UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
               ---------------------------------------------------

                                   FORM 10-QSB

[X]   Quarterly Report under Section 13 or 15(d ) of the Securities Exchange Act
      of 1934
      For the quarterly period ended: September 30, 2004

[ ]   Transition report pursuant to Section 13 or 15(d) of the Securities
      Exchange Act of 1934
      For the Transition period from _____________ to _____________

                         Commission file number: 1-12966

                            CLEARSTORY SYSTEMS, INC.
                             (FORMERLY INSCI CORP.)
             (Exact name of registrant as specified in its charter)

              DELAWARE                                   06-1302773
------------------------------------        -----------------------------------
      (State of incorporation)              (IRS employer identification number)

                         One Research Drive, Suite 200B
                              Westborough, MA 01581
                    (Address of principal executive offices)

         Issuer's telephone number, including area code: (508) 870-4000

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.

Yes |X|   No |_|

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

TITLE OF EACH CLASS                             OUTSTANDING DECEMBER 13, 2004
-------------------                             -----------------------------
Common Stock, par value $.10                             5,992,287

Transitional Small Business Disclosure Format (check one)

Yes |_|   No |X|
<PAGE>

                            CLEARSTORY SYSTEMS, INC.

                                      INDEX


                                                                          PAGE
                                                                          ----
PART I    FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Balance Sheet as of September 30, 2004
   (Unaudited) and March 31, 2004                                           3

Condensed Consolidated Statements of Operations for the Three and
   Six Months Ended September 30, 2004 and 2003 (Unaudited)                 4

Condensed Consolidated Statements of Cash Flows for the Six Months
   Ended September 30, 2004 and 2003 (Unaudited)                            5

Notes to Condensed Consolidated Financial Statements                        6

Item 2. Management's Discussion and Analysis or Plan of Operation           10

Item 3. Controls and Procedures                                             22


PART II   OTHER INFORMATION

Item 1. Legal Proceedings                                                   22

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds         22

Item 4. Submission of Matters to a Vote of Security Holders                 23

Item 6. Exhibits                                                            23

        Signature                                                           23

        Exhibit Index                                                       24


                                       2
<PAGE>

                            CLEARSTORY SYSTEMS, INC.
                      CONDENSED CONSOLIDATED BALANCE SHEET
                               SEPTEMBER 30, 2004
                    (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                               SEPTEMBER 30,     MARCH 31,
                                                                   2004            2004
                                                               ------------    ------------
                                                                (UNAUDITED)
<S>                                                            <C>             <C>
                                     ASSETS

Current Assets:
  Cash and cash equivalents                                    $        694    $        751
     Accounts receivable, net of allowance for
       doubtful accounts of $8 and $10, respectively                  1,664           2,128
     Prepaid expenses and other current assets                          439             358
                                                               ------------    ------------
       Total current assets
                                                                      2,797           3,237

Property and Equipment, net                                           1,720           1,479
Capitalized software                                                  1,008             242
Goodwill, net                                                         1,223           1,223
Other assets                                                            224             244
                                                               ------------    ------------
                                                               $      6,972    $      6,425
                                                               ============    ============

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
     Accounts payable and accrued expenses                     $      2,677    $      1,975
     Advances against accounts receivable sold with recourse          1,067           1,412
     Deferred revenue                                                 2,244           2,374
     Capital leases, current portion                                    146              85
                                                               ------------    ------------
          Total current liabilities                                   6,134           5,846

Long term liabilities:
    Deferred rent                                                       370             185
    Capital leases, net of current portion                              176              42
                                                               ------------    ------------
          Total long term liabilities                                   546             227

Commitments and contingencies

Stockholders' equity:
  Series C Convertible Preferred Stock                                   31              27
  Series B Convertible Preferred Stock                                    1               1
     8% Convertible Preferred Stock                                       1               1
     Common stock                                                       599             599
     Additional paid-in capital                                      54,970          54,243
     Accumulated deficit                                            (55,310)        (54,519)
                                                               ------------    ------------
          Total stockholders' equity                                    292             352
                                                               ------------    ------------
                                                               $      6,972    $      6,425
                                                               ============    ============
</TABLE>

              THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
                       CONSOLIDATED FINANCIAL STATEMENTS.


                                        3
<PAGE>

                            CLEARSTORY SYSTEMS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)
                    (in thousands, except per share amounts)

                                       THREE MONTHS ENDED     SIX MONTHS ENDED
                                          SEPTEMBER 30,         SEPTEMBER 30,
                                       ------------------    ------------------
                                         2004       2003       2004       2003
                                       -------    -------    -------    -------

Revenue
  Product                              $   945    $   472    $ 2,170    $ 1,550
  Services                               1,632      1,318      3,390      2,318
                                       -------    -------    -------    -------
    Total revenue                        2,577      1,790      5,560      3,868
                                       -------    -------    -------    -------
Cost of revenue
  Product                                   63         54        126         81
  Services                                 936        412      1,763        685
                                       -------    -------    -------    -------
    Total cost of revenue                  999        466      1,889        766
                                       -------    -------    -------    -------
Gross profit                             1,578      1,324      3,671      3,102
                                       -------    -------    -------    -------
Expenses
  Sales and marketing                      717        638      1,458      1,294
  Product development                      591        700      1,203      1,310
  General and administrative               837        527      1,451        874
  Non-recurring items                     --          380       --          380
                                       -------    -------    -------    -------
                                         2,145      2,245      4,112      3,858
                                       -------    -------    -------    -------
Operating loss                            (567)      (921)      (441)      (756)

Interest expense, net                      (28)      (101)       (54)      (208)
                                       -------    -------    -------    -------
Net loss before taxes                     (595)    (1,022)      (495)      (964)

Provision for taxes                         --         --         --         --
                                       -------    -------    -------    -------

Net loss                                  (595)    (1,022)      (495)      (964)

Preferred stock dividends                 (151)       (43)      (296)       (84)
                                       -------    -------    -------    -------
Net loss attributable to common
  shareholders                         $  (746)   $(1,065)   $  (791)   $(1,048)
                                       =======    =======    =======    =======
Loss per common share:
  Basic and diluted                    $ (0.12)   $ (0.19)   $ (0.13)   $ (0.19)
                                       =======    =======    =======    =======
Weighted average shares outstanding:
  Basic and diluted                      5,992      5,478      5,992      5,378
                                       =======    =======    =======    =======

              THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
                       CONSOLIDATED FINANCIAL STATEMENTS.


