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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-QSB

(Mark One)

For the quarterly period ended September 30, 2003

For the transition period from                  to                     

Commission file number 0-22405

INFORMATION ANALYSIS INCORPORATED

(Exact name of small business issuer as specified in its charter)

11240 Waples Mill Road, Suite 400, Fairfax, VA 22030

(Address of principal executive offices)

(703) 383-3000

(Issuer’s telephone number)

(Former name, former address and former fiscal year, if changed since last report)

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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  x    No  ¨

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:

Common Stock, par value $0.01, 10,283,515 shares as of November 10, 2003

Transitional Small Business Disclosure Format (Check one):    Yes  ¨    No  x

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INFORMATION ANALYSIS INCORPORATED

FORM 10-QSB

Index

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INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of the consolidated financial statements

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INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of the consolidated financial statements

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INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of the consolidated financial statements

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INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of the consolidated financial statements

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PART I

Item 1. Financial Statements.

INFORMATION ANALYSIS, INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

The accompanying consolidated financial statements have been prepared by Information Analysis Incorporated (“IAI” or the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission. Financial information included herein is unaudited; however, in the opinion of management, all adjustments (which include normal recurring adjustments) considered necessary for a fair presentation have been made. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted pursuant to such rules and regulations, but the Company believes that the disclosures made are adequate to make the information presented not misleading. For more complete financial information, these financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2002 included in the Company’s annual report on Form 10-KSB. Results for interim periods are not necessarily indicative of the results for any other interim period or for the full fiscal year.

Item 2. Management’s Discussion and Analysis of Financial Condition or Plan of Operation

Cautionary Statement Regarding Forward-Looking Statements

This Form 10-QSB contains forward-looking statements regarding the Company’s business, customer prospects, or other factors that may affect future earnings or financial results that are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. Such statements involve risks and uncertainties which could cause actual results to vary materially from those expressed in the forward-looking statements. Investors should read and understand the risk factors detailed in the Company’s 10-KSB for the fiscal year ended December 31, 2002 and in other filings with the Securities and Exchange Commission.

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Net Income (Loss) Per Share

Earnings per share are presented in accordance with SFAS No. 128, “Earnings Per Share.” This statement requires dual presentation of basic and diluted earnings per share on the face of the income statement. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock, except for periods when the Company reports a net loss because the inclusion of such items would be antidilutive.

The following is a reconciliation of the amounts used in calculating basic and diluted net income per common share.

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Three Months Ended September 30, 2003 Versus Three Months Ended September 30, 2002

Revenue

IAI’s revenues in the third quarter of fiscal 2003 were $1,483,104, compared to $1,223,879 in the third quarter of fiscal 2002, an increase of 21.2%. Professional services revenue was $1,426,486 versus $943,801, an increase of 51.1%, and product revenue was $56,618 versus $280,078, a decrease of 79.8%. The increase in professional services revenue is due primarily to new contracts on which work began during the second quarter of fiscal 2003. Revenues in fiscal 2003 increased from first to second quarter by 28.6% and from second to third quarter by 25.4%. The decrease in product revenue is primarily due to the completion of contracts under which significant sales of the Company’s ICONS suite of conversion tools were recognized in 2002.

Gross Margins

Gross margin was $283,653, or 19.1% of sales, in the third quarter of fiscal 2003 versus $384,456, or 31.4% of sales, in the third quarter of fiscal 2002. Of the $283,653 in 2003, $286,337 was attributable to services and ($2,684) was attributable to software sales. Gross margin, as a percentage of sales, was 20.1% for professional services and (4.7)% for software sales for third quarter 2003. In the third quarter of 2002, the Company reported gross margins of 25.3% for professional services and 52.1% for software sales. The decrease in professional services gross margin is attributed to the expiration of higher margin contracts that were included in the third quarter of fiscal 2002. The decrease in software sales gross margin is attributed to a decrease in contracts under which the Company collects licensing fees for its ICONS suite of conversion software.

Selling, General and Administrative

Selling, general and administrative expenses (SG&A) were $263,637, or 17.8% of revenues, in the third quarter of 2003 versus $405,923, or 33.2% of revenues, in the third quarter of 2002, a decrease in expenses of 35.1%. The Company continues to control expenses and reduce them wherever practical, and believes that only marginal increases in SG&A will result from even significant increases in the number of contracts under which it operates.

