UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
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, 2009




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. 000-24015







STEELCLOUD,
INC.


(Exact
name of registrant as specified in its charter)




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




14040
Park Center Road, Herndon,
VA         20171


(Address
of principal executive
offices)         (Zip
code)




(703)
674-5500


(Registrant’s
telephone number, including area code)




(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 þ No o




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files).


Yes o No o




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definition of “accelerated filer,” “large accelerated” and “smaller reporting
company” in Rule 12b-2 of the Exchange Act. (Check one)


Large
Accelerated filer oAccelerated filer oNon-accelerated
filer oSmaller Reporting Company þ




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


Yes o No þ




As of
June 1, 2009 there were 14,962,876 shares of the registrant’s common stock
outstanding.





SteelCloud,
Inc.


Form
10-Q Index


for
the Quarterly period ended April 30, 2009




PART
      I. FINANCIAL INFORMATION
                                          1ITEM
      1.
                                          FINANCIAL
      STATEMENTS
                                          1ITEM
      2.
                                          MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
                                          2ITEM
      3.
                                          QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
                                          13ITEM
      4T.
                                          CONTROLS
      AND PROCEDURES
                                          14PART
      II. OTHER INFORMATION
                                          14ITEM
      1.
                                          LEGAL
      PROCEEDINGS
                                          14ITEM 1A.
                                          RISK
      FACTORS
                                          14ITEM
      2.
                                          UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
                                          16ITEM
      3.
                                          DEFAULTS
      UPON SENIOR SECURITIES
                                          16ITEM
      4.
                                          SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
                                          16ITEM
      5.
                                          OTHER
      INFORMATION
                                          16ITEM
      6.
                                          EXHIBITS
                                          16SIGNATURES
                                          17


i




PART
I. FINANCIAL INFORMATION




ITEM
      1.
            FINANCIAL
      STATEMENTS




Index
to Financial Statements




Condensed
      Consolidated Balance Sheet
                
                
                F–1Unaudited
      Condensed Consolidated Statements of Operations
                
                
                F–2Unaudited
      Condensed Consolidated Statements of Cash Flows
                
                
                F–3Notes
      to Unaudited Condensed Consolidated Financial Statements
                
                
                F–4


1


STEELCLOUD,
INC.


CONDENSED
CONSOLIDATED BALANCE SHEET




October
      31,
                            
                            
                            April
      30,2008
                            
                            
                            2009(unaudited)ASSETSCurrent
      assetsCash
      and cash equivalents
                            
                            $
                            752,351
                            
                            
                            $
                            538,164Accounts
      receivable, net
                            
                            
                            1,571,673
                            
                            
                            
                            302,291Inventory,
      net
                            
                            
                            521,920
                            
                            
                            
                            461,227Prepaid
      expenses and other current assets
                            
                            
                            130,446
                            
                            
                            
                            157,612Deferred
      contract costs
                            
                            
                            -
                            
                            
                            
                            25,000Total
      current assets
                            
                            
                            2,976,390
                            
                            
                            
                            1,484,294Property
      and equipment, net
                            
                            
                            626,440
                            
                            
                            
                            539,053Equipment
      on lease, net
                            
                            
                            442,099
                            
                            
                            
                            2,180Other
      assets
                            
                            
                            7,020
                            
                            
                            
                            12,109Total
      assets
                            
                            $
                            4,051,949
                            
                            
                            $
                            2,037,636LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilitiesAccounts
      payable
                            
                            $
                            718,316
                            
                            
                            $
                            482,443Accrued
      expenses
                            
                            
                            561,009
                            
                            
                            
                            441,253Notes
      payable, current
                            
                            
                            7,538
                            
                            
                            
                            7,719Unearned
      revenue
                            
                            
                            8,882
                            
                            
                            
                            36,596Total
      current liabilities
                            
                            
                            1,295,745
                            
                            
                            
                            968,011Long-term
      liabilitiesNotes
      payable, long-term
                            
                            
                            7,903
                            
                            
                            
                            3,998Other
      long-term
                            
                            
                            132,055
                            
                            
                            
                            174,814Total
      long-term liabilities
                            
                            
                            139,958
                            
                            
                            
                            178,812Stockholders’
      equityPreferred
      stock, $.001 par value: 2,000,000 shares authorized, no shares issued and
      outstanding at October 31, 2008 and April 30, 2009
                            
                            
                            –
                            
                            
                            
                            –Common
      stock, $.001 par value: 50,000,000 shares authorized, 15,138,376 and
      15,342,376 shares issued at October 31, 2008 and April 30, 2009,
      respectively
                            
                            
                            15,138
                            
                            
                            
                            15,342Additional
      paid in capital
                            
                            
                            50,902,172
                            
                            
                            
                            51,030,239Treasury
      stock, 400,000 shares at October 31, 2008 and April 30,
    2009
                            
                            
                            (3,432,500
                            )
                            
                            
                            (3,432,500
                            )Accumulated
      deficit
                            
                            
                            (44,868,564
                            )
                            
                            
                            (46,722,268
                            )Total
      stockholders’ equity
                            
                            
                            2,616,246
                            
                            
                            
                            890,813Total
      liabilities and stockholders’ equity
                            
                            $
                            4,051,949
                            
                            
                            $
                            2,037,636




The
Accompanying Notes Are an Integral Part of these Condensed Consolidated
Financial Statements


F-1


STEELCLOUD,
INC.


UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS




Three
      Months Ended
                          April
      30,
                        
                        
                        Six
      Months Ended
                          April
      30,2008
                        
                        
                        2009
                        
                        
                        2008
                        
                        
                        2009RevenuesProducts
                        
                        $
                        7,827,740
                        
                        
                        $
                        958,263
                        
                        
                        $
                        13,080,767
                        
                        
                        $
                        1,306,165Services
                        
                        
                        556,894
                        
                        
                        
                        238,600
                        
                        
                        
                        1,110,339
                        
                        
                        
                        779,608Total
      revenues
                        
                        
                        8,384,634
                        
                        
                        
                        1,196,863
                        
                        
                        
                        14,191,106
                        
                        
                        
                        2,085,773Cost
      of revenuesProducts
                        
                        
                        6,435,320
                        
                        
                        
                        826,048
                        
                        
                        
                        11,051,123
                        
                        
                        
                        1,238,472Services
                        
                        
                        480,204
                        
                        
                        
                        166,709
                        
                        
                        
                        920,513
                        
                        
                        
                        613,558Total
      cost of revenues
                        
                        
                        6,915,524
                        
                        
                        
                        992,757
                        
                        
                        
                        11,971,636
                        
                        
                        
                        1,852,030Gross
      profit
                        
                        
                        1,469,110
                        
                        
                        
                        204,106
                        
                        
                        
                        2,219,470
                        
                        
                        
                        233,743Selling
      and marketing
                        
                        
                        281,718
                        
                        
                        
                        144,280
                        
                        
                        
                        601,962
                        
                        
                        
                        280,254Research
      and product development
                        
                        
                        208,888
                        
                        
                        
                        102,273
                        
                        
                        
                        407,113
                        
                        
                        
                        203,754General
      and administrative
                        
                        
                        973,440
                        
                        
                        
                        807,921
                        
                        
                        
                        1,887,793
                        
                        
                        
                        1,530,643Severance
      and restructuring
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        73,205Income
      (loss) from operations
                        
                        
                        5,064
                        
                        
                        
                        (850,368
                        )
                        
                        
                        (677,398
                        )
                        
                        
                        (1,854,113
                        )Interest
      income, net
                        
                        
                        4,827
                        
                        
                        
                        410
                        
                        
                        
                        11,242
                        
                        
                        
                        410Income
      (loss) before income taxes
                        
                        
                        9,891
                        
                        
                        
                        (849,958
                        )
                        
                        
                        (666,156
                        )
                        
                        
                        (1,853,703
                        )Provision
      for income taxes
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Net
      income (loss)
                        
                        $
                        9,891
                        
                        
                        $
                        (849,958
                        )
                        
                        $
                        (666,156
                        )
                        
                        $
                        (1,853,703
                        )Income
      (loss) per share (basic and diluted):Basic
      and diluted income (loss) per share
                        
                        $
                        0.00
                        
                        
                        $
                        (0.06
                        )
                        
                        $
                        (0.05
                        )
                        
                        $
                        (0.13
                        )Weighted–average
      shares outstanding:Basic
                        
                        
                        14,323,458
                        
                        
                        
                        14,828,849
                        
                        
                        
                        14,320,179
                        
                        
                        
                        14,783,698Diluted
                        
                        
                        14,667,606
                        
                        
                        
                        14,828,849
                        
                        
                        
                        14,320,179
                        
                        
                        
                        14,783,698




The
Accompanying Notes Are an Integral Part of these Condensed Consolidated
Financial Statements


F-2


STEELCLOUD,
INC.


UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS




Six
      Months Ended
                  April
      30,2008
              
              
              2009Operating
      activitiesNet
      loss
              
              $
              (666,156
              )
              
              $
              (1,853,703
              )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
              
              
              252,956
              
              
              
              196,153Stock-based
      compensation
              
              
              163,519
              
              
              
              128,271Changes
      in operating assets and liabilities:Accounts
      receivable
              
              
              579,248
              
              
              
              1,269,382Inventory
              
              
              (418,560
              )
              
              
              60,693Deferred
      contract costs
              
              
              38,630
              
              
              
              (25,000
              )Prepaid
      expenses and other assets
              
              
              54,393
              
              
              
              (32,255
              )Accounts
      payable
              
              
              2,575,761
              
              
              
              (235,873
              )Unearned
      revenue
              
              
              (48,852
              )
              
              
              27,714Accrued
      expenses and other liabilities
              
              
              (421,708
              )
              
              
              (76,997
              )Net
      cash provided by (used in) operating activities
              
              
              2,109,231
              
              
              
              (541,616
              )Investing
      activities(Purchase)
      sale of property and equipment
              
              
              (27,138
              )
              
              
              331,153Net
      cash (used in) provided by investing activities
              
              
              (27,138
              )
              
              
              331,153Financing
      activitiesProceeds
      from exercise of common stock options
              
              
              10,173
              
              
              
              -Payments
      on notes payable
              
              
              (7,792
              )
              
              
              (3,725
              )Net
      cash provided by (used in) financing activities
              
              
              2,381
              
              
              
              (3,725
              )Net
      increase (decrease) in cash and cash equivalents
              
              
              2,084,474
              
              
              
              (214,187
              )Cash
      and cash equivalents at beginning of period
              
              
              2,622,654
              
              
              
              752,351Cash
      and cash equivalents at end of period
              
              $
              4,707,128
              
              
              $
              538,164Supplemental
      cash flow informationInterest
      paid
              
              $
              5,756
              
              
              $
              1,393Income
      taxes paid
              
              $
              -
              
              
              $
              -




The
Accompanying Notes Are an Integral Part of these Condensed Consolidated
Financial Statements


F-3


1. Nature
of Business and Basis of Presentation




Founded
in 1987, SteelCloud, Inc. (the “Company” or “SteelCloud”) is a developer and
manufacturer of integrated computer systems and appliance solutions for the
federal, Independent Software Vendors (“ISV”), and Blackberry
markets.  SteelCloud designs, manufactures and integrates specialized
servers for federal market prime contractors (“federal integrators”) and ISV’s
who use the specialized servers to deliver application software to their
clients.




SteelCloud
has developed SteelWorks® Mobile (“SteelWorks Mobile”), an appliance solution
specifically for the BlackBerry Enterprise Server (“BES”).  SteelWorks
Mobile was developed in conjunction with Research in Motion
(“RIM”).  SteelWorks Mobile is an integrated server appliance that
enables virtually any size organization to implement the BES at a fraction of
the cost, time, and resource commitment.  SteelCloud has filed for
patent protection for the SteelWorks Mobile technology it created for the
installation wizard, backup and restore features.  These patents are
currently pending approval from the U.S. Patent and Trademark
Office.  Additionally, SteelCloud developed SteelWorks FedMobile, a
BlackBerry Enterprise Server appliance solution specifically for the Department
of Defense (“DoD”) and other related agencies.  The SteelWorks
FedMobile appliance builds upon SteelWorks Mobile by automating the application
of the Defense Information Systems Agency’s and DoD’s Security Technical
Implementation Guide (“STIG”) to the BES installation process.  The
STIG mandates the policies for which the DoD and related agencies must operate
their wireless communications.  As a result, SteelCloud’s FedMobile
appliance allows DoD organizations to implement a STIG compliant BES
infrastructure in a fraction of the time, cost, or resources necessary to what
is otherwise a time intensive and manual STIG process.




For ISV
customers, SteelCloud designs, manufactures and integrates low-maintenance
servers (called “appliances” in this market) so ISVs can make their software
product easier to deploy and support, more competitive and open new markets by
delivering their application software on fully-integrated, ready-to-use
appliances.




In
addition, the Company serves information technology end users directly, in both
the public and private sectors, with products and services focused on IT-centric
solutions.  SteelCloud’s IT centric solutions consist primarily of
consulting and staff augmentation services.




The
following unaudited condensed financial statements have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission. Certain
information and note disclosures normally included in annual financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to those rules and regulations, although
the Company believes that the disclosures made are adequate to make the
information not misleading.  It is suggested that these condensed
financial statements be read in conjunction with the financial statements and
the Footnotes thereto included in the Company’s latest Annual Report on Form
10-K, as amended.




All
adjustments that are of a normal recurring nature, in the opinion of management,
are necessary for a fair presentation for the periods presented have been
reflected as required by Regulation S-X, Rule 10-01.




The
Company’s consolidated financial statements for the three and six months ended
April 30, 2009 do not give effect to any adjustments to recorded amounts and
their classifications, which would be necessary should the Company be unable to
continue as a going concern and therefore, be required to realize its assets and
discharge its liabilities in other than the normal course of business and at
amounts different from those reflected in the consolidated financial
statements.




Going
Concern




SteelCloud
has had recurring annual operating losses since its fiscal year ended October
31, 2004.  SteelCloud expects that such losses will continue at least
through its fiscal year ending October 31, 2009.  The report of
SteelCloud’s independent registered public accounting firm on SteelCloud’s
consolidated financial statements for the fiscal year ended October 31, 2008
contains an explanatory paragraph regarding SteelCloud’s ability to continue as
a going concern based upon its history of net losses.


F-4


SteelCloud
is dependent upon available cash and operating cash flow to meet its capital
needs.  SteelCloud is considering all strategic options to improve its
liquidity and provide it with working capital to fund its continuing business
operations which include equity offerings, asset sales or debt financing as
alternatives to improve SteelCloud’s cash needs; however, there can be no
assurance that SteelCloud will be successful in negotiating financing on terms
agreeable to it or at all.  If adequate funds are not available or are
not available on acceptable terms, SteelCloud will likely not be able to take
advantage of unanticipated opportunities, develop or enhance services or
products, respond to competitive pressures, or continue as a going
concern.  There is no assurance that SteelCloud will be successful in
raising working capital as needed.  Further, there are no assurances
that SteelCloud will have sufficient funds to execute its business plan, pay its
operating expenses and obligations as they become due or generate positive
operating results.




SteelCloud
is in the process of executing on several restructuring initiatives which
include the following:




•
              A
      reorganization that included personnel terminations from all parts of the
      organization;•
              Elimination
      of all non-essential costs;•
              Reduction
      of occupancy costs; and•
              Obtaining
      capital or bridge financing.





While
SteelCloud believes that these initiatives will better align its costs with its
anticipated revenues going forward, it will take time for these initiatives to
have an impact on SteelCloud’s net revenue and operating
income.  Furthermore, in reviewing its business strategies,
SteelCloud’s management has determined that it is in the Company’s best interest
to focus its resources and investments on its BlackBerry-related technologies
and products.  The Company is evaluating strategic alternatives for
the disposition of its other businesses.




2. Subsequent
Events




On May
22, 2009, the Company entered into a Stipulation/Consent Order with CRP (the
“Stipulation”), pursuant to an Affidavit and Statement of Account (the
“Affidavit”), stating, as declared by a general manager of Jones Lang LaSalle, a
property management company and agent for CRP Holdings A-1, LLC (“CRP”), the
landlord of 14040 Park Center Road, Suite 210, Herndon, Virginia 20171 (the
“Premises”), that CRP, as landlord, was seeking a judgment against the Company
for: (i) possession of the Premises, and (ii) monetary damages for nonpayment of
rent due under a sublease, dated September 28, 2004, by and between us and NEC
America, Inc. (“NEC”) (the “Sublease”), and a subsequent assignment of the
Sublease to CRP from NEC, dated December 15, 2008.  In the Stipulation
the Company acknowledged that the balance due for rent and additional rent for
the Premises was $168,637.96, together with attorney’s fees and court expenses
of $7,041.00 through May 22, 2009 (the “Judgment Amount”).  Pursuant
to the Stipulation, the Company paid $30,000 (the “Forbearance Payment”) on May
22, 2009 toward the Judgment Amount.  Further the Company agreed to,
and has, vacated the Premises.  CRP agreed to stay enforcement of the
Judgment Amount until the earlier of (a) the Company’s receipt of capital in the
amount of at least $500,000, or (b) May 31, 2010.  The matter was
returned to the court’s files pending the Company’s compliance with the terms of
the Stipulation.  The Company has accrued the balance due for rent of
approximately $139,000 in its April 30, 2009 balance sheet.


F-5


3.  Recently
Issued Accounting Pronouncements




Effective
November 1, 2008, the Company adopted the provisions of Statement of Financial
Accounting Standards No. 157, “Fair Value Measurements” (“SFAS No. 157”) and
Statement of Financial Accounting Standards No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities” (“SFAS No. 159”).  SFAS
157, which defines fair value, establishes a framework for measuring fair value
in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”), and
expands disclosures about fair value measurements.  SFAS 157 clarifies
that fair value is an exit price, representing the amount that would be received
to sell asset or paid to transfer a liability in an orderly transaction between
market participants.  SFAS 159 permits an entity to measure certain
financial assets and financial liabilities at fair value with changes in fair
value recognized in earnings each period. For the three and six month periods
ended April 30, 2009, the Company has elected not to use the fair value option
permitted under SFAS 159 for any of its financial assets and financial
liabilities that are not already recorded at fair value.