                                        4
<PAGE>

                            CLEARSTORY SYSTEMS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                  SIX MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
                                   (UNAUDITED)
                                 (in thousands)

                                                              2004        2003
                                                            -------     -------
Cash flows from operating activities:
  Net loss                                                  $  (495)    $  (964)
  Reconciliation of net loss to net cash provided by
    (used in) operating activities:
  Depreciation and amortization                                 247          71
  Non-cash restructuring and other charges                       --        (180)
  Deferred rent                                                 185          --
  Changes in assets and liabilities:
      Accounts receivable                                       464         437
      Prepaid expenses and other current assets                 (81)         21
      Other assets                                               20          31
      Accounts payable and accrued expenses                     687         252
      Deferred revenue                                         (130)       (311)
                                                            -------     -------
Net cash provided by (used in) operating activities             897        (643)

Cash flows from investing activities:
  Capitalized software                                         (766)         --
  Capital expenditures                                         (488)        (77)
  Purchase of net assets of WebWare                              --        (627)
                                                            -------     -------
Net cash used in investing activities                        (1,254)       (704)

Cash flows from financing activities:
  Net advances (repayments) from sale of receivables           (345)        169
  Proceeds from sale and leaseback                              240          --
  Payments on capital leases                                    (45)         --
  Proceeds from issuance of Series C preferred stock            450       1,000
  Series B Preferred dividends paid                              --         (84)
  Repayments on long term convertible debt                       --        (144)
                                                            -------     -------
Net cash provided by financing activities                       300         941
                                                            -------     -------

Net decrease in cash                                            (57)       (406)
Cash, beginning of period                                       751         771
                                                            -------     -------
Cash, end of period                                         $   694     $   365
                                                            =======     =======

              THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
                       CONSOLIDATED FINANCIAL STATEMENTS.


                                        5
<PAGE>

                            CLEARSTORY SYSTEMS, INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

NATURE OF BUSINESS AND BASIS OF PRESENTATION

      The consolidated financial statements included in this report have been
prepared by ClearStory Systems, Inc., (the "Company" or "ClearStory"), without
audit, pursuant to the rules and regulations of the Securities and Exchange
Commission regarding interim financial reporting. In addition, certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted pursuant to such rules
and regulations relating to interim condensed financial statements However, the
Company believes that the disclosures contained herein are adequate to make the
information presented not misleading. The financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's annual report on Form 10-KSB for the fiscal year ended March 31, 2004.
The results for the three and six months ended September 30, 2004 may not be
indicative of the results that may be expected for the year ending March 31,
2005 or for any other future period.

      On October 28, 2004, at the Annual Meeting of Stockholders, the Company's
name was changed from INSCI Corp. to ClearStory Systems, Inc. (OTCBB: CSYS).

      ClearStory is a leading provider of integrated enterprise content
management ("ECM") solutions. ClearStory's proven technology provides a solid
foundation for managing the full spectrum of enterprise content, from documents
to e-mail, and graphics to video. By bringing digital assets and business
content together through a unified Web services platform, ClearStory readily
enables content use in e-commerce, customer service, marketing content
management and regulatory compliance applications.

      In the opinion of the management of the Company, the accompanying
unaudited financial statements reflect all adjustments (of a normal and
recurring nature) that are necessary to present fairly the financial position of
the Company as of September 30, 2004 and the results of operations for the three
and six months ended September 30, 2004 and 2003 and cash flows for the six
months ended September 30, 2004 and 2003.

      The accompanying consolidated financial statements for the six months
ended September 30, 2004 and 2003 include the operations of the Company and its
wholly-owned subsidiaries, WCORP, Inc. ("WCORP") and Lognet 2000, Inc.
("Lognet"). WCORP was established August 26, 2003 to acquire certain assets and
liabilities of WebWare(R) Corporation ("WebWare"). WCORP acquired certain assets
and assumed certain liabilities of WebWare on September 5, 2003. Additional
subsidiaries of the Company are InfiniteSpace.com, Corp. ("InfiniteSpace"), The
Internet Broadcasting Company, Inc. ("IBC") and INSCI (UK) Limited, all of which
are no longer active. All significant intercompany transactions and balances
have been eliminated in the preparation of these financial statements.

RECENTLY ISSUED ACCOUNTING STANDARDS

      In April 2004, the Financial Accounting Standards Board's ("FASB")
Emerging Issues Task Force ("EITF") reached a consensus on EITF No. 03-06,
PARTICIPATING SECURITIES AND THE TWO-CLASS METHOD UNDER FASB STATEMENT NO. 128,
EARNINGS PER SHARE. EITF 03-06 addresses a number of questions regarding the
computation of earnings per share by companies that have issued securities other
than common stock that contractually entitle the holder to participate in
dividends and earnings of the company when, and if, it declares dividends on its
common stock. The issue also provides further guidance in applying the two-class
method of calculating earnings per share, clarifying what constitutes a
participating security and how to apply the two-class method of computing
earning per share once it is determined that a security is participating,
including how to allocate undistributed earnings to such a security. EITF 03-06
is effective for fiscal periods beginning after March 31, 2004. The adoption of
EITF 03-06 is not expected to have a material effect on our financial position
or results of operations.


                                        6
<PAGE>

ACQUISITION

      On September 5, 2003, the Company's wholly owned subsidiary, WCORP,
acquired certain assets and assumed certain liabilities of WebWare Corporation
("WebWare") from Diablo Management Group, as assignee for the benefit of
creditors of WebWare. The total purchase price was $1.3 million. Additionally,
the Company incurred closing costs of $127,000. The Company paid cash of
$500,000 and issued 716,204 shares of its common stock valued at $800,000. The
Company has granted registration rights for these shares, which are subject to a
lock up agreement. This transaction has been accounted for as a purchase and
accordingly, the operating results have been included in the Company's
consolidated results of operations from the date of acquisition.

