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 January 31, 2010




OR




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




For the
transition period from __________ to ________




Commission
File No. 0-24015







STEELCLOUD,
INC.


(Exact
name of registrant as specified in its charter)




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




20110
      Ashbrook Place, Suite 130, 20147(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 (§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 o
                  Accelerated
      filer o
                  Non-accelerated
      filer o
                  Smaller
      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
March 11, 2010 there were 16,040,001 shares of the registrant’s common stock
outstanding.







SteelCloud,
Inc.


Form
10-Q Index


for
the Quarterly period ended January 31, 2010




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
                      
                      7ITEM
      4.
                      CONTROLS
      AND PROCEDURES
                      
                      7PART
      II. OTHER INFORMATION
                      
                      8ITEM
      1.
                      LEGAL
      PROCEEDINGS
                      
                      8ITEM
      1A.
                      RISK
      FACTORS
                      
                      8ITEM
      2.
                      UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
                      
                      8ITEM
      3.
                      DEFAULTS
      UPON SENIOR SECURITIES
                      
                      9ITEM
      4.
                      SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
                      
                      9ITEM
      5.
                      OTHER
      INFORMATION
                      
                      9ITEM
      6.
                      EXHIBITS
                      
                      9SIGNATURES
                      
                      
                      10


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,
                      
                      
                      January
      31,2009
                      
                      
                      2010(unaudited)ASSETSCurrent
      assetsCash
      and cash equivalents
                      
                      $
                      60,650
                      
                      
                      $
                      44,288Accounts
      receivable, net
                      
                      
                      147,203
                      
                      
                      
                      207,922Inventory,
      net
                      
                      
                      10,587
                      
                      
                      
                      13,217Prepaid
      expenses and other current assets
                      
                      
                      141,259
                      
                      
                      
                      157,820Deferred
      contract costs
                      
                      
                      33,830
                      
                      
                      
                      -Total
      current assets
                      
                      
                      393,529
                      
                      
                      
                      423,247Property
      and equipment, net
                      
                      
                      166,754
                      
                      
                      
                      24,176Equipment
      on lease, net
                      
                      
                      1,456
                      
                      
                      
                      1,094Other
      assets
                      
                      
                      5,374
                      
                      
                      
                      2,245Total
      assets
                      
                      $
                      567,113
                      
                      
                      $
                      450,762LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilitiesAccounts
      payable
                      
                      $
                      577,197
                      
                      
                      $
                      602,391Accrued
      expenses
                      
                      
                      174,763
                      
                      
                      
                      189,811Notes
      payable, current
                      
                      
                      217,919
                      
                      
                      
                      378,593Total
      current liabilities
                      
                      
                      969,879
                      
                      
                      
                      1,170,795Long-term
      liabilitiesDeferred
      rent, long-term
                      
                      
                      269,332
                      
                      
                      
                      262,586Other
      long-term
                      
                      
                      1,129
                      
                      
                      
                      1,129Total
      long-term liabilities
                      
                      
                      270,461
                      
                      
                      
                      263,715Stockholders’
      equityPreferred
      stock, $.001 par value: 2,000,000 shares authorized, no shares issued and
      outstanding at October 31, 2009 and January 31, 2010
                      
                      
                      –
                      
                      
                      
                      –Common
      stock, $.001 par value: 80,000,000 shares authorized, 15,993,501 and
      16,040,001 shares issued at October 31, 2009 and January 31, 2010,
      respectively
                      
                      
                      15,994
                      
                      
                      
                      16,040Additional
      paid in capital
                      
                      
                      51,348,405
                      
                      
                      
                      51,414,359Treasury
      stock, 400,000 shares at October 31, 2009 and January 31,
    2010
                      
                      
                      (3,432,500
                      )
                      
                      
                      (3,432,500
                      )Accumulated
      deficit
                      
                      
                      (48,605,126
                      )
                      
                      
                      (48,981,647
                      )Total
      stockholders’ equity
                      
                      
                      (673,227
                      )
                      
                      
                      (983,748
                      )Total
      liabilities and stockholders’ equity
                      
                      $
                      567,113
                      
                      
                      $
                      450,762




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
                  January 31,2009
              
              
              2010Revenues
              
              
              555,579
              
              
              
              365,278Cost
      of revenues
              
              
              457,723
              
              
              
              208,091Gross
      profit
              
              
              97,856
              
              
              
              157,187Selling
      and marketing
              
              
              101,671
              
              
              
              102,692Research
      and product development
              
              
              43,317
              
              
              
              53,647General
      and administrative
              
              
              604,076
              
              
              
              639,479Severance
      and restructuring
              
              
              73,205
              
              
              
              -Loss
      from operations
              
              
              (724,413
              )
              
              
              (638,631
              )Interest
      expense
              
              
              (1,239
              )
              
              
              (71,460
              )Other
      income, net
              
              
              1,239
              
              
              
              333,571Loss
      before income taxes
              
              
              (724,413
              )
              
              
              (376,520
              )Provision
      for income taxes
              
              
              –
              
              
              
              –Loss
      from continuing operations
              
              
              (724,413
              )
              
              
              (376,520
              )Loss
      from discontinued operations, net of tax
              
              
              (279,332
              )
              
              
              -Net
      loss
              
              
              (1,003,745
              )
              
              
              (376,520
              )Basic
      and diluted income (loss) per share:Continuing
      operations
              
              $
              (0.05
              )
              
              $
              (0.02
              )Discontinued
      operations
              
              
              (0.02
              )
              
              
              -Basic
      and diluted income (loss) per share
              
              $
              (0.07
              )
              
              $
              (0.02
              )Weighted–average
      shares outstanding, basic and diluted
              
              
              14,739,200
              
              
              
              15,611,897




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


F–2


STEELCLOUD,
INC.


UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS




Three Months Ended
                  January 31,2009
              
              
              2010Operating
      activitiesNet
      loss
              
              $
              (1,003,745
              )
              
              $
              (376,520
              )Adjustments
      to reconcile net (loss) to net cash (used in) provided by operating
      activities:Depreciation
      and amortization
              
              
              101,214
              
              
              
              145,431Gain
      on sale of professional services assets
              
              
              -
              
              
              
              (140,000
              )Stock-based
      compensation
              
              
              7,649
              
              
              
              21,000Amortization
      of deferred rent
              
              
              -
              
              
              
              (6,746
              )Warrant
      based expense
              
              
              -
              
              
              
              55,677Changes
      in operating assets and liabilities:Accounts
      receivable
              
              
              1,176,317
              
              
              
              (60,719
              )Inventory
              
              
              81,585
              
              
              
              (2,630
              )Prepaid
      expenses and other assets
              
              
              6,820
              
              
              
              (13,432
              )Deferred
      contract costs
              
              
              (25,000
              )
              
              
              33,830Accounts
      payable
              
              
              (307,033
              )
              
              
              25,195Unearned
      revenue
              
              
              415,304
              
              
              
              -Accrued
      expenses and other liabilities
              
              
              (16,176
              )
              
              
              15,043Net
      cash provided (used) by operating activities
              
              
              436,935
              
              
              
              (303,871
              )Investing
      activitiesProceeds
      from sale of professional services assets
              
              
              -
              
              
              
              140,000Purchase
      of property and equipment
              
              
              -
              
              
              
              (2,491
              )Net
      cash provided (used) in investing activities
              
              
              -
              
              
              
              137,509Financing
      activitiesProceeds
      from notes payable
              
              
              -
              
              
              
              150,000Payments
      on notes payable
              
              
              (1,851
              )
              
              
              -Net
      cash provided (used) in financing activities
              
              
              (1,851
              )
              
              
              150,000Net
      increase (decrease) in cash and cash equivalents
              
              
              435,084
              
              
              
              (16,362
              )Cash
      and cash equivalents at beginning of period
              
              
              752,351
              
              
              
              60,650Cash
      and cash equivalents at end of period
              
              $
              1,187,435
              
              
              $
              44,288Supplemental
      cash flow informationInterest
      paid
              
              $
              1,239
              
              
              $
              15,785Income
      taxes paid
              
              $
              –
              
              
              $
              –Supplemental
      disclosure of non-cash investing and financing activitiesDiscount
      on note payable
              
              $
              -
              
              
              $
              45,001




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


F–3


STEELCLOUD,
INC.


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS




1.
            Nature
      of Business and Basis of
Presentation




Founded
in 1987, SteelCloud, Inc. (referred to herein as the “Company,” or “SteelCloud”)
is a developer of mobility appliance software solutions primarily for the
Research In Motion® (“RIM”) BlackBerry market.  SteelCloud designs and
integrates its software into specialized server appliances targeted at
Department of Defense (“DoD”), public sector, commercial, and remote hosting
customers.  Until July 2009, SteelCloud offered computer
integration solutions for the federal marketplace and Independent Software
Vendors.  In July 2009, SteelCloud entered into an Asset Purchase
Agreement with NCS Technologies, Inc., a Virginia corporation (“NCS”), pursuant
to which SteelCloud agreed to sell to NCS, and NCS agreed to purchase, all of
SteelCloud’s right, title and interest in and to the assets relating to our
computer integration business.  Further, in July 2009 SteelCloud’s
management and Board of Directors determined to shift the focus of our
operations, resources and investments to our BlackBerry-related technologies and
products.




SteelCloud
was originally incorporated as Dunn Computer Operating Company on July 27,
1987 under the laws of the Commonwealth of Virginia.  On February 26,
1998, Dunn Computer Corporation ("Dunn") was formed and incorporated in the
Commonwealth of Virginia to become a holding company for several entities
including Dunn Computer Operating Company.  The Company's subsidiary
is International Data Products ("IDP"), acquired in May 1998.  On May
15, 2001, the shareholders approved an amendment to the Company’s articles of
incorporation to change the corporate name from Dunn Computer Corporation to
SteelCloud, Inc.  On December 31, 2003, Dunn was merged with
and into SteelCloud.  On February 17, 2004, the Company acquired the
assets of Asgard Holding, LLC ("Asgard").  In July of 2006, as part of
its restructuring efforts, the Company closed its sales office and ceased all of
its operations in Florida.  The Company’s former subsidiaries, Puerto
Rico Industrial Manufacturing Operations Acquisition Corporation (“PRIMO”), and
STMS Corporation (“STMS”), are inactive.




