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

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

The following discussion should be read in conjunction with the consolidated financial statements and Footnotes thereto included in Item 1 in this Quarterly Report on Form 10-Q,and with our Annual Report on Form 10-K for the fiscal year ended October 31, 2008 as amended, filed by us with the SEC.

OVERVIEW

Founded in 1987, we are a developer of mobility appliance 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 ("DoD"), public sector, commercial, and remote hosting customers.

Recent Developments

Board of Directors Investment

On June 15, 2009, we sold an aggregate of 350,000 shares of our common stock, $.001 par value, to our seven directors, for aggregate cash proceeds of $87,500.
The shares of common stock were sold at $0.25 per share, or $.01 higher than the closing price of the common stock on the date of sale. Each share of common stock is accompanied by one warrant to purchase one additional share of common stock (the "Warrant"). The Warrants are exercisable for five years from the date of issuance at an exercise price of $0.25 per share. The seven directors have entered into a lock-up agreement with us, restricting their ability to exercise the Warrants until we receive shareholder approval for the issuance of the Warrants.

Loan and Note Payable

On July 1, 2009, we entered into a Business Loan and Security Agreement with Caledonia Capital Corporation, a Delaware Corporation (the Lender") pursuant to which the Lender agreed to lend us $250,000 in the form of a Secured Promissory Note (the Note") which was issued on July 1, 2009. The Note bears interest at a rate of 15% per annum, and is payable in quarterly installments commencing three months after the Issuance Date, or October 1, 2009. The principal amount of the Note is due and payable in full on December 29, 2009 (the "Maturity Date"). There are no penalties for early prepayment of the Note.

In the event that any installment of principal and/or interest due under the Note is not received by the Lender within ten (10) days after the date when the same is due, then we shall be required to pay a late charge of 5.0% of such installment.

Additionally, in the event that we receive investments from one or more investors in one or more transactions in an aggregate amount in excess of $750,000, whether in the form of cash, negotiable or non-negotiable instruments or any form of payment in exchange for the issuance of any certificated or non-certificated security, whether in the form of debt or equity (an "Equity Raise"), at any time between the Issuance Date and the Maturity Date, shall be required, within five (5) business days after the Equity Raise first exceeds $750,000, to curtail the accrued interest and outstanding principal balance of the Note by an amount equal to the amount by which the Equity Raise then exceeds $750,000 (but in no event by more than the then outstanding principal balance and interest accrued on the Note). Until delivery of such funds to the Lender, all such funds shall be deemed held in trust by us for and on behalf of the Lender. All funds that we deliver to the Lender from the Equity Raise shall be deemed prepayments of the Note.

Pursuant to the Agreement and the Note, our obligations thereunder are secured by a first priority lien in and to all of our 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, we issued to the Lender a warrant to purchase up to 625,000 shares of our common stock, par value $0.001 per share. The Warrant is exercisable for four years at an exercise price of $0.15 per share. We determined fair value of these warrants utilizing the Black-Sholes method. The fair value of these warrants at issuance date was approximately $130,000.

Sale of Integration Business

On July 10, 2009, we entered into an Asset Purchase Agreement (the "Agreement") with NCS Technologies, Inc., a Virginia corporation ("NCS"), pursuant to which we agreed to sell to NCS, and NCS agreed to purchase from us, all of our right, title and interest in and to the assets relating to our computer integration business. The purchase price was $475,000 of which $150,000 was paid as a deposit and the remaining $325,000 is an earn-out amount, which is payable from and to the extent of revenue NCS receives during the three-year period after the closing date from certain existing and prospective clients, at a rate equal to 15% of the net sales price received by NCS from such clients. Any payments by NCS to us are due on or before the 10th business day following the month in which NCS receives the payments from the client(s).

We have classified the integration business as discontinued operations for the three and nine month periods ending July 31, 2009 as well as all comparative periods presented. Certain amounts have been reclassified in order to conform to current period presentation.