In
February 2008, the FASB issued Staff Position No. 157-2, “Effective Date of FASB
Statement No. 157” (“FSP 157-2”).  FSP 157-2 deferred the effective
date of FAS 157 for all nonfinancial assets and nonfinancial liabilities to
fiscal years beginning after November 15, 2008.  The Company is in the
process of evaluating the effect, if any, the adoption of FSP 157-2 will have on
its financial statements.




In
October 2008, the FASB issued Staff Position No. 157-3, “Determining the Fair
Value of a Financial Asset When the Market for that Asset is not Active” (“FSP
157-3”).  FSP 157-3 provides guidance for determining the fair value
of a financial asset in an inactive market.  The Company is in the
process of evaluating the effect, if any, the adoption of FSP 157-3 will have on
its financial statements.




In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141 (Revised 2007) “Business Combinations” (“SFAS No. 141R”).  SFAS
No. 141R, which replaces SFAS No. 141, requires that the acquisition method of
accounting (which SFAS No. 141 called the “purchase method”) be used for all
business combinations and for an acquirer to be identified for each business
combination.  SFAS No. 141R also establishes principles and
requirements for how the acquirer recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree; recognizes and measures the goodwill
acquired in the business combination or a gain from a bargain purchase; and
determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business
combination.  SFAS No. 141R also requires that acquisition-related
costs be recognized separately from the business combination.  SFAS
No. 141R will apply prospectively to business combinations for which the
acquisition date is after fiscal years beginning on or after December 15,
2008.  The Company is in the process of evaluating the effect, if any,
the adoption of SFAS No. 141(R) will have on its financial
statements.




In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
160, “Noncontrolling Interests in Consolidated Financial Statements — an
amendment of ARB No. 51” (“SFAS No. 160”).  SFAS No. 160 requires all
entities to report noncontrolling (minority) interests in subsidiaries as equity
in the consolidated financial statements.  Its intention is to
eliminate the diversity in practice regarding the accounting for transactions
between an entity and noncontrolling interests.  This statement is
effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008.  Earlier adoption is
prohibited.  The Company is in the process of evaluating the effect,
if any, the adoption of SFAS No. 160 will have on its financial
statements.




In May
2008, The FASB issued Statement of Financial Accounting Standards No.162 “The
Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”), which
reorganizes the U.S. Generally Accepted Accounting Principles (“GAAP”)
hierarchy.  SFAS 162 is intended to improve financial reporting by
providing a consistent framework for determining what accounting principles
should be used in preparing GAAP financial statements.  With the
issuance of SFAS 162, the FASB concluded that the GAAP hierarchy should be
directed toward the entity and not its auditor, and reside in the accounting
literature established by the FASB as opposed to the American Institute of
Certified Accountants Statement on Auditing Standards No. 69, The Meaning of
Present Fairly in Conformity With Generally Accepted Accounting
Principles”.  SFAS 162 will become effective 60 days following the
Securities and Exchange Commission’s (the “SEC”) approval of the Public
Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present
Fairly in Conformity With Generally Accepted Accounting Principles” and is not
expected to have any impact on the Company’s financial
statements.


F-6




In May
2009, the FASB issued SFAS No. 165, "Subsequent Events" ("SFAS 165"). SFAS 165
is intended to establish general standards of accounting for and disclosure of
events that occur after the balance sheet date but before financial statements
are issued or are available to be issued. It requires the disclosure of the date
through which an entity has evaluated subsequent events and the basis for
selecting that date, that is, whether that date represents the date the
financial statements were issued or were available to be issued. SFAS 165
is effective for interim or annual financial periods ending after June 15,
2009.  The Company is in the process of evaluating the effect, if any
the adoption SFAS 165 will have on its financial statements.




4. Significant
Customers




For the
three and six month periods ended April 30, 2009, 40% and 30% of the Company’s
revenues respectively, were recognized due from a single government
agency.    As of April 30, 2009, 16% of the account
receivable balance included amounts due from the government agency.




5. Equity




Stock-based
Compensation




The
Company recognized approximately $121,000 and $100,000 of stock-based
compensation expense during the three month periods ended April 30, 2009 and
2008, respectively.  Stock-based compensation expense for the
three-month period ended April 30, 2009 and 2008 increased the Company’s basic
and diluted loss per share by $0.01.  The Company recognized
approximately $128,000 and $164,000 of stock-based compensation expense during
the six month periods ended April 30, 2009 and 2008,
respectively.  Stock-based compensation expense for the six month
periods ended April 30, 2009 and 2008 decreased the Company’s basic and diluted
loss per share by $0.01.  The estimated fair value of the Company’s
stock-based awards is amortized on a straight-line basis over the awards’
original service period.




On
February 28, 2009, the Company entered into an Employment Agreement Amendment
with Kevin Murphy, the Company’s current Chief Financial Officer in which Mr.
Murphy agreed to forfeit options to purchase an aggregate of 225,000 shares of
the Company’s common stock, $0.001 par value per share and instead entered into
separate Incentive Stock Option and Restricted Stock agreements with the
Company.  Pursuant to the Incentive Stock Option agreement Mr. Murphy
was granted an option to purchase 150,000 shares of common stock, which shall
vest quarterly in arrears over a one year period.  Pursuant to the
Restricted Stock Agreement with the Company, Mr. Murphy shall receive 90,000
shares of restricted stock which shall vest ratably over 12 months, or 7,500
shares per month, so long as Mr. Murphy is employed by the Company on the last
day of each month.  The cancellation and reissuance of equity awards
to Mr. Murphy was treated as a modification of Mr. Murphy’s forfeited awards in
accordance with SFAS No. 123R.




Restricted
Stock




During
the three and six month periods ended April 30, 2009, the Company granted
300,000 and 546,000 shares of restricted common stock, pursuant to its Amended
2007 Stock Option and Restricted Stock Plan.  The fair value of the
restricted stock was determined based upon the closing stock price on the date
of grant.  The restricted stock grants vest quarterly over a one year
period.  As of April 30, 2009, 150,000 of the restricted stock grants
vested.  The Company’s restricted stock grants are accounted for as
equity awards and are recognized on a straight-line basis over the requisite
service period.  The Company’s restricted stock agreements do not
contain any post-vesting restrictions.  For the three and six month
periods ended April 30, 2009, the Company recognized $58,000 and $85,000 of
stock-based compensation expense associated with these restricted stock
awards.  The Company recognized a credit of approximately $43,000 due
to the reversal of previously recognized stock-based compensation on unvested
stock options forfeited during the three and six month periods ended April 30,
2008 and 2009.




Additional
Paid-in Capital




Additional
paid in capital has increased approximately $121,000 and $128,000 during the
three and six month periods ended April 30, 2009, respectively due to stock
based compensation expense.


F-7


6. Unearned
Revenue and Deferred Contract Costs




Unearned
revenue and deferred contract costs includes amounts received from customers for
which revenue and the associated costs of the revenue has not been recognized.
This generally results from certain customer contracts, ISV releases,
warranties, hardware maintenance and support, and consulting services. The
unearned revenue and contract costs associated with customer contracts and ISV
releases represents payments received for milestones achieved prior to
recognition of revenue. This revenue and associated cost will be recognized as
products are shipped. Revenues and associated costs from warranties and hardware
maintenance and support are recognized ratably over the service term selected by
the customer. Service revenues and associated costs from consulting are
recognized as the services are performed.




7. Inventories




Inventories
consisted of the following:




October 31,
                  
                  
                  April
      30,2008
                  
                  
                  2009Raw
      materials
                  
                  $
                  344,898
                  
                  
                  $
                  249,505Work
      in
      process
                  
                  
                  -
                  
                  
                  
                  53,895Finished
      goods
                  
                  
                  177,022
                  
                  
                  
                  157,827$
                  521,920
                  
                  
                  $
                  461,227





8. 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. The
dilutive weighted average number of common stock outstanding excluded potential
common stock from stock options and warrants of approximately 214,00 and 786,000
for the three month periods ended April 30, 2009 and 2008, respectively, and
13,000 and 381,000 for the six month periods ended April 30, 2009 and 2008,
respectively.  These shares were excluded from the earnings per share
calculation due to their antidilutive effect resulting from the loss from
operations.




9. Income
Tax




On
November 1, 2007, the Company adopted FASB Interpretation No. 48 “Accounting for
Uncertainty in Income Taxes” (“FIN 48”). FIN 48 prescribes a recognition
threshold that a tax position is required to meet before being recognized in the
financial statements and provides guidance on derecognition, measurement,
classification, interest and penalties, accounting in interim periods,
disclosure and transition issues.  The Company has an unrecognized tax
benefit of approximately $61,000 and does not expect any of this amount to
reverse in the next twelve months.  The amount of unrecognized tax
benefits that, if recognized, would impact the effective tax rate is
$0.




The
Company conducts business in the U.S. and is subject to tax in that
jurisdiction. As a result of its business activities, the Company files tax
returns that are subject to examination by the respective federal and state tax
authorities. For income tax returns filed by the Company, the Company is no
longer subject to U.S. federal, or state tax examination by tax authorities for
years before October 31, 2005, although carryforward tax attributes that were
generated prior to October 31, 2005 may still be adjusted upon examination by
tax authorities if they either have been or will be utilized.  The
Company’s accounting policy is to recognize interest and penalties related to
income tax matters in general and administrative expense. The Company had $0
accrued forinterest
and penalties as of April 30, 2009.