The components of the purchase price and allocation are as follows (in
thousands):

Purchase price:
       Cash                                                          $      500
       716,204 shares of ClearStory common stock                            800
       Acquisition costs                                                    127
                                                                     ----------

            Total consideration plus acquisition costs               $    1,427
                                                                     ==========

Allocation of purchase price:
       Fair value of assets acquired, net of $783 in
         liabilities assumed                                         $      204
       Purchase price in excess of fair value of net
         assets acquired allocated to goodwill                            1,223
                                                                     ----------

            Total                                                    $    1,427
                                                                     ==========

      Goodwill, in accordance with SFAS No. 142, ACCOUNTING FOR THE IMPAIRMENT
OR DISPOSAL OF LONG-LIVED ASSETS, will be tested for impairment annually and
whenever there is an impairment indicator. No impairment charges have been
recorded as of September 30, 2004.

      Unaudited pro forma operating results for the six months ended September
30, 2003, assuming the purchase of the assets of WebWare occurred on March 31,
2003, is as follows (in thousands):

                                                                     SIX MONTHS
                                                                        ENDED
                                                                      SEPTEMBER
                                                                      30, 2003
                                                                     ----------
Revenue                                                              $    4,457
Net loss from continuing operations                                      (3,410)
Net loss attributable to common shareholders                             (3,494)
Basic and diluted loss per share attributable to
   common shareholders                                               $    (0.63)

EARNINGS (LOSS) PER COMMON SHARE

      Basic and diluted net earnings (loss) per share is presented in conformity
with SFAS No. 128, EARNINGS PER SHARE, for all periods presented. In accordance
with SFAS No. 128, basic net earnings (loss) per common share was determined by
dividing net earnings (loss) applicable to common stockholders by the weighted
average common shares outstanding during the period. Basic and diluted net
earnings (loss) per share are the same because all outstanding common stock
equivalents have been excluded as they are anti-dilutive.

      For the three and six months ended September 30, 2004, approximately 17.1
million shares from stock options, warrants and convertible securities were
excluded due to their anti-dilutive effect. For the three months and six months
ended September 30, 2003, approximately 10.6 million and 9.6 million shares,
respectively, from stock options, warrants and convertible securities were
excluded due to their anti-dilutive effect.


                                        7
<PAGE>

GEOGRAPHIC INFORMATION

      The Company operates as a single reportable segment as a developer and
distributor of software solutions for the enterprise content management ("ECM")
market.

      Revenue was derived from customers in the following geographic areas (in
thousands):

                                    THREE MONTHS ENDED         SIX MONTHS ENDED
                                       SEPTEMBER 30,             SEPTEMBER 30,
                                   -------------------       -------------------
                                    2004         2003         2004         2003
                                   ------       ------       ------       ------

North America                      $2,274       $1,545       $4,980       $3,381
Europe                                195          111          387          230
Other                                 108          134          193          257
                                   ------       ------       ------       ------

                                   $2,577       $1,790       $5,560       $3,868
                                   ======       ======       ======       ======

ADVANCES AGAINST RECEIVABLES SOLD WITH RECOURSE

      On November 2, 2004, the Company entered into a new factoring agreement
("Factoring Agreement") with Benefactor Funding Corporation ("Benefactor") which
replaced its existing financing agreement with another financing company.
Pursuant to the Factoring Agreement, the Company will sell certain accounts
receivable to Benefactor at a purchase price, for each accepted account, equal
to (i) 98.75% of the face amount of the applicable account receivable less (ii)
Benefactor's fees and the amount of any trade or cash discounts, credits or
allowances, set-offs or any other applicable reductions or adjustments. The
Company has also granted Benefactor a security interest in all of the Company's
assets to secure the payment and performance of all obligations under the
Factoring Agreement.

SERIES C CONVERTIBLE PREFERRED STOCK

      On September 22, 2004, the Company amended its Series C Convertible
Preferred Stock Purchase Agreements dated as of September 9, 2003 and December
31, 2003 with SCP Private Equity Investors II, LP ("SCP") and CSSMK, LLC
("CSSMK"), respectively, whereby the Company sold an additional 180,450 shares
of Series C Convertible Preferred Stock ("Series C Preferred") at $1.9396 per
share to SCP for the sum of $350,000 and sold an additional 51,557 shares of
Series C Preferred to CSSMK at $1.9396 per share for the sum of $100,000.

      For the period ended September 30, 2004, the Company also issued a total
of $281,000 of Series C Preferred in settlement of accrued dividends of $81,000
on its Series B Convertible Preferred Stock ("Series B Preferred") and $200,000
in accrued dividends on its Series C Preferred. The Company has recorded an
additional $38,000 in accrued dividends associated with its Series B Preferred
and Series C Preferred at September 30, 2004.

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

                                                                SIX MONTHS ENDED
                                                                 SEPTEMBER 30,
                                                                ---------------
                                                                 2004      2003
                                                                -----     -----
                                                                 (IN THOUSANDS)
Non-cash investing and financing activities:
  Series C Preferred Stock issued in settlement
        of accrued dividends                                    $ 281     $  --
  Common Stock issued in connection with the
        purchase of certain assets of WebWare
                                                                   --       800
  Capital lease obligations assumed with the
        purchase of certain assets of WebWare
                                                                   --       181
  Goodwill and other assets acquired in connection
        with the purchase of certain assets of WebWare
                                                                   --     1,898



                                        8
<PAGE>

STOCK-BASED COMPENSATION

      The Company has elected to follow Accounting Principles Board Opinion
("APB") No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related
interpretations in accounting for its employee stock options. Under APB No. 25,
when the exercise price of employee stock options is equal to or greater than
the market price of the underlying stock on the date of grant no compensation
expense is recorded. The Company discloses information relating to the fair
value of stock-based compensation awards in accordance with SFAS No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION.

      The Company computed the pro forma disclosures required under SFAS No. 123
for all stock options granted to employees and directors of the Company as of
September 30, 2003 and 2004, using the Black-Scholes option pricing model
prescribed by SFAS No. 123.

