SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                             ---------------------

                               AMENDMENT NO. 1 TO
                                  FORM 10-KSB
                              --------------------
                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended                                          Commission
   December 31, 1996                                            File No. 33-9390
   -----------------                                            ----------------

                       INFORMATION ANALYSIS INCORPORATED
                       ---------------------------------
             (Exact name of Registrant as specified in its charter)

         Virginia                                                     54-1167364
         --------                                                     ----------
(State or other jurisdiction of                                    (IRS Employer
incorporation or organization)                               Identification No.)

11240 Waples Mill Road, Suite 400
Fairfax, Virginia                                                          22030
-----------------                                                          -----
(Address of principal executive offices)                              (Zip Code)

(Registrant's telephone number,
including area code)                                              (703) 383-3000
                                                                  --------------

Securities registered pursuant to Section 12(b) of the Act:

                                      NONE
                                      ----

Securities registered pursuant to Section 12(g) of the Act:

                                      NONE
                                      ----

         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   [x]                 No
                              -------                  -------

         The issuer's revenue for its most recent fiscal year was $11,218,845.

         The  aggregate  market value of the  Registrant's  Common Stock held by
nonaffiliates as of December 31, 1996 was approximately $16,567,539.

         As of December  31, 1996 the  Registrant  had 509,999  shares of Common
Stock outstanding.


<PAGE>


Item 1.  Business


General
-------

         Since its  incorporation  in 1979,  Information  Analysis  Incorporated
("IAI" or the  "Company") has been engaged in various facets of the computer and
information  field.  IAI has continually  adapted the nature of its services and
the types of its  products  it markets to the  changing  information  technology
needs of its client and prospective  client base.  Today,  IAI's  activities are
primarily related to software  conversions,  information systems  reengineering,
systems integration,  application development,  hardware and software consulting
services,  software sales and support services.  Software sales are limited to a
few types of products which IAI believes it can successfully sell based upon its
familiarity  with a particular  market niche and potential  purchasers for those
products.

         Over the last several  years,  in order to broaden its revenue base and
secure  projects  with more long  range  potential,  the  Company  has sought to
acquire  rights to  software  products  or tools which can either be licensed to
others or which can provide  substantial  value-added  benefits to IAI's  client
base in connection with IAI's professional  services. One such product which the
Company has recently  acquired is Computer Aided Software  Translator,  commonly
referred  to as CAST.  The  rights to CAST  were  acquired  from its  developer,
Kenneth Parsons.  The  consideration for the purchase was payment to Mr. Parsons
of up to $100,000 for application  against certain liabilities he possessed plus
a royalty  equal to 10% of all license  revenues the Company  thereafter  earned
from  CAST  up to a  maximum  royalty  payment  to Mr.  Parsons  of  $1,000,000.
Incidental  to the  acquisition,  Mr.  Parsons also  obtained  employment by the
Company and received 675,000 stock options which were to vest through January 1,
1999.

         CAST was  initially  developed  to serve  as a  software  reengineering
computer language  translator which allows its users to migrate from older types
of computer languages to more modern day languages. Because of the reengineering
functionality  inherent in CAST,  this software  program is also able to remedy,
primarily  on an automated  basis,  the Year 2000  problem  which many  computer
systems now confront.  This problem  encompasses  a deficiency  inherent in many
existing software  applications whereby a two-digit date representation has been
used to depict the year with the  century  component  fixed as "19".  This means
that many computer systems will not recognize or be able to process transactions
in which  reference  to years  after  1999 is  required.  The end result of this
limitation is that any application software which must identify,  manipulate, or
calculate  date-related  values  outside of the 1900-1999  date range will fail.
This  failure can play havoc with the most basic of  programs  such as post 1999
payrolls,  invoicing, and insurance benefit claims. Because of the potential for
failure,  numerous companies are, or will be, assessing the nature and extent of
their Year 2000 problem.  Likewise,  companies,  such as IAI, are  attempting to
access the Year 2000 marketplace through remedial products and services.

         Because of the  prospects  associated  with CAST,  in 1996 the  Company
commenced its transition from primarily a professional  services  orientation to
that of a product provider for the Year 2000 remediation  market.  This required
and is requiring a

                                                                               2

<PAGE>


significant  investment  in marketing  and technical  resources  during the year
which will continue  through 1997. The anticipated  returns from this investment
will not be  realized  until  companies  commence  their  Year 2000  remediation
efforts  assuming CAST becomes a tool which is used within the Year 2000  arena.
Even if CAST is used as a  Year 2000  tool,  the  Company  does  not  anticipate
earning any revenues from CAST until the fourth quarter of 1997. Notwithstanding
this  transition, the Company has continued to maintain its traditional business
base  as  a  professional  services  provider.   The  Company  anticipates  that
information  technology  services of the nature it has provided in the past will
remain as part of the Company's  business but if its objectives related  to CAST
are  achieved,  the  professional  services  component  of its  business  should
diminish  as an  overall percentage  of its  revenues.  This base business helps
support  and  cover  the  Company's  general  and  administrative  expenses  and
provides a level of security should the Company's prospects related to  CAST not
materialize.

CAST

          CAST  is a  core  tool  which  was  primarily  designed  for  software
reengineering.  Remediation  of the Year  2000  problem  in and of  itself  is a
software  reengineering effort. The capacities of CAST are ideal for application
in the Year 2000  remediation  arena.  CAST enables a computer user to determine
the technical  complexity of computer code,  such as that in which the Year 2000
problem is engrained,  and then provides an automated and consistent  tool which
can reengineer the software so as to eliminate the two digit reference to years.

         The design and structure of CAST has evolved over 15 years based upon a
rigorous understanding of multiple languages,  databases,  platforms,  operating
environments and unique system  characteristics.  CAST's genesis was to serve as
an automated  software  migration tool to enable  software users to migrate from
one computer  language to another.  This application is best suited for software
reengineering  efforts  primarily  associated  with  downsizing  from  mainframe
computers to file servers. For this reason, IAI anticipates that CAST will serve
as a revenue  producing  vehicle for IAI even after most  systems have met their
Year 2000 challenge.

         CAST itself is roughly  500,000  lines of  modularized  code which uses
highly  sophisticated  algorithms  to translate  the source  environment  into a
Meta-code which, if required, can be translated into a target environment.  This
process involves a large, rigorous set of logic and decision rules which analyze
and account for each  individual  data element and logic structure in a dynamic,
virtual,  logical  construct  before  translation  begins.  The  constraints and
migration  rules  which  guide  the  conversion   process  are  established  and
controlled  by a series of tables  which  define the  relationships  between the
variables, environments and the logical constructs in the starting versus target
environments.  The  design  and use of these  tables  can also allow the user to
modify the target environment functionality in the translation.

         Another  benefit of CAST is that it also creates  system  documentation
and an audit trail of the conversion process. This can be generated in a variety
of formats  based on user  preference.  The  functionality  of CAST results in a
significant reduction of the time required for system testing and re-integration
and mitigates operational and liability risks associated with manual approaches.

                                                                               3


<PAGE>

         Overall, CAST provides its users with the following capabilities:

       o  To  translate  from one  operating  system to another,  such as from a
          closed mainframe to an open UNIX environment
       o  To  translate  from a  programming  language  that no  longer  meets a
          company's  needs to a more modern  language  or  newer  version  of  a
          current language
       o  To  alter a database  management system to a more versatile and useful
          system  without  losing  any  of  the  valuable  data  stored  in  the
          database system
       o  To  alter  a  teleprocessing  monitor  environment  to a  newer,  more
          supportable  environment
       o  To  perform  any  combination of the above options while providing the
          information manager  with the flexibility  to leverage  and manage the
          risk profile present within all conversion environments

         As for the  application  of  CAST  within  the  Year  2000  remediation
environment,  companies  can  undertake a varied  approach  towards  remediation
coupled with migration.  In this regard,  Year 2000 remediation can occur absent
further  reengineering.  Alternatively,  a two step strategy of remediating Year
2000  impacts can occur  followed by a later full  translation  of the Year 2000
compliant  software  applications  to a new  language,  database  or platform of
choice.  Lastly,  remediation  of  Year  2000  can  occur  while  simultaneously
translating software into a new language, database or platform.

         IAI is developing a multiple  pronged  strategy for marketing  CAST. As
part of this  strategy,  the  Company  anticipates  licensing  CAST to  software
sellers which are in the process of developing  Year 2000  remediation  packages
for use by their client bases.  The Company  believes that many of these sellers
will also use CAST as a service  provider  in a  maintenance  capacity  to their
clients.  The Company is also pursuing solution providers which will be offering
Year 2000 remediation  services to their client bases both within and outside of
Year 2000 "factories"  which the Company believes will be established to address
Year 2000  efforts  from a single  site with  multiple  employees  dedicated  to
assessing and  remediating  non-Year 2000  compliant  code.  It is the Company's
objective  to receive  fees from these  licenses  tied to the number of lines of
code which are  evaluated.  This part of the  Company's  strategy will allow the
Company  to  piggyback  on the  sales  forces of the  companies  to whom Cast is
licensed.