F-8


10. Commitments
and Contingencies




The
Company has accrued approximately $51,000 pertaining to payroll taxes and
related interest resulting from the failure to report certain employee
reimbursements as compensation.  The Company intends to file the
necessary returns to resolve the contingency.


F-9




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




References
herein to “we”, “our”, “ours” and “us” are to SteelCloud, Inc.




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, our ability to obtain financing in the short
term, risks associated with the integration of businesses following an
acquisition, concentration of revenue from one source, competitors with broader
product lines and greater resources, emergence into new markets, the termination
of any of our significant contracts or partnerships, our inability to maintain
working capital requirements to fund future operations or our 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 Quarterly Report
on Form 10-Q with the Securities and Exchange Commission (the “SEC”) and should
not be relied upon as of any subsequent date. Unless otherwise required by
applicable law, we do not undertake, and we specifically disclaim, 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 Footnotes thereto included in Item 1 in this Quarterly
Report on Form 10-Q,and with our Annual Report on Form 10-K for the fiscal year
ended October 31, 2008 as amended, filed by us with the SEC.




OVERVIEW




Founded
in 1987, we are a developer and manufacturer of integrated computer systems and
appliance solutions for the federal, ISV, and Blackberry markets.  We
design, manufacture and integrate specialized servers for federal market prime
contractors (“federal integrators”) and Independent Software Vendors (“ISV”s)
who use the specialized servers to deliver application software to their
clients.




BlackBerry®
Enterprise Server Solution (SteelWorks® Mobile)




As an
extension of our ISV business, we developed SteelWorks® Mobile (“SteelWorks
Mobile”), an appliance solution specifically for the BlackBerry Enterprise
Server (“BES”).  SteelWorks Mobile was developed in conjunction with
Research in Motion (“RIM”).   SteelWorks Mobile is an integrated
server appliance that enables virtually any size organization to implement the
BES at a fraction of the cost, time, and resource commitment.  We have
filed for patent protection for the SteelWorks Mobile technology we created for
the installation wizard, backup and restore features.  These patents
are currently pending approval from the U.S. Patent and Trademark
Office.




In
addition, we developed SteelWorks FedMobile, our BlackBerry Enterprise Server
appliance solution specifically for the Department of Defense (“DoD”) and other
related agencies.  The SteelWorks FedMobile appliance builds upon
SteelWorks Mobile by automating the application of the Defense Information
Systems Agency’s and DoD’s Security Technical Implementation Guide (“STIG”) to
the BES installation process.  The STIG mandates the policies for
which the DoD and related agencies must operate their wireless
communications.  As a result, our FedMobile appliance allows DoD
organizations to implement a STIG compliant BES infrastructure in a fraction of
the time, cost, or resources necessary to what is otherwise a time intensive and
manual STIG process.


2


Federal
Systems Integrator




Federal
integrators outsource their specialized requirements to us and consider us to be
an integral part of their product and service delivery capability.  We
design and manufacture specialized embedded and integrated computing systems
that are the foundation upon which the integrators develop and deliver their
application software.




Our
specialized service allows our customers to outsource computer system
integration in order that they may concentrate on their core application
software and services.  As a result, integrators improve customer
satisfaction, shorten time to delivery and lower overall development
costs.




We
complement our embedded integrated computing systems, which are often designed
to withstand harsh environmental conditions, with software integration, quality
testing and program lifecycle management services.  We also provide
configuration management, logistics and support services that are unavailable
from traditional computer vendors.




Independent
Software Vendors




For our
ISV customers, we are their “virtual hardware engineering
division.”  Similar to our federal integrator business, we create a
unique product for the ISV by integrating the ISV’s software onto a specialized
appliance platform running Linux, FreeBSD, or one of Microsoft’s operating
systems.




In
addition, we augment the ISV’s internal capabilities by taking responsibility
for those tasks which are necessary to successfully bring an appliance to
market, but which are impractical for the ISV to perform.  Services
include branding, asset tagging, supply chain and inventory management,
fulfillment, logistics and program management.  The final ISV
deliverable is a branded, unique, optimized appliance that is ready-to-deploy
when it arrives at the ISV’s end customer’s site.




Our
specialized servers and appliances are engineered and developed according to New
Product Realization procedures which are compliant with our ISO 9001:2000
Certified Quality Management System.




Professional
Services




We
provide information technology (“IT”) consulting and contract staffing solutions
for our commercial and government clients.  Our consultants are
subject matter experts in network infrastructure complexities and security
technologies including firewalls, content inspection, intrusion detection, spam
and vulnerability scanning.  For our contract staffing solutions, our
personnel function as “virtual” employees, performing work directly under the
auspices of client management and serve as an extension of the client’s in-house
staff resources.




Research
and Product Development




By
investing in product development, we believe we will have more control over the
functionality and marketing of our products.  We also believe that the
resulting intellectual property will increase the competitiveness of our
offerings and improve product margins.  For the three and six months
ended April 30, 2009, we incurred research and development costs of
approximately $102,000 and $204,000, respectively.  We will continue
to incur costs for product development in the future.


3


GSA
Contract




We have a
multiple award schedule contract with the U.S. General Services Administration
(the “GSA Contract”).  The GSA Contract was originally awarded in
April 1996.  It was renewed in fiscal years 2002 and 2007, and is
valid through March 31, 2012.  In August 2006, GSA Contract auditors
awarded us an “Outstanding” rating for our management and execution of the GSA
Contract.  The GSA Contract enables government IT purchasers to
acquire all of their needed goods and services from a particular vendor and
largely limits the competition to selected vendors holding GSA
Contracts.  For the three and six months ended April 30, 2009, our GSA
Contract had sales of approximately $174,000 and $433,000, respectively, which
accounted for approximately 15% and 21%, respectively, of our net
revenues.




Nasdaq




On March
23, 2009, we received notice, under Marketplace Rule 4310(c)(3)(the “Rule”),
that our common stock is subject to potential delisting from the Nasdaq Capital
Market because we do not have a minimum of $2,500,000 in stockholders’ equity,
$35,000,000 market value of listed securities, or $500,000 of net income from
continuing operations for the most recently completed fiscal year or two of the
three most recently completed fiscal years.  We provided NASDAQ with a
specific plan of how we intend to achieve and sustain compliance with all the
Nasdaq Capital Market listing requirements, including a time frame for
completion of such plan.  Our plan includes the following two
strategies: (i) increasing our stockholders equity in excess of the minimum
$2,500,000 requirement by raising between $3,000,000 to $4,000,000 through an
equity transaction; and (ii) identifying a strategic partner interested in
either merging with or acquiring us.  On April 28, 2009 we received
notice from Nasdaq indicating that Nasdaq had granted our request for an
extension of time to regain compliance with the Nasdaq listing
requirements.  The terms of the extension include: (a) on or before
July 6, 2009, we must complete an equity transaction or a merger/and or
acquisition, and (b) we must make appropriate disclosures to the SEC and Nasdaq
on a Form 8-K.  In the event we do not satisfy the terms of this
extension, Nasdaq will provide us with written notification that our securities
will be delisted.




CRITICAL
ACCOUNTING POLICIES AND ESTIMATES




The
preparation of financial statements in conformity with US Generally Accepted
Accounting Principles requires management to make certain judgments, estimates
and assumptions that could affect the reported amounts of assets and liabilities
at the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. We based our estimates and assumptions on
historical experience and on various other assumptions believed to be
applicable, and evaluated them on an on-going basis to ensure they remained
reasonable under current conditions. Actual results could differ significantly
from those estimates.  No changes to our critical accounting policies
have taken place since October 31, 2008.





Recently
Issued Accounting Pronouncements




Effective
November 1, 2008, we adopted the provisions of Statement of Financial Accounting
Standards No. 157, “Fair Value Measurements” (“SFAS No. 157”) and Statement of
Financial Accounting Standards No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities” (“SFAS No. 159”).  SFAS 157, which
defines fair value, establishes a framework for measuring fair value in
accordance with U.S. Generally Accepted Accounting Principles (“GAAP”), and
expands disclosures about fair value measurements.  SFAS 157 clarifies
that fair value is an exit price, representing the amount that would be received
to sell asset or paid to transfer a liability in an orderly transaction between
market participants.  SFAS 159 permits an entity to measure certain
financial assets and financial liabilities at fair value with changes in fair
value recognized in earnings each period. For the three and six month periods
ended April 30, 2009, we have elected not to use the fair value option permitted
under SFAS 159 for any of our financial assets and financial liabilities that
are not already recorded at fair value.




In
February 2008, the FASB issued Staff Position No. 157-2, “Effective Date of FASB
Statement No. 157” (“FSP 157-2”).  FSP 157-2 deferred the effective
date of FAS 157 for all nonfinancial assets and nonfinancial liabilities to
fiscal years beginning after November 15, 2008.  We are in the process
of evaluating the effect, if any, the adoption of FSP 157-2 will have on our
financial statements.