The
accompanying financial statements include the accounts of SteelCloud and its
subsidiaries, IDP, PRIMO, and STMS.  All intercompany accounts and
activity have been eliminated in the consolidation process.





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.




Going
Concern




SteelCloud
has had recurring annual operating losses since its fiscal year ended October
31, 2004.  SteelCloud expects that such losses may continue at least
through its fiscal year ending October 31, 2010.  The report of
SteelCloud’s independent registered public accounting firm on SteelCloud’s
consolidated financial statements for the fiscal year ended October 31, 2009
contains an explanatory paragraph regarding SteelCloud’s ability to continue as
a going concern based upon its history of net losses, net working capital
deficit and uncertainty regarding its ability to satisfy its obligations as they
come due in the near term.





The
Company’s Term Loan of $250,000 and Line of Credit of $150,000 (as discussed in
Note 6) mature on March 31, 2010 and the Company is currently in negotiations
with the Lender to extend the due date of these debt
instruments.  While the Lender has indicated a willingness to extend
the due date of these debt instruments, no final agreement for such extension is
in place.  If the Company is not able to renegotiate these debts and
other sources of funds to satisfy these debts do not materialize in a timely
manner, the Company will be in default on these debts.


F–4


STEELCLOUD,
INC.


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





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 obtain working capital to fund its continuing business operations,
including equity offerings, asset sales or debt financings; 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.





2.
            Management
      Change




On
November 23, 2009, Steven Snyder was named Senior Vice President of Finance,
Principal Financial Officer and Secretary.





On
November 30, 2009, Kevin Murphy, the Company’s Chief Financial Officer, resigned
from all of his positions with the Company.





3.
            New
      Accounting Pronouncements




There
have been no recent accounting pronouncements or changes in accounting
pronouncements during the three months ended January 31, 2010, as compared to
the recent accounting pronouncements described in the 2009 Annual Report that
have been implemented, are of significance, or are of potential significance, to
the Company.




4.
            Significant
      Customers




For the
three month period ended January 31, 2010, 70% of the Company’s revenues and 66%
of the accounts receivable balance were attributed to two
customers.




5.
            Equity




Stock-based
Compensation




The
Company recognized approximately $21,000 and $7,600 of stock-based compensation
expense during the three month periods ended January 31, 2010 and 2009,
respectively. Stock-based compensation expense for the three-month period ended
January 31, 2010 and 2009 increased the Company’s basic and diluted loss per
share by $0.00 and $0.00, respectively. The estimated fair value of the
Company’s stock-based awards is amortized on a straight-line basis over the
awards’ original service period.




Additional
Paid-in Capital




Additional
paid in capital has increased approximately $66,000 during the three month
period ended January 31, 2010 due to warrants issued in connection with the Line
of Credit as discussed in Note 6 of approximately $45,000 and stock-based
compensation expense of approximately $21,000.




6.
            Debt




Term
Loan




On July
1, 2009, the Company entered into a Business Loan and Security Agreement (the
“Agreement”) with Caledonia Capital Corporation, a Delaware corporation (the
“Lender”) pursuant to which the Lender agreed to lend to SteelCloud $250,000 in
the form of a Secured Promissory Note (the “Note”) which was issued on July 1,
2009 (the “Issuance Date”).  The Note initially had an interest rate
of 15% per annum, was payable in quarterly installments commencing three months
after the Issuance Date, or October 1, 2009, and the principal amount of the
Note was due and payable in full on December 29, 2009 (the “Maturity
Date”). On
December 29, 2009, the Company entered into an Allonge to Note (the "Allonge")
with the Lender, which amended the terms of the Agreement by, among other
things, (a) increasing the annual interest rate of the Note to 20%, (b)
providing that accrued interest under the Note shall be payable in monthly
installments commencing on February 1, 2010, and continuing on the first
business day of each successive month, (c) paying an extension fee of $25,000
and (d) extending the Maturity Date of the Note to March 31,
2010.  The extension fee of $25,000, or 10% of the Term Loan,
reflected a 5% late payment fee in accordance with the original debt and a 5%
fee for the modification of terms.  This transaction has been recorded
as a debt modification in accordance with ASC 470, whereby the $25,000 extension
fee was capitalized and amortized over the new term of the
Note.


F–5


STEELCLOUD,
INC.


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





Pursuant
to the Agreement and the Note, the Company’s obligations thereunder are secured
by a first priority lien in and to all of the Company’s intellectual property
rights, title and interest in and to the SteelWorks® Mobile integrated server
appliance software.





As an
inducement to the Lender to make the loan to the Company, the Company issued to
the Lender a warrant to purchase up to 625,000 shares of the Company’s common
stock, par value $0.001 per share.  The Warrant is exercisable for
four years at an exercise price of $0.15 per share.  The Company
determined the fair value of these warrants utilizing the Black-Sholes
Model.  The fair value of these warrants at issuance date was
approximately $130,000.





