based on a
single operating unit.

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|8. | Significant Customer
|-- | --------------------

For the three and six
months ending April 30, 2005, the Company had multiple contracts with one
significant third party customer, Lockheed Martin. Lockheed Martin revenues were
approximately 67% and 71% of total net revenues for the three months and six
months ended April 30, 2005, respectively. Accounts receivable balances at
October 31, 2004 and April 30, 2005 included amounts due from Lockheed Martin of
approximately 63% and 73%, respectively, of total net accounts receivable.

|9. | Recent Accounting Pronouncements
|-- | --------------------------------

In December 2004, the
FASB issued SFAS No.123 (revised 2004), Share-Based Payment.
Statement 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. In April 2005,
the Securities and Exchange Commission amended the compliance dates for
implementing Statement 123(R). Public entities (other than those filing as small
business issuers) will be required to apply Statement 123(R) effective as of the
beginning of the next fiscal year that begins after June 15, 2005, with early
adoption encouraged. The Company expects to adopt 123(R) November 1, 2005 and is
currently evaluating which alternatively permitted method of adoption will be
used and the financial statement impact of the adoption of Statement 123(R).

|10. | Reclassification
|--- | ----------------

Certain prior years
amounts have been reclassified to conform to current year presentation.

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

Certain statements
contained herein may constitute forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. The words or phrases
would be, will allow, intends to, will
likely result, are expected to, will continue,
is anticipated, estimate, project, or
similar expressions are intended to identify forward-looking
statements. Because such statements include risks and uncertainties,
actual results may differ materially from those expressed or implied by such
forward-looking statements. Factors that could cause actual results to differ
materially include, but are not limited to, risks associated with the
integration of businesses following an acquisition, competitors with broader
product lines and greater resources, emergence into new markets, the termination
of any of the Companys significant contracts, the Companys inability
to maintain working capital requirements to fund future operations, or the
Companys inability to attract and retain highly qualified management,
technical and sales personnel. Statements made herein are as of the date of the
filing of this Form 10-Q with the Securities and Exchange Commission and should
not be relied upon as of any subsequent date. Unless otherwise required by
applicable law, the Company does not undertake, and the Company specifically
disclaims, any obligation to update any forward-looking statements to reflect
occurrences, developments, unanticipated events or circumstances after the date
of such statement.

The following discussion
should be read in conjunction with the consolidated financial statements and
notes thereto included in Item 1 in this Quarterly Report on Form 10-Q and our
Annual Report on Form 10-K for the fiscal year ended October 31, 2004 filed by
the Company with the Securities and Exchange Commission.

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OVERVIEW

SteelCloud designs and
manufactures ready-to-deploy server appliances through strategic relationships
with software and technology companies. Products are sold through system
integrators and in collaboration with strategic partners specializing in network
security solutions. The Company is also developing its own proprietary software
and appliances under the SteelCloud brand. SteelCloud compliments its software
and appliance solutions with an expert professional services consulting
organization.

Appliances and Servers

The Company designs and
manufactures specialized servers and infrastructure solutions for large
commercial and government integrators as well as for certain governmental
agencies. The Companys specialized servers are designed to meet the
precise needs of volume customers and reduce the customers investments in
logistics, integration capacity and support. The Company enhances its
custom-design and manufacturing capability by providing custom supply chain and
logistics support services to its partners.

In addition, the Company
integrates either its partners or other third-party software into a
custom-designed server platform or appliance and manufactures the product under
a co-branded name or its partners brand name. This allows the partner to
deliver a complete turnkey solution.

Security Solutions

The Company serves the
network security marketplace with a suite of network security products from its
strategic partners. The Company sells the products to end users along with
SteelCloud consulting, installation and integration services.

SteelClouds
professional consulting services organization provides clients with a seamless
extension of their Information Technology (IT) organizations. Expert
technical services include network analysis, network security audits and
appraisals, incident response and remediation services, system design and
managed security services. SteelCloud provides these professional services to
public sector organizations as well as to commercial customers.

Advanced Technology

The Company has
established an advanced technology organization that designs and develops
SteelCloud intellectual property in the form of proprietary SteelCloud software
products. The Company will market these SteelCloud-brand software and appliance
products during its fiscal 2005 fourth quarter. The products will be sold
directly to select end user organizations and through channel partners who buy
and resell the products to their end user customers.

