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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended January 31, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period from __________ to ________
 Commission File No. 0-24015
 STEELCLOUD, INC.
  VIRGINIA
    
    54-1890464(State or other jurisdiction of incorporation or
    
    (I.R.S. Employer Identification No.)organization)14040 Park Center Road, Herndon, VA
    
    20171(Address of principal executive offices)
    
    (Zip code)
 
   þ o
   Large Accelerated filer o
    
    Accelerated filer o
    
    Non-accelerated filer þ
  o þ




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Description
    
    
    
    PagePart I.
    
    Financial InformationItem 1.
    
    Financial Statements
    
    
    1Consolidated Balance Sheets as of October 31, 2005 and January 31, 2006
    
    
    1Consolidated Statements of Operations for the three month periods
ended January 31, 2005 and 2006
    
    
    2Consolidated Statements of Cash Flows for the three month periods
ended January 31, 2005 and 2006
    
    
    3Notes to the Consolidated Financial Statements
    
    
    4Item 2.
    
    Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    9Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risks
    
    
    15Item 4.
    
    Controls and Procedures
    
    
    15Part II.
    
    Other Information
    
    
    17Item 1.
    
    Legal Proceedings
    
    
    17Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    17Item 3.
    
    Defaults Upon Senior Securities
    
    
    17Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    17Item 5.
    
    Other Information
    
    
    17Item 6.
    
    Exhibits
    
    
    17




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PART I. FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 STEELCLOUD, INC.
 
 CONSOLIDATED BALANCE SHEET
 October 31,
    
    
    January 31,2005
    
    
    2006(unaudited)ASSETSCurrent assetsCash and cash equivalents
    
    $
    6,657,367
    
    
    $
    4,983,782Accounts receivable, net
    
    
    5,777,154
    
    
    
    6,308,313Inventory, net
    
    
    1,218,596
    
    
    
    2,024,471Prepaid expenses and other current assets
    
    
    264,968
    
    
    
    251,570Deferred contract cost
    
    
    94,549
    
    
    
    90,315Total current assets
    
    
    14,012,634
    
    
    
    13,658,451Property and equipment, net
    
    
    1,255,666
    
    
    
    1,216,934Equipment on lease, net
    
    
    698,285
    
    
    
    618,185Goodwill and other intangible assets, net
    
    
    4,571,992
    
    
    
    4,543,214Deferred tax asset
    
    
    400,000
    
    
    
    400,000Other assets
    
    
    114,060
    
    
    
    101,419Total assets
    
    $
    21,052,637
    
    
    $
    20,538,203LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesAccounts payable
    
    $
    3,467,028
    
    
    $
    3,770,693Accrued expenses
    
    
    953,552
    
    
    
    966,793Notes payable, current
    
    
    70,952
    
    
    
    71,103Unearned revenue
    
    
    339,537
    
    
    
    311,827Total current liabilities
    
    
    4,831,069
    
    
    
    5,120,416Notes payable, long-term
    
    
    63,088
    
    
    
    45,249Other
    
    
    161,166
    
    
    
    164,527Total long-term liabilities
    
    
    224,254
    
    
    
    209,776Stockholders equityPreferred stock, $.001 par value: 2,000,000 shares authorized, no shares
 issued and outstanding at October 31, 2005 and January 31, 2006
    
    
    
    
    
    
    Common stock, $.001 par value: 50,000,000 shares authorized,
 14,449,271 and 14,455,521 shares issued at October 31, 2005  and January 31,
2006, respectively
    
    
    14,449
    
    
    
    14,456Additional paid in capital
    
    
    49,579,868
    
    
    
    49,621,442Treasury stock, 400,000 shares at
October 31, 2005 and January 31, 2006,
respectively
    
    
    (3,432,500
    )
    
    
    (3,432,500
    )Accumulated deficit
    
    
    (30,164,503
    )
    
    
    (30,995,387
    )Total stockholders equity
    
    
    15,997,314
    
    
    
    15,208,011Total liabilities and stockholders equity
    
    $
    21,052,637
    
    
    $
    20,538,203
  1




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STEELCLOUD, INC.
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 (unaudited)
 Three Months EndedJanuary 31,2005
    
    
    2006RevenuesProducts
    
    $
    8,223,458
    
    
    $
    5,988,038Services
    
    
    840,135
    
    
    