The loan
amount of $250,000 was allocated between the note payable and warrants based
upon their relative fair values. The difference between the face amount of the
note of $250,000 and the note payable amount of $164,425 recorded at date of
execution represents the debt discount of $85,575 which will be amortized over
the life of the note.  To determine the fair value of the warrants,
management used the Black-Scholes Model which includes assumptions on the period
end stock price, historical stock volatility, risk free interest rate and term
of warrants.





Line
of Credit





On
November 3, 2009, the Company entered into a Line of Credit and Security
Agreement (the "Agreement") with the Lender pursuant to which the Lender agreed
to extend to the Company a revolving line of credit in the amount of $150,000,
in the form of a Revolving Line of Credit Promissory Note (the "Line of Credit
Note"). The Line of Credit Note bears interest at a rate of 15% per annum, and
is payable in monthly installments commencing 30 days after SteelCloud issued
the Note (November 3, 2009). The principal amount of the Line of Credit Note,
together with interest accrued and unpaid thereon and all other sums due, shall
be due and payable in full upon the earlier to occur of (a) March 31, 2010, or
(b) the date the Company shall have raised a total of not less than $1,000,000
in capital invested in the equity of the Company which is accompanied by the
Company issuing shares of stock which were not trading in the public markets
prior to the date of the Line of Credit Note ("New Equity Capital"). There are
no penalties for early prepayment of the Line of Credit Note.  The
Line of Credit Note is a revolving promissory note. Principal advances may be
made, from time to time, by the Lender up to the principal amount of the Line of
Credit Note, and principal payments may be made, from time to time by the
Company to reduce the principal balance owing pursuant to the Line of Credit
Note.




Pursuant
to the Agreement and the Line of Credit Note, the Company's obligations
thereunder are secured by a lien in and to all of the Company’s rights, title
and interest in and to its furniture, fixtures, equipment, supplies,
receivables, intangibles, and inventory, together with all present and future
substitutions, replacements and accessories thereto and all present and future
proceeds and products thereof, in any form whatsoever (the
"Collateral").




As an
inducement to the Lender to make a loan under the Agreement, the Company shall
issue to the Lender a warrant (the "Warrant") to purchase 2.5 shares of the
Company's common stock, par value $0.001 per share, for every dollar the Company
borrows pursuant to the Agreement. The Warrant is exercisable for four years at
an exercise price of $0.25 per share.


F–6


STEELCLOUD,
INC.


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





On
November 4, 2009, SteelCloud borrowed $60,000 pursuant to the Agreement and the
Line of Credit Note, and issued to the Lender a Warrant to purchase up to
150,000 shares of SteelCloud’s common stock.  On November 23, 2009,
SteelCloud borrowed $90,000 pursuant to the Agreement and the Line of Credit
Note, and issued to the Lender a Warrant to purchase up to 225,000 shares of
SteelCloud’s common stock.





The Line
of Credit amount of $150,000 was allocated between the Line of Credit Note
payable and Warrants based upon their relative fair values. The difference
between the face amount of the Line of Credit Note of $150,000 and the note
payable amount of $104,999 recorded at date of execution represents the debt
discount of $45,001 which will be amortized over the life of the
note.  To determine the fair value of the Warrants, management used
the Black-Scholes Model which includes assumptions on the period end stock
price, historical stock volatility, risk free interest rate and term of
warrants.





Debt
Maturities





The
Company’s Term Loan of $250,000 and Line of Credit of $150,000 mature on March
31, 2010 and the Company is currently in negotiations with the Lender to extend
the due date of these debt instruments.  While the Lender has
indicated a willingness to extend the due date of these debt instruments, no
final agreement for such extension is in place.  If the Company is not
able to renegotiate these debts, and other sources of funds to satisfy these
debts do not materialize in a timely manner, the Company will be in default on
these debts.





7.
            Fair
      Value of Financial Instruments





The
Company believes the carrying value of both its Term Loan and Line of Credit at
January 31, 2010 approximates  their fair value due to their
short-term maturity.


8.
              Inventories




Inventories
consisted of the following:




October 31,
                        
                        
                        January 31,2009
                        
                        
                        2010Raw
      materials
                        
                        $
                        6,259
                        
                        
                        $
                        6,448Work
      in process
                        
                        
                        -
                        
                        
                        
                        -Finished
      goods
                        
                        
                        4,328
                        
                        
                        
                        6,769$
                        10,587
                        
                        
                        $
                        13,217


F–7


STEELCLOUD,
INC.


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





9.
              Property,
      Plant and Equipment




As
discussed in Note 14, the Company signed a lease for new headquarters in
Ashburn, Virginia on February 2, 2010 and subsequently vacated its Herndon,
Virginia facilities.  The Company has entered negotiations with the
landlord of its Herndon, Virginia lease in order to effect an early termination
of that lease, but a final agreement have not been reached as of the date of
this report.  During the first quarter of fiscal 2010, the Company
amortized the remaining balance, or approximately $138,000, of its leasehold
improvements related to this facility.




10.
              Interest
      Expense




In the
three month period ended January 31, 2010, the Company incurred interest expense
of $15,785 on its notes payable and amortized $55,675 of the discount on notes
payable attributable to the warrants issued in connection with those
notes.