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|11
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CRITICAL
ACCOUNTING POLICIES

The Company believes the
following represent its critical accounting policies:

Significant
Customer Contracts

In fiscal 2004, The
Company was awarded several contracts by Lockheed Martin valued at more than $15
million for customized servers. These contracts included options for the
government integrator to purchase a substantial number of additional appliances.
Additional contract options were exercised early in fiscal year 2005 and the
total contract value currently exceeds $22 million. For the three and six months
ending April 30, 2005, the Company recognized revenue associated with these
contracts of approximately $5.6 and $11.5 million respectively. Given the nature
of the products manufactured by the Company as well as the delivery schedules
established by its partners, revenue and accounts receivable concentration by
any single customer will fluctuate from quarter to quarter. Future revenues and
results of operations could be adversely affected should this customer reduce
its purchases, eliminate product lines or choose not to continue to buy products
and services from SteelCloud.

In February 2003, the
Company was awarded several contracts by Lockheed Martin valued at more than
$2.7 million for customized servers. The Company commenced work under the
contracts in February 2003, and completed the contracts in fiscal year 2004. The
Company did not recognize any revenue associated with these contracts in fiscal
year 2005.

Revenue Recognition

The Company recognizes
revenue in accordance with Staff Accounting Bulletin No, 104, Revenue
Recognition in Financial Statements (SAB104). SAB 104 requires that four
basic criteria be met before revenue can be recognized: (1) persuasive evidence
of an arrangement exists; (2) delivery has occurred or services have been
rendered; (3) the sellers price to the buyer is fixed or determinable; and
(4) collectibility is reasonably assured.

For product sales to
commercial customers, the Company recognizes revenue at the time of shipment
(shipping FOB shipping point) when both title andrisk of loss transfers
to the customer. For product sales to government customers, the Company
recognizes revenue when customer receipt of goods is confirmed (shipping FOB
destination) and risk of loss transfers to the customer. For technology support
services under time and material contracts, the Company recognizes revenue as
services are provided. Revenue from hardware leased to customers under operating
lease arrangements is recognized over the contract term. When product and
installation services that are not essential to the functionality of the product
are sold as part of a bundled agreement, the fair value of the installation
services, based on the price charged for the services when sold separately, is
deferred and recognized when the services are performed. The products sold are
generally covered by a warranty for periods ranging from one to three years. The
Company accrues an estimated warranty reserve in the period of sale to provide
for estimated costs for warranty services.

The Company is a
value-added reseller for certain software products. When resold software
licenses, and related maintenance, customization and training services are all
provided together to an individual customer, the Company recognizes revenue for
the arrangement after the Company has delivered the software license and the
customer has approved all customization and training services provided. In
instances where the Company only resells the software license and maintenance to
the customer, the Company recognizes revenue after the customer has acknowledged
and accepted delivery of the software. The software manufacturer is responsible
for providing software maintenance. Accordingly, revenue from maintenance
contracts is recognized upon delivery or acceptance, as the Company has no
future obligation to provide the maintenance services and no right of return
exists.

The Company incurs
shipping and handling costs, which are recorded in cost of revenues.

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Segment Reporting

FASB Statement No. 131,
Disclosures about Segments of an Enterprise and Related Information, establishes
standards for reporting information about operating segments. Operating segments
are defined as components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision maker, or decision making group, in deciding how to allocate resources
and in assessing performance. FASB Statement No. 131, Disclosures about Segments
of an Enterprise and Related Information, also establishes a quantitative
threshold, whereby an enterprise should report separately information about an
operating segment if its reported revenue is 10% or more of the combined revenue
of all reported operating segments. The Company is organized on the basis of
products and services. However, the Company does not evaluate the performance of
its segments based on earnings. The Companys chief operating decision
maker is the Companys President. While the President is apprised of a
variety of financial metrics and information, the President makes decisions
regarding how to allocate resources and assess performance based on a single
operating unit.

Deferred Tax Assets

Deferred tax assets and
liabilities are recorded to reflect the tax consequences on future years of
temporary differences of revenue and expense items for financial statement and
income tax purposes. A valuation allowance is provided to reduce related assets
to an amount that is more likely than not realizable. The Company determines its
valuation allowance pursuant to the provisions of Financial Accounting Standards
Board Statement of Financial Accounting Standards Number 109, Accounting for
Income Taxes, which requires the Company to weigh all positive and negative
evidence including past operating results and forecasts of future taxable
income. If forecasts of taxable income change in the future, the Company may be
required to adjust the valuation allowance against deferred tax assets, which
would result in additional tax expense or benefit.