         The Company will also seek  strategic  relationships  to undertake Year
2000 services in conjunction with others. The Company  anticipates  serving in a
subcontractor  capacity to companies  undertaking  modernization and remediation
efforts to large  system  users such as federal  agencies.  The Company may from
time to time  seek its own  direct  engagements  with  end-users,  as well.  The
Company  believes such  engagements  will constitute a primary source of revenue
after Year 2000 remediation  efforts are resolved as many companies direct their
attention  to  downsizing  and  language  modernization,  areas  where CAST also
possesses functionality.

         For  the  benefit  of all  CAST  users,  the  Company  is  planning  on
developing a seven day, 24 hour per day, help desk.  Therefore,  irrespective of
the manner in which CAST is  channeled  into the  marketplace,  the Company will
maintain  primary  responsibility  for  supporting  the product.  Under  certain
circumstances,  this product

                                                                               4

<PAGE>


support may also develop into an additional source of CAST derived revenue.

         The Company believes that substantial competition will arise within the
Year 2000 marketplace.  It is the Company's aim to distinguish  itself from most
of the competition in two principal  respects.  First, many Year 2000 solutions,
once the  non-compliant  code is  identified,  will require  manual  remediation
undertaken  in  a  work  bench  environment.  CAST,  on  the  other  hand,  will
substantially  automate the remediation  process.  Second,  CAST, because it has
been developed to translate multiples languages, can be used as a more extensive
remediation tool for a number of different platforms and database  environments.
Many  other  tools will be  narrowly  focused,  such as IBM COBOL,  and will not
provide any reengineering capabilities outside this focus.

Computer Related Services
-------------------------

         In 1996,  the Company  continued to provide a broad range of consulting
services  to  its  clients.  These  services  included  transition  engineering,
feasibility and requirements  analysis,  systems  planning  analysis and design,
data base design and management,  software development,  and project management.
Primarily  as a result of  consulting  services  provided  to its  clients,  the
Company has developed  expertise for  particular  applications  in areas such as
financial information,  systems for the U.S. Customs Service, personnel systems,
and state-of-the-art  applications utilizing artificial  intelligence and expert
systems. The Company continues to maintain,  through its personnel,  proficiency
in a multiple number of computer languages,  hardware and software products, and
software applications in both the local area network and mainframe environments.

         In 1996,  the  Company's  revenue  from its computer  related  services
business   declined  by  $2,839,315.   Approximately  90%  of  this  decline  is
attributable to the loss of the Company's  prime contract with the U.S.  Customs
Services ("USCS").  Notwithstanding the loss of this prime contract, the Company
continues to provide services to the USCS in its capacity as a subcontractor but
at substantially  reduced  engagement  levels from those which existed while the
Company  possessed a prime  contract with the USCS. The Company is attempting to
generate  additional   engagements  to  replace  what  it  anticipates  will  be
approximately  a $5,000,000  reduction in revenue  earned in 1997 through  USCS.
Nonetheless,  because  members  of  senior  management  have  been  and  will be
primarily  devoting  their  efforts to CAST,  the Company is  uncertain,  and no
assurances  can be given,  to what  extent the  Company  will be  successful  in
securing  additional  sources of  computer  related  services  business so as to
compensate for the loss of revenue formerly generated through the Company's USCS
contract.

         Traditionally,  IAI's clients have spanned a wide range of  enterprises
in the private sector along with government agencies.  This was also the case in
1996 as IAI  provided  services to companies  such as The Arbitron  Corporation,
Lockheed Martin, Commonwealth Aluminum, Computer Sciences Corporation,  and Mass
Mutual. In 1996,  governmental clients included the U.S. Army Personnel Command,
General  Services  Administration,   U.S.  Air  Force,  USCS,  Veterans  Benefit
Administration,  Department of Energy, and the U.S. Navy. In 1996, IAI's largest
client remained the USCS.  Although the Company's  contract with USCS expired on
April 30, 1996, the Company continued to provide services throughout the year to
USCS in the capacity as

                                                                               5

<PAGE>


a subcontractor.  The total revenue derived in 1996 directly and indirectly from
and through USCS constituted 57.9% of the Company's revenues.

         In  1996,  approximately  91% of the  Company's  revenues  was  derived
through  government  contracts either in IAI's capacity as a prime contractor or
subcontractor.  After  expiration  of the contact with USCS,  all of the revenue
from  government   contracts  was  obtained  in  the  Company's  capacity  as  a
subcontractor to other government contractors.

Software Sales
--------------

         In 1996, IAI continued to maintain  marketing rights to the proprietary
software product,  Jetform. Jetform is an electronic forms solution which allows
users  to  electronically   create  and  complete  any  form  on  multi-platform
environments.  IAI serves as a reseller of Jetform,  specifically in the Federal
government  market where  buyers can  purchase  the product  through the General
Services Administration schedule.

         Total Jetform  related revenue in 1996 was $415,504.  This  represented
both sales of the product and  accompanying  services such as training and forms
development.  The  Company  sold  additional  Jetform  product to over one dozen
Federal agencies.

Employees
---------

         As of  December  31,  1996,  the  Company  employed  74  full-time  and
part-time   individuals.   In  addition,   the  Company  maintained  independent
contractor   relationships   with  seven  individuals  for  computer   services.
Approximately  90% of the Company's  professional  employees  have at least four
years of related experience. For computer related services, the Company believes
that the diverse professional  opportunities and interaction among its employees
contribute to maintaining a stable professional staff with limited turnover.

Marketing
---------

         For its  information  technology  services other than CAST, the Company
relies upon a marketing staff of one full time marketing executive combined with
program  managers  and other senior  management  to market its  services.  These
individuals  principally  concentrate on the marketing of professional  services
and software products. In addition to these individuals, the Company's technical
staff is  encouraged to assist in marketing  the  Company's  systems  design and
programming services.

Backlog
-------

         As  of  December  31,  1996,  the  Company  estimated  its  backlog  at
approximately   $7,019,881.   Of  the  entire  backlog,   the  Company  projects
approximately  95% will be completed by December 31, 1997. This backlog consists
of  outstanding  contracts and general  commitments  from current  clients.  The
Company  regularly  provides  services to certain  clients on an as-needed basis
without  regard to a specific  contract.  General  commitments  represent  those
services  which the  Company  anticipates  providing  to such  clients  during a
twelve-month period.

                                                                               6

<PAGE>


Competition
-----------

         The  computer  services  industry  is highly  competitive.  Many of the
Company's  competitors are larger and have greater financial  resources than the
Company.  Smaller  firms  also  present  significant  competition.  The  Company
competes  for  government  and  commercial  contracts,  either  directly or as a
subcontractor,  on the basis of competitive  procurements.  The Company believes
that its  long-term  success  depends  upon its  ability to  consistently  offer
quality  services at  competitive  prices.  This approach is designed to satisfy
current client requirements and to attract new business opportunities.

Principal Clients
-----------------

         In 1996 the USCS, under its contract with IAI and under subcontracts to
IAI, remained the principal client of the Company.  In this regard,  the revenue
from  USCS  accounted  for  57.9%  of IAI  revenue.  The USCS  contract  expired
September 30, 1995,  but was extended  through April 30, 1996.  IAI continues to
provide  services to USCS as a subcontractor to several prime  contractors.  IAI
anticipates  this revenue will continue  indefinitely  as the USCS  continues to
encourage its current  prime  contractors  to avail  themselves of the Company's
services.  The only other  significant  client for IAI was the U.S. Army through
IAI's subcontract with PRC Inc. which accounted for 12.9% of revenue.

Item 2.  Property

         Through the end of 1996,  the  Company's  offices  were located at 2222
Gallows  Road,  Dunn  Loring,  Virginia.  In March 1997,  the Company  moved its
offices to 11240 Waples Mill Road,  Suite 400,  Fairfax,  VA. 22030.  At its new
offices,  IAI holds a lease for  18,280  square  feet.  This  lease  expires  on
February 28, 2004.

Item 3.  Legal Proceedings

         The  Company  is  currently  engaged  in  three  litigation  cases of a
material nature. One case was filed in the fourth quarter of 1995 by the Company
through its subsidiary,  Allied Health and Informations Systems, Inc. ("AHISI"),
in the United States District Court for the District of Delaware  against Prison
Health Services,  Inc. ("PHS").  In this case, the Company is seeking payment of
accounts  receivable of approximately  $185,000 and other damages emanating from
the  subcontract  PHS granted to the  Company's  subsidiary  to provide  certain
healthcare   services  in  Maryland   prisons.   PHS  has   counterclaimed   for
reimbursement of  overpayments.  The Company is currently of the opinion that it
will prevail in this  litigation and that the amount due the Company far exceeds
any overpayments, if any, made to PHS.