4


In
October 2008, the FASB issued Staff Position No. 157-3, “Determining the Fair
Value of a Financial Asset When the Market for that Asset is not Active” (“FSP
157-3”).  FSP 157-3 provides guidance for determining the fair value
of a financial asset in an inactive market.  We are in the process of
evaluating the effect, if any, the adoption of FSP 157-3 will have on our
financial statements.




In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141 (Revised 2007) “Business Combinations” (“SFAS No. 141R”).  SFAS
No. 141R, which replaces SFAS No. 141, requires that the acquisition method of
accounting (which SFAS No. 141 called the “purchase method”) be used for all
business combinations and for an acquirer to be identified for each business
combination.  SFAS No. 141R also establishes principles and
requirements for how the acquirer recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree; recognizes and measures the goodwill
acquired in the business combination or a gain from a bargain purchase; and
determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business
combination.  SFAS No. 141R also requires that acquisition-related
costs be recognized separately from the business combination.  SFAS
No. 141R will apply prospectively to business combinations for which the
acquisition date is after fiscal years beginning on or after December 15,
2008.  We are in the process of evaluating the effect, if any, the
adoption of SFAS No. 141R will have on our financial statements.




In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
160, “Noncontrolling Interests in Consolidated Financial Statements — an
amendment of ARB No. 51” (“SFAS No. 160”).  SFAS No. 160 requires all
entities to report noncontrolling (minority) interests in subsidiaries as equity
in the consolidated financial statements.  Its intention is to
eliminate the diversity in practice regarding the accounting for transactions
between an entity and noncontrolling interests.  This statement is
effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008.  Earlier adoption is
prohibited.  We are in the process of evaluating the effect, if any,
the adoption of SFAS No. 160 will have on our financial statements.




In May
2008, The FASB issued Statement of Financial Accounting Standards No.162 “The
Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”), which
reorganizes the GAAP hierarchy.  SFAS 162 is intended to improve
financial reporting by providing a consistent framework for determining what
accounting principles should be used in preparing GAAP financial
statements.  With the issuance of SFAS 162, the FASB concluded that
the GAAP hierarchy should be directed toward the entity and not its auditor, and
reside in the accounting literature established by the FASB as opposed to the
American Institute of Certified Accountants Statement on Auditing Standards No.
69, The Meaning of Present Fairly in Conformity With Generally Accepted
Accounting Principles”.  SFAS 162 will become effective 60 days
following the SEC’s approval of the Public Accounting Oversight Board amendments
to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally
Accepted Accounting Principles” and is not expected to have any impact on our
financial statements.




In May
2009, the FASB issued SFAS No. 165, "Subsequent Events" ("SFAS 165"). SFAS 165
is intended to establish general standards of accounting for and disclosure of
events that occur after the balance sheet date but before financial statements
are issued or are available to be issued. It requires the disclosure of the date
through which an entity has evaluated subsequent events and the basis for
selecting that date, that is, whether that date represents the date the
financial statements were issued or were available to be issued. SFAS 165
is effective for interim or annual financial periods ending after June 15,
2009.  We are in the process of evaluating the effect, if any, the
adoption of SFAS No. 165 will have on our financial statements.


5




RESULTS
OF OPERATIONS




The
overall economic downturn has impacted virtually every area of our
business.  There were and continue to be reductions in quantities
ordered from our commercial and government clients as well as continued delays
of anticipated program awards that were originally planned for late fiscal 2008
and early fiscal 2009.




For
the three months ended April 30, 2009 compared to the three months ended April
30, 2008:




Net
Revenue Discussion:




The
following table summarizes our net revenue for the three months ended April 30,
2008 and 2009 in dollars and as a percentage of net revenues.




Three
      Months Ended April 30,2008
                
                
                2009
                
                
                Increase
      (decrease)%
      of Net
                
                
                
                
                
                %
      of NetDollars
                
                
                Revenues
                
                
                Dollars
                
                
                Revenues
                
                
                Dollars
                
                
                PercentageProducts
                
                $
                7,827,740
                
                
                
                93.36
                %
                
                $
                958,263
                
                
                
                80.06
                %
                
                $
                (6,869,477
                )
                
                
                (87.76
                )%Services
                
                
                556,894
                
                
                
                6.64
                %
                
                
                238,600
                
                
                
                19.94
                %
                
                
                (318,294
                )
                
                
                (57.16
                )%Total  net
      revenues
                
                $
                8,384,634
                
                
                
                100.00
                %
                
                $
                1,196,863
                
                
                
                100.00
                %
                
                $
                (7,187,771
                )
                
                
                (85.73
                )%





The
decrease in product revenue is primarily attributable to our exiting the
reseller business and continued program delays with our integrator business. Due
to the current economic decline, we experienced a significant reduction in our
Integrator and ISV opportunities. Our ISV opportunities also declined as our
customers merged and/or were acquired resulting in lower demand for our
products.




The
decrease in service revenue for the three-month period ended April 30, 2009 as
compared to the same period in fiscal 2008 is the result of our completing a
large services contract in December 2008.  We anticipate service
revenues to fluctuate in the near future due to the current state of the U.S.
economy.




Gross
Profit Discussion:




The
following table summarizes our gross profit for the three months ended April 30,
2008 and 2009 in dollars, as a percentage of gross profit and as a percentage of
net revenues.




Three
      Months Ended April 30,2008
                    
                    
                    2009
                    
                    
                    Increase
      (decrease)%
      of
                      Gross
                    
                    
                    
                    
                    
                    %
      of
                      GrossDollars
                    
                    
                    Profit
                    
                    
                    Dollars
                    
                    
                    Profit
                    
                    
                    Dollars
                    
                    
                    PercentageProducts
                    
                    $
                    1,392,420
                    
                    
                    
                    94.78
                    %
                    
                    $
                    132,215
                    
                    
                    
                    64.78
                    %
                    
                    $
                    (1,260,205
                    )
                    
                    
                    (90.50
                    )%Products
      - GM%
                    
                    
                    17.79
                    %
                    
                    
                    
                    
                    
                    
                    13.80
                    %Services
                    
                    
                    76,690
                    
                    
                    
                    5.22
                    %
                    
                    
                    71,891
                    
                    
                    
                    35.22
                    %
                    
                    $
                    (4,799
                    )
                    
                    
                    (6.26
                    )%Services
      – GM%
                    
                    
                    13.77
                    %
                    
                    
                    
                    
                    
                    
                    30.13
                    %Total
      gross profit
                    
                    $
                    1,469,110
                    
                    
                    
                    100.00
                    %
                    
                    $
                    204,106
                    
                    
                    
                    100.00
                    %
                    
                    $
                    (1,265,004
                    )
                    
                    
                    (86.11
                    )%Total
      – GM%
                    
                    
                    17.52
                    %
                    
                    
                    
                    
                    
                    
                    17.05
                    %


6


The
decrease in gross profit percentage for the three months ended April 30, 2009 as
compared to the same period in fiscal 2008 is primarily due to the allocation of
our fixed cost.  Although we were able to better align our variable
expenses with our revenue, we were not able to significantly reduce our fixed
facility expenses during the three months ended April 30, 2009.  As a
result of the reduced volume of revenue and corresponding production activity
that occurred during the three months ended April 30, 2009, we included abnormal
amounts of idle facility expense in our cost of goods sold for the three months
ended April 30, 2009 compared to the same period in 2008.




The
increase in services gross profit for the three months ended April 30, 2009 as
compared to the same period in fiscal 2008 is primarily attributable to the
completion of a low margin services contract in December 2008.




Operating
Expense Discussion:




The
following table summarizes our operating expenses for the three months ended
April 30, 2008 and 2009 in dollars and as a percentage of net
revenues.




Three
      Months Ended April 30,2008
                    
                    
                    2009
                    
                    
                    Increase
      (decrease)%
      of Net
                    
                    
                    
                    
                    
                    %
      of NetDollars
                    
                    
                    Revenues
                    
                    
                    Dollars
                    
                    
                    Revenues
                    
                    
                    Dollars
                    
                    
                    PercentageSelling
      and marketing
                    
                    $
                    281,718
                    
                    
                    
                    3.36
                    %
                    
                    $
                    144,280
                    
                    
                    
                    12.05
                    %
                    
                    $
                    (137,438
                    )
                    
                    
                    (48.79
                    )%Research
      and product development
                    
                    
                    208,888
                    
                    
                    
                    2.49
                    %
                    
                    
                    102,273
                    
                    
                    
                    8.55
                    %
                    
                    
                    (106,615
                    )
                    
                    
                    (51.04
                    )%General
      and administrative
                    
                    
                    973,440
                    
                    
                    
                    11.61
                    %
                    
                    
                    807,921
                    
                    
                    
                    67.50
                    %
                    
                    
                    (165,519
                    )
                    
                    
                    (17.00
                    )%Total
      operating expenses
                    
                    $
                    1,464,046
                    
                    
                    
                    17.46
                    %
                    
                    $
                    1,054,474
                    
                    
                    
                    88.10
                    %
                    
                    $
                    (409,572
                    )
                    
                    
                    (27.98
                    )%





The
decrease in selling and marketing expense is the result of aligning expenses to
our current and future business models. For the three months ended April 30,
2009 compared to the three months ended April 30, 2008, marketing activities and
expense associated with selling and marketing personnel decreased as a result of
cost cutting efforts. We will continue to evaluate our costs relative to our
revenues and gross margins.