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RESULTS OF
OPERATIONS

For the three and
six months ended April 30, 2005 compared to the three and six months ended April
30, 2004

Product revenues
increased to $8,924,494 and $17,147,952 for the three and six months ended April
30, 2005 from $4,636,361 and $7,931,674 for the same period in fiscal 2004, an
increase of $4,288,133 and $9,216,278, or 92.5% and 116.2%, respectively. The
increase is primarily attributable to deliveries associated with several
significant contracts with Lockheed Martin during the first and second quarters
of fiscal year 2005. These contracts are currently valued at approximately $22
million from which the Company generated revenue of approximately $5.6 million
during the second quarter of fiscal year 2005 and approximately $11.5 million
for the six month period ending April 30, 2005. These deliveries resulted in an
increase in revenues of approximately $4.9 million and $10.6 million for the
three and six month periods ended April 30, 2005 as compared to the same periods
in fiscal 2004. This increase offset a decrease in reselling revenues for the
six month period ended April 30, 2005 as compared to the same period in fiscal
2004. This decrease is attributable to certain organizational and restructuring
changes within one of the Companys significant reselling partners during
fiscal 2004 which impacted the Companys reselling activities and
associated consulting services. Accordingly, the Company is engaging new
reselling partners in an effort to enhance and diversify its product offerings
and expand its revenue base. As such, revenue activities have been impacted as
time and resources are required to cultivate these new relationships.

Service revenues
decreased to $759,544 and $1,599,679 for the three and six months ended April
30, 2005 from $1,155,403 and $2,023,787 for the same period in fiscal 2004, a
decrease of $395,859 or 34.3% and $424,108 or 21.0% respectively. The decrease
in service revenues for the three and six month periods ended April 30, 2005 as
compared to the same periods in fiscal 2004 is primarily the result of the
aforementioned changes in the Companys reselling partner relationships
which is a key driver of services revenues. Partially offsetting this decrease
was the increase in service revenues attributable to the Asgard acquisition.
Service revenue associated with the acquisition of Asgard for the six month
period ending April 30, 2005 increased to approximately $275,000 from $141,000
in the same period in fiscal year 2004. No revenues associated with the Asgard
acquisition were recognized in the first quarter of fiscal year 2004.

Product gross margin, as
a percentage of net revenues, decreased to 25.0% for the three months ended
April 30, 2005 from 28.0% for the same period in fiscal 2004. Product gross
margin, as a percentage of net revenues, increased to 26.3% for the six months
ended April 30, 2005 from 22.6% for the same period in fiscal 2004. The decrease
in gross margin for the three months ended April 30, 2005 is primarily due to
higher margin sales associated with the completion of a significant contract in
the second quarter of fiscal 2004. The increase in gross margin for the six
months ended April 30, 2005 is due to lower product costs realized, with the
significant product backlog, as the Company utilized its cash on hand and
purchasing power to take advantage of product discounts, incentives and rebates
available in the marketplace. In addition, start up costs associated with the
Companys contracts from fiscal year 2004 were primarily incurred during
the initial delivery phase. As the Company anticipated, gross margins have
increased since these initial deliveries.

The gross margin for
services, as a percentage of net revenues, was 38.0% for the three months ended
April 30, 2005 and 2004. The gross margin for services, as a percentage of net
revenues, decreased to 33.6% for the six months ended April 30, 2005 from 36.5%
for the same period in fiscal 2004. The decrease in gross margin from services
is the result of lower service revenue associated with the resale products in
the first half of fiscal year 2005 as compared to the similar period in fiscal
year 2004. The Company expects gross margin as a percentage of net revenues to
fluctuate from quarter to quarter as product lines expand, new products are
brought to market, start up costs are incurred and new discounts, incentives and
rebates become available.

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Sales and marketing
expenses decreased to $367,608 for the three months ended April 30, 2005 from
$514,530 for the same period in fiscal 2004, a decrease of $146,922 or 28.6%.
Sales and marketing expenses decreased to $809,593 for the six months ended
April 30, 2005 from $984,815 for the same period in fiscal 2004, a decrease of
$175,222 or 17.8%. The decrease is primarily attributable to increased sales and
marketing expenses incurred in early fiscal 2004 for anticipated growth. As a
result, the Company received significant contract awards at the end of fiscal
year 2004. Additionally, sales and marketing efforts associated with new server
appliance relationships in 2004 did not generate the business results
anticipated. As a result, the Company has realigned its resources in fiscal 2005
to better support its more successful product lines and bring new products to
market. The Company anticipates selling and marketing expenses to increase to
support its new products.