      The effect of applying SFAS No. 123 would be as follows:

<TABLE>
<CAPTION>
                                                                 THREE MONTHS ENDED           SIX MONTHS ENDED
                                                                    SEPTEMBER 30,               SEPTEMBER 30,
                                                              ------------------------    ------------------------
                                                                  2004         2003           2004         2003
                                                              ----------    ----------    ----------    ----------
                                                                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                           <C>           <C>           <C>           <C>
Net loss attributable to common shareholders  - As reported   $     (746)   $   (1,065)   $     (791)   $   (1,048)
                                                              ==========    ==========    ==========    ==========
Net loss attributable to common shareholders  - Pro forma     $     (877)   $   (1,065)   $   (1,053)   $   (1,048)
                                                              ==========    ==========    ==========    ==========

Basic and diluted net loss per share:
     As reported                                              $    (0.12)   $    (0.19)   $    (0.13)   $    (0.19)
                                                              ==========    ==========    ==========    ==========
     Pro forma - SFAS 123                                     $    (0.15)   $    (0.19)   $    (0.18)   $    (0.19)
                                                              ==========    ==========    ==========    ==========
</TABLE>

COMMITMENTS AND CONTINGENCIES

LEGAL PROCEEDINGS

      The Company is a defendant in an action commenced by one of its customers
for the return of certain pre-petition payments made prior to the customer's
bankruptcy petition in the amount of approximately $121,000. The Company is
contesting the action and is asserting a number of affirmative defenses on its
behalf. The outcome of these proceedings cannot be determined with certainty.
The Company does not believe that the resolution of this matter will have a
material adverse effect on the Company's consolidated financial position or
results of operations.


                                       9
<PAGE>


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS

      THE FOLLOWING DISCUSSION OF THE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE THREE MONTHS ("SECOND QUARTER OF FISCAL 2005") AND THE SIX
MONTHS ("FIRST HALF OF FISCAL 2005") ENDED SEPTEMBER 30, 2004 AND THE THREE
MONTHS ("SECOND QUARTER OF FISCAL 2004") AND THE SIX MONTHS ("FIRST HALF OF
FISCAL 2004") ENDED SEPTEMBER 30, 2003 AND DISCUSSION OF FINANCIAL CONDITION AT
SEPTEMBER 30, 2004 SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS
AND THE RELATED NOTES THERETO INCLUDED ELSEWHERE IN THIS FORM 10-QSB AND THE
AUDITED FINANCIAL STATEMENTS AND NOTES THERETO AND MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INCLUDED IN OUR ANNUAL
REPORT ON FORM 10-KSB FOR THE YEAR ENDED MARCH 31, 2004, WHICH HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "SEC"). THE FOLLOWING
DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT REFLECT OUR BUSINESS, PLANS,
ESTIMATES AND BELIEFS. OUR RESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED
IN THE FORWARD-LOOKING STATEMENTS.

      On October 28, 2004, at our Annual Meeting of the Stockholders, we
received approval to change our name from INSCI Corp. to ClearStory Systems,
Inc. to more appropriately describe our current positioning as a leading
provider of solutions to the enterprise content management ("ECM") market. Our
highly scalable solutions provide storage, access and presentment for
mission-critical documents, reports, statements, e-mail and high-value digital
assets necessary for business operations, or regulatory compliance. The industry
recognized that highly scaleable archive solutions support high volume
ingestion, digital asset preservation, and on-line presentment and delivery
functions via internal networks, or via the World Wide Web. With the addition of
web-enabled capabilities, our customers can take advantage of e-commerce to
improve communication, customer satisfaction, and productivity while potentially
decreasing operating costs. We have acquired certain assets and liabilities of
WebWare Corp., a leading provider of content management solutions for the
digital asset management ("DAM") market on September 5, 2003. These advanced
solutions offer broad management capability for rich media content such as
video, voice, audio, graphics and related media.

      We were founded to capture and preserve high volumes of mission critical
business information. Our product offering includes web-based presentment
capabilities for documents such as bank statements, 401(k) statements, customer
and vendor statements, explanation of benefits ("EOBs"), and transaction
confirmation documents. We have expanded our product offerings to include e-mail
archiving and notification capabilities as well as the ability to capture, store
and deliver high value digital assets such as video, voice on demand, graphics
and presentations. These offerings provide our customers with the ability to
increase internal communication, improve productivity and increase customer
satisfaction and communication. With the addition of the WebWare ActiveMedia(TM)
product offering, we have substantially expanded our digital archive and rich
media asset management capabilities and support business efforts such as video
and voice on demand, and marketing content management.

      The ESP+(TM) Solutions Suite provides a highly scalable digital content
repository that is designed to meet the demands of high-volume environments that
require the preservation of wide-ranging digital assets (legacy computer output,
documents, e-mail correspondence, MS Office files, imaged documents and digital
voice documents). Its three-tier scalable architecture is designed to meet the
unique demands of large-scale implementations, with Java-based application
program interface ("API") for seamless integration with third party applications
such as Websites, Customer Relationship Management ("CRM") service providers and
others. The ESP+ Solutions Suite manages millions of documents for immediate
availability and supports internet-based access to this content by thousands of
concurrent users.

      ActiveMedia provides a secure, central repository where rich media files
such as graphics, documents, video, animation, voice and other formats of rich
media are organized and stored, and may be delivered to desktops, websites,
print publications, or video on demand. The application is offered as a standard
licensed application and is also available in a web-based hosted environment on
a subscription basis. The flexible Java 2 Enterprise Edition ("J2EE") based
design offers a scalable three-tier architecture that takes advantage of
industry standard Web Services description language and a standard operating
access protocol ("SOAP") application program interface ("API"). The advanced
architecture offers substantially increased market opportunities through the
seamless integration with other third party application services providers.


