INFORMATION ANALYSIS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) Cautionary Statement Regarding Forward-Looking Statements This Form 10-Q contains forward-looking statements regarding our 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 our Form 10-K for the fiscal year ended December 31, 2011 and in other filings with the Securities and Exchange Commission.

We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control. This list highlights some of the risks which may affect future operating results. These are the risks and uncertainties we believe are most important for you to consider. Additional risks and uncertainties, not presently known to us, which we currently deem immaterial or which are similar to those faced by other companies in our industry or business in general, may also impair our business operations. If any of the following risks or uncertainties actually occurs, our business, financial condition and operating results would likely suffer. These risks include, among others, the following: changes in the funding priorities of the U.S. federal government; changes in the way the U.S. federal government contracts with businesses; terms specific to U.S. federal government contracts; our failure to keep pace with a changing technological environment; intense competition from other companies; inaccuracy in our estimates of the cost of services and the timeline for completion of contracts; non-performance by our subcontractors and suppliers; our dependence on key personnel; our dependence on third-party software and software maintenance suppliers; our failure to adequately integrate businesses we may acquire; fluctuations in our results of operations and the resulting impact on our stock price; the exercise of outstanding options; our failure to adequately protect our intellectual property; the limited public market for our common stock; and our forward-looking statements and projections may prove to be inaccurate.

In some cases, you can identify forward-looking statements by terms such as "may," "will," "should," "could," "would," "expect," "plans," "anticipates," "believes," "estimates," "projects," "predicts," "intends," "potential" and similar expressions intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We discuss many of these risks in greater detail under the heading "Risk Factors" in Item 1A. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this report. Except as required by law, we assume no obligation to update any forward-looking statements after the date of this report.

Our Business Founded in 1979, IAI is in the business of modernizing client information systems, developing and maintaining information technology systems, and performing consulting services to government and commercial organizations. We have performed software conversion projects for over 100 commercial and government customers, including Computer Sciences Corporation, IBM, Computer Associates, Sprint, Citibank, U.S. Department of Homeland Security, U.S.

Treasury Department, U.S. Department of Agriculture, U.S. Department of Energy, U.S. Army, U.S. Air Force, U.S. Department of Veterans Affairs, and the Federal Deposit Insurance Corporation. Today, we primarily apply our technology, services and experience to legacy software migration and modernization for commercial companies and government agencies, and to developing web-based solutions for agencies of the U.S. federal government.

Three of our customers, one of which isa U.S. government agency with which we contract directly and two of which are companies with which we contract for services to U.S. government agencies represent material portions of our revenue. These customers accounted for 31.4% (direct) and 21.5%, and 19.7% (under subcontract) of revenue in the first nine months of 2012.

12 --------------------------------------------------------------------------------Information Analysis Incorporated Form 10-Q Third Quarter 2012 Three Months Ended September 30, 2012versus Three Months Ended September 30, 2011 Revenue Our revenues in the third quarter of 2012 were $1,735,775, compared to $1,662,700 in 2011, an increase of 4.4%. Professional services revenue was $1,363,421 versus $1,329,592, an increaseof 2.5%, and software product and maintenance revenue was $372,354 versus $333,108, an increase of 11.8%.The increase in professional services revenue was due to a new contract and to increases in activity in some of our existing contracts in excess of the contracts that expired, were completed, and that decreased activity since September 30, 2011. The increase in our software product and maintenance revenue was primarily due to new productand maintenance orders that were received after September 30, 2011, for which the revenue recognized during the third quarter of 2012 exceeded that of the expiring maintenance contracts for which revenue was recognized during the same period in 2011. Software product sales and associated margins are subject to considerable fluctuation from period to period, based on the product mix sold.

Gross Margins Gross margin was $569,838, or 32.8% of sales, in the third quarter of 2012 versus $682,444, or 41.0% of sales, in the third quarter of 2011. For the quarter ended September 30, 2012, $544,495 of the gross margin was attributable to professional services at a gross margin percentage of 39.9%, and $25,343 of the gross margin was attributable to software sales at a gross margin percentage of 6.8%. In the same quarter in 2011, we reported gross margins of $627,575, or 47.2% of sales for professional services and $54,869, or 16.5% of sales for software sales. Gross margin on professional services decreased in terms of both dollars and as a percentage of sales due to the expiration of or decreased activity of some more profitable services contracts, as well as a shift on certain contracts in the ratio of services work invoiced as fixed price per unit to work invoiced as time and materials. Gross margin on software sales decreased in terms of both dollars and as a percentage of sales, despite increases in revenue, due to narrower margins on existing product lines and more competitive bidding processes. Software product sales and associated margins are subject to considerable fluctuation from period to period, based on the product mix sold.

Selling, General and Administrative Expenses Selling, general and administrative expenses, exclusive of sales commissions, were $388,913, or 22.4% of revenues, in the third quarter of 2012 versus $434,295, or 26.1% of revenues, in the thirdquarter of 2011. These expenses decreased $45,383, or 10.4%, due largely to decreases in bad debt expense, net of increases infringe benefits applied to overhead and administrative labor and recruiting expenses.