The
decrease in research and product development expense for the three months ended
April 30, 2009 compared to the three months ended April 30, 2008 is the result
of our aligning expenses to our current and future business
models.  We believe that research and product development expenses
will fluctuate from quarter to quarter as we develop and introduce new products
into the marketplace.




The
decrease in general and administrative expenses for the three months ended April
30, 2009 compared to the three months ended April 30, 2008 is primarily
attributable to cost cutting efforts. The cost reductions continue to include
curtailing expenses related to non-revenue generating activities, terminating
non-essential employees, and instituting across the board departmental expense
reductions.


7




Other
Income (Expense) Discussion:




The
following table summarizes our other income (expense) for the three months ended
April 30, 2008 and 2009 in dollars and as a percentage of net
revenues.




Three
      Months Ended April 30,2008
                    
                    
                    2009
                    
                    
                    Increase
      (decrease)%
      of Net
                    
                    
                    
                    
                    
                    %
      of NetDollars
                    
                    
                    Revenues
                    
                    
                    Dollars
                    
                    
                    Revenues
                    
                    
                    Dollars
                    
                    
                    PercentageInterest
      income
                    
                    $
                    4,827
                    
                    
                    
                    0.06
                    %
                    
                    $
                    410
                    
                    
                    
                    0.03
                    %
                    
                    $
                    (4,417
                    )
                    
                    
                    (91.51
                    )%Total
      interest income
                    
                    $
                    4,827
                    
                    
                    
                    0.06
                    %
                    
                    $
                    410
                    
                    
                    
                    0.03
                    %
                    
                    $
                    (4,417
                    )
                    
                    
                    (91.51
                    )%





The decrease in net interest income for
the three-month period ended April 30, 2009 is attributable to the recording of
interest relating to payroll taxes resulting from the failure to report certain
employee reimbursements as compensation offsetting lower interest earned as a
result of lower cash balances compared to the same period in fiscal year
2008.




Net
Income (Loss) Discussion:




The
following table summarizes our net (loss) for the three months ended April 30,
2008 and 2009 in dollars and as a percentage of net revenues.


Three Months Ended April
      30,2008
                                                                                      
                                                                                      
                                                                                      2009
                                                                                      
                                                                                      
                                                                                      Increase (decrease)Dollars
                                                                                      
                                                                                      
                                                                                      % of Net
                                                                                        Revenues
                                                                                      
                                                                                      
                                                                                      Dollars
                                                                                      
                                                                                      
                                                                                      % of Net
                                                                                        Revenues
                                                                                      
                                                                                      
                                                                                      Dollars
                                                                                      
                                                                                      
                                                                                      PercentageNet
      income (loss)
                                                                                      
                                                                                      $
                                                                                      9,891
                                                                                      
                                                                                      
                                                                                      
                                                                                      0.12
                                                                                      %
                                                                                      
                                                                                      $
                                                                                      (849,958
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (71.02
                                                                                      )%
                                                                                      
                                                                                      $
                                                                                      (859,849
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (8693.25
                                                                                      )%





The
increase in net loss for the three months ended April 30, 2009 as compared to
the same period in fiscal 2008 is a result of lower revenues and corresponding
gross margin dollars.  We continue to manage our costs relative to our
revenue.


8


For
the six months ended April 30, 2009 compared to the six months ended April 30,
2008:




Net
Revenue Discussion:




The
following table summarizes our net revenue for the six months ended April 30,
2008 and 2009 in dollars and as a percentage of net revenues.




Six
      Months Ended April 30,2008
                
                
                2009
                
                
                Increase
      (decrease)%
      of Net
                
                
                
                
                
                %
      of NetDollars
                
                
                Revenues
                
                
                Dollars
                
                
                Revenues
                
                
                Dollars
                
                
                PercentageProducts
                
                $
                13,080,767
                
                
                
                92.18
                %
                
                $
                1,306,165
                
                
                
                62.62
                %
                
                $
                (11,774,602
                )
                
                
                (90.01
                )%Services
                
                
                1,110,339
                
                
                
                7.82
                %
                
                
                779,608
                
                
                
                37.38
                %
                
                
                (330,731
                )
                
                
                (29.79
                )%Total  net
      revenues
                
                $
                14,191,106
                
                
                
                100.00
                %
                
                $
                2,085,773
                
                
                
                100.00
                %
                
                $
                (12,105,333
                )
                
                
                (85.30
                )%





The
decrease in product revenue is primarily attributable to our exiting of the
reseller business and continued program delays with our integrator business. Due
to the current economic decline, we experienced a significant reduction in our
Integrator and ISV opportunities. Our ISV opportunities also declined as our
customers merged and/or were acquired resulting in lower demand for our
products.




The
decrease in service revenue for the six month period ended April 30, 2009 as
compared to the same period in fiscal 2008 is the result of us completing a
large services contract in December 2008.  We anticipate service
revenues to fluctuate in the near future due to the current state of the U.S.
economy.




Gross
Profit Discussion:




The
following table summarizes our gross profit for the six months ended April 30,
2008 and 2009 in dollars, as a percentage of gross profit and as a percentage of
net revenues.




Six
      Months Ended April 30,2008
                    
                    
                    2009
                    
                    
                    Increase
      (decrease)%
      of
                      Gross
                    
                    
                    
                    
                    
                    %
      of
                      GrossDollars
                    
                    
                    Profit
                    
                    
                    Dollars
                    
                    
                    Profit
                    
                    
                    Dollars
                    
                    
                    PercentageProducts
                    
                    $
                    2,029,644
                    
                    
                    
                    91.45
                    %
                    
                    $
                    67,693
                    
                    
                    
                    28.96
                    %
                    
                    $
                    (1,961,951
                    )
                    
                    
                    (96.66
                    )%Products
      - GM%
                    
                    
                    15.52
                    %
                    
                    
                    
                    
                    
                    
                    5.18
                    %Services
                    
                    
                    189,826
                    
                    
                    
                    8.55
                    %
                    
                    
                    166,050
                    
                    
                    
                    71.04
                    %
                    
                    $
                    (23,776
                    )
                    
                    
                    (12.53
                    )%Services
      – GM%
                    
                    
                    17.10
                    %
                    
                    
                    
                    
                    
                    
                    21.30
                    %Total
      gross profit
                    
                    $
                    2,219,470
                    
                    
                    
                    100.00
                    %
                    
                    $
                    233,743
                    
                    
                    
                    100.00
                    %
                    
                    $
                    (1,985,727
                    )
                    
                    
                    (89.47
                    )%Total
      – GM%
                    
                    
                    15.64
                    %
                    
                    
                    
                    
                    
                    
                    11.21
                    %





The
decrease in gross profit percentage for the six months ended April 30, 2009 as
compared to the same period in fiscal 2008 is primarily due to the allocation of
our fixed cost.  Although we were able to align our variable expenses
with our revenue, we were not able to significantly reduce our fixed facility
expenses during the six months ended April 30, 2009.  As a result of
the reduced volume of revenue and corresponding production activity that
occurred during the six months ended April 30, 2009, we included abnormal
amounts of idle facility expense in our cost of goods sold for the six months
ended April 30, 2009 compared to the same period in 2008.




The
increase in services gross profit for the six months ended April 30, 2009 as
compared to the same period in fiscal 2008 is primarily attributable to the
completion of a low margin services contract in December 2008.


9




Operating
Expense Discussion:




The
following table summarizes our operating expenses for the six months ended April
30, 2008 and 2009 in dollars and as a percentage of net revenues.




Six
      Months Ended April 30,2008
                    
                    
                    2009
                    
                    
                    Increase
      (decrease)%
      of Net
                    
                    
                    
                    
                    
                    %
      of NetDollars
                    
                    
                    Revenues
                    
                    
                    Dollars
                    
                    
                    Revenues
                    
                    
                    Dollars
                    
                    
                    PercentageSelling
      and marketing
                    
                    $
                    601,962
                    
                    
                    
                    4.24
                    %
                    
                    $
                    280,254
                    
                    
                    
                    13.44
                    %
                    
                    $
                    (321,708
                    )
                    
                    
                    (53.44
                    )%Research
      and product development
                    
                    
                    407,113
                    
                    
                    
                    2.87
                    %
                    
                    
                    203,754
                    
                    
                    
                    9.77
                    %
                    
                    
                    (203,359
                    )
                    
                    
                    (49.95
                    )%General
      and administrative
                    
                    
                    1,887,793
                    
                    
                    
                    13.30
                    %
                    
                    
                    1,530,643
                    
                    
                    
                    73.38
                    %
                    
                    
                    (357,150
                    )
                    
                    
                    (18.92
                    )%Severance
      and restructuring
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    73,205
                    
                    
                    
                    3.51
                    %
                    
                    
                    73,205
                    
                    
                    
                    100.00
                    %Total
      operating expenses
                    
                    $
                    2,896,868
                    
                    
                    
                    20.41
                    %
                    
                    $
                    2,087,856
                    
                    
                    
                    100.10
                    %
                    
                    $
                    (809,012
                    )
                    
                    
                    (27.93
                    )%





The
decrease in selling and marketing expense is the result of aligning expenses to
our current and future business models. For the six months ended April 30, 2009
compared to the six months ended April 30, 2008, marketing activities and
expense associated with selling and marketing personnel decreased as a result of
cost cutting efforts.