Research and product
development expenses increased to $177,813 and $391,295 for the three and six
months ended April 30, 2005 from $124,973 and $275,417 for the same periods in
fiscal 2004, an increase of $52,840 or 42.3% for the three month period ending
April 30, 2005 and $115,878 or 42.1% for the six month period ending April 30,
2005. The increase is primarily the result of the Company intensifying its
research and product development work in an effort to release new proprietary
products in mid-to-late fiscal year 2005. On May 3, 2005, the Company announced
one of its new products, SteelCloud Audit Compliance System (ACS), which will be
available for customer deliveries in the Companys fourth fiscal quarter of
2005. The Audit Compliance Product incorporates patent-pending SteelCloud
intellectual property. The Company expects to continue to incur additional
research and product development costs in future quarters as new products are
brought to market.

General and
administrative expenses increased to $1,578,450 for the three months ended April
30, 2005 from $1,411,661 for the same period in fiscal 2004, an increase of
$166,789 or 11.8%. General and administrative expenses decreased to $3,024,794
for the six months ended April 30, 2005 from $3,202,767 for the same period in
fiscal 2004, a decrease of $177,973 or 5.6%. The decrease is largely
attributable to non-recurring costs such as professional services of
approximately $85,000, accrued severance pay of approximately $140,000 and
accrued regulatory costs of $45,000 that were incurred in the first half of
fiscal year 2004. This decrease was partially offset by costs associated with
the Companys facilities move of approximately $150,000 in April 2005. As a
percentage of revenue, general and administrative expenses decreased to 16% for
the three month period ending April 30, 2005 from 24% for the same period in
fiscal 2004. For the six month period ended April 30, 2005, general and
administrative expenses, as a percentage of revenue, decreased to 16% from 32%
for the same period in fiscal 2004. These decreases were a result of the
significant revenue growth in 2005. Although the Company continues to manage its
costs relative to its revenues and gross margins, additional resources will be
required in order to support its new product lines. In addition, the Company
expects to incur additional general and administrative expenses associated with
Sarbanes-Oxley compliance. However, at present, it is difficult to predict the
timing and extent of such costs to be incurred in fiscal 2005 due to the
recently announced delay in the implementation date for certain provisions
related to internal control reporting. Management is currently assessing the
impact of this deferral on its compliance plans.

Interest income, net,
increased to $4,362 for the three months ended April 30, 2005 from $1,597 of
interest expense, net, for the same period in fiscal 2004, an increase of $5,959
or 373.1%. Interest income, net, increased to $12,071 for the six months ended
April 30, 2005 from $11,645 for the same period in fiscal 2004, an increase of
$426 or 3.7%. The increase in interest income is the result of a non-recurring
interest charge incurred in the second quarter of fiscal year 2004 for
approximately $14,000. Otherwise, the Companys average cash balance, and
corresponding interest income, for the three and six month periods ending April
30, 2005 was lower than the comparable periods in fiscal year 2004. This
decrease in interest income is the result of the Companys utilization of
its cash balance for its purchasing efforts undertaken to take advantage of
available vendor discounts, incentives and rebates.

The Company reported net
income of $367,809 and $782,602 from operations for the three and six months
ended April 30, 2005, as compared to a net loss of $(315,929) and $(1,922,028)
from operations for the same period in fiscal 2004. The increase in net income
for the three and six months ended April 30, 2005 as compared to the same
periods in fiscal 2004 is attributable to the Companys increased
deliveries of products associated with significant contract awards. The Company
has also realigned its resources and streamlined operating costs to better
position itself in its significant markets.

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LIQUIDITY AND
CAPITAL RESOURCES

As of April 30, 2005, the
Company had working capital of $10.0 million. The Company believes cash on hand
together with cash generated from operations will provide sufficient financial
resources to finance current operations of the Company through fiscal 2005.

For the six months ended April 30, 2005, the Company
generated $2,066,066 in cash flow from operations. The Company generated cash from the collection of its
accounts receivables of $3,604,958 and reduction of inventory of $333,478. In addition, the Company
experienced an increase in accrued expenses of $73,089 and deferred contract revenues of $337,731. The cash
generated was primarily used to pay accounts payable of $3,158,987.

