##### 



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended January 31, 2007
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File No. 0-24015
 STEELCLOUD, INC.
  VIRGINIA
(State or other jurisdiction of incorporation or 
organization)
    
    54-1890464
(I.R.S. Employer Identification No.)14040 Park Center Road, Herndon, VA
(Address of principal executive offices)
    
    20171
(Zip code)
 
   þ o
  Large Accelerated filer  o
    
    Accelerated filer  o
    
    Non-accelerated filer  þ
  o þ




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##### 



Description
    
    
    
    PagePart I.
    
    Financial InformationItem 1.
    
    Financial Statements
    
    
    1Consolidated Balance Sheets as of October 31, 2006 and January 31, 2007
    
    
    1Consolidated Statements of Operations for the three month periods
ended January 31, 2006 and 2007
    
    
    2Consolidated Statements of Cash Flows for the three month periods
ended January 31, 2006 and 2007
    
    
    3Notes to the Consolidated Financial Statements
    
    
    4Item 2.
    
    Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    9Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risks
    
    
    17Item 4.
    
    Controls and Procedures
    
    
    17Part II.
    
    Other Information
    
    
    17Item 1.
    
    Legal Proceedings
    
    
    17Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    18Item 3.
    
    Defaults Upon Senior Securities
    
    
    18Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    18Item 5.
    
    Other Information
    
    
    18Item 6.
    
    Exhibits
    
    
    18




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##### 



PART I. FINANCIAL INFORMATION
 ITEM 1. FINANCIAL STATEMENTS
 STEELCLOUD, INC.  CONSOLIDATED BALANCE SHEET
 October 31,
    
    
    January 31,2006
    
    
    2007(unaudited)ASSETSCurrent assetsCash and cash equivalents
    
    $
    3,655,163
    
    
    $
    3,385,430Accounts receivable, net
    
    
    3,840,583
    
    
    
    2,802,683Inventory, net
    
    
    1,144,820
    
    
    
    1,285,359Prepaid expenses and other current assets
    
    
    206,287
    
    
    
    248,985Deferred contract cost
    
    
    217,494
    
    
    
    221,264Total current assets
    
    
    9,064,347
    
    
    
    7,943,721Property and equipment, net
    
    
    1,039,752
    
    
    
    994,827Equipment on lease, net
    
    
    441,866
    
    
    
    356,958Other assets
    
    
    57,092
    
    
    
    62,142Total assets
    
    $
    10,603,057
    
    
    $
    9,357,648LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesAccounts payable
    
    $
    2,639,346
    
    
    $
    2,165,052Accrued expenses
    
    
    1,139,373
    
    
    
    988,212Notes payable, current
    
    
    14,629
    
    
    
    14,711Unearned revenue
    
    
    200,813
    
    
    
    649,030Total current liabilities
    
    
    3,994,161
    
    
    
    3,817,005Notes payable, long-term
    
    
    28,991
    
    
    
    25,106Other, including severance obligations
    
    
    367,741
    
    
    
    273,937Total long-term liabilities
    
    
    396,732
    
    
    
    299,043Stockholders equityPreferred
stock, $.001 par value: 2,000,000 shares authorized, no shares
issued and outstanding at October 31, 2006
and January 31, 2007
    
    
    
    
    
    
    Common stock, $.001 par value: 50,000,000
shares authorized, 14,662,176 shares issued
at October 31, 2006 and January 31, 2007
    
    
    14,662
    
    
    
    14,662Additional paid in capital
    
    
    49,834,658
    
    
    
    50,000,249Treasury stock, 400,000 shares at October
31, 2006 and January 31, 2007
    
    
    (3,432,500
    )
    
    
    (3,432,500
    )Accumulated deficit
    
    
    (40,204,656
    )
    
    
    (41,340,811
    )Total stockholders equity
    
    
    6,212,164
    
    
    
    5,241,600Total liabilities and stockholders equity
    
    $
    10,603,057
    
    
    $
    9,357,648
 .
 1




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##### 



STEELCLOUD, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
 Three Months EndedJanuary 31,2006
    
    
    2007RevenuesProducts
    
    $
    5,502,408
    
    
    $
    3,890,161Services
    
    
    674,617
    
    
    
    532,906Total revenues
    
    
    6,177,025
    
    
    
    4,423,067Cost of revenuesProducts
    
    
    4,340,074
    
    
    
    3,265,974Services
    
    
    473,914
    
    
    
    371,078Total cost of revenues
    
    
    4,813,988
    
    
    
    3,637,052Gross profit
    
    
    1,363,037
    
    
    
    786,015Selling and marketing
    
    
    500,174
    
    
    
    418,109Research and product development
    
    
    178,363
    
    
    