The
decrease in research and product development for the six months ended April 30,
2009 compared to the six months ended April 30, 2008 is the result of our
aligning expenses to our current and future business models.  We
believe that research and product development expenses will fluctuate from
quarter to quarter as we develop and introduce new products into the
marketplace.




The
decrease in general and administrative expenses for the six months ended April
30, 2009 compared to the six months ended April 30, 2008 is primarily
attributable to cost cutting efforts. The cost reductions continue to include
curtailing expenses related to non-revenue generating activities, terminating
non-essential employees, and instituting across the board departmental expense
reductions.




The
increase in severance and restructuring costs for the six months ended April 30,
2009 compared to the six months ended April 30, 2008 is the result of incurring
severance payments in the amount of $73,205 associated with the termination of
our former CEO and President’s employment agreement during the three months
ended January 31, 2009.


10




Other
Income (Expense) Discussion:




The
following table summarizes our other income (expense) for the six months ended
April 30, 2008 and 2009 in dollars and as a percentage of net
revenues.




Six
      Months Ended April 30,2008
                    
                    
                    2009
                    
                    
                    Increase
      (decrease)%
      of Net
                    
                    
                    
                    
                    
                    %
      of NetDollars
                    
                    
                    Revenues
                    
                    
                    Dollars
                    
                    
                    Revenues
                    
                    
                    Dollars
                    
                    
                    PercentageInterest
      income
                    
                    $
                    11,242
                    
                    
                    
                    0.08
                    %
                    
                    $
                    410
                    
                    
                    
                    0.02
                    %
                    
                    $
                    (10,832
                    )
                    
                    
                    (96.35
                    )%Total
      interest income
                    
                    $
                    11,242
                    
                    
                    
                    0.08
                    %
                    
                    $
                    410
                    
                    
                    
                    0.02
                    %
                    
                    $
                    (10,832
                    )
                    
                    
                    (96.35
                    )%





The decrease in net interest income for
the six-month period ended April 30, 2009 is attributable to the recording of
interest relating to payroll taxes resulting from the failure to report certain
employee reimbursements as compensation offsetting lower interest earned as a
result of lower cash balances compared to the same period in fiscal year
2008.




Net
(Loss) Discussion:




The
following table summarizes our net (loss) for the six months ended April 30,
2008 and 2009 in dollars and as a percentage of net revenues.




Six
      Months Ended April 30,2008
            
            
            2009
            
            
            Increase (decrease)Dollars
            
            
            % of Net
              Revenues
            
            
            Dollars
            
            
            % of Net
              Revenues
            
            
            Dollars
            
            
            PercentageNet
      (loss)
            
            $
            (666,156
            )
            
            
            (4.69)
            %
            
            $
            (1,853,703
            )
            
            
            (88.87
            )%
            
            $
            1,187,547
            
            
            
            178.27
            %




The
increase in net loss for the six months ended April 30, 2009 as compared to the
same period in fiscal 2008 is a result of lower revenues and corresponding gross
margin dollars.  We continue to manage our costs relative to our
revenue.




LIQUIDITY
AND CAPITAL RESOURCES




We have
experienced recurring losses from operations and negative cash
flows.  For the six months ended April 30, 2009, we incurred a net
loss of $1,853,703 and an accumulated deficit of $46,722,268 as of that
date.  The report from our independent registered public accounting
firm on our audited financial statements at October 31, 2008 contains an
explanatory paragraph regarding doubt as to our ability to continue as a going
concern as a result of our net loss from operations.  Despite our
history of revenues, we can give no assurance that we will be able to maintain
or increase our revenues in fiscal 2009 or that we will be successful in
reaching profitability or generate positive cash flows from our
operations.  We are considering all strategic options to improve our
liquidity and provide us with working capital to fund our continuing business
operations including equity offerings, asset sales and debt financing as
alternatives to improve our cash needs; however; we can offer no assurance that
we will be successful in identifying, obtaining or negotiating financing
terms.  If adequate funds are not available or are not available on
terms acceptable to us, we will likely not be able to take advantage of
unanticipated opportunities, develop or enhance services or products, respond to
competitive pressures, or continue as a going concern.




Our
consolidated financial statements for the three and six months ended April 30,
2009 do not give effect to any adjustments to recorded amounts and their
classifications, which would be necessary should we be unable to continue as a
going concern and therefore, be required to realize our assets and discharge our
liabilities in other than the normal course of business and at amounts different
from those reflected in the consolidated financial statements.


11


As of
April 30, 2009, we had cash and cash equivalents of approximately $538,000 and
working capital of approximately $516,000.  We do not have any working
capital commitments nor do we presently have any external sources of working
capital.  Historically, our revenues have not been sufficient to fund
our operations and we have relied on capital provided through the sale of equity
securities.  Our working capital needs in future periods will depend
primarily on the rate at which we can increase our revenues while controlling
our expenses and decreasing the use of cash from
operations.  Additional capital is needed to fund acquisitions of
additional companies or assets, although we are not a party to any pending
agreements at this time and, accordingly, cannot estimate the amount of capital
which may be necessary, if any, for acquisitions.  We believe cash on
hand together with cash generated from operations will not be adequate to
sustain our operations until our next fiscal quarter and that additional
financing is needed.  We are currently in the process of registering
shares of our common stock to sell directly to investors in order to raise
additional capital.  We can provide no assurances that any such
financings will be consummated.




For the
six months ended April 30, 2009, we used $542,000 in cash from operating
activities. Our primary use of cash was to finance our operating
loss.  The use and availability of our cash is affected by the timing,
pricing, and magnitude of orders for our products, and the timing of cash
outflows relating to these orders.




We
generated approximately $331,000 from our investing activities for the six
months ended April 30, 2009.




Off-Balance
Sheet Arrangements




Contractual
Obligations and Commercial Commitments




We have
significant contractual obligations for fiscal year 2009 and beyond for our
operating leases and employment agreements.




On
February 27, 2009, we entered into a lease amendment with the landlord of one of
our operation facilities whereby the current lease, which is presently scheduled
to expire on August 31, 2014, has been amended to provide for (i) the extension
of the lease term for a period of one (1) year and four (4) months ending on
December 31, 2015, and (ii) certain other modifications, including a reduction
in our rent cash payments by approximately $60,000 and $34,000 for the fiscal
years 2009 and 2010, respectively.  Our monthly straight-line rent
expense will be approximately $21,000 a month for the length of the
lease.




On May
22, 2009, we entered into a Stipulation/Consent Order with CRP (the
“Stipulation”), pursuant to an Affidavit and Statement of Account (the
“Affidavit”), stating, as declared by a general manager of Jones Lang LaSalle, a
property management company and agent for CRP Holdings A-1, LLC (“CRP”), the
landlord of 14040 Park Center Road, Suite 210, Herndon, Virginia 20171 (the
“Premises”), that CRP, as landlord, was seeking a judgment against us for: (i)
possession of the Premises, and (ii) monetary damages for nonpayment of rent due
under a sublease, dated September 28, 2004, by and between us and NEC America,
Inc. (“NEC”) (the “Sublease”), and a subsequent assignment of the Sublease to
CRP from NEC, dated December 15, 2008.  In the Stipulation we
acknowledged that the balance due for rent and additional rent for the Premises
was $168,637.96, together with attorney’s fees and court expenses of $7,041.00
through May 22, 2009 (the “Judgment Amount”).  Pursuant to the
Stipulation, we paid $30,000 (the “Forbearance Payment”) on May 22, 2009 toward
the Judgment Amount.  Further we agreed to, and have, vacated the
Premises.  CRP agreed to stay enforcement of the Judgment Amount until
the earlier of (a) our receipt of capital in the amount of at least $500,000, or
(b) May 31, 2010.  The matter was returned to the court’s files
pending our compliance with the terms of the Stipulation.


12


On
February 5, 2009, we entered into an Executive Retention Agreement (the “2009
Agreement”) with Brian Hajost, our current President and Chief Executive
Officer, effective as of January 16, 2009.  Pursuant to the terms of
the 2009 Agreement, as compensation for Mr. Hajost serving as our President and
Chief Executive Officer, Mr. Hajost receives (a) a semi-monthly salary of
$8,333.33 (or $200,000 annually); (b) a stock grant of 156,000 shares of our
common stock, which will vest ratably over 12 months; and (c) a stock option
grant of 300,000 shares of our common stock, which will vest ratably over a
three year term and have a five year exercise period.  The 2009
Agreement further provides that in the event we terminate Mr. Hajost’s
employment without cause (other than due to Mr. Hajost’s request), or if Mr.
Hajost terminates his employment for good reason, Mr. Hajost will be entitled to
(a) if the termination takes place within three months from the date of the 2009
Agreement, two months salary, (b) if the termination takes place between three
and six months from the date of the 2009 Agreement, three months salary, (c) if
the termination takes place between six months and one year from the date of the
2009 Agreement, six months salary, (d) if the termination takes place after the
first year anniversary of the 2009 Agreement, 12 months salary.  In
the event that a majority of our stock or a substantial portion of our assets
are acquired, the acquisition closes while Mr. Hajost is employed by us, and Mr.
Hajost’s employment with us is terminated without cause (other than due to Mr.
Hajost’s request) within 30 days of the acquisition, Mr. Hajost will be entitled
to severance pay equal to the lesser of (a) 24 months salary based on his annual
rate of pay for the calendar year before the calendar year of termination from
service, or (b) two times the IRS limit for qualified plans provided for in 26
U.S.C. § 401(a)(17) for the calendar year of termination of
service.