For the six months ended
April 30, 2005, the Company invested $1,319,392 in property and equipment. These
expenditures consisted of purchases of equipment leased to customers and
improvements made to the Companys new leased facilities.

For the six months ended
April 30, 2005, the Company generated $2,124,280 from financing activities. As
of April 30, 2005, the Company had an outstanding balance on its line of credit
of $2,000,000 and available borrowing capacity of $1,500,000. The Company
anticipates using its line of credit occasionally in conjunction with its
business needs.

On March 21, 2005, the
Company renewed its bank line of credit that allows the Company to borrow an
amount to the lesser of its collateralized cash on hand or $3.5 million. The
line of credit bears interest at the LIBOR Market Index rate plus 1.25%. The
line of credit is secured by all assets of the Companyand expires on
March 31, 2006.

In addition, the Company
assumed $170,138 of Asgards debt by executing two three-year promissory
notes. The promissory notes each bear interest at 4% and mature in February
2007. The Company makes monthly aggregate payments of $4,726 plus accrued
interest. The outstanding balance on the two notes at April 30, 2005 was
$103,973.

From time to time, the
Company may pursue strategic acquisitions or mergers, which may require
significant additional capital to satisfy unusual or infrequent expenses. In
such event, the Company may seek additional financing of debt and/or equity.

Contractual
Obligations and Commercial Commitments:

The Companys
significant contractual obligations as of April 30, 2005 are for debt and
operating leases. In April 2005 the Company moved its headquarters and
operations facilities. The obligation for these leases, expiring in August 2009
and August 2014, is approximately $44,000 a month. Debt by year of maturity and
future rental payments under operating lease agreements are presented below. The
Company does not have any purchase obligations, capital lease obligations or any
material commitments for capital expenditures as of April 30, 2005. The Company
has not engaged in off-balance sheet financing, commodity contract trading or
significant related party transactions.

|                        |                       
|----------------------- | ----------------------
|Contractual Obligations | Payments Due by Period
|                        |                       
|                        | Total                 
|                        |                       
|Notes Payable - Current |                       
|                        |                       
|Long Term Debt          |                       
|                        |                       
|Operating Lease         |                       
|                        |                       

Management believes that
these commitments will be satisfied with current operating cash flow.

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ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to
market risk related to fluctuations in interest rates on its debt. Increase in
prevailing interest rates could increase the Companys interest payment
obligations relating to variable rate debt. For example, a 100 basis point
increase in interest rates would increase annual interest expense by $35,000 if
the Company fully utilized its existing line of credit.

ITEM 4. CONTROLS
AND PROCEDURES

Evaluation of
SteelCloud's Disclosure Controls and Internal Controls

SteelCloud evaluated the
effectiveness of the design and operation of its disclosure controls and
procedures, or Disclosure Controls, as of the end of the period
covered by this quarterly report on Form 10-Q. This evaluation, or
Controls Evaluation, was performed under the supervision, and with
the participation, of management, including our Chairman of the Board, Chief
Executive Officer and Director (CEO), our President, and our Chief
Financial Officer (CFO).

CEO,
President and CFO Certifications

The certifications of the
CEO, President, and the CFO required by Rule 13a-15(e) of the Securities
Exchange Act of 1934, as amended, or the Rule 13a-15(e)
Certifications are filed as Exhibit 31 of this quarterly report on Form
10-Q. This Controls and Procedures section of the quarterly report includes the
information concerning the Controls Evaluation referred to in the Rule 13a-15(e)
Certifications and it should be read in conjunction with the Rule 13a-15(e)
Certifications for a more complete understanding of the topics
presented.

Disclosure
Controls and Internal Control over Financial Reporting

Disclosure Controls are
controls and other procedures designed to ensure that information required to be
disclosed in our reports filed under the Securities Exchange Act of 1934, as
amended, such as this quarterly report, is recorded, processed, summarized and
reported within the time periods specified in the U.S. Securities and Exchange
Commissions rules and forms. Disclosure Controls include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed in our reports filed under the Exchange Act is accumulated and
communicated to our management, including our CEO, President, and CFO, or
persons performing similar functions, as appropriate to allow timely decisions
regarding required disclosure.