Commission expense was $139,148, or 8.0% of revenues, in the third quarter of 2012 versus $186,909, or 11.2% of revenues, in the third quarter of 2011. This decrease of $47,761, or 25.6%, is due to thedecreasesin gross margins and operating income on commissionable contracts, which drive commission earned at varying rates for each salesperson.

Net Income Net income for the three months ended September 30, 2012, was $43,422, or 2.5% of revenue, versus net income of $63,133, or 3.8 % of revenue, for the same period in 2011. The decrease in net income despite an increase in revenue is due to the expiration of and decreases in activity of higher margin contracts for professional services, shifts in the types of services provided under some professional services contracts, and decreasing margins on software and maintenance sales resulting from the way suppliers do business and customer utilization of more competitive bidding processes.

Nine Months Ended September 30, 2012 versus Nine Months Ended September 30, 2011Revenue Our revenues in the first nine months of 2012 were $5,684,356, compared to $4,706,918 in 2011, an increase of 20.8%. Professional services revenue was $3,891,417 versus $3,580,792, an increase of 8.7%, and software product and maintenance revenue was $1,792,939 versus $1,126,126, an increase of 59.2%. The increase in professional services revenue was due to the addition of a new contract and to increases in activity in some of our existing contracts in excess of the contracts that expired, were completed, and that decreased activity since September 30, 2011. The increase in our software product and maintenance revenue was primarily due to a few new product and maintenance orders that were received after September 30, 2011. Software product sales and associated margins are subject to considerable fluctuation from period to period, based on the product mix sold.

13 -------------------------------------------------------------------------------- Information Analysis Incorporated Form 10-Q Third Quarter 2012 Gross Margins Gross margin was $1,819,256, or 32.0% of sales, in the first nine months of 2012 versus $1,799,507, or 38.2% of sales, in the first nine months of 2011. For the nine months ended September 30, 2012, $1,696,861 of the gross margin was attributable to professional services at a gross margin percentage of 43.6%, and $122,395of the gross margin was attributable to software sales at a gross margin percentage of 6.8%. In the same period in 2011, we reported gross margins of $1,593,794, or 44.5% of sales for professional services and $205,713, or 18.3% of sales for software sales. Gross margin on professional services increased in terms of dollars due to the increases in revenue, but decreased as a percentage of sales due to the expiration of or decreased activity of some more profitable services contracts, as well as a shift on certain contracts in the ratio of services work invoiced as fixed price per unit to work invoiced as time and materials. Gross margin on software sales decreased in terms of both dollars and as a percentage of sales, despite increases in revenue, due to narrower margins on existing product lines and more competitive bidding processes. Software product sales and associated margins are subject to considerable fluctuation from period to period, based on the product mix sold.

Selling, General and Administrative Expenses Selling, general and administrative expenses, exclusive of sales commissions, were $1,261,325, or 22.2% of revenues, in the first nine months of 2012 versus $1,199,281, or 25.5% of revenues, in the first nine months of 2011. These expenses increased $62,044, or 5.2%, due largely to increases in overhead and administrative labor and fringe benefits applied to overhead labor, offset by decreases in bad debt expenses.

Commission expense was $490,317, or 8.6% of revenues, in the first nine months of 2012 versus $504,906, or 10.7% of revenues, in the first nine months of 2011. This decrease of $14,589, or 2.9 is due to the decreases in gross margins and operating income on commissionable contracts, which drive commission earned at varying rates for each salesperson.

Net Income Net income for the nine months ended September 30, 2012, was $72,316, or 1.3% of revenue, versus net income of $101,320, or 2.2 % of revenue, for the same period in 2011. The decrease in net income is due to decreases in margins on product and maintenance sales, for which sales increased while gross margins decreased.

Liquidity and Capital Resources Our cash and cash equivalents balance, when combined with our cash flow from operations during the first nine months of 2012, were sufficient to provide financing for our operations. Our net cash provided by combining our operating, investing,and financing activities in the first nine months of 2012 was $1,031,109. Our net cash provided, when added to a beginning balance of $1,280,926 yielded cash and cash equivalents of $2,312,035 as of September 30, 2012. Our accounts receivable balances decreased $1,953,561 and our accounts payable balances decreased $906,499, primarily due to product-related invoices that were outstanding at the prior year end. We had no non-current liabilities as of September 30, 2012.

We have a revolving line of credit with a bank providing for demand or short-term borrowings of up to $1,000,000. The line became effective December 20, 2005, and expires on December 1, 2012. As of September 30, 2012, no amounts were outstanding under this line of credit. At September 30, 2012, $596,000 was available under this line of credit based on our outstanding accounts receivable.

Given our current cash position and operating plan, we anticipate that we will be able to meet our cash requirements for the next twelve months and beyond.

We presently lease our corporate offices on a contractual basis with certain timeframe commitments and obligations. We believe that our existing offices will be sufficient to meet our foreseeable facility requirement. Should we need additional space to accommodate increased activities, management believes we can secure such additional space on reasonable terms.

We have no material commitments for capital expenditures.

We have no off-balance sheet arrangements.

14 -------------------------------------------------------------------------------- Information Analysis Incorporated Form 10-Q Third Quarter 2012

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