On
February 28, 2009, we entered into an Employment Agreement Amendment (the
“Amended Agreement”) with Kevin Murphy, our current Chief Financial Officer,
pursuant to which the terms of Mr. Murphy’s employment agreement, dated June 8,
2004, as amended on October 26, 2007 and December 31, 2008, were amended. Under
the terms of the Amended Agreement, Mr. Murphy’s annual base salary was reduced
to $193,500, from $215,000 and Mr. Murphy’s monthly general business allowance
was reduced to $500, from $1,000. The terms of the Amended Agreement further
provide that (a) Mr. Murphy agrees to forfeit options to purchase an aggregate
of 225,000 shares of our common stock, $0.001 par value per share (the “Common
Stock”), (b) Mr. Murphy shall enter into a separate Incentive Stock Option
agreement with us, pursuant to which Mr. Murphy shall be granted an option to
purchase 150,000 shares of our common stock, which shall vest quarterly in
arrears over a one year period, and (c) Mr. Murphy shall enter into a separate
Restricted Stock Agreement with us, pursuant to which Mr. Murphy shall receive
90,000 shares of restricted stock which shall vest ratably over 12 months, or
7,500 shares per month, so long as Mr. Murphy is employed by us on the last day
of each month.




As of
April 30, 2009 the total obligation of our employment agreements for fiscal year
2009 is approximately $197,000 and does not include applicable employment taxes
and potential bonuses.




We do not
have any purchase obligations, capital lease obligations or any material
commitments for capital expenditures.  We have not engaged in
off-balance sheet financing, commodity contract trading or significant related
party transactions.




ITEM
      3.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK




We are a
“smaller reporting company” as defined by Rule 12b-2 of the Securities Exchange
Act of 1934, as amended, and are not required to provide the information under
this item.


13




ITEM
      4T.
            CONTROLS
      AND PROCEDURES




Disclosure
Controls and Procedures




We have
established disclosure controls and procedures to ensure that material
information relating to our company is made known to the officers who certify
our financial reports and to other members of our senior management and our
Board of Directors.




A control
system, no matter how well conceived and operated, can provide only reasonable,
not absolute, assurance that the objectives of the control system are met.
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 a company have been detected. Our disclosure controls and
procedures are designed to provide reasonable assurance of achieving our
objectives. Based upon their evaluation as of April 30, 2009, our Principal
Executive and Principal Financial and Accounting Officer have concluded that our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934) are effective at such
date.




Changes
in Internal Control Over Financial Reporting




There
were no changes in our internal control over financial reporting during our
fiscal quarter ended April 30, 2009 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.




PART
II. OTHER INFORMATION




ITEM
      1.
            LEGAL
      PROCEEDINGS




On May
22, 2009, we entered into a Stipulation, pursuant to an Affidavit, stating, as
declared by a general manager of Jones Lang LaSalle, a property management
company and agent for CRP, the landlord of the Premises, that CRP, as landlord,
was seeking a judgment against us for: (i) possession of the Premises, and (ii)
monetary damages for nonpayment of rent due under a sublease, dated September
28, 2004, by and between us and NEC (the “Sublease”), and a subsequent
assignment of the Sublease to CRP from NEC, dated December 15,
2008.  In the Stipulation we acknowledged Judgment
Amount.  Pursuant to the Stipulation, we made the Forbearance Payment
on May 22, 2009 toward the Judgment Amount.  Further we agreed to, and
have, vacated the Premises.  CRP agreed to stay enforcement of the
Judgment Amount until the earlier of (a) our receipt of capital in the amount of
at least $500,000, or (b) May 31, 2010.  The matter was returned to
the court’s files pending our compliance with the terms of the
Stipulation.





There are
routine legal claims pending against us 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 our financial condition
and results of operation.




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




ITEM
      1A.
            RISK
      FACTORS




RISKS
RELATED TO OUR BUSINESS




Our auditors have expressed doubt
regarding our ability to continue as a going concern.





The
report of our independent registered public accounting firm on our consolidated
financial statements for the fiscal year ended October 31, 2008 contains an
explanatory paragraph regarding our ability to continue as a going concern based
upon our history of net losses.  We have had recurring annual operating
losses since our fiscal year ended October 31, 2004.  We expect that
such losses will continue at least through our fiscal year ending October 31,
2009.


14


We cannot offer
assurances that any of the strategic options that we are considering to improve
our liquidity and provide us with working capital will occur or be
successful.





We are
considering a variety of strategic options to improve our liquidity and provide
us with working capital to fund our continuing business operations.  These
options include equity offerings, asset sales, debt financing and merger
and acquisition transactions as alternatives to improve our cash needs. 
However, there can be no assurance that we will be successful in negotiating or
concluding any of these transactions.  If we are unable to consummate
one or more of these transactions, and adequate funds are not available to us or
are not available on acceptable terms, we will likely not be able to continue as
a going concern.





We
may not be able to continue our operations without additional
funding.





As of
April 30, 2009, we had cash and cash equivalents of approximately $538,000 and
working capital of approximately $516,000.  We require additional
financing, which we may obtain through issuance of debt and/or equity. Such
financing, may not be forthcoming. As widely reported, the domestic financial
markets have been extremely volatile in recent months.  If such
conditions and constraints continue, we may not be able to acquire additional
funds either through credit markets or through equity markets. Even if
additional financing is available, it may not be available on terms we find
favorable. Failure to secure the needed additional financing will have an
adverse effect on our ability to remain in business.





We
may not be able to compete successfully against current and future
competitors.





The
market for our products and services is highly competitive. Many of our
competitors offer broader product lines and have substantially greater
financial, technical, marketing and other resources than we do, which could
seriously harm our net sales and results of operation. Additionally, our
competitors may receive beneficial prices from purchasing component parts in
large quantities and may be party to product and process technology license
arrangement that are more favorable in terms of pricing and availability than
our arrangements. As a result, we may have difficulty increasing our market
share.




RISKS
RELATED TO OUR COMMON STOCK




Our
stock may be subject to substantial price and volume fluctuations due to a
number of factors, many of which are beyond our control that may prevent our
stockholders from reselling our common stock at a profit.




The
securities markets have experienced significant price and volume fluctuations in
recent months and the market price of our common stock has been volatile. This
market volatility, as well as general economic, market or political conditions,
has, and could continue to, reduce the market price of our common stock. In
addition, our operating results could be below the expectations of public market
analysts and investors, and in response the market price of our common stock
could decrease significantly. Investors may be unable to resell their shares of
our common stock for a profit. The decline in the market price of our common
stock and market conditions generally may adversely affect our ability to raise
additional capital.




If
our common stock is delisted from the Nasdaq Capital Market, the market price of
our common stock could decrease significantly.




If we are
unable to satisfy the Nasdaq Capital Market continued listing criteria in the
future, our common stock may be delisted from the Nasdaq Capital Market. If this
occurs, trading, if any, in our common stock would thereafter be conducted in
the over-the-counter market on the “pink sheets” or the Over-the-Counter
Bulletin Board. If our common stock is delisted from the Nasdaq Capital Market,
a shareholder may find it more difficult to dispose of, or to obtain quotations
as to the price of our common stock. Additionally, if our common stock is
delisted from the Nasdaq Capital Market, the market price of our common stock
could decrease significantly.


15




We
may issue more shares in connection with a merger or acquisition; this would
result in substantial dilution.




Any
merger or acquisition effected by us may result in the issuance of additional
securities without stockholder approval and may result in substantial dilution
in the percentage of our common stock held by our then existing stockholders.
Moreover, the common stock issued in any such merger or acquisition transaction
may be valued on an arbitrary or non-arm’s-length basis by our management,
resulting in an additional reduction in the percentage of common stock held by
our then existing stockholders. Our Board of Directors has the power to issue
any or all of such authorized but unissued shares without stockholder approval.
To the extent that additional shares of common stock or preferred stock are
issued in connection with a business transaction, combination or otherwise,
dilution to the interests of our stockholders will occur and the rights of the
holders of Common Stock might be materially adversely affected.




ITEM
      2.
            UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS




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.




ITEM
      6.
            EXHIBITS




Exhibit
      11.1
              Statement
      of computation of earnings per share.Exhibit
      31.1
              Certification
      of Chief Executive Officer and President Pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.Exhibit
      31.2
              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.


16




SIGNATURES




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




June
      15, 2009
                      STEELCLOUD,
      INC.By:
                      /s/
      Brian H. HajostName:
      Brian H. HajostTitle:
      Chief Executive Officer and PresidentBy:
                      /s/
      Kevin MurphyName:
      Kevin MurphyTitle:
      Chief Financial
Officer


17