    142,827General and administrative
    
    
    1,504,036
    
    
    
    1,375,457Amortization of other intangible assets
    
    
    28,778
    
    
    
    -(Loss) from operations
    
    
    (848,314
    )
    
    
    (1,150,378
    )Interest income, net
    
    
    17,430
    
    
    
    14,223Net (loss)
    
    
    (830,884
    )
    
    
    (1,136,155
    )(Loss) per share (basic and diluted):Basic and
diluted (loss) per share
    
    $
    (0.06
    )
    
    $
    (0.08
    )Weighted-average shares outstanding, basic and diluted
    
    
    14,049,760
    
    
    
    14,262,176
 .
 2




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##### 



STEELCLOUD, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
 Three Months EndedJanuary 31,2006
    
    2007Operating activitiesNet (loss)
    
    $
    (830,884
    )
    
    $
    (1,136,155
    )Adjustments to reconcile net (loss) to net cash
provided by (used in) operating activities:Depreciation and amortization
    
    
    190,472
    
    
    
    158,239Stock-based compensation
    
    
    34,293
    
    
    
    125,591Warrant-based
expense
    
    
    
    
    
    
    40,000Changes in operating assets and liabilities:Accounts receivable
    
    
    (531,159
    )
    
    
    1,037,900Inventory
    
    
    (805,875
    )
    
    
    (140,539
    )Prepaid expenses and other assets
    
    
    26,039
    
    
    
    (47,748
    )Deferred contract costs
    
    
    4,234
    
    
    
    (3,770
    )Accounts payable
    
    
    303,665
    
    
    
    (474,294
    )Unearned revenue
    
    
    (30,008
    )
    
    
    458,511Accrued expenses and other liabilities
    
    
    18,900
    
    
    
    (255,259
    )Net cash (used in) operating activities
    
    
    (1,620,323
    )
    
    
    (237,524
    )Investing activitiesPurchase of property and equipment
    
    
    (42,862
    )
    
    
    (28,406
    )Financing activitiesProceeds from exercise of common stock options
    
    
    7,288
    
    
    
    -Payments on notes payable
    
    
    (17,688
    )
    
    
    (3,803
    )Net cash (used in) financing activities
    
    
    (10,400
    )
    
    
    (3,803
    )Net (decrease) in cash and cash equivalents
    
    
    (1,673,585
    )
    
    
    (269,733
    )Cash and cash equivalents at beginning of period
    
    
    6,657,367
    
    
    
    3,655,163Cash and cash equivalents at end of period
    
    $
    4,983,782
    
    
    $
    3,385,430Supplemental cash flow informationInterest paid
    
    $
    1,128
    
    
    $
    342Income taxes paid
    
    $
    -
    
    
    $
    -
 .
 3




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##### 



STEELCLOUD, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 1. Nature of Business and Basis of Presentation
    TM
   2. Reclassification
 Reporting Revenue Gross as a Principal versus Net as an Agent.
   4




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##### 



3. Significant Accounting Policies
 Deferred Tax Assets
 Accounting for Income Taxes
 4. Equity
 Share-Based Payment
  Incentive Stock Option Plans
    5




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##### 



Quarter ended January 31, 2007Expected term (years)1
    
    2.50 to 3.25Expected stock price volatility2
    
    58.2% to 59.3%Risk-free interest rate3
    
    4.61% to 4.67%
 
 1
    -
    Expected term.Expected term for the stock option awards was calculated
based upon the simplified method set out in the SEC Staff Accounting Bulletin No. 107 ( SAB
107).2
    -
    Expected stock price volatility.Expected stock price volatility for ESPP
awards is calculated using the weighted average of the Companys historical volatility over
the expected term of the award.3
    -
    Risk-free interest rate.The risk-free interest rate is calculated based on
the U.S Treasury yield curve on the grant date and the expected term of the award.  Weighted-Weighted-
    
    
    AverageAverage
    
    
    RemainingExercise
    
    
    ContractualShares
    
    
    Price
    
    
    Term (years)Outstanding at October 31, 2006
    
    
    581,925
    
    
    $
    1.90Exercisable at October 31, 2006
    
    
    517,925
    
    
    $
    1.85Options granted
    
    
    1,372,500
    
    
    $
    0.65Options exercised
    
    
    
    
    
    
    Options canceled or expired
    
    
    (103,425
    )
    
    $
    1.51Outstanding at January 31, 2007
    
    
    1,851,000
    
    
    $
    1.00
    
    
    
    4.14Exercisable at January 31, 2007
    
    
    644,750
    
    
    $
    1.61
    
    
    
    3.02
    Options Outstanding
    
    Options ExercisableWeighted-
    
    Average
    
    
    