         In the fourth  quarter,  1994,  a medical  malpractice  claim was filed
against  AHISI and others  resulting  from the  failure to  properly  diagnose a
bulging disk that eventually  left the plaintiff a  quadriplegic.  This case was
initially filed as a health claims arbitration case under Maryland's malpractice
law and was recently  transferred  to the Circuit  Court of  Washington  County,
Maryland.  Although the Company is of the opinion that the plaintiff may be in a
position to recover substantial  damages, the extent of AHISI's liability should
be covered by malpractice insurance.

                                                                               7

<PAGE>


         In April, 1995, a case was filed against AHISI and others in the United
States  District  Court of  Maryland  in which a woman  is  seeking  unspecified
damages  emanating  from alleged  sexually  harassing  conduct of a former AHISI
employee.  The  claimant  was not an AHISI  employee but was employed by another
contractor at the Maryland  correctional  institution  at which AHISI was also a
contractor.  Claims in this lawsuit against AHISI arising under federal law have
been  dismissed.  Common law claims and claims under Maryland law remain.  Based
upon the law and the facts  surrounding  this case, the Company does not believe
it will have any liability of a material nature to the claimant.

Item 4.  Submission of Matters to a Vote of Security Holders

         In the fourth quarter of 1996,  the Company  had its  annual meeting of
shareholders at which Sandor Rosenberg, George T. DeBakey, James C. Wester, John
D. Sanders and Bonnie K. Wachtel were elected as directors.

                                    PART II

Item 5.  Market for Registrant's Common Equity and Related Stockholders' Matters

         The Company's  Common Stock is traded in the  over-the-counter  market.
The range of bid price quotations for the last two years on a quarter-by-quarter
basis is as follows:

         ====================================       =======================
                          1995                                 1996
         ====================================       =======================
         Qtr.          1st   2nd   3rd   4th        1st   2nd   3rd    4th
         ------------------------------------       -----------------------
         Low Bid        4     4     4     4          4     4     4      4
         ------------------------------------       -----------------------
         High Bid       4     4     4     4          4     4     4     61
         ====================================       =======================

         The  quotations  on which  these  data are based  reflect  inter-dealer
prices without adjustment for retail markup, markdown or commission, and may not
necessarily represent actual transactions. The above bids have not been adjusted
to reflect a three for one stock split which was declared in January, 1997.

         As of December 31, 1996,  the Company had 575  stockholders  of record.
The Company has never paid a cash dividend on its Common  Stock,  and intends to
follow a policy of  retaining  earnings to finance  future  growth and  possible
acquisitions.  Accordingly,  the Company does not anticipate the payment of cash
dividends to the holders of Common Stock in the foreseeable future.

                                                                               8

<PAGE>


Item 6.  Management's Discussion and Analysis of Financial Condition and
Results of Operations

Results of Operations 1996 Compared to 1995
-------------------------------------------

         The Company's overall 1996 revenues  declined by $4,478,051,  or 28.5%,
to  $11,218,845  from  $15,696,896  in 1995.  Of this  decline,  $2,839,315  was
attributed to computer and software related services, principally as a result of
the Company's  loss of its contract  with USCS from which the Company's  revenue
declined by $2,576,685,  and  $1,638,736 was attributed to AHISI.  By the end of
1995, the Company had for the most part phased out AHISI's  business but for one
small contract. In 1996, AHISI only produced $46,143 of revenue.

         In 1996,  the  Company's  gross profit  margin  increased to 20.4% from
18.8% in 1995. This improvement  resulted from the Company's  ability to achieve
better  margins on its  contracts and the  cessation of AHISI's  contracts  from
which lower margins were being  realized.  Selling,  general and  administrative
expenses as a percentage  of revenue,  however,  increased to 22.3% in 1996 from
18.8% in 1995.  The  Company  believes  two factors  account for this  increase.
First,  the Company began to incur  significant  expenses from its  CAST-related
activities  as it  transitioned  to a product  dominated  company.  Second,  the
Company incurred higher than usual legal fees from its  unsuccessful  protest of
the award to another bidder of the USCS contract the Company  maintained through
April 30, 1996.

         As a result of the  above  factors,  after  considering  the  effect of
interest and taxes, in 1996 the Company sustained a loss of $159,674.  This loss
was $85,041 higher than 1995's loss of $74,633.  Solely from operations  without
giving any effect to  interest  and taxes,  IAI's loss in 1996 was  $213,368,  a
reversal of $215,947 from 1995's $2,579 gain from operations.

         In 1997 and  thereafter,  the Company  does not  foresee  any  material
changes in its revenue generation capacity from its non-CAST activities. Because
a majority  of the  Company's  marketing  efforts  will be devoted to CAST,  the
Company  believes  that its  traditional  revenue  sources will remain static at
best. The Company remains optimistic,  however, that the prospects are favorable
for a material increase in revenue primarily  attributed to CAST licenses.  Even
so,  no  assurances  can  be  provided  that  the  objectives  the  Company  has
established for CAST will be realized.  The Company recognizes that CAST is only
one of several competing  products that have been, or will be, introduced to the
marketplace  as a  Year  2000  remediation  tool.  Moreover,  to  the  Company's
knowledge,  no product,  including  CAST, has been fully tested as a remediation
tool.  It will not be until the Year 2000 market  begins to mature that IAI will
be in a position to better  assess its  prospects.  Against  this  backdrop,  it
should be noted that nothing has yet come to the  Company's  attention  that has
suggested to the Company that CAST will not be successfully deployed.

         The  revenue  potential  from  CAST  also  depends  upon  the  computer
languages,  platforms  and  databases  which CAST is  successfully  developed to
address.  Through the end of 1996,  most  development  efforts were  directed to
languages,  platforms and databases  upon which  Computer  Associates'  software
operates.  Discussions of a strategic nature between IAI and Computer Associates
prompted these efforts towards Computer Associates marketplace. Throughout 1997,
IAI anticipates  expanding CAST's  functionality

                                                                               9

<PAGE>


so that CAST can be utilized in  remediation  efforts on  multiple platforms and
for various languages.

         IAI is not in a position to project with any  reasonable  certainty the
actual  amount of revenue  that CAST can  generate.  Estimates  abound as to the
scope of the Year 2000  market  and the lines of  software  code  which  must be
analyzed. Notwithstanding this uncertainty, IAI must gear its operations towards
a projected  successful launch of CAST especially  because of the time sensitive
window  in which  Year 2000  remediation  efforts  must  occur.  Therefore,  IAI
anticipates increased levels of CAST related expenditures following 1996.

Liquidity and Capital Resources
-------------------------------

         In 1996, as in 1995, the Company  financed its operations  from current
collections  and through  advances under its line of credit with its bank. As of
December 31, 1996 the  Company's  outstanding  balance on its line of credit was
$0, a $550,000  decrease over the prior year.  Cash and cash  equivalents at the
end of 1996 had  increased  by  $266,870 in  comparison  to the end of the prior
year.  The Company's line of credit was renewed on June 25, 1996 but the Company
reduced the amount available thereunder from $2,000,000 to $1,500,000. This line
of credit expires June 19, 1997 at which time it is subject to renewal.

         In 1996,  the Company  realized  that its  internally  generated  funds
coupled  with its line of credit  would not provide it with  sufficient  working
capital to fund its CAST-related activities.  Therefore, by the end of 1996, the
Company  began to consider  various  alternatives  to raise  additional  capital
including a private  placement or venture  capital with the aim of  completing a
financing round in the first quarter of 1997.

Item 7.  Financial Statements

         The following Financial Statements are filed as part of this report:


                                                                         Page(s)
                                                                         -------
      (i)    Report of Independent Certified Public                         19
                     Accountants

      (ii)   Consolidated Balance Sheet as of December 31, 1996           20-21

      (iii)  Consolidated Statements of Operations                          22
                     for the Years Ended
                     December 31, 1996 and 1995

      (iv)  Consolidated Statements of Changes in Stockholders' Equity      23
                     for the Years Ended
                     December 31, 1996 and 1995

      (v)  Consolidated Statements of Cash Flows for the Years              24
                     Ended December 31, 1996 and 1995

      (vi)  Notes to Consolidated Financial Statements                    25-37

                                                                              10

<PAGE>


Item 8.  Disagreements of Accounting and Financial Disclosure

         None.

                                    PART III

Item 9.  Directors and Executive Officers of the Registrant

         The executive officers and directors of the Company are:

             Name                      Position with the Company
             ----                      -------------------------

             Sandor Rosenberg          Chairman of the Board, President
                                       and Secretary
             Richard S. DeRose         Executive Vice President and Treasurer
             George T. DeBakey         Director
             John D. Sanders           Director
             James D. Wester           Director
             Bonnie K. Wachtel         Director


         Directors  serve until the next annual meeting of shareholders or until
successors have been elected and qualified.  Officers serve at the discretion of
the Board of Directors.