11.
              Other
      Income




Legal
settlement




In
December 2007 the Company was notified that there was a class action lawsuit
settlement with defendants which may have affected entities who directly
purchased Dynamic Random Access Memory (“DRAM”) during the period of April 1,
1999 through June 30, 2002.  As a purchaser of DRAM from one of the
defendants during that period, the Company submitted a claim of approximately
$1.4 million.  In December 2009 the Company received a payment of
$155,757 as a result of this settlement.




Royalties




The
Company earned $36,352 of royalties associated with the July 2009 sale of its
Integration Business.




Sale
of Professional Services Assets




On
January 11, 2010, the Company entered into a Purchase and Sale Agreement
(referred to herein as “Agreement”) with Global Technology Partners, Inc., a
Maryland Corporation (referred to herein as “Purchaser”).  Pursuant to
the Agreement the Company sold to the Purchaser a large portion of its
professional services assets, consisting of certain consulting contracts and
related agreements, and assigned all of its rights to employment and independent
contractor contracts for certain of the Company’s contractors and employees
engaged in the consulting business (referred to herein as
“Assets”).  As consideration for the sale of the Assets, the Purchaser
agreed to pay a base price of one hundred forty thousand dollars ($140,000) of
which (a) seventy thousand dollars ($70,000) was paid upon the execution of the
Agreement, and (b) seventy thousand dollars ($70,000) which was paid on January
15, 2010.




12.
              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 shares outstanding excluded potential
common shares from stock options of approximately 317,000 and 1,800 for the
three month periods ended January 31, 2010 and 2009, respectively. These shares
were excluded from the earnings per share calculation due to their antidilutive
effect resulting from the loss from operations.


F–8


STEELCLOUD,
INC.


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS




13.
              Income
      Tax




The
Company accounts for uncertainty in income taxes using a more-likely-than-not
recognition threshold based on the technical merits of the tax position
taken.  Tax positions that meet the more-likely-than-not recognition
threshold should be measured as the largest amount of the tax benefits,
determined on a cumulative probability basis, which is more likely than not to
be realized upon effective settlement in the financial
statements.  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 Company has a valuation allowance against the
full amount of its net deferred tax assets and therefore, the amount of
unrecognized tax benefits that, if recognized, would impact the effective tax
rate is zero.




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, 2006, although carryforward tax attributes that were
generated prior to October 31, 2006 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 for interest and penalties as of January 31, 2010.




14.
            Commitments
      and Contingencies




The
Company has accrued approximately $50,000 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.




15.
            Subsequent
      Events




Subsequent
events are current as of March 19, 2010.




On
February 19, 2010, the Company moved into its new headquarters in Ashburn,
Virginia.  The Company has entered into negotiations with the landlord
of its Herndon, Virginia lease in order to effect an early termination of that
lease, but a final agreement has not been reached as of the date of this report.
No provision has been made for a lease termination liability as of January 31,
2010.




On March
16, 2010, the Company’s Registration Statement on Form S-1 was declared
effective by the Securities and Exchange Commission, authorizing the Company to
offer up to 16,000,000 shares of its common stock together with 16,000,000
common stock purchase warrants on a best efforts basis at a fixed price between
$0.07 and $0.30 per share and an exercise price per warrant equal to 150% of the
final offering share price.  The Company cannot offer any assurance
that it will be successful in selling any of the shares registered pursuant to
the Registration Statement.


F–9




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




Certain
statements contained herein may constitute forward-looking statements . The
words or phrases “would be,” “will allow,” “intends to,” “will likely result,”
“are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or
similar expressions are intended to identify “forward-looking statements.”
Because such statements include risks and uncertainties, actual results may
differ materially from those expressed or implied by such forward-looking
statements. Factors that could cause actual results to differ materially
include, but are not limited to, risks associated with our ability to obtain
financing in the short term; general economic and business conditions; industry
capacity; industry trends; competition; changes in business strategy or
development plans; project performance; and availability of qualified personnel;
and the risk factors set forth from time to time in the reports we file with the
Securities and Exchange Commission (the “SEC”). Statements made herein are as of
the date of the filing of this Quarterly Report on Form 10-Q with 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 Part I - Item 1 in this
Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal
year ended October 31, 2009 as amended, filed by us with the SEC.




OVERVIEW




Founded
in 1987, SteelCloud, Inc. (referred to herein as the “Company,” or “SteelCloud,”
“we,” “our,” “ours,” and “us”), is a developer of mobility appliance and
software solutions primarily for the Research in Motion (“RIM”) BlackBerry
market. We design and integrate our software into specialized server appliances
targeted at Department of Defense, public sector, commercial, and remote hosting
customers. In addition, we are a world-wide provider of RIM hosting
licenses.