                                       10
<PAGE>

      We distribute our products through a combination of our direct sales force
and through our Alliance Partners. Revenue is net of discounts and allowances
given to our Alliance Partners. In Fiscal 2004 and 2003, we derived
approximately 48% and 47%, respectively, of our total revenues from our Alliance
Partners. Revenues consist of one time license fees, and service, maintenance
and subscription revenues. Sales to end-users generally include a software
license, professional services, and maintenance contracts. Additionally, the
Active Media product is also offered under a hosting contract whereby we are the
application service provider ("ASP"). ASP sales typically include monthly
recurring revenues that are recognized as earned. We also market and license our
products on an international basis through our Alliance Partners. Our strategic
relationships include Unisys Corporation, Xerox Corporation, PFPC, AGFA and
Ascent Media. We consider the development of a successful Alliance Partner
program as a key element for our future growth.

SIGNIFICANT ACCOUNTING POLICIES

      Financial Reporting Release No. 60, which was recently issued by the SEC,
requires all registrants to discuss critical accounting policies or methods used
in the preparation of the financial statements. The notes to the consolidated
financial statements included in our annual report on Form 10-K for the year
ended March 31, 2004, which has been filed with the SEC, includes a summary of
the significant accounting policies and methods used in the preparation of our
consolidated financial statements.

      Further, we have made a number of estimates and assumptions that affect
reported amounts of assets, liabilities, revenues and expenses, and actual
results may differ from those estimates. The areas that require the greatest
degree of management judgment are the assessment of the recoverability of
long-lived assets, primarily goodwill and capitalized software costs.
Capitalized software costs, which consist primarily of payroll and related
expenses, is capitalized once technological feasibility, which is defined as
completion of beta testing, is established. It is then amortized when the
product is released over an estimated useful life of three to five years.

      We believe that full consideration has been given to all relevant
circumstances that we may be subject to, and the financial statements accurately
reflect our best estimate of the results of operations, financial position and
cash flows for the periods presented.

COMPARISON OF RESULTS OF OPERATIONS

The following tables compare total revenues for the periods indicated (in
thousands):

                                             THREE MONTHS ENDED SEPTEMBER 30,
                                             --------------------------------
                                               2004        2003      % CHANGE
                                             --------    --------    --------

Product revenues                             $    945    $    472         100%
Professional services                             323         174          86
Maintenance and hosting contract revenues       1,309       1,144          14
                                             --------    --------    --------

      Total revenues                         $  2,577    $  1,790          44%
                                             ========    ========    ========

                                              SIX MONTHS ENDED SEPTEMBER 30,
                                             --------------------------------
                                               2004        2003      % CHANGE
                                             --------    --------    --------

Product revenues                             $  2,170    $  1,550          40%
Professional services                             751         324         132
Maintenance and hosting contract revenues       2,639       1,994          32
                                             --------    --------    --------

      Total revenues                         $  5,560    $  3,868          44%
                                             ========    ========    ========


                                       11
<PAGE>

SECOND QUARTER OF FISCAL 2005 AS COMPARED TO SECOND QUARTER OF FISCAL 2004:

REVENUES

      Revenues for the Second Quarter of Fiscal 2005 increased by $787,000, or
44%, to $2,577,000 as compared to revenues of $1,790,000 for the Second Quarter
of Fiscal 2004. Approximately $562,000 of the total revenue increase was
attributable to the inclusion of WebWare for the entire Second Quarter of Fiscal
2005. Product revenues increased by $473,000, or 100%, to $945,000 in the Second
Quarter of Fiscal 2005 as compared to $472,000 in the Second Quarter of Fiscal
2004. The increase in product revenues was due to increased product sales of
$249,000 and an increase of $224,000 of WebWare products included in the
operations for the entire second quarter in Fiscal 2005. Professional service
revenues increased $149,000, or 86%, to $323,000 in the Second Quarter of Fiscal
2005 as compared to $174,000 in the Second Quarter of Fiscal 2004. The increase
in professional services revenues was due to increased product sales and an
increase of $68,000 of WebWare professional services included in the operations
for the entire Second Quarter of Fiscal 2005. Maintenance and hosting revenues
increased $165,000, or 14%, to $1,309,000 in the Second Quarter of Fiscal 2005
as compared to $1,144,000 in the Second Quarter of Fiscal 2004. The increase in
maintenance and hosting revenues was primarily due to an increase of $270,000 in
WebWare maintenance and hosting revenues included in the operations for the
entire second quarter in Fiscal 2005 which was partially offset by reduced
maintenance renewals. Maintenance contract revenues are earned ratably over the
term of the contract commencing upon receipt of payment or when other acceptance
is received. Hosting contract revenues are earned ratably over the period
invoiced, typically monthly or quarterly.

      For the Second Quarter of Fiscal 2005, two customers accounted for 23% and
11% of our total revenues while one customer accounted for 26% of our total
revenues for the Second Quarter of Fiscal 2004.

GROSS PROFIT

      Gross profit for the Second Quarter of Fiscal 2005 increased $254,000 or
19% to $1,578,000 as compared to gross profit of $1,324,000 for the Second
Quarter of Fiscal 2004. The increase in gross profit is related to the increase
in product and service revenue as previously noted partially offset by increased
service expenses and costs associated with the hosting center. Gross margin
percentage decreased to 61% for the Second Quarter of Fiscal 2005 from 74% for
the Second Quarter of Fiscal 2004. The decline in gross margin was primarily the
result of the inclusion of service and maintenance revenues associated with
WebWare which currently operate at substantially lower gross margins than our
historical performance and the inclusion of costs associated with our hosting
center as we continue to invest in this solution.

SALES AND MARKETING

      Sales and marketing expenses for the Second Quarter of Fiscal 2005
increased $79,000, or 12%, to $717,000, as compared to $638,000 for the Second
Quarter of Fiscal 2004. The increase of $79,000 is primarily due to the
expansion of our direct sales force, increased marketing expenses due to costs
associated with WebWare being included in the operations for the entire Second
Quarter of 2005 and an increase in marketing costs associated with the
re-branding of our suite of products along with our Company name change to
ClearStory Systems, Inc.

      Sales and marketing expenses expressed as a percentage of sales decreased
to 28% in the Second Quarter of Fiscal 2005 compared to 36% in the Second
Quarter of Fiscal 2004 primarily due to the increase in revenue.