         Sandor Rosenberg, 50,  has been President  and  Chairman  of the  Board
since 1979.  Mr. Rosenberg  holds a  B.S. degree in  Aerospace  Engineering from
Rensselear Polytechnic Institute, and has done  graduate  studies in  Operations
Research at George Washington University.

         Richard S. DeRose, 58, has been Executive  Vice  President  since 1991.
From 1979 to 1991 he served as the President and CEO for  DHD, Inc.  Mr.  DeRose
holds a  B.S. degree in Science from the  U.S. Naval Academy  and an M.S. degree
in Computer  Systems  Management  from the  U.S.  Naval  Post  Graduate  School,
Monterey.   Mr. DeRose has been involved  in computer  services sales,  finance,
and operations for the past 20 years.

         George T. DeBakey, 47, has been a director since 1989.  Since 1989, Mr.
DeBakey has been an  international  business  and  education  consultant.  Also,
starting in 1992,  Mr. DeBakey became Director of the International and Business
Trade  Program  at  American  University.  From  1987 to 1989,  Mr. DeBakey  was
Executive Director of the  Information  Technology  Association  of America.  In
addition, he served as  Deputy Assistant Secretary at the Department of Commerce
from  1985 to 1987  responsible  for the  high technology  industries  for trade
policy and trade promotion.  He has a  B.S. from Drake University,  his Master's
of International  Management  from  American  Graduate  School of  International
Management, and his M.B.A. from Southern Methodist University.

         John D. Sanders, 58, has been a Director since 1983.  From 1986 to 1996
Mr. Sanders served as  Chairman  and  CEO of  TechNews, Inc.,  publisher  of the
Washington Technology newspaper.  Mr. Sanders obtained a  B.E.E. degree from the
University of Louisville and  M.S. and  Ph.D. degrees in  Electrical Engineering
from Carnegie-Mellon University.  He is a member  of the board of  directors of:
Daedalus Enterprises, Inc., an

                                                                              11

<PAGE>


electronics   equipment   manufacturer;   Industrial  Training  Corporation,   a
manufacturer of video-based  training programs;  and  Tork, Inc.,  an electrical
equipment manufacturer.

         James D. Wester, 58, has been a Director  since 1985.  He  has  been  a
computer services marketing consultant  for more than  15 years.  Since 1984, he
has been president of Results, Inc.  Mr. Wester  obtained a  B.M.E. degree  from
Auburn University and an M.B.A. from George Washington University.

         Bonnie K. Wachtel, 41, has been a Director since 1992.  Since 1984, she
has  served  as  vice president  and  general  counsel  of  Wachtel & Co., Inc.,
investment  bankers  in  Washington, D.C.  Ms. Wachtel  holds  B.A.  and  M.B.A.
degrees from the University of  Chicago  and  a  J.D.  from  the  University  of
Virginia.  She is a director of Integral Systems, Inc.,  a provider of  computer
systems  and  software   for  the  satellite  communications  market;   and  VSE
Corporation provider of technical services to the federal government.

         There are no family  relationships  between any  directors or executive
officers of IAI.

Item 10. Executive Compensation

         The  following  table  sets forth the  compensation  paid over the last
three  fiscal  years  to  the  Company's  chief  executive   officer  and  other
individuals serving as executive officers as of December 31, 1996:

                                                                              12

<PAGE>


                           Summary Compensation Table
<TABLE>
<CAPTION>
------------------------ --------- ----------------------------- ----------------- ------------------------------
       Name and                                                                              Number of
       Principal                                                                           Stock Options
       Position            Year               Salary                  Bonus                   Granted
------------------------ --------- ----------------------------- ----------------- ------------------------------
<S> <C>
Sandor Rosenberg           1996              $100,000              $15,000                       -
President                  1995              $100,007              $25,900                       -
                           1994              $ 99,910              $30,000                       -
------------------------ --------- ----------------------------- ----------------- ------------------------------
Richard DeRose             1996              $110,730              $27,500                    10,000
Exec Vice President        1995              $109,730              $30,900                       -
and Treasurer              1994              $ 99,622              $30,000                       -
------------------------ --------- ----------------------------- ----------------- ------------------------------
</TABLE>

         No executive  officer has received any  perquisite  and other  personal
benefits,  securities  or property  which exceed the lesser of $50,000 or 10% of
the total annual salary and bonus reported for such executive officer.

         The  following  table  sets  forth  all  option  grants  in 1996 to all
executive officers:

                        Option Grants in Last Fiscal Year
<TABLE>
<CAPTION>
----------------- -------------- ------------------------------------ ------------------- ----------------------------
                                 % Of Total Options Granted
Name              Granted        To Employees In Fiscal Year          Exercise Price      Expiration Date
----------------- -------------- ------------------------------------ ------------------- ----------------------------
<S> <C>
Richard S.        10,000                        4.6%                        $4.00         June 17, 2006
DeRose
----------------- -------------- ------------------------------------ ------------------- ----------------------------
</TABLE>

         The following table sets forth information  concurring each exercise of
stock options during 1996 by all executive officers:


                Aggregated Option Exercises in Last Fiscal Year
                            and FY End Option Values
<TABLE>
<CAPTION>
------------------ ------------------------ ------------------- ------------------------------- ----------------------
                                                                                                       Value of
                                                                                                    Unexercised In-
                                                                     Number of Securities             The Money
                     Shares Acquired on       Value Realized        Underlying Unexercised        Options At FY End
      Name                Exercise                                  Options At FY End (#)                 ($)
------------------ ------------------------ ------------------- ------------------------------- ----------------------
<S> <C>
Richard DeRose              1500                 $78,075                    23,500                   $1,331,000
------------------ ------------------------ ------------------- ------------------------------- ----------------------
</TABLE>

         In 1996, the Company  compensated each of its outside  directors at the
rate of $500 per quarter or $2,000 per year. No director  received any grants of
options or other securities in their capacity as a director.

                                                                              13

<PAGE>


Item 11. Security Ownership of Certain Beneficial Owners and Management

         Set forth below is information  concerning  beneficial ownership by any
person  known to the  Company  to be the owner of more than five  percent of the
Company's  Common Stock,  by each  directors  and  executive  officer and by all
directors and executive officers as a group:

<TABLE>
<CAPTION>

Name and                           Amount and Nature of
Address of Beneficial              Beneficial Owner (2)            Percentage Class
---------------------              --------------------            ----------------
<S> <C>
Sandor Rosenberg (1)               215,500                         42.3%
   Chairman and President

Richard S. DeRose (1)              23,600(3)                       4.4%
   Executive Vice President

James D. Wester, Director (1)      43,500(4)                       7.9%

John D. Sanders, Director          8,100                           1.6%
4600 N. 26th Street
Arlington, VA  22207

Bonnie K. Watchel                  13,200                          2.6%
1101 14th Street, N.W.
Washington, D.C.  20001

George T. DeBakey                  1,000(5)                        *
5303 Marlyn Drive
Bethesda, MD  20832

All directors and executive        304,900                         52.9%
officers as a group

* Less than one percent

(1) Unless  otherwise  noted,  all addresses are c/o the Company at 11240 Waples
Mill Road, Fairfax, VA 22030.
(2) All shares are held outright by the individual listed below.
(3) Includes  23,500  options,  3,500  of  which  are  exercisable at  $5.00 per
share and expire on June 23,2002,  10,000 of  which  are  exercisable  at  $4.50
per   share   and  expire   on  January  4,  2003  and   10,000   of  which  are
exercisable at $4.00 per share and expire on June 17, 2006. All expiration dates
are subject to continuation of Mr. DeRose's  employment.
(4) Includes a warrant exercisable  for 12,000  shares at  $5.00 per share which
expires on February 24, 2003 and  30,000  stock  options  exercisable  at  $4.00
per share which expire on June 19, 2006.
(5) Represents a warrant  exercisable for 1,000 shares at a price of  $7.50  per
share which expires on June 30, 1999.

Item 12. Certain Relationships and Related Transactions

         In 1996, the Company  repurchased from Sandor Rosenberg,  its president
and a director, 13,000 shares of its Common Stock at an aggregate purchase price
of $53,250.  In 1995,  17,200 shares were  repurchased  from Mr. Rosenberg at an
aggregate purchase price of $72,663.
         In  September  1996,  in order to provide the Company  with  additional
working  capital  for  development  of the  CAST  product,  James C.  Wester,  a
director, agreed to advance up to

                                                                              14

<PAGE>


$300,000 to the Company. In exchange for these advances,  the Company  agreed to
pay Mr. Wester 20% of all CAST license revenues the Company receives  up to 150%
of the advances Mr. Wester has extended.

         In order to compensate  Mr. Wester for various  consulting  services he
has rendered to the Company for which he has not received any cash remuneration,
in June 1996,  the Company  granted  Mr.  Wester  30,000 ten year stock  options
exercisable at $4.00 per share,  the then current value of the Company's  Common
Stock.