SteelWorks®




In
conjunction with RIM, we developed an appliance solution specifically for the
BlackBerry Enterprise Server (“BES”).  We believe the BES appliance
solution is the single best way to implement the BES software
environment.  SteelWorks is an integrated server appliance that
enables virtually any size organization to implement the BES in a fraction of
the time and at a fraction of the cost or resources allocated to this otherwise
time intensive, manual process.  We have filed for three patents for
the appliance related to the 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 BES appliance solution
specifically for the Department of Defense (“DoD”) and other related
agencies.  The SteelWorks FedMobile appliance builds upon our
commercial appliance by automating the application of the Defense Information
Systems Agency’s (“DISA”) 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 those
agencies to be STIG compliant in a fraction of the time and at a fraction of the
cost or resources allocated to this otherwise time intensive, manual
process.




In
January 2010, we announced the availability of SteelWorks FLEX+.  This
offering combines the standard commercial SteelWorks appliance with BES hosting
licensing.  SteelWorks FLEX+ allows our BES hosting
partners to install and manage a complete solution, including infrastructure and
licensing, at a customer site.  FLEX+ provides SteelCloud
with the ability to recognize revenue from both the appliance sale and the BES
licensing.


2


Hosting
Licenses




From
October to December of 2009, we entered into six agreements with RIM, or with
RIM international subsidiaries to distribute and manage BES hosted licensing to
RIM Alliance Members in the U.S. and 105 countries worldwide.  As of
the end of January, we had agreements with 40 domestic and international BES
hosting providers to supply and manage hosting licenses.  Revenue from
hosting licenses are billed and recognized on a monthly basis. We anticipate
that hosting license revenue will increase throughout the fiscal year as the
current BES hosters enter into agreements with us and new hosters are developed,
especially in developing international markets.  By the end of fiscal
2010, we believe that we will recognize a majority of our hosting revenue from
international markets.




Professional
Services




We
provide information technology consulting for our clients.  Our
consultants are subject matter experts in mobility technology.




Sale
of Professional Service Assets





On
January 11, 2010, we entered into a Purchase and Sale Agreement (the “Purchase
Agreement”) with Global Technology Partners, Inc., a Maryland Corporation (the
“Purchaser”). Pursuant to the Purchase Agreement we sold to the Purchaser a
large portion of our professional services assets, consisting of certain
consulting contracts and related agreements, and assigned all of our rights to
employment and independent contractor contracts for certain of our contractors
and employees engaged in the consulting business (the “Assets”). As
consideration for the sale of the Assets, the Purchaser agreed to pay a base
price of one hundred forty thousand dollars ($140,000) (the “Base Price”). In
addition to the Base Price, the Purchase Agreement provides for contingent
payments in the amount of (a) one hundred thousand dollars ($100,000) in the
event certain payments are made pursuant to certain of the Assets, and (b)
twenty percent (20%) of the gross margin from revenue generated from new
contracts awarded to the Purchaser for the period beginning from January 11,
2010 and ending on January 11, 2011. Pursuant to the Purchase Agreement, the
parties agreed to cooperate in obtaining novations of all governmental contracts
included in the Assets. We agreed to guarantee payment of all liabilities and
the performance of all obligations that Purchaser assumed under any governmental
contracts included in the Assets. The Purchase Agreement contains standard
representations and warranties for a transaction of this type. The terms of the
transaction were the result of arm‘s length negotiations between the Purchaser
and us.




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 months ended
January 31, 2010, we incurred research and development costs of approximately
$54,000.  We will continue to incur costs for product development in
the future.




CRITICAL
ACCOUNTING POLICIES AND ESTIMATES




The
preparation of financial statements in conformity with US Generally Accepted
Accounting Principles (“GAAP”) 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, 2009.





New
Accounting Pronouncements




There
have been no recent accounting pronouncements or changes in accounting
pronouncements during the three months ended January 31, 2010, as compared to
the recent accounting pronouncements described in the 2009 Annual Report that we
have implemented, or that are of significance, or potential significance, to
us.




3




RESULTS
OF OPERATIONS




For
the Three Months Ended January 31, 2010 Compared to the Three Months Ended
January 31, 2009:




Revenue
Discussion:




Revenues
decreased by approximately 34.3%, or $190,300, to $365,278 for the three-month
period ended January 31, 2010, as compared to $555,579 for the same period in
fiscal 2009.  The decrease was primarily attributable to a decrease in
our professional services as a result of our completing a large service contract
in December 2008 combined with the sale of professional services assets in
January 2010.




Gross
Profit Discussion:




Gross
profit increased by approximately 60.6%, or $59,331, to $157,187 for the
three-month period ended January 31, 2010 as compared to $97,856 for the same
period in fiscal 2009.  The increase was primarily attributable to
improved margins on a professional services contract begun in November 2009 as
well as the gross margins generated from the new business related to Hosting
Licenses.




Operating
Expense Discussion:




The
following table summarizes our operating expenses for the three months ended
January 31, 2009 and 2010 in dollars and as a percentage of net
revenues.