Profits

The Company generated an operating income before other expenses of $20,016 in the third quarter of 2003 compared to an operating loss before other expenses of $21,377 in the third quarter of 2002. There was net income of $10,682 for the third quarter of 2003 versus a net loss of $29,801 for the same period in 2002. The change in profitability is directly related to the overall increase in contract revenues related to new contracts as explained in the Revenue section above.

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Nine Months Ended September 30, 2003 Versus Nine Months Ended September 30, 2002

Revenue

IAI’s revenues in the first nine months of fiscal 2003 were $3,585,554, compared to $4,837,059 in the first nine months of fiscal 2002, a decrease of 25.9%. Professional services revenue was $3,338,714 versus $4,301,275, a decrease of 22.4%, and product revenue was $246,840 versus $535,784, a decrease of 53.9%. In the third and fourth quarters of fiscal year 2002 and the first quarter of fiscal year 2003, several of the Company’s contracts expired. The Company believes the United States federal government’s delays in passing a fiscal 2003 budget, and in appropriating that budget, the decreasing tax revenues in all levels of government, and concerns over Department of Homeland Security and Department of Defense matters relating to the war in Iraq caused decisions regarding numerous new and follow-on federal government contracts to be delayed. After the cessation of major military operations in the Iraq war, the Company quickly won two multi-year, multi-million dollar contracts, as well as some additional work.

Gross Margins

Gross margin was $733,446, or 20.5% of sales, in the first nine months of fiscal 2003 versus $1,512,041, or 31.3% of sales, in the first nine months of fiscal 2002. Of the $733,446 in 2003, $728,994 was attributable to services and $4,452 was attributable to software sales. Gross margin, as a percentage of sales, was 21.8% for professional services and 1.8% for software sales for the first nine months of 2003. In the same period of 2002, the Company reported gross margins of 30.7% for professional services and 35.4% for software sales. The decrease in professional services gross margin is attributed to an increase in the use of consultant labor on some of the Company’s newer contracts, which increases direct labor costs and decreases fringe benefit costs and the costs of carrying employees between contracts. The decrease in software sales gross margin is attributed to a decrease in contracts under which the Company collects licensing fees for its ICONS suite of conversion software.

Selling, General and Administrative

Selling, general and administrative expenses (SG&A) were $966,592, or 27.0% of revenues, in the first nine months of 2003 versus $1,354,813, or 28.0% of revenues, in the first nine months of 2002, a decrease in expenses of 28.7%. The Company continues to control expenses and reduce them wherever practicable.

Profits

The Company generated an operating loss before other expenses of $233,146 in the first nine months of 2003 compared to operating income before other expenses of $157,228 in the first nine months of 2002. There was a net loss of $253,623 for the first nine months of 2003 versus a net income of $144,041 for the same period in 2002. The change in profitability is directly related to the overall decrease in contract revenues related to expired contracts as explained in the Revenue section above.

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Liquidity and Capital Resources

Through the first nine months of 2003, the Company financed its operations from current collections and through its bank line of credit. Cash and cash equivalents at September 30, 2003 were $4,196 compared to $80,502 at December 31, 2002. As of September 30, 2003 the Company had an outstanding balance on its line of credit of $537,000.

The Company is in default with its line of credit with First Virginia Bank as a result of the Company’s failure to maintain a financial condition satisfactory to the bank. However, First Virginia Bank has agreed to extend its forbearance agreement to November 28, 2003. The Company is in negotiations with various organizations to obtain new financing.

The Company believes that if revenue continues at the level reported in the nine months ended September 30, 2003, it will derive insufficient cash flow to relieve all payables essential to the continuing operation of the business. Any additional material reduction in revenue could have a material adverse effect on the Company’s operational capabilities. The Company has won additional contracts, however, and believes that with the increased revenue, its cash flow will improve and will be sufficient to operate the business. Cash flow from operations is insufficient, however, to provide the additional working capital that is necessary to repay approximately $325,000 of past due payables. The Company cannot state with certainty that it will not need additional cash resources at some point in fiscal 2003 or 2004. Accordingly, the Company may from time to time consider additional equity offerings to finance business expansion. The Company is uncertain that it will be able to raise additional capital.

The Company has no material commitments for capital expenditures.

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Item 3. Controls and procedures

(a) Evaluation of Disclosure Controls and Procedures. Within 90 days of this report, under the supervision of and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c)). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC reports. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

(b) Changes in Internal Controls. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, nor were there any significant deficiencies or material weaknesses in the Company’s internal controls. Accordingly, no corrective actions were required or undertaken.

PART II - OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

See Exhibit Index on page 12.

SIGNATURES

In accordance with the requirements of the Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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Exhibit Index

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