In November 1996, the Company agreed to reduce the exercise price from $5.50 per
share to $4.75 per share  under  10,000  warrants  of which John D.  Sanders,  a
director,  was the holder of 3,000 and Bonnie K.  Wachtel,  a director,  was the
holder  of  2,500.  These  10,000  warrants  were  issued  in  1986  as  partial
compensation for  underwriting and other investment  banking services which were
provided  by Wachtel & Co.,  Inc.  The  reduction  was in  consideration  of the
holders of the  warrants  agreeing to forgo  registration  rights for the shares
obtained upon exercise of the warrants for a period of one year from exercise.

Item 13.  Exhibits and Reports on Form 8-K

See,  exhibit  index which index is  incorporated  herein by  reference.

(a) No reports were filed on Form 8-K during the last quarter of this report.

                                                                              15

<PAGE>



SIGNATURES

Pursuant to the requirements of Section 13 or 15(d), of the Securities  Exchange
Act of 1934,  the  registrant  has duly  caused  this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.

                                               INFORMATION ANALYSIS INCORPORATED


                                         By:   _________________________________
                                               Sandor Rosenberg, President
                                                        June 30, 1997

Pursuant to the requirements of the Securities Act of 1934, this report has been
signed below by the  following  persons on behalf of the  registrant  and in the
capacities and on the dates indicated.

    Signature                      Title                           Date

_________________             Chairman of the Board           June ____, 1997
Sandor Rosenberg              and President

_________________             Director                        June ____, 1997
Brendan Dawson

_________________             Director                        June ____, 1997
Charles May

_________________             Director                        June ____, 1997
John D. Sanders

_________________             Director                        June ____, 1997
Bonnie K. Wachtel

_________________             Director                        June ____, 1997
James D. Wester

_________________             Treasurer                       June ____, 1997
Richard S. DeRose

                                                                              16

<PAGE>


                        INFORMATION ANALYSIS INCORPORATED

                              -------------------

                        CONSOLIDATED FINANCIAL STATEMENTS
                                       AND
                          INDEPENDENT AUDITORS' REPORT
                           DECEMBER 31, 1996 AND 1995
                   (WITH INDEPENDENT AUDITORS' REPORT THEREON)


                                       17

<PAGE>


                                TABLE OF CONTENTS


Description                                                           Pages
-----------                                                           -----

Independent Auditors' Report                                           19
Consolidated Balance Sheet                                            20-21
Consolidated Statements of Operations                                  22
Consolidated Statements of Changes in Stockholder's Equity             23
Consolidated Statements of Cash Flows                                  24
Notes to Consolidated Financial Statements                            25-37



                                       18

<PAGE>

                          INDEPENDENT AUDITORS' REPORT


To the Board of Directors
Information Analysis Incorporated

         We  have  audited  the  accompanying   consolidated  balance  sheet  of
Information Analysis  Incorporated and subsidiaries as of December 31, 1996, and
the related  consolidated  statements of  operations,  changes in  stockholders'
equity and cash flows for each of the two years then ended.  These  consolidated
financial  statements are the  responsibility of the Company's  management.  Our
responsibility  is  to  express  an  opinion  on  these  consolidated  financial
statements based on our audits.

         We conducted our audits in accordance with generally  accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures  used and significant  estimates made by management,
as well as evaluating the overall financial statement  presentation.  We believe
that our audits provide a reasonable basis for our opinion.

         In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Information Analysis  Incorporated and subsidiaries as of December 31, 1996, and
the consolidated  results of operations and cash flows for each of the two years
then ended in conformity with generally accepted accounting principles.



March 7, 1997

Bethesda, Maryland                     Rubino & McGeehin, Chartered

                                       19

<PAGE>

               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEET
                                December 31, 1996

                                     ASSETS

Current assets
     Cash and cash equivalents ...............................        $  323,886
     Accounts receivable .....................................         1,355,284
     Employee advances .......................................            34,323
     Income taxes receivable .................................           201,554
     Deferred income taxes ...................................            98,662
     Prepaid expenses ........................................           104,554
     Other receivables .......................................           192,686
                                                                      ----------

         Total current assets ................................         2,310,949

Fixed assets
     At cost, net of accumulated depreciation
     and amortization of $1,205,486 ..........................           241,311

Equipment under capital leases
     Net of accumulated amortization of $56,053 ..............            49,768

Capitalized software .........................................           186,964
Investments ..................................................            10,000
Goodwill .....................................................            70,554
Other receivables ............................................           226,694
Other assets .................................................            24,980
                                                                      ----------

Total assets .................................................        $3,121,220
                                                                      ==========




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


                                       20



<PAGE>

               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEET
                                December 31, 1996

                       LIABILITIES & STOCKHOLDERS' EQUITY

Current liabilities
     Accounts payable ......................................        $   413,942
     Accrued payroll .......................................            262,754
     Other accrued liabilities .............................             58,896
     Current portion of long-term debt .....................            120,300
     Current maturities of capital
         lease obligations .................................             18,229
     Deferred rent .........................................                852
                                                                    -----------

         Total current liabilities .........................            874,973

Long-term debt .............................................             90,380
Capital lease obligations,  net of
     current portion .......................................             41,334
Deferred income taxes ......................................             27,020
                                                                    -----------

         Total liabilities .................................          1,033,707
                                                                    -----------

Common stock, par value $0.01
     1,000,000 shares authorized; 677,178
     shares issued .........................................              6,772
Paid in capital in excess of par value .....................          1,139,240
Retained earnings ..........................................          1,795,814
Less treasury stock; 167,179 shares at cost ................           (854,313)
                                                                    -----------

         Total stockholders' equity ........................          2,087,513
                                                                    -----------

Total liabilities and stockholders' equity .................        $ 3,121,220
                                                                    ===========



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


                                       21

<PAGE>

               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS

                                               For the Years Ended December 31,
                                               --------------------------------

                                                     1996            1995
                                                 ------------    ------------
Sales
     Professional fees .......................   $ 10,803,341    $ 15,436,643
     Software sales ..........................        415,504         260,253
                                                 ------------    ------------
          Total sales ........................     11,218,845      15,696,896
                                                 ------------    ------------

Cost of sales
     Cost of professional fees ...............      8,675,377      12,511,118
     Cost of software sales ..................        260,245         224,477
                                                 ------------    ------------
          Total cost of sales ................      8,935,622      12,735,595
                                                 ------------    ------------

Gross profit .................................      2,283,223       2,961,301

Selling, general and administrative expenses .      2,496,591       2,958,722
                                                 ------------    ------------

(Loss) income from operations ................       (213,368)          2,579

Other income and (expenses)
     Interest income .........................         12,716           7,554
     Interest expense ........................        (35,644)       (110,748)
                                                 ------------    ------------

Loss before provision for income taxes .......       (236,296)       (100,615)

Benefit for income taxes .....................        (76,622)        (25,982)
                                                 ------------    ------------

Net loss .....................................   $   (159,674)   $    (74,633)
                                                 ============    ============





Loss per common and common
     equivalent share ........................   $      (0.26)   $      (0.15)

Weighted average common and common
     equivalent shares outstanding ...........        624,139         478,561



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

                                       22

<PAGE>

               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                 For the Years Ended December 31, 1996 and 1995



</TABLE>
<TABLE>
<CAPTION>
                                               Shares of
                                                Common                   Additional
                                                 Stock        Common       Paid in     Retained     Treasury
                                              Outstanding     Stock        Capital     Earnings      Stock         Total
                                                --------    ---------    ----------   ----------   ---------    ----------
<S> <C>
Balances, December 31, 1994 .................    621,178    $   6,212    $  771,923   $2,030,121   $(720,150)   $2,088,106
     Exercise of stock options ..............         54                        296                                    296
     Purchase of treasury stock .............                                                        (80,913)      (80,913)
     Net loss ...............................                                            (74,633)                  (74,633)
                                                --------    ---------    ----------   ----------   ---------    ----------

Balances, December 31, 1995 .................    621,232        6,212       772,219    1,955,488    (801,063)    1,932,856
     Exercise of stock options and warrants .     49,696          497       209,580                                210,077
     Tax benefit of stock option compensation                               132,504                                132,504
     Stock issued for ISSC acquisition ......      6,250           63        24,937                                 25,000
     Purchase of treasury stock .............                                                        (53,250)      (53,250)
     Net loss ...............................                                           (159,674)                 (159,674)
                                                --------    ---------    ----------   ----------   ---------    ----------

Balances, December 31, 1996 .................    677,178    $   6,772    $1,139,240   $1,795,814   $(854,313)   $2,087,513
                                                ========    =========    ==========   ==========   =========    ==========
</TABLE>