Three
      Months Ended January 31,2009
                          
                          
                          2010
                          
                          
                          Increase
      (decrease)%
      of Net
                          
                          
                          
                          
                          
                          %
      of NetDollars
                          
                          
                          Revenues
                          
                          
                          Dollars
                          
                          
                          Revenues
                          
                          
                          Dollars
                          
                          
                          PercentageSelling
      and marketing
                          
                          $
                          101,671
                          
                          
                          
                          18.3
                          %
                          
                          $
                          102,692
                          
                          
                          
                          28.1
                          %
                          
                          $
                          1,021
                          
                          
                          
                          1.0
                          %Research
      and product development
                          
                          
                          43,317
                          
                          
                          
                          7.8
                          %
                          
                          
                          53,647
                          
                          
                          
                          14.7
                          %
                          
                          
                          10,330
                          
                          
                          
                          23.8
                          %General
      and administrative
                          
                          
                          604,076
                          
                          
                          
                          108.7
                          %
                          
                          
                          639,479
                          
                          
                          
                          175.1
                          %
                          
                          
                          35,403
                          
                          
                          
                          5.9
                          %Severance
      and restructuring
                          
                          
                          73,205
                          
                          
                          
                          13.2
                          %
                          
                          
                          -
                          
                          
                          
                          0.0
                          %
                          
                          
                          (73,205
                          )
                          
                          
                          (100.00
                          )%Total
      operating expenses
                          
                          $
                          822,269
                          
                          
                          
                          148.0
                          %
                          
                          $
                          795,818
                          
                          
                          
                          217.9
                          %
                          
                          $
                          (26,451
                          )
                          
                          
                          (69.3
                          )%





The
increase in research and product development for the three months ended January
31, 2010 compared to the three months ended January 31, 2009 is the result of
our continued investment in our core products.  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
increase in general and administrative expenses for the three months ended
January 31, 2010 compared to the three months ended January 31, 2009 is
primarily attributable to the impairment of leasehold improvements.




The
decrease in severance and restructuring costs for the three months ended January
31, 2010 compared to the three months ended January 31, 2009 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.


4




Other
Income (Expense) Discussion:




Interest
expense




In the
three month period ended January 31, 2010, we incurred interest expense of
$15,785 on our notes payable and amortized $55,675 of the discount on notes
payable attributable to the warrants issued in connection with those
notes.




Legal
settlement




In
December 2007 we were notified that there was a class action lawsuit settlement
with defendants which may have affected entities who directly purchased Dynamic
Random Access Memory (“DRAM”) during the period of April 1, 1999 through June
30, 2002.  As a purchaser of DRAM from one of the defendants during
that period, we submitted a claim of approximately $1.4 million.  In
December 2009 we received a payment of $155,757 as a result of this
settlement.




Royalties




We earned
$36,352 of royalties associated with the July 2009 sale of our Integration
Business.




Sale
of Professional Services Assets




As
described more fully in Part I
- Item 2 – Overview - Sale of Professional Services Assets, we received
$140,000 for the sale of certain Professional Services Assets.




LIQUIDITY
AND CAPITAL RESOURCES




We have
experienced recurring losses from operations and negative cash flows. For the
three months ended January 31, 2010, we incurred a net loss of $376,520 and an
accumulated deficit of $48,981,647 as of that date. The report from our
independent registered public accounting firm on our audited financial
statements at October 31, 2009 contains an explanatory paragraph regarding doubt
as to our ability to continue as a going concern as a result of our history of
net losses from operations, net working capital deficit and uncertainty
regarding the our ability to satisfy obligations as they become due in the near
future. Despite our history of revenues, we can give no assurance that we will
be able to maintain or increase our revenues in fiscal 2010 or that we will be
successful in reaching profitability or generating positive cash flows from our
operations. We are considering all strategic options to improve our liquidity
and to obtain 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.




On March
16, 2010 our Registration Statement on Form S-1 (the “Registrant Statement”) was
declared effective by the SEC, authorizing us to offer up to 16,000,000 shares
of our common stock together with 16,000,000 common stock purchase warrants on a
best efforts basis at a fixed price between $0.07 and $0.30 per share and an
exercise price per warrant equal to 150% of the final offering share
price.  We cannot offer any assurance that we will be successful in
selling any of the shares registered pursuant to the Registration
Statement..




As of
January 31, 2010, we had cash and cash equivalents of $44,288 and a working
capital deficit of $747,548. As of March 11, 2010, we have approximately $35,000
of cash on hand, which is adequate for less than one month of operations. 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.


5


Our Term
Loan of $250,000 and Line of Credit of $150,000 mature on March 31, 2010 and we
are currently in negotiations with the Lender to extend the due date of these
debt instruments.  While the Lender has indicated a willingness to
extend the due date of these debt instruments, no final agreement for such
extension is in place.  If we are not able to renegotiate these debts
and other sources of funds to satisfy these debts do not materialize in a timely
manner, we will be in default on these debts.




For the
three months ended January 31, 2010, we used approximately $164,000 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 used
approximately $2,000 from our investing activities and generated $150,000 from
financing activities for the three months ended January 31, 2010.




Our
consolidated financial statements for the three months ended January 31, 2010 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.




COMMITMENTS




On
February 27, 2009, we entered into a lease amendment with the landlord of our
prior operation facility, whereby the lease for that facility, which was
scheduled to expire on August 31, 2014, was 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. Monthly rent for the lease was
approximately $21,000 inclusive of operating expenses.  We are
negotiating a settlement with our landlord to terminate this lease in advance of
its expiration in December 2015.