PRODUCT DEVELOPMENT

      Product development expenses, net of capitalized software, for the Second
Quarter of Fiscal 2005 decreased by $109,000, or 16%, to $591,000 as compared to
$700,000 for the Second Quarter of Fiscal 2004. We capitalized $391,000 of
product development costs associated with the development of our next generation
application in the Second Quarter of Fiscal 2005 as compared to none in the
Second Quarter of Fiscal 2004. This application achieved technological
feasibility in the fourth quarter of Fiscal 2004. Excluding the impact of the
software capitalization, total product development expenses for the Second
Quarter of Fiscal 2005 would have increased by $282,000, or 40%, to $982,000 as
compared to $700,000 for the Second Quarter of 2004. The increase in product
development costs is


                                       12
<PAGE>

attributable to the product development efforts associated with our next
generation application mentioned above and the further development of formalized
quality assurance and documentation procedures.

      Product development expenses, excluding the impact of the software
capitalization, expressed as a percentage of sales was 38% in the Second Quarter
of Fiscal 2005, compared to 38% in the Second Quarter of Fiscal 2004.

GENERAL AND ADMINISTRATIVE

      General and administrative expenses for the Second Quarter of Fiscal 2005
increased $310,000, or 59%, to $837,000 as compared to $527,000 for the Second
Quarter of Fiscal 2004. We moved to a new corporate facility that includes a
data-hosting center on March 1, 2004. While the new lease provides for rent
abatement through February 2005, we continued to be obligated for rent on our
previous facility through September 2004. Accordingly, we recorded rent expense
for both facilities for the Second Quarter of Fiscal 2005, which resulted in an
increase of rent expense of $113,000 compared to the Second Quarter of Fiscal
2004. The remainder the increase in general and administrative expense is
primarily attributable to the inclusion WebWare general and administrative
expense for the entire Second Quarter of Fiscal 2005 and $80,000 for state and
local taxes associated with previous years.

      General and administrative expense, expressed as a percentage of revenues,
was 29% for both the Second Quarter of Fiscal 2005 and Fiscal 2004.

NON-RECURRING ITEMS

      The non-recurring items of $380,000 for the Second Quarter of Fiscal 2004
consisted of severance, relocation, and moving expenses and other charges
incurred as part of a plan to realign our operations subsequent to the
acquisition of WebWare.

INTEREST EXPENSE, NET

      Interest expense for the Second Quarter of Fiscal 2005 decreased $73,000,
or 72%, to $28,000 as compared to $101,000 for the Second Quarter of Fiscal
2004. The decrease was due to the lower level of borrowings in the current
fiscal quarter as $1.9 million of convertible debt was converted to Series C
Convertible Preferred Stock as of March 31, 2004, as well as a lower interest
rate on operating debt.

PROVISION FOR TAXES

      No provision for or benefit from federal, state or foreign income taxes
was recorded for the Second Quarter of Fiscal 2005 or for the Second Quarter of
Fiscal 2004 because we incurred net operating losses and fully reserved our
deferred tax assets as their future realization could not be determined.

FIRST HALF OF FISCAL 2005 AS COMPARED TO FIRST HALF OF FISCAL 2004:

REVENUES

      Revenues for the First Half of Fiscal 2005 increased by $1,692,000, or
44%, to $5,560,000 as compared to revenues of $3,868,000 for the First Half of
Fiscal 2004. Approximately $2,063,000 of the total revenue increase was
attributable to the inclusion of WebWare for the entire First Half of Fiscal
2005. Product revenues increased by $620,000 or 40% to $2,170,000 in the First
Half of Fiscal 2005 as compared to $1,550,000 in the First Half of Fiscal 2004.
Approximately $1,084,000 of the increase in product revenues was due to WebWare
being included in the operations for the entire First Half in Fiscal 2005. This
increase was partially offset by a decrease of $457,000 in revenue from our ESP
products. Professional service revenues increased $427,000, or 132%, to $751,000
in the First Half of Fiscal 2005 as compared to $324,000 in the First Half of
Fiscal 2004 due to increased product installations and $321,000 from having
WebWare included in the operations for the entire First Half of Fiscal 2005.
Maintenance and hosting revenues increased $645,000, or 32% to $2,639,000 in the
First Half of Fiscal 2005 as compared to $1,994,000 in the First Half of Fiscal
2004. The increase in maintenance and hosting revenues was


                                       13
<PAGE>

primarily due to an increase of approximately $668,000 in hosting revenue and
$190,000 in maintenance revenue related to WebWare being included in the
operations for the entire First Half in Fiscal 2005.

      For the First Half of Fiscal 2005, one customer accounted for
approximately 12% of our total revenues while two customers accounted for
approximately 17% and 12% of out total revenue for the First Half of Fiscal
2004.

GROSS PROFIT

      Gross profit for the First Half of Fiscal 2005 increased $569,000, or 18%,
to $3,671,000 as compared to gross profit of $3,102,000 for the First Half of
Fiscal 2004. The increase in gross profit is related to the increase in product
and service revenue as previously noted. Gross margin decreased to 66% for the
First Half of Fiscal 2005 as compared to 80% for the First Half of Fiscal 2004.
The decline in gross margins was primarily the result of the inclusion of
service and maintenance revenues associated with WebWare, which currently
operate at substantially lower gross margins than our historical gross margins
and additional costs associated with our hosting center as we continue to invest
in this solution.

SALES AND MARKETING

      Sales and marketing expenses for the First Half of Fiscal 2005 increased
$164,000, or 13%, to $1,458,000 as compared to sales and marketing expenses of
$1,294,000 for the First Half of Fiscal 2004. The increase in sales and
marketing expenses was attributable to higher commissions as a result of the
increase in revenues and an increase in marketing costs associated with the our
re-branding of our suite of products along with our Company name change to
ClearStory Systems, Inc.

      Sales and marketing expenses expressed as a percentage of sales decreased
to 26% in the First Half of Fiscal 2005 compared to 34% in the First Half of
Fiscal 2004.