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

                                       23


<PAGE>

               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS


<TABLE>
<CAPTION>
                                                                     For the Years Ended December 31,
                                                                     --------------------------------
                                                                          1996            1995
                                                                      ------------    ------------
<S> <C>
Cash flows from operating activities
      Cash received from customers ................................   $ 13,389,621    $ 16,345,476
      Cash paid to suppliers and employees ........................    (12,336,956)    (15,279,871)
      Interest received ...........................................         12,716           7,554
      Interest paid ...............................................        (35,644)       (110,748)
      Income taxes received (paid) (net) ..........................             --          57,293
                                                                      ------------    ------------
         Net cash  provided by operating expenses .................      1,029,737       1,019,704
                                                                      ------------    ------------

Cash flows from investing activities
      Purchase of ISSC, net of cash received ......................        (47,422)             --
      Acquisition of furniture and equipment ......................        (91,471)        (79,983)
      Proceeds from sale of equipment .............................             --          25,687
      Increase in capitalized software ............................       (186,964)             --
                                                                      ------------    ------------
         Net cash used in investing activities ....................       (325,857)        (54,296)
                                                                      ------------    ------------

Cash flows from financing activities
      Net payments under bank revolving line of credit ............       (550,000)       (842,000)
      Reduction of debt related to acquisition of ISSC ............        (26,276)             --
      Principal payments on debt and capital leases ...............        (17,561)        (20,986)
      Repurchase of common stock ..................................        (53,250)        (80,913)
      Proceeds from exercise of incentive stock options ...........        210,077             296
                                                                      ------------    ------------
         Net cash used by financing activities ....................       (437,010)       (943,603)
                                                                      ------------    ------------

Net increase in cash and cash equivalents .........................        266,870          21,805

Cash and cash equivalents at beginning of the period ..............         57,016          35,211

                                                                      ------------    ------------
Cash and cash equivalents at end of the period ....................   $    323,886    $     57,016
                                                                      ------------    ------------


Reconciliation of net loss to cash provided by operating activities


Net loss ..........................................................   $   (159,674)   $    (74,633)

Adjustments to reconcile net loss to net cash provided
 by operating activities
      Depreciation and amortization ...............................        192,035         173,530
      Tax benefit of stock option compensation ....................        132,504              --
      Gain/loss on sale of fixed assets and investments ...........           (231)         (1,113)
      Changes in operating assets and liabilities
          Accounts receivable .....................................      2,170,776         648,580
          Other receivables and prepaid expenses ..................       (180,483)        (40,275)
          Accounts payable and accrued expenses ...................       (939,352)        292,528
          Deferred rent ...........................................        (10,224)        (10,224)
          Income tax receivable/liability .........................       (175,614)         31,311

                                                                      ------------    ------------
Net cash provided (used) by operating activities ..................   $  1,029,737    $  1,019,704
                                                                      ============    ============
</TABLE>


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


                                       24


<PAGE>

               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Operations

 Information  Analysis  Incorporated  (the Company) was  incorporated  under the
corporate  laws of the  Commonwealth  of  Virginia in 1979 to develop and market
computer  applications  software  systems,  programming  services,  and  related
software products and automation systems.

Principles of Consolidation

The consolidated  financial  statements  include the accounts of the Company and
its wholly owned subsidiaries, Allied Health & Information Systems, Inc. (AHISI)
and International  Software System Corporation (ISSC).  Upon consolidation,  all
material intercompany accounts,  transactions and profits are eliminated.  AHISI
commenced  operations in 1991;  ISSC was acquired in 1996.  Goodwill,  resulting
from the Company's acquisition of ISSC is being amortized over a two-year period
which is the expected term of ISSC's contracts.

Investments  in  companies  less  than  20%  owned  are  reported  at cost  less
allowances for permanent  decline in value.  Income is recognized when dividends
are declared. No dividends were declared in 1996 or 1995.

Accounting Estimates

The preparation of financial  statements in conformity  with generally  accepted
accounting principles requires management to make estimates and assumptions that
affect certain  reported amounts and  disclosures.  Accordingly,  actual results
could differ from these estimates.

Revenue Recognition

Revenue from cost-plus-fixed-fee  contracts is recognized on the basis of direct
costs plus indirect  costs  incurred and an allocable  portion of the fixed fee.
Revenue from fixed-price contracts is recognized on the percentage-of-completion
method,  measured by the cost-to-cost  method for each contract,  with costs and
estimated profits recorded as work is performed.  Revenue from time and material
contracts is recognized  based on fixed hourly rates for direct hours  expended.
The fixed  hourly rate  includes  direct  labor,  indirect  expenses and profit.
Material and other specified direct costs are recorded at actual cost.

Contract  costs include all direct  material and labor costs and those  indirect
costs  related to  contract  performance.  Provisions  for  estimated  losses on
uncompleted  contracts  are made in the period in which  losses are  determined.
Changes  in  job  performance,  job  conditions,  and  estimated  profitability,
including  final  contract  settlements,  may result in  revisions  to costs and
income and are recognized in the period in which the revisions are determined.

                                       25

<PAGE>


               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Cash and Cash Equivalents

For purposes of the  statement of cash flows,  the Company  considers all highly
liquid investments with maturities of sixty days or less at the time of purchase
to be cash  equivalents.  Deposits are maintained with a federally insured bank.
Balances at times exceed insured  limits,  but management does not consider this
to be a significant concentration of credit risk.

Fixed Assets

Fixed  assets are  stated at cost and are  depreciated  using the  straight-line
method over the estimated useful lives of the assets. Leasehold improvements are
amortized over the term of the lease or the estimated  life of the  improvement,
whichever is shorter. Maintenance and minor repairs are charged to operations as
incurred. Gains and losses on dispositions are recorded in current operations.

Software Development Costs

The Company  has  capitalized  costs  related to the  development  of a software
product, Computer Aided Software Translator (CAST). In accordance with Statement
of Financial  Accounting  Standards No. 86,  capitalization of costs begins when
technological  feasibility  has been  established  and ends when the  product is
available for general  release to customers.  Amortization  will be computed and
recognized  for the product when  available  for market  based on the  product's
estimated  total  sales or economic  life.  Capitalized  costs and  amortization
periods are  management's  estimates and may have to be modified due to inherent
technological changes in software development.

Deferred Rent

Rental expense on operating leases is charged to operations over the life of the
lease using the straight-line  method.  Differences  between the amounts charged
and the amounts paid are recorded as deferred rent.

Earnings Per Share

Earnings per common  equivalent share is based on the weighted average number of
common shares and common share  equivalents  outstanding  during the year.  When
dilutive,  stock  options are included as share  equivalents  using the modified
treasury stock method.  Under that method,  earnings per share data are computed
as if the options and warrants were exercised at the beginning of the period (or
at the time of  issuance,  if later) and as if the funds  obtained  thereby were
used to purchase  common stock  during the period.  Fully  diluted  earnings per
share amounts have not been presented because they are not materially dilutive.

                                       26


<PAGE>

               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Income Taxes

Deferred  income tax assets and  liabilities  are  recognized  for the estimated
future tax effects of the  differences  between the financial  statement and tax
bases of assets and  liabilities  given the  provisions of enacted tax laws. The
provision  for  income  taxes  consists  of the  income tax for the year and the
change in the deferred tax liability or asset.

Fair Market Value of Financial Instruments

The Company's  financial  instruments  include trade  receivables  and payables,
other receivables and notes payable.  Management  believes the carrying value of
financial  instruments  approximates  their fair market value,  unless disclosed
otherwise in the accompanying notes.

Reclassification

Certain accounts in the prior year financial  statements have been  reclassified
for  comparative  purposes to conform with the  presentation in the current year
financial statements.

2.    INDUSTRY SEGMENT AND CREDIT CONCENTRATION

During 1996 and 1995, the Company's operations included two reportable segments:
computer applications and healthcare. The computer applications segment includes
those  operations  involved in  developing  and marketing  computer  application
software  systems  and  providing  programming  services.  The  Company  and its
subsidiary,  ISSC, operate in this segment.  Approximately 92% of this segment's
revenue in 1996,  and 82% in 1995,  came from  contracts and  subcontracts  with
departments  and agencies of the federal  government.  In 1996,  the Company was
informed  that it was  unsuccessful  in obtaining the renewal of a contract with
the United States Customs Service.  Approximately  58% of this segment's revenue
in 1996 and 65% in 1995,  came from the contract with the United States  Customs
Service.

The healthcare segment, operated by AHISI, is involved in providing the services
of certified  physician  assistants,  nurses and medical  doctors to  healthcare
facilities  operated  by third  parties  in  conjunction  with  state  and local
governments,  and  the  federal  government.  The  Company  has  phased  out the
activities of this business  segment and anticipates that no future revenue will
be generated from this business segment after 1996.