    674,617Total revenues
    
    
    9,063,593
    
    
    
    6,662,655Cost of revenuesProducts
    
    
    5,934,618
    
    
    
    4,825,704Services
    
    
    591,302
    
    
    
    473,914Total cost of revenues
    
    
    6,525,920
    
    
    
    5,299,618Gross profit
    
    
    2,537,673
    
    
    
    1,363,037Selling and marketing
    
    
    441,985
    
    
    
    500,174Research and product development
    
    
    213,482
    
    
    
    178,363General and administrative
    
    
    1,446,344
    
    
    
    1,504,036Amortization of other intangible assets
    
    
    28,778
    
    
    
    28,778Income (loss) from operations
    
    
    407,084
    
    
    
    (848,314
    )Interest income, net
    
    
    7,709
    
    
    
    17,430Net income (loss)
    
    $
    414,793
    
    
    $
    (830,884
    )Earnings (loss) per share (basic and diluted):Net basic and diluted earnings (loss) per share
    
    $
    0.03
    
    
    $
    (0.06
    )Weighted-average shares outstanding, basic
    
    
    13,835,870
    
    
    
    14,049,760Weighted-average shares outstanding, diluted
    
    
    14,389,234
    
    
    
    14,049,760
  2




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STEELCLOUD, INC.
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (unaudited)
 Three Months EndedJanuary 31,2005
    
    
    2006Operating activitiesNet income (loss)
    
    $
    414,793
    
    
    $
    (830,884
    )Adjustments to reconcile net (loss) income to net
cash (used in) provided by operating activities:Depreciation and amortization
    
    
    197,612
    
    
    
    190,472Stock-based compensation
    
    
    
    
    
    
    34,293Changes in operating assets and liabilities, net
of effects of acquisition:Accounts receivable
    
    
    3,776,703
    
    
    
    (531,159
    )Inventory
    
    
    (1,606,912
    )
    
    
    (805,875
    )Prepaid expenses and other assets
    
    
    36,350
    
    
    
    26,039Deferred contract costs
    
    
    (593,667
    )
    
    
    4,234Accounts payable
    
    
    (1,096,772
    )
    
    
    303,665Accrued expenses
    
    
    243,669
    
    
    
    18,900Unearned revenue and other liabilities
    
    
    981,499
    
    
    
    (30,008
    )Net cash provided by (used in) operating activities
    
    
    2,353,275
    
    
    
    (1,620,323
    )Investing activitiesPurchase of property and equipment
    
    
    (154,789
    )
    
    
    (42,862
    )Financing activitiesProceeds from exercise of common stock options
    
    
    25,757
    
    
    
    7,288Payments on notes payable
    
    
    (18,205
    )
    
    
    (17,688
    )Net cash provided by (used in) financing activities
    
    
    7,552
    
    
    
    (10,400
    )Net increase (decrease) in cash and cash
equivalents of operations
    
    
    2,206,038
    
    
    
    (1,673,585
    )Cash and cash equivalents at beginning of period
    
    
    3,108,941
    
    
    
    6,657,367Cash and cash equivalents at end of period
    
    $
    5,314,979
    
    
    $
    4,983,782Supplemental cash flow informationInterest paid
    
    $
    1,557
    
    
    $
    1,128Income taxes paid
    
    $
    
    
    
    $
    
  3




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STEELCLOUD, INC.
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 1. Nature of Business and Basis of Presentation
     2. Employee Stock Options
 Share-Based Payment
  4




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Accounting
for Stock Issued to Employees Accounting for Stock Based
Compensatio Accounting for Stock-Based CompensationTransition and
Disclosure
 Three Months EndedJanuary 31, 2005Net income   as reported
    
    $
    414,793Add: compensation expense recorded under APB
No. 25
    
    
    Deduct: SFAS 123R compensation expense
    
    
    349,651Net income  pro forma
    
    $
    65,142Net earnings per share:Basic and Diluted  as reported
    
    $
    0.03Basic and Diluted  pro forma
    
    $
    0.01
 Incentive Stock Option Plans
    5




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Weighted-Weighted-
    
    
    AverageAverage
    
    
    RemainingExercise
    
    
    ContractualShares
    
    
    Price
    
    
    Term (in years)Outstanding at October 31, 2005
    
    
    2,448,910
    
    
    $
    1.99Options granted
    
    
    