PRODUCT DEVELOPMENT

      Product development expenses, net of capitalized software, for the First
Half of Fiscal 2005 decreased by $107,000, or 8%, to $1,203,000 as compared to
$1,310,000 for the First Half of Fiscal 2004. We capitalized $766,000 of product
development costs associated with the development of its next generation
application for the First Half of Fiscal 2005 as compared no costs being
capitalized for the First Half of Fiscal 2004. This application achieved
technological feasibility in the fourth quarter of Fiscal 2004. Excluding the
impact of the software capitalization, total product development expenses for
the First Half of Fiscal 2005 would have increased by $659,000, or 50%, to
$1,969,000 as compared to $1,310,000 for the First Half of Fiscal 2004. The
increase in product development costs is attributable to the product development
efforts associated with our next generation application mentioned above and the
development of formalized quality assurance and documentation procedures.

      Product development expense, net of capitalized software, expressed as a
percentage of revenues for the First Half of Fiscal 2005 was 22%, compared to
34% of revenues for the First Half of Fiscal 2004. Excluding the impact of
software capitalization, product development expense, expressed as a percentage
of revenues, for the First Half of Fiscal 2005 would have been 35%, compared to
34% of revenues for the First Half of 2004.

GENERAL AND ADMINISTRATIVE

      General and administrative expenses for the First Half of Fiscal 2005
increased $577,000, or 66%, to $1,451,000 as compared to $874,000 for the First
Half of Fiscal 2004. We moved to a new corporate facility that includes our data
hosting facility on March 1, 2004. While the new lease provided for a rent
abatement through February 2005, we continued to be obligated for rent on our
previous facility through September 2004. Accordingly, we recorded rent expense
for both facilities for the First Half of Fiscal 2005 which resulted in an
increase of rent expense of $269,000, compared to the First Half of Fiscal 2004.
The remainder the increase in general and administrative expense is primarily
attributable to the inclusion WebWare general and administrative expense for the
entire First Half of Fiscal 2005 and $80,000 for state and local taxes
associated with previous years.


                                       14
<PAGE>

      General and administrative expense, expressed as a percentage of revenues,
was 26% for the First Half of Fiscal 2005 as compared to 23% for the First Half
of Fiscal 2004.

NON-RECURRING ITEMS

      The non-recurring items of $380,000 for the First Half of 2004 consisted
of severance, relocation, and moving expenses and other expenses incurred as
part of a plan to realign our operations subsequent to the acquisition of
WebWare.

INTEREST EXPENSE, NET

      Interest expense for the First Half of Fiscal 2005 decreased $154,000, or
74%, to $54,000 as compared to $208,000 for the First Half of Fiscal 2004. The
decrease was due to the lower level of borrowings in the current fiscal quarter
as $1.9 million of convertible debt was converted to Series C Convertible
Preferred Stock as of March 31, 2004, as well as a lower interest rate on
operating debt.

PROVISION FOR TAXES

      No provision for or benefit from federal, state or foreign income taxes
was recorded for the First Half of Fiscal 2005 or the First Half of Fiscal 2004
because we incurred net operating losses and fully reserved deferred tax assets
as their future realization could not be determined.

LIQUIDITY AND CAPITAL RESOURCES

      Our cash flows are summarized below for the periods indicated: (in
thousands)

                                             ------------------------------
                                             SIX MONTHS ENDED SEPTEMBER 30,
                                             ------------------------------
                                                   2004                2003
                                                   ----                ----
Cash provided by (used in):
  Operating activities                       $      897          $     (643)
  Investing activities                           (1,254)               (704)
  Financing activities                              300                 941
                                             ----------          ----------

Net decrease in cash                                (57)               (406)
Cash, beginning of period                           751                 771
                                             ----------          ----------

Cash, end of period                          $      694          $      365
                                             ==========          ==========

      Net cash provided by operating activities was $897,000 in the First Half
of Fiscal 2005 compared to net cash used in operating activities of $643,000 in
the prior year period. The increase in cash from operations is primarily due to
our lower net loss for the First Half of 2005, increased non-cash expenses and
an increase in accounts payable and accrued expenses. As of September 30, 2004,
the Company had a working capital deficit of $3,257,000 compared to a working
capital deficit of $3,170,000 at September 30, 2003 and a working capital
deficit of $2,609,000 as of March 31, 2004. For the Second Quarter of Fiscal
2005, the days sales outstanding (DSO) was 58 days compared to a DSO of 70 days
for the quarter ended March 31, 2004 and 83 days for the quarter ended September
30, 2003.

      Net cash used in investing activities was $1,254,000 in the First Half of
Fiscal 2005 compared to $704,000 in the prior year period. For the First Half of
2005, we utilized funds of $766,000 for capitalized software development costs
and $488,000 of funds for capital expenditures primarily attributable to the
completion of our hosted data center, other equipment relating to the relocation
of corporate facilities and for computer equipment associated with our product
development activities. During the First Half of Fiscal 2004, we utilized
$627,000 of funds for the acquisition of the assets and certain liabilities of
WebWare. Additionally, we issued 716,204 shares of our common stock in
connection with this acquisition which we valued at $800,000.

      Net cash provided by financing activities was $300,000 in the First Half
of Fiscal 2005 compared to net cash provided by financing activities of $941,000
in the prior year period. Cash provided in the First Half of Fiscal


                                       15
<PAGE>

2005 was a result of the proceeds from the issuance of preferred stock of
$450,000, proceeds from a capital lease of $240,000, partially offset by a
reduction of $345,000 of advances against accounts receivable and payments on
capital leases.

      We anticipate, based upon our current operating outlook, that our cash
balance of approximately $694,000 as of September 30, 2004 supplemented by
additional advances under our Factoring Agreement will be sufficient to satisfy
our operations and capital requirements for the next twelve months. There can be
no assurance, however, that such funds will not be expended prior thereto. In
the event our plans change, or our assumptions change, or prove to be inaccurate
(due to unanticipated expenses, difficulties, delays or otherwise), we may have
insufficient funds to support our operations.