                                       27

<PAGE>


               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


2.    INDUSTRY SEGMENT AND CREDIT CONCENTRATION (CONTINUED)

Summarized  financial  information  by business  segment for 1996 and 1995 is as
follows:

                                                  1996                  1995
                                                  ----                  ----
Net Sales

             Computer Applications           $11,172,702           $14,012,017
             Healthcare                           46,143             1,684,879

Income (loss) from operations (pre-tax)

           Computer Application                  (95,594)              333,198
           Healthcare                           (117,774)             (330,619)

Identifiable assets

            Computer Applications              2,007,393             3,361,013
            Healthcare                           315,868               494,616

Capital Expenditures

            Computer Applications                 91,471                79,354
            Healthcare                                 -                   629

Depreciation and Amortization

            Computer Applications                180,569               155,289
            Healthcare                            11,466                18,241


Operating income by business segment excludes interest income,  interest expense
and  miscellaneous  income and expense items that could not be  identified  with
either segment.  Other than those acquired by AHISI,  all furniture,  equipment,
and  capital  leases  and  their  related   depreciation  and  amortization  are
considered the assets and expenses,  respectively,  of the computer  application
segment.  Capitalized software costs and goodwill and their related amortization
are also considered assets and expenses of the computer  application segment. In
addition,   accounts  receivable  are  considered  identifiable  assets  of  the
respective  segment.  Cash and cash equivalents,  and the remaining other assets
are considered corporate assets. There were no significant intersegment sales or
transfers during 1996 and 1995.

                                       28

<PAGE>


               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

3.    ACQUISITION

On June 5, 1996, the Company completed an acquisition of the outstanding  common
stock of  International  Software  Services,  Inc. (the predecessor to ISSC) for
$370,289, of which $133,333 was paid (in cash and stock) at closing and $236,956
of which is payable by June 1998 to the former  owner (see Note 6). The business
acquisition  was accounted for as a purchase.  The  operations of ISSC since the
date of acquisition are included in the consolidated  statement of operations of
the Company for the year ended  December 31, 1996.  The cost of the  acquisition
exceeded  the fair value of the net assets  acquired by  $99,605.  The excess is
being  amortized  as goodwill on a  straight-line  basis over a two-year  period
which is the expected term of ISSC's contracts.

The  following   summarized  pro  forma  (unaudited)   information  assumes  the
acquisition had occurred on January 1, 1995.

                                              1996           1995
                                              ----           ----

         Net sales        As reported     $11,218,845    $15,696,896
                          Pro forma       $11,680,000    $16,460,000

         Net Income       As reported     $  (159,674)   $   (74,633)
                          Pro forma       $   (75,000)   $   (73,000)

         Primary loss     As reported     $     (0.26)   $     (0.15)
         per share        Pro forma       $     (0.12)   $     (0.15)


4.    RECEIVABLES

Accounts receivable at December 31, 1996, consist of the following:

             Billed - Federal government               $124,598
                 Billed - prime contractors             848,245
                 Billed - commercial                    236,941
                                                     ----------

                     Total billed                     1,209,784
                                                     ----------
                 Unbilled - Federal government            2,482
                 Unbilled - prime contractors           110,726
                 Unbilled - commercial                   32,292
                                                     ----------

                     Total unbilled                     145,500
                                                     ----------
                  Total accounts receivable          $1,355,284
                                                     ==========

                                       29


<PAGE>

               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


4.    RECEIVABLES (CONTINUED)

Unbilled  receivables are for services  provided  through the balance sheet date
which are expected to be billed and collected within one year.

Included in other receivables at December 31, 1996, are the following:

        Receivables from former customers net of
        present value discount and allowance for
        uncollectibility totaling $274,880                      $ 258,809

        Receivable from employee, due in monthly
        payments of $386 plus interest at 8.75%.
        Final payment due in 2001.                                 27,885

        Other non-trade receivables expected to be
        collected by December 31, 1997                            132,686
                                                                 --------

        Total                                                     419,380

        Less current portion                                     (192,686)
                                                                 --------
        Non current portion                                     $ 226,694
                                                                 ========

5.    FIXED ASSETS

A summary of fixed assets and  equipment  under  capital  leases at December 31,
1996, is as follows:



        Furniture and equipment              $ 1,474,939
        Leasehold improvements                    40,666
        Motor vehicles                            37,013
                                             -----------
                                               1,552,618
        Accumulated depreciation and
              amortization                    (1,261,539)
                                             -----------
        Total                                $   291,079
                                             ===========

                                       30

<PAGE>


               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


6.    FINANCING

At December  31,  1996,  the Company had a revolving  line of credit with a bank
providing for demand or short-term  borrowings  of up to  $1,500,000.  This line
expires  on June 19,  1997.  Drawings  against  this line are  based on  varying
percentages  of the  Company's  accounts  receivable  balances  depending on the
source of the  receivables  and their age.  Interest on  outstanding  amounts is
payable monthly at the bank's prime rate (8.75% at December 31, 1996) plus 1/2%.
The lender has a first priority security  interest in the Company's  receivables
and a direct  assignment  of its major U.S.  Government  contracts.  The line of
credit,  among other  covenants,  requires  the  Company to comply with  certain
financial ratios. At December 31, 1996, there was no outstanding  balance on the
line.

Additionally, at December 31, 1996, the Company is liable to the former owner of
ISSC (see Note 3) in the  amount of  $210,680.  This  liability  is  payable  as
follows: 1997 - $120,300; 1998 - $90,380.


7.    COMMITMENTS AND CONTINGENCIES

Capital Leases

The future  minimum  payments under capital leases for equipment and the present
value of the minimum lease payments are as follows:

       Year ending December 31
       -----------------------
       1997                                                 $ 24,318
       1998                                                   27,367
       1999                                                   15,132
                                                            --------
       Total minimum lease payments                           66,817
       Less amount representing interest                      (7,254)
                                                            --------
       Total obligation representing principal                59,563
       Less current portions of capital lease obligations    (18,229)
                                                            --------
       Long-term portion of capital lease obligations       $ 41,334
                                                            ========

                                       31

<PAGE>


               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


7.    COMMITMENTS AND CONTINGENCIES (CONTINUED)

Operating Leases

Rent expense was  $236,466,  and $263,031 for the years ended  December 31, 1996
and 1995, respectively.

The future  minimum  rental  payments to be made under  noncancelable  operating
leases, principally for facilities, are as follows:

        Year ending December 31
        -----------------------
        1997                                 $284,512
        1998                                  295,709
        1999                                  304,580
        2000                                  313,717
        2001                                  323,129
        2002 through 2004                     675,630
                                           ----------

        Total minimum rent payments        $2,197,277
                                           ==========

The  above  minimum  lease  payments  reflect  the base  rent  under  the  lease
agreements.  However,  these base rents shall be  adjusted  each year to reflect
increases in the consumer price index and the Company's  proportionate  share of
real estate tax increases on the leased property. The Company entered into a new
lease in February 1997 with a seven-year  term ending in 2004. The minimum lease
payments are included in the above amounts.

The  leases are  secured by  irrevocable  letters of credit for  $26,982.  As of
December 31, 1996, none of the letters of credit have been used.

Royalties

In August 1996,  the Company  entered into an agreement to purchase the software
product  CAST (see Note 1). As part of the  agreement,  royalties  of 10% of the
CAST  licensing  fees  collected by the Company will be paid to the seller.  The
aggregate  amount of the royalties  pursuant to this  agreement  will not exceed
$1,000,000.

Also in  August  1996,  the  Company  entered  into  an  agreement  whereby,  in
consideration of an expense sharing arrangement,  the Company will pay royalties
of 20% of the CAST licensing fees collected by the Company.
The royalties will not exceed $150,000.

                                       32

<PAGE>


               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


7.    COMMITMENTS AND CONTINGENCIES (CONTINUED)

In October 1993, the Company  purchased  ownership  rights to a software product
called  Migrator.  Included in the purchase  price is an obligation  for royalty
payments of 10% on all Migrator  licensing fees  collected  during the four year
period  following  the sale.  As of December 31, 1996, no license fees have been
collected.


Government Contracts

Company sales to  departments  or agencies of the United States  Government  are
subject to audit by the Defense  Contract  Audit Agency  (DCAA).  Audits by DCAA
have not  been  performed  for any  years.  Management  is of the  opinion  that
disallowances,  if any,  by DCAA for  unaudited  years  will not  result  in any
material adjustments to the financial statements.