Internal control over
financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles and includes those policies and procedures that (1)
pertain to the maintenance of records that in reasonable detail accurately and
fairly reflect the transactions and dispositions of our assets; (2) provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that our receipts and expenditures are being made
only in accordance with authorizations of our management and directors; and (3)
provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of our assets that could have a
material effect on the financial statements.

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Limitations on the
Effectiveness of Controls

Our management, including
our CEO, President, and CFO, does not expect that our Disclosure Controls or our
internal controls will prevent all error and all fraud. A control system, no
matter how well designed and operated, can provide only reasonable, not
absolute, assurance that the control systems objectives will be met.
Further, the design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative
to their costs. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within SteelCloud have been detected. These
inherent limitations include the realities that judgments in decision-making can
be faulty, and that breakdowns can occur because of simple error or mistake.
Controls can also be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the controls. The
design of any system of controls is based in part upon certain assumptions about
the likelihood of future events, and there can be no assurance that any design
will succeed in achieving its stated goals under all potential future
conditions. Over time, controls may become inadequate because of changes in
conditions or deterioration in the degree of compliance with associated policies
or procedures. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be
detected.

Conclusions

Based upon the Controls
Evaluation, our CEO, President, and CFO have concluded that, subject to the
limitations noted above, our Disclosure Controls are effective to ensure that
material information relating to SteelCloud is made known to management,
including the CEO, President, and CFO, particularly during the period when our
periodic reports are being prepared.

During the period covered
by this quarterly report on Form 10-Q, there were no changes in our internal
control over financial reporting that have materially affected or are reasonably
likely to materially affect our internal control over financial reporting.

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PART II. OTHER
INFORMATION

ITEM 1. LEGAL
PROCEEDINGS

There are routine legal
claims pending against the Company that occur in the ordinary course of
business, but in the opinion of management, liabilities, if any, arising from
such claims will not have a material adverse effect on the financial condition
and results of operation of the Company.

Other than the items
previously disclosed, we are not a party in any other material legal
proceedings.

ITEM 2. CHANGES IN
SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY  SECURITIES

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR
SECURITIES

Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

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ITEM 6. EXHIBITS AND REPORTS ON FORM
8-K

(a)  Exhibits

|Exhibit 11.1 | Statement of computation of earnings per share.*                                                                           
|------------ | ---------------------------------------------------------------------------------------------------------------------------
|Exhibit 31.1 | Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.*                       
|Exhibit 31.2 | Certification of President Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.*                                     
|Exhibit 31.3 | Certification of Chief Financial Officer Pursuant to Section 302 of the  Sarbanes-Oxley
Act of 2002.*                      
|Exhibit 32.1 | Certification Pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of
the Sarbanes  Oxley Act of 2002.*
|Exhibit 32.2 | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes  Oxley Act of 2002.* 
|Exhibit 32.3 | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes  Oxley Act of 2002.* 

* The Exhibit attached to
this Form 10-Q shall not be deemed filed for purposes of Section 18
of the Securities Exchange Act of 1934 (the Exchange Act) or
otherwise subject to liability under that section, nor shall it be deemed
incorporated by reference in any filing under the Securities Act of 1933, as
amended, or the Exchange Act, except as expressly set forth by specific
reference in such filing.

(b)  Reports on Form 8-K

On April 21, 2005, the
Company filed a report on Form 8-K pursuant to Item 8.01 Other
Events and Item 9.01 Financial Statements and Exhibits.

On March 10, 2005, the
Company filed a report on Form 8-K pursuant to Item 2.02 Results of
Operations and Financial Condition and Item 9.01 Financial
Statements and Exhibits.

On March 9, 2005, the
Company filed a report on Form 8-K pursuant to Item 8.01 Other
Events and Item 9.01 Financial Statements and Exhibits.

On March 3, 2005, the
Company filed a report on Form 8-K pursuant to Item 8.01 Other
Events and Item 9.01 Financial Statements and Exhibits.

On February 28, 2005, the
Company filed a report on Form 8-K pursuant to Item 8.01 Other
Events.

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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.

|June 10, 2005 |                                                                            | STEELCLOUD, INC.
|------------- | -------------------------------------------------------------------------- | ----------------
|             
|             
|              | By: /s/ Thomas P. DunneName: Thomas P. DunneTitle: Chief Executive Officer
|             
|              | By: /s/ Brian HajostName: Brian HajostTitle: President                    
|             
|              | By: /s/ Kevin MurphyName: Kevin MurphyTitle: Chief Financial Officer      

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