    
    
    Weighted-Average
    
    Remaining
    
    
    
    
    
    AverageNumber
    
    Exercise
    
    Contractual
    
    Number
    
    ExerciseRange of Exercise Prices
    
    Outstanding
    
    Price
    
    Life
    
    Outstanding
    
    Price$0.55-$1.75
    
    
    1,528,500
    
    
    $
    0.71
    
    
    
    4.44
    
    
    
    356,000
    
    
    $
    1.00$1.76-$4.50
    
    
    322,500
    
    
    $
    2.36
    
    
    
    2.73
    
    
    
    288,750
    
    
    $
    2.36$0.55-$4.50
    
    
    1,851,000
    
    
    $
    1.00
    
    
    
    4.14
    
    
    
    644,750
    
    
    $
    1.61
 6




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##### 



Weighted-AverageGrant-DateShares
    
    
    Fair ValueNonvested at October 31, 2006
    
    
    64,000
    
    
    $
    1.76Options granted
    
    
    1,372,500
    
    
    $
    0.28Options vested
    
    
    (201,500
    )
    
    $
    0.34Options forfeited
    
    
    (28,750
    )
    
    $
    1.65Nonvested at January 31, 2007
    
    
    1,206,250
    
    
    $
    0.32
  Employee Stock Purchase Plan
    Warrants
  5.	Debt
  6.	Deferred Revenue
  7




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##### 



7. Earnings Per Share
  8. Segment Reporting
 Disclosures about Segments of an Enterprise and Related Information
 9. Significant Customers
  8




---



##### 



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




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##### 



OVERVIEW
    TM
 Federal Integrator and ISV Business
    TM
  10




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##### 



End User Solutions
   Research and Development
  TM TM
  Significant Customer Contracts
  Notices from Nasdaq
  11




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##### 



CRITICAL ACCOUNTING POLICIES AND ESTIMATES
  Recently Issued Accounting Pronouncements
 Accounting
Changes and Error Corrections Accounting
Changes, Reporting Accounting Changes
in Interim Financial Statements.
 Accounting for Uncertainty in Income Taxes
 Fair Value
Measurements
 Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements
 12




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##### 



RESULTS OF OPERATIONS
 For the months ended January 31, 2007 compared to the three months ended January 31, 2006
 Net Revenue Discussion:
  Three Months Ended January 31,2006
    
    
    2007
    
    
    Increase (decrease)% of Net
    
    
    
    
    
    
    % of NetDollars
    
    
    Revenues
    
    
    Dollars
    
    
    Revenues
    
    
    Dollars
    
    PercentageProducts
    
    $
    5,502,408
    
    
    
    89.08
    %
    
    $
    3,890,161
    
    
    
    87.95
    %
    
    $
    (1,612,247
    )
    
    
    (29.30
    )%Services
    
    
    674,617
    
    
    
    10.92
    %
    
    
    532,906
    
    
    
    12.05
    %
    
    
    (141,711
    )
    
    
    (21.01
    )%Total net revenues
    
    $
    6,177,025
    
    
    
    100.00
    %
    
    $
    4,423,067
    
    
    
    100.00
    %
    
    $
    (1,753,958
    )
    
    
    (28.39
    )%
   Gross Margin Discussion:
  Three Months Ended January 31,2006
    
    2007
    
    Increase (decrease)% of Net
    
    
    
    
    
    % of NetDollars
    
    Margin
    
    Dollars
    
    Margin
    
    Dollars
    
    PercentageProducts
    
    $
    1,162,334
    
    
    
    85.28
    %
    
    $
    624,187
    
    
    
    79.41
    %
    
    $
    (538,147
    )
    
    
    (46.30
    )%Products
 GM%
    
    
    21.12
    %
    
    
    
    
    
    
    16.05
    %Services
    
    $
    200,703
    
    
    
    14.72
    %
    
    
    161,828
    
    
    
    20.59
    %
    
    $
    (38,875
    )
    
    
    (19.37
    )%Services  GM%
    
    
    29.75
    %
    
    
    
    
    
    
    30.37
    %Total gross margin
    
    $
    1,363,037
    
    
    
    100.00
    %
    
    $
    786,015
    
    
    
    100.00
    %
    
    $
    (577,022
    )
    
    
    (42.33
    )%Total  GM%
    
    
    22.07
    %
    
    
    
    
    
    
    17.77
    %
 13




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##### 



Operating Expense Discussion:
  Three Months Ended January 31,2006
    
    2007
    
    Increase (decrease)% of Net
    
    
    
    
    
    % of NetDollars
    
    Revenues
    
    Dollars
    
    Revenues
    
    Dollars
    
    PercentageSelling and marketing
    
    $
    500,174
    
    
    