8.  INCOME TAXES

The provision for income taxes consists of the following:


                                                              December 31
                                                              -----------
                                                         1996             1995
                                                         ----             ----
Current (benefit) expense

     Federal .................................        $(67,021)        $  9,996
     State ...................................         (14,846)           2,216
                                                       -------          -------
                                                       (81,867)          12,212
                                                       -------          -------

Deferred expense (benefit)

     Federal .................................           4,294          (31,268)
     State ...................................             951           (6,926)
                                                       -------          -------
                                                         5,245          (38,194)
                                                       -------          -------

Benefit for income taxes .....................        $(76,622)        $(25,982)
                                                       =======          =======

                                       33

<PAGE>


               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


8.  INCOME TAXES (CONTINUED)

The items that give rise to the deferred tax expense  (benefit)  shown above are
as follows:

                                                              December 31
                                                              -----------
                                                         1996             1995
                                                         ----             ----

Depreciation ....................................       $ 8,020        $  9,500
Vacation expense ................................        (2,775)         13,106
Bad debt expense ................................            --         (60,800)
                                                        -------        --------

  Tax effects of temporary differences ..........       $ 5,245        $(38,194)
                                                        =======        ========

The tax effect of significant  temporary  differences  representing deferred tax
assets and liabilities at December 31, 1996, are as follows:

Vacation .................................................               $37,862
Bad debt expense .........................................                60,800
                                                                         -------
  Deferred tax asset .....................................               $98,662
                                                                         =======

Depreciation - deferred tax liability ........................           $27,020
                                                                         =======

The  provision  for income  taxes is at an  effective  rate  different  from the
federal statutory rate due principally to the following:


                                                               December 31
                                                               -----------
                                                           1996          1995
                                                           ----          ----

Loss before taxes ..................................    $(236,296)    $(100,615)
                                                          =======       =======
Income taxes (benefit) on above amount
    at federal statutory rate ......................      (80,341)      (34,209)
State income taxes net of federal benefit ..........      (10,870)       (4,648)
Effect of graduated tax brackets, change
    in estimates, and other non deductible
    items ..........................................       14,589        12,875
                                                          -------       -------

Benefit for income taxes ...........................    $ (76,622)    $ (25,982)
                                                          =======       =======
                                       34

<PAGE>


               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


9.   STOCK OPTIONS AND WARRANTS

The Company has two stock option plans, the second plan becoming  effective June
25,  1996.  The  combined  plans  provide for the  granting of stock  options to
certain employees,  directors and consultants.  The maximum number of shares for
which options may be granted under the plans is 200,000 (increased to 250,000 in
January 1997).  Options expire no later than ten years from the date of grant or
when employment ceases,  whichever comes first, and vest over periods determined
by the board of directors.  The exercise  price of each option equals the quoted
market price of the Company's stock on the date of grant.

The stock option plan is accounted for under  Accounting  Principles Board (APB)
Opinion No. 25.  Accordingly,  no compensation has been recognized for the plan.
Had compensation  cost for the plans been determined based on the estimated fair
value of the options at the grant dates  consistent with the method of Statement
of Financial  Accounting  Standards (SFAS) No. 123, the Company's net income and
earnings per share would have been:

                                             1996                  1995
                                             ----                  ----

Net  loss             As reported        $  (159,674)           $  (74,633)
                      Pro forma          $  (424,000)           Not applicable

Loss per share        As reported        $     (0.26)           $    (0.15)
                      Pro forma          $     (0.68)           Not applicable


The fair value of the options  granted in 1996 is  estimated  on the date of the
grant using the Black-Scholes options - pricing model assuming the following: no
dividend  yield,  risk-free  interest  rate of 6 %,  expected  volatility  of 40
percent, and an expected term of the options of two years.

At December 31, 1996, options to purchase stock under this plan were outstanding
to employees as follows:

             Number of shares             Exercise price per share
             ----------------             ------------------------

                       32                         $ 3.00
                  168,200                           4.00
                   10,200                           4.50
                    4,500                           5.00
                      200                           5.50
                    1,500                          11.75
                   10,000                          14.50


                                       35

<PAGE>



               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


9.   STOCK OPTIONS AND WARRANTS (CONTINUED)

Of these 194,632 options,  134,632 options are exercisable  immediately,  50,000
options at $4 per share are exercisable over two years, and 10,000 options at $4
per  share  are   exercisable   when  certain   revenue  amounts  are  realized.
Transactions involving the plan were as follows:

                                                   December 31
                                                   -----------
                                            1996                 1995
                                    -------------------   ------------------
                                              Weighted             Weighted
                                                Average              Average
                                     Shares      Price    Shares      Price
                                     ------      -----    ------      -----

  Outstanding, beginning of year     37,828     $ 4.73    43,443     $  4.77
  Granted                           215,500     $ 4.54         -           -
  Exercised                         (39,696)    $ 4.10       (54)    $  5.50
  Canceled                          (19,000)    $ 4.74    (5,561)    $  5.01
                                    -------              -------

  Outstanding, end of year          194,632     $4.65     37,828     $  4.73
                                    =======              =======


The board of directors  has also granted  warrants to directors  and  employees.
During 1996, no warrants to acquire  shares of common stock were granted to such
persons.  The total warrants  exercised in 1996 were 10,000 and warrants expired
were 5,000.  As of December  31,  1996,  outstanding  warrants  are 13,000.  The
purchase  price for shares  issued upon  exercise of these  warrants  range from
$5.00 to $7.50 per share. These warrants are exercisable immediately.


10.   RETIREMENT PLANS

The  Company  adopted a Cash or  Deferred  Arrangement  Agreement  (CODA)  which
satisfies the  requirements  of section 401(k) of the Internal  Revenue Code, on
January 1, 1988. This defined contribution  retirement plan covers substantially
all  employees.  Each  participant  can  elect to have up to 6% of their  salary
reduced and  contributed to the plan. The Company is required to make a matching
contribution  of 25% of  this  salary  reduction.  The  Company  can  also  make
additional contributions at its discretion.  Amounts expensed under the plan for
the  years  ended  December  31,  1996  and  1995,  were  $47,029  and  $44,549,
respectively.

The  Company  does not  provide  post  employment  benefits  and,  as a  result,
Statement of Financial  Accounting Standards No. 106 does not have any impact on
these financial statements.

                                       36

<PAGE>


               INFORMATION ANALYSIS INCORPORATED AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


11.   LITIGATION

At December 31, 1996, the Company is involved in litigation with a former inmate
at a correctional facility where the Company has provided medical services.  The
case is a  malpractice  claim  against  the  Company  as well as  other  related
parties. The plaintive seeks $1,550,000 in damages. The Company has insurance to
cover claims of up to $1 million per occurrence,  and there are other defendants
who will likely contribute to either a settlement or a judgment,  if any. In the
opinion of management, there will be no material adverse effect on the Company's
financial  statements  as a result  of this  litigation.  No  amounts  have been
accrued in the financial statements related to this matter.

12.   SUBSEQUENT EVENTS

Common Stock

Subsequent to December 31, 1996, the board of directors increased the authorized
shares of the Company's  common stock from  1,000,000 to  10,000,000  shares and
authorized a three for one split of its outstanding common stock.

Private Placement Memorandum

In March 1997, the Company completed a private placement memorandum which raised
$5,000,000  in exchange for 285,714  shares of the Company's  common stock.  The
funds  will be  utilized  for the  further  development  of the  Company's  CAST
software  product  (see Note 1) and the pursuit of CAST  business  opportunities
during 1997 and 1998.

                                       37

<PAGE>




                                INDEX OF EXHIBITS
<TABLE>
<CAPTION>

Exhibit No.       Description                                                                Page No.
<S> <C>
3.1               Amended and Restated Articles of Incorporation                              40-43
                  effective March 18, 1997.

3.2               Amended By-Laws of the Company incorporated by referenced to the            44
                  Company's Form S-18 filed with the SEC on Form S-18 dated
                  November 20, 1986 (Commission File No. 33-9390).

10.1              Office Lease for 18,280 square feet at 11240 Waples Mill Road,              45-77
                  Fairfax, Virginia 22030.

10.2              Company's 401(k) Profit Sharing Plan through Aetna Life Insurance           78-118
                  and Annuity Company.

10.3              1986 Stock Option Plan incorporated by reference from the                   119
                  Company's Form S-8 filed on December 20, 1988 with the SEC.

10.4              1996 Stock Option Plan incorporated by reference from the                   120
                  Company's Form S-8 filed on June 25, 1996 with the SEC.

10.5              Line of Credit Agreement with First Virginia Bank incorporated by           121
                  reference from Form 10-KSB for the fiscal year ending December
                  31, 1995 filed with the SEC on April 15, 1996 (Commission File
                  No. 33-9390).

10.6              Warrant Agreement between George DeBakey, a director, and the               122-138
                  Company dated June 1, 1989.

10.7              Warrant Agreement between James C. Wester, a director, and the              139-145
                  Company dated February 24, 1993.

10.8              Software Purchase Agreement between Kenneth K. Parsons and the              146-150
                  Company for the purchase of CAST software.


10.9              Royalty Agreement between James C. Wester and                               151-154


<PAGE>



                  the Company in exchange for development expense advances.

10.10             Common Stock Purchase Agreement dated June 5, 1996, between                 155
                  the Company and Stephen E. Petruzzo for the purchase of
                  International  Software Services  Corporation,
                  incorporated  by  reference  to the  Company's
                  Form 8-K filed on July 16, 1996 with the SEC.

10.11             Registration Rights Agreement dated February 27, 1997 between               156-167
                  the Company and certain purchases of Common Stock.


21.1              List of Subsidiaries.                                                       168-169
</TABLE>


<PAGE>