NASDAQ Listing

On March 23, 2009, we received notice, under NASDAQ Marketplace Rule 4310(c)(3), that our common stock was subject to potential delisting from the NASDAQ Capital Market because we did not meet the criteria of NASDAQ Listing Rule 5550(b) (the "Rule") and did not have a minimum of $2,500,000 in stockholders' equity, $35,000,000 market value of listed securities, or $500,000 of net income from continuing operations for the most recently completed fiscal year or two of the three most recently completed fiscal years. We provided NASDAQ with a specific plan of how we intended to achieve and sustain compliance with all the NASDAQ Capital Market listing requirements, including a time frame for completion of such plan. Our plan included the following two strategies: (i) increasing our stockholders equity in excess of the minimum $2,500,000 requirement by raising between $3,000,000 to $4,000,000 through an equity transaction; and (ii) identifying a strategic partner interested in either merging with or acquiring us. On April 28, 2009 we received notice from NASDAQ indicating that NASDAQ had granted our request for an extension of time to regain compliance with the Rule. Pursuant to the terms of the extension, we were required to: (a) on or before July 6, 2009, complete an equity transaction or a merger and/or acquisition, and (b) make appropriate disclosures to the SEC and NASDAQ on a Form 8-K. We were not able to complete an equity transaction or a merger and/or acquisition by July 6, 2009, and on July 8, 2009, we received written notification from NASDAQ stating that we did not meet the terms of the extension, and that, as a result, our common stock would be subject to suspension from trading at the opening of business on July 17, 2009, and delisted from NASDAQ. The notification stated that a hearing request made to the NASDAQ Hearing Panel (the "Panel") to appeal the determination would stay the delisting of our common stock pending the Panel's decision. On July 15, 2009, we requested a hearing to appeal the determination before the Panel and to present our plan for regaining compliance with the Rule (the "Appeal"). On August 4, 2009, we received notice that NASDAQ received our Appeal, and that the delisting action has been stayed, pending a final written decision by the Panel after an oral/written hearing (the "Hearing"), where we were required to demonstrate our ability to regain and sustain compliance with the Rule. The Hearing was held at 11:00 A.M. EST, on September 3, 2009. We presented our updated plan of compliance to the Panel on that date. We are awaiting response from the Panel regarding the determination of its appeal. There can be no assurance that the Panel will grant our request for continued listing.

Business Overview

BlackBerry® Enterprise Server Solution (SteelWorks®)

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

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

Professional Services

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

Research and Product Development

By investing in product development, we believe we will have more control over the functionality and marketing of our products. We also believe that the resulting intellectual property will increase the competitiveness of our offerings and improve product margins. For the three and nine months ended July 31, 2009, we incurred research and development costs of approximately $54,000 and $152,000, respectively. We will continue to incur costs for product development in the future.

GSA Contract

We have a multiple award schedule contract with the U.S. General Services Administration (the "GSA Contract"). The GSA Contract was originally awarded in April 1996. It was renewed in fiscal years 2002 and 2007, and is valid through March 31, 2012. In August 2006, GSA Contract auditors awarded us an "Outstanding" rating for our management and execution of the GSA Contract. The GSA Contract enables government IT purchasers to acquire all of their needed goods and services from a particular vendor and largely limits the competition to selected vendors holding GSA Contracts. For the three and nine months ended July 31, 2009, our GSA Contract had sales of approximately $150,000 and $976,000 , respectively.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

Recently Issued Accounting Pronouncements

Effective November 1, 2008, we adopted the provisions of Statement of Financial Accounting Standards No. 157, "Fair Value Measurements" ("SFAS No. 157") and Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS No. 159"). SFAS 157, which defines fair value, establishes a framework for measuring fair value in accordance with U.S. Generally Accepted Accounting Principles ("GAAP"), and expands disclosures about fair value measurements. SFAS 157 clarifies that fair value is an exit price, representing the amount that would be received to sell asset or paid to transfer a liability in an orderly transaction between market participants. SFAS 159 permits an entity to measure certain financial assets and financial liabilities at fair value with changes in fair value recognized in earnings each period. For the three and six month periods ended July 31, 2009, we have elected not to use the fair value option permitted under SFAS 159 for any of our financial assets and financial liabilities that are not already recorded at fair value.

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

In October 2008, the FASB issued Staff Position No. 157-3, "Determining the Fair Value of a Financial Asset When the Market for that Asset is not Active" ("FSP 157-3"). FSP 157-3 provides guidance for determining the fair value of a financial asset in an inactive market. We adopted FAS 157-3 as of the quarter ended July 31, 2009. The adoption did not have a material impact on the financial statements.

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

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

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

In May 2009, the FASB issued SFAS No. 165, "Subsequent Events" ("SFAS 165"). SFAS 165 is intended to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for selecting that date, that is, whether that date represents the date the financial statements were issued or were available to be issued. We adopted SFAS 165 as of July 31, 2009.

In April 2009, the FASB issued FSP FAS 107-1 and APB-28-1, "Interim Disclosure about Fair Value of Financial Instruments" (FSP 107-1/APB 28-1). FSP 107-1/APB 28-1 requires interim disclosures regarding the fair values of financial instruments that are within the scope of FAS 107, "Disclosures about the Fair Value of Financial Instruments". Additionally, FSP107-1/APB28-1 requires disclosure of the methods and significant assumptions used to estimate the fair value of financial instruments on an interim basis as well as changes of the methods and significant assumptions from prior periods. FSP 107-1/APB 28-1 does not change the accounting treatment for these financial instruments and is effective for interim reporting periods ending after June 15, 2009. We adopted FSP 107-1/APB 28-1 during the quarter ended July 31, 2009 and disclosed the fair value of our financial instruments in the financial statements.