    
    
    
    Options exercised
    
    
    (6,250
    )
    
    
    1.17Options canceled or expired
    
    
    (115,001
    )
    
    
    2.37Outstanding at January 31, 2006
    
    
    2,327,659
    
    
    $
    1.98
    
    
    
    2.20Exercisable at January 31, 2006
    
    
    2,114,784
    
    
    $
    1.94
    
    
    
    2.07
    Options Outstanding
    
    
    Options ExercisableWeighted-
    
    
    Average
    
    
    
    
    
    
    Weighted-Average
    
    
    Remaining
    
    
    
    
    
    
    AverageNumber
    
    
    Exercise
    
    
    Contractual
    
    
    Number
    
    
    ExerciseRange of Exercise Prices
    
    Outstanding
    
    
    Price
    
    
    Life
    
    
    Outstanding
    
    
    Price$0.55-$1.75
    
    
    864,425
    
    
    $
    0.95
    
    
    
    0.71
    
    
    
    857,175
    
    
    $
    0.95$1.76-$4.50
    
    
    1,463,234
    
    
    
    2.58
    
    
    
    3.08
    
    
    
    1,257,609
    
    
    
    2.61$0.55-$4.50
    
    
    2,327,659
    
    
    $
    1.98
    
    
    
    2.20
    
    
    
    2,114,784
    
    
    $
    1.94
  Employee Stock Purchase Plan
  Accounting under
Statement 123 for Certain Employee Stock Purchase Plans with a Look-Back Option
 6




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3. Operating Leases
  4. Debt
   5. Deferred Revenue
  6. Earnings Per Share
  7. Segment Reporting
 Disclosures about Segments of an Enterprise and Related Information
 7




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8. Significant Customer
  9. Recent Accounting Pronouncements
 Share-Based Payment Accounting for Stock-Based Compensation, Accounting for Stock
Issued to Employees
 8




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
   9




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OVERVIEW
    Appliances and Servers
 TM
  Network Security and Infrastructure Solutions
   Advanced Technology
 TM TM
 10




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Significant Customer Contracts
   CRITICAL ACCOUNTING POLICIES
  Revenue Recognition
 Revenue
Recognition in Financial Statements, corrected copy
 Revenue Arrangements with Multiple Deliverables Revenue Arrangements with Multiple Deliverables
     11




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Deferred Tax Assets
 Accounting for Income Taxes
 RESULTS OF OPERATIONS
 For the three months ended January 31, 2006 compared to the three months ended January 31, 2005
    12




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LIQUIDITY AND CAPITAL RESOURCES
   13




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Contractual Obligations and Commercial Commitments:
  Contractual Obligations
    
    Payments Due by PeriodLess than 1
    
    
    
    
    
    
    
    
    
    
    More than 5Total
    
    
    year
    
    
    1-3 years
    
    
    3-5 years
    
    
    yearsNotes Payable  Current
    
    $
    71,103
    
    
    $
    71,103
    
    
    
    
    
    
    
    
    
    
    
    Long Term Debt
    
    $
    45,249
    
    
    
    
    
    
    $
    31,658
    
    
    $
    13,591
    
    
    
    Operating Lease
    
    $
    3,536,981
    
    
    $
    615,689
    
    
    $
    1,231,378
    
    
    $
    723,614
    
    
    $
    966,300
  14




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4. CONTROLS AND PROCEDURES
 Evaluation of SteelClouds Disclosure Controls and Internal Controls
  CEO, President and CFO Certifications
  Disclosure Controls and Internal Control over Financial Reporting
   15




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Limitations on the Effectiveness of Controls
  Conclusions
   16




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PART II. OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
   
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES
  
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 ITEM 5. OTHER INFORMATION
  
 ITEM 6. 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. 17




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SIGNATURES
  March 15, 2006
    
    STEELCLOUD, INC.By:
    
    /s/ Thomas P. DunneName: Thomas P. DunneTitle: Chief Executive OfficerBy:
    
    /s/ Brian HajostName: Brian HajostTitle: PresidentBy:
    
    /s/ Kevin MurphyName: Kevin MurphyTitle: Chief Financial Officer
 18