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 (the “Sublease”), dated September 28, 2004, by and between us
and NEC America, Inc. (“NEC”), 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 $168,638,
together with attorney‘s fees and court expenses of $7,041 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.





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.


6





On
February 2, 2010, we entered into a Lease Agreement (the “February Lease”) with
Merritt-AB5, LLC (the “Landlord”), pursuant to which we will rent approximately
3,461 square feet in the property located at 20110 Ashbrook Place, Suite 130,
Ashburn, Virginia 20147 (the “Ashburn Premises”) for our operations facility.
The term of the February Lease is for one year beginning on the later to occur
of (i) February 15, 2010, (ii) the date the Landlord completes certain work on
the Ashburn Premises, or (iii) the date when we occupy the Ashburn Premises (the
“Term”). The Term may be extended for two additional successive one year
periods. The monthly rent is $6,489.38, or $77,872.50 for the first year,
inclusive of operating expenses. If we determine to extend the Term, the monthly
rent for the second year will be $6,684.06 or $80,208.68 per year, and the
monthly rent for the third year will be $6,884.58 or $82,614.94 per
year.





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.




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 January 31, 2010, 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) were not effective as of the end of
the fiscal quarter ended January 31, 2010.  In making this evaluation,
our Chief Executive Officer and Principal Financial Officer considered, among
other matters, the material weakness in our internal control over financial
reporting described in our Annual Report on Form 10-K for the fiscal year ended
October 31, 2009, as filed with the SEC on February 5, 2010, as
amended.




Changes
in Internal Control Over Financial Reporting




There
have been no significant changes in our internal controls over financial
reporting during the quarter ended January 31, 2010 that have altered our
conclusion as to the ineffectiveness of such controls.


7




PART
II. OTHER INFORMATION




ITEM
      1.
            LEGAL
      PROCEEDINGS




On May
22, 2009, we entered into a Stipulation/Consent Order with CRP, referred to as
the “Stipulation,” pursuant to an Affidavit and Statement of Account, referred
to as 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,
referred to as “CRP,” the landlord of 14040 Park Center Road, Suite 210,
Herndon, Virginia 20171, referred to as 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, referred to as the
“Sublease,” dated September 28, 2004, by and between us and NEC America, Inc.,
referred to as “NEC,” 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, referred to as the “Judgment Amount.”  Pursuant to the
Stipulation, we paid $30,000, referred to as 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 the financial condition
and results of operation of the Company.




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




ITEM
      1A.
            RISK
      FACTORS




Not applicable.




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




On
November 3, 2009, we entered into a Line of Credit and Security Agreement,
referred to as the “Agreement,” with the Lender pursuant to which the Lender
agreed to extend to us a revolving line of credit in the amount of $150,000, in
the form of a Revolving Line of Credit Promissory Note, referred to as the “Line
of Credit Note.”  The Line of Credit Note bears interest at a rate of
15% per annum, and is payable in monthly installments commencing 30 days after
November 3, 2009, which was the date when we issued the Line of Credit
Note.  The principal amount of the Line of Credit Note, together with
interest accrued and unpaid thereon and all other sums due, shall be due and
payable in full upon the earlier to occur of (a) March 31, 2010, or (b) the date
we shall have raised a total of not less than $1,000,000 in capital invested in
our equity which is accompanied by our issuing shares of stock which were not
trading in the public markets prior to the date of the Line of Credit
Note.   There are no penalties for early prepayment of the Line
of Credit Note.  The Line of Credit Note is a revolving promissory
note.  Our obligations under the Agreement and the Line of Credit Note
are secured by a lien in and to all of our rights, title and interest in and to
its furniture, fixtures, equipment, supplies, receivables, intangibles, and
inventory, together with all present and future substitutions, replacements and
accessories thereto and all present and future proceeds and products thereof, in
any form whatsoever.  As an inducement to the Lender to make the loan,
we agreed to issue to the Lender a warrant, referred to as the “Warrant,” to
purchase 2.5 shares of our common stock for every dollar we borrow pursuant to
the Agreement.  The Warrant is exercisable for four years at an
exercise price of $0.25 per share.  The exercise price may be adjusted
in the event of any stock dividend, stock split, stock combination,
reclassification or similar transaction. On November 4, 2009, we borrowed
$60,000 pursuant to the Agreement and the Line of Credit Note, and issued to the
Lender a Warrant to purchase up to 150,000 shares of our common
stock.  On November 23, 2009, we borrowed $90,000 pursuant to the
Agreement and the Line of Credit Note, and issued to the Lender a Warrant to
purchase up to 225,000 shares of our common stock.


8


We relied
on the exemption from the registration provisions of the Securities Act of 1933,
as amended, contained in Section 4(2) thereof for each of the transactions
described above.




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.


9




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.




March
      19, 2010
              STEELCLOUD,
      INC.By:
              /s/
      Brian H. HajostName:
      Brian H. HajostTitle:
      Chief Executive Officer and PresidentBy:
              /s/
      Steven SnyderName:
      Steven SnyderTitle:
      Principal Financial Officer, Principal Accounting Officer and
      Controller




10