    8.10
    %
    
    $
    418,109
    
    
    
    9.45
    %
    
    $
    (82,065
    )
    
    
    (16.41
    )%General and
administrative
    
    
    1,504,036
    
    
    
    24.35
    %
    
    
    1,375,457
    
    
    
    31.10
    %
    
    
    (128,579
    )
    
    
    (8.55
    )%Research and product
development
    
    
    178,363
    
    
    
    2.89
    %
    
    
    142,827
    
    
    
    3.23
    %
    
    
    (35,536
    )
    
    
    (19.92
    )%Amortization of goodwill
    
    
    28,778
    
    
    
    0.47
    %
    
    
    
    
    
    
    0.00
    %
    
    
    (28,778
    )
    
    
    (100.00
    )%Total operating expenses
    
    $
    2,211,351
    
    
    
    35.80
    %
    
    $
    1,936,393
    
    
    
    43.78
    %
    
    $
    (274,958
    )
    
    
    (12.43
    )%
    14




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##### 



Other Income Discussion:
  Three Months Ended January 31,2006
    
    2007
    
    Increase (decrease)% of Net
    
    
    
    
    
    % of NetDollars
    
    Revenues
    
    Dollars
    
    Revenues
    
    Dollars
    
    PercentageInterest income
net
    
    $
    17,430
    
    
    
    0.28
    %
    
    $
    14,223
    
    
    
    0.32
    %
    
    $
    (3,207
    )
    
    
    (18.40
    )%Total other income
    
    $
    17,430
    
    
    
    0.28
    %
    
    $
    14,223
    
    
    
    0.32
    %
    
    $
    (3,207
    )
    
    
    (18.40
    )%
  Net (Loss) Discussion:
  Three Months Ended January 31,2006
    
    2007
    
    Increase (decrease)% of Net
    
    
    
    
    
    % of NetDollars
    
    Revenues
    
    Dollars
    
    Revenues
    
    Dollars
    
    PercentageNet (loss)
    
    $
    (830,884
    )
    
    
    (13.45
    )%
    
    $
    (1,136,155
    )
    
    
    (25.69
    )%
    
    $
    305,271
    
    
    
    36.74
    %
  15




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##### 



LIQUIDITY AND CAPITAL RESOURCES
        Contractual Obligations and Commercial Commitments:
  Payments Due by PeriodContractual Obligations
    
    Total
    
    
    Less than 1 year
    
    
    1-3 years
    
    
    4-5 years
    
    
    After 5 yearsNotes payable
    
    $
    39,817
    
    
    $
    14,711
    
    
    $
    19,143
    
    
    $
    5,963
    
    
    
    Operating leases
    
    
    2,762,728
    
    
    
    564,196
    
    
    
    965,656
    
    
    
    537,982
    
    
    
    694,894Employment
agreements
    
    
    745,000
    
    
    
    408,542
    
    
    
    336,458
    
    
    
    
    
    
    
    Total
    
    $
    3,547,545
    
    
    $
    987,449
    
    
    $
    1,321,257
    
    
    $
    543,945
    
    
    $
    694,894
  16




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##### 



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  ITEM 4. CONTROLS AND PROCEDURES
 Evaluation of SteelClouds Disclosure Controls and Internal Controls
  Limitations
  Changes in Internal Controls Over Financial Reporting
  PART II. OTHER INFORMATION
 ITEM 1. LEGAL PROCEEDINGS
   ITEM
1A. RISK FACTORS
  17




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##### 



ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  ITEM 3. DEFAULTS UPON SENIOR SECURITIES
  ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  ITEM 5. OTHER INFORMATION
  ITEM 6. EXHIBITS
 Exhibit 11.1
    
    Statement of computation of earnings per share.Exhibit 31.1
    
    Certification of Chief Executive Officer and President
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.Exhibit 31.2
    
    Certification of Chief Operating Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.Exhibit 31.3
    
    Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.Exhibit 32.1
    
    Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes  Oxley Act of 2002.Exhibit 32.2
    
    Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes  Oxley Act of 2002.Exhibit 32.3
    
    Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes  Oxley Act of 2002.
 18




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##### 



SIGNATURES
  March 19, 2007
    
    STEELCLOUD, INC.By:
    
    /s/ Clifton W. Sink, Jr.Name:
    
    Clifton W. Sink, Jr.Title:
    
    Chief Executive Officer and PresidentBy:
    
    /s/ Robert RichmondName:
    
    Robert RichmondTitle:
    
    Chief Operating OfficerBy:
    
    /s/ Kevin MurphyName:
    
    Kevin MurphyTitle:
    
    Chief Financial Officer
 19