In April 2009, the FASB issued FSP 115-2 and FAS 124-2, "Recognition and Presentation of Other-Than-Temporary Impairment" (FSP 115-2/124-2). FSP 115-2/124-2 amends the requirements for the recognition and measurement of other-than-temporary impairments for debt securities by modifying the pre-existing "intent and ability" indicator. Under FSP 115-2/124-2, an other-than-temporary impairment is triggered when there is an intent to sell the security, it is more likely than not the security will be required to be sold before recovery, or the security is not expected to recover the entire amortized cost basis of the security. Additionally, FSP 115-2/124-2 changes the presentation of another-than-temporary impairment in the income statement for those impairments involving credit losses. The credit loss component will be recognized in earnings and the remainder of the impairment will be recorded in other comprehensive income. FSP 115-5 2/124-2 is effective for interim and annual reporting periods ending after June 15, 2009. We adopted FSP 115-5 2/124-2 as of the quarter ended July 31, 2009.

RESULTS OF OPERATIONS

The overall economic downturn has impacted virtually every area of our business. As a result, on July 10, 2009, we sold our hardware integration business to NCS. Accordingly, we have reclassified amounts associated with this business as discontinued operations. The discussion below represents our analysis of the continuing operations. Discontinued operations are also discussed below, separately.

For the three months ended July 31, 2009 compared to the three months ended July 31, 2008:

Net Revenue Discussion:

The following table summarizes our net revenue for the three months ended July
31, 2008 and 2009 in dollars and as a percentage of net revenues.

                                                     Three Months Ended July 31,
                                  2008                         2009                   Increase (decrease)
                                       % of Net                     % of Net
                         Dollars       Revenues       Dollars       Revenues        Dollars        Percentage

Products                $  57,228           6.33 %   $  88,518          31.42 %   $    31,290            54.68 %
Services                  846,215          93.67 %     193,187          68.58 %      (653,028 )         (77.17 )%
Total net revenues      $ 903,443         100.00 %   $ 281,705         100.00 %   $  (621,738 )         (68.82 )%

The increase in product revenue is primarily attributable to the introduction of our new SteelWorks Mobile appliances. Fiscal year 2008 product revenues relate to other technology products that are not related to the SteelWorks Mobile appliances. Accordingly, we experienced 100% growth in this appliance product in fiscal 2009. The SteelWorks Mobile appliance was launched in early fiscal 2009 and we anticipate sales will increase in future periods as demand for the product increases.

The decrease in service revenue for the three-month period ended July 31, 2009 as compared to the same period in fiscal 2008 is the result of our completing a fiscal 2008 large services contract in December 2008. We anticipate service revenues will continue to fluctuate in future periods given the current economic environment.

Gross Profit Discussion:

The following table summarizes our gross profit for the three months ended July
31, 2008 and 2009 in dollars, as a percentage of gross profit and as a
percentage of net revenues.

                                                    Three Months Ended July 31,
                                 2008                        2009                   Increase (decrease)
                                        % of                        % of
                                        Gross                       Gross
                         Dollars       Profit        Dollars       Profit         Dollars        Percentage

Products                $  23,076         11.94 %   $  53,016         44.47 %   $    29,940           129.75 %
Products - GM%              40.32 %                     59.89 %

Services                  170,249         88.06 %      66,190         55.53 %      (104,059 )         (61.12 )%
Services - GM%              20.12 %                     34.26 %

Total gross profit      $ 193,325        100.00 %   $ 119,206        100.00 %   $   (74,119 )         (38.34 )%
Total - GM%                 21.40 %                     42.32 %

The increase in product gross profit percentage for the three months ended July 31, 2009 as compared to the same period in fiscal 2008 is primarily the result of our new SteelWorks Mobile appliance. Given the amount of intellectual property and software created and developed for this product, we will achieve significantly higher product gross margins as compared to the hardware integration business. We anticipate that the gross product margins will fluctuate from quarter to quarter based on new functions and features created for the product. We believe that our gross margin percentage for our SteelWorks Mobile family of products will be between 40% and 60%.

The increase in services gross profit for the three months ended July 31, 2009 as compared to the same period in fiscal 2008 is primarily attributable to the completion of a low margin services contract in December 2008.

Operating Expense Discussion:

The following table summarizes our operating expenses for the three months ended
July 31, 2008 and 2009 in dollars and as a percentage of net revenues.

                                                       Three Months Ended July 31,
                                    2008                          2009                   Increase (decrease)
                                          % of Net                     % of Net
                           Dollars        Revenues       Dollars       Revenues        Dollars        Percentage

Selling and marketing    $   248,557          27.51 %   $ 153,412          54.46 %   $   (95,145 )         (38.28 )%
Research and product
development                   58,066           6.43 %      53,637          19.04 %        (4,429 )          (7.63 )%
General and
administrative               899,042          99.51 %     591,397         209.93 %      (307,645 )         (34.22 )%
Total operating
expenses                 $ 1,205,665         133.45 %   $ 798,446         283.43 %   $  (407,219 )         (33.78 )%

The decrease in selling and marketing expense is the result of aligning expenses to our current and future business models to focus on our SteelWorks Mobile products. For the three months ended July 31, 2009 compared to the three months ended July 31, 2008, marketing activities and expenses associated with selling and marketing personnel decreased as a result of cost cutting efforts. We . . .