"FORWARD-LOOKING" STATEMENTS UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT:

      This Quarterly Report contains statements which constitute forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
These statements appear in a number of places in this Quarterly Report and
include all statements that are not statements of historical fact regarding the
intent, belief or expectations of ClearStory and its management. These
statements are based upon a number of assumptions and estimates, which are
subject to significant uncertainties, many of which are beyond our control.
Words such as "may," "would," "could," "will," "expect," "anticipate,"
"believe," "intend," "plan" and "estimate" are meant to identify such
forward-looking statements. Such forward-looking statements are not guarantees
and actual results may differ materially from those expressed or implied by such
forward-looking statements. Factors that could cause actual results to differ
materially include, but are not limited to our ability to achieve or maintain
growth or profitability, our ability to execute our business strategy
successfully, our ability to obtain financing and to pay off our existing
liabilities and fund our working capital needs, our relationship with our
existing lenders, our relationship with our customers and suppliers, increased
competition, possible system failures and rapid changes in technology and other
factors discussed in this Quarterly Report and in our other filings with the
Securities and Exchange Commission.

QUARTERLY RESULTS:

      Quarterly revenues and results of operations may fluctuate as the result
of a variety of factors, including the lengthy sales cycle for our products, the
proportion of revenues attributable to software license fees versus services,
the amount of revenue generated by alliances with other companies distributing
our products, demand for our products and services, the size and timing of
individual license transactions, the introduction of new products and product
enhancements by us or our competitors, changes in customer budgets and capital
expenditures, competitive conditions in the industry and general economic
conditions. Additionally, the sale of our products generally involves a
significant commitment of capital by our customers and may be delayed due to
time-consuming authorization procedures within an organization. Other factors
affecting our operating results include our ability to design and introduce on a
timely basis new products which compete effectively on the basis of price and
performance, product obsolescence, technological changes, competition and
competitive pressures on price, the ability to hire and retain qualified
personnel and general economic conditions affecting the investment by potential
customers in technology based investments. There is no assurance that we can
maintain or increase our sales volume going forward or that we will be able to
achieve a profit in the marketing of our products.

BUSINESS RISKS

      An investment in our common stock involves a high degree of risk. You
should consider carefully the following risks, and consult with your own legal,
tax and financial advisors.

OUR FORMER INDEPENDENT PUBLIC ACCOUNTANTS, GOLDSTEIN & MORRIS PC RESIGNED
EFFECTIVE OCTOBER 20, 2004.

      On October 20, 2004, Goldstein & Morris informed us that they were
resigning as our independent registered public accounting firm. Prior to October
20, 2004, Goldstein & Morris had not previously advised management or our audit
committee of its intention to resign its engagement as our independent
registered public accounting firm. The resignation was not sought or recommended
by our audit committee. As a result of Goldstein & Morris' resignation, the
interim financial statements included in this quarterly report on Form 10-QSB
were not reviewed within 45 days


                                       16
<PAGE>

by an independent public accountant as required by Item 310(b) of Regulation
S-B. Moreover, our business and our results of operations may be adversely
impacted by Goldstein & Morris' resignation in that:

      o     We expect to incur substantial additional legal and accounting fees
            relating to disclosure and other regulatory compliance matters
            associated with the resignation of Goldstein & Morris; and

      o     Our management has already spent, and is expected to continue to
            spend, considerable time and effort on matters related to the
            resignation of Goldstein & Morris.

      On November 22, 2004, the Company's audit committee engaged Miller, Ellin
& Company, LLP as its new independent public accounting firm for the year ended
March 31, 2005.

WE HAVE A HISTORY OF LOSSES AND OUR ABILITY TO BE PROFITABLE DEPENDS ON A NUMBER
OF FACTORS THAT WE MAY BE UNABLE TO CONTROL.

      We have incurred substantial operating losses since our inception, which
has resulted in an accumulated deficit of $55,310,000, as of September 30, 2004.
For the year ended March 31, 2004 and the six months ended September 30, 2004,
we incurred net losses of $2,324,000 and $495,000, respectively. Through our
wholly owned subsidiary, WCORP, we acquired certain assets and liabilities of
WebWare and as a result, we experienced operating losses in the fiscal year
March 31, 2004 while we focused our efforts on integration and market
enhancement initiatives. There can be no assurance that that revenues will
continue to increase from current levels to allow us to become profitable or
that any expense reduction actions we may take, will allow us to become
profitable, or not affect future revenues or our market position.

      Our quarterly sales and operating results have varied significantly, and
may vary in the future, as a result of several factors such as:

   o  Size and timing of software license orders
   o  Sales mix of installed versus hosted licenses
   o  Completion of backlog orders
   o  Acceptance and sign off of service contracts
   o  Maintenance contract renewal rates
   o  Regulatory compliance
   o  Seasonality
   o  Customer budgetary constraints and timelines
   o  Availability of embedded third party products or tool sets
   o  Availability of Alliance Partner products
   o  Financial condition of Alliance Partners
   o  Variations of Alliance Partner strategies
   o  Product introduction and acceptance
   o  Competitive pricing
   o  License revenues as a percentage of revenues
   o  Changes in product distribution channels
   o  Changes in sales force
   o  Variations in expense levels
   o  Change of business strategy
   o  General economic conditions
   o  International exchange rates
   o  Changes in accounting pronouncements

      A significant amount of our license and service revenues are derived from
a limited number of customers. Such orders are typically placed within the
specific financial quarter when revenue is recognized, and we expect this trend
to continue. The placement of such orders is typically at the end of a fiscal
quarter requiring shipment, and if a new customer, the implementation of the
licensed product. The sales cycle is typically lengthy for a new licensed
customer and less time for an existing customer. Revenue recognition for service
contracts requires the acceptance


                                       17
<PAGE>

and sign off from a customer. The amount of licensed product and service
backlogs at the end of a quarter is typically immaterial. We have historically
experienced increased revenues in the third fiscal quarter compared to the
preceding fiscal quarters. We also experience variations in product demand due
to customer budgetary constraints that may be imposed within a fiscal year.
Additionally, we may experience changes in product demand due to changes in
budgetary timelines. As a consequence, we experience difficulty in forecasting
license and service revenues, particularly at the beginning of the fiscal
quarter.

      We distribute products through Alliance Partners. Changes in the strategy,
product offering, financial condition, material changes in the sales force,
availability of hardware or software products, product defects and material
changes in customer support and changes in our relationships with our Alliance
Partners may affect product orders and revenues in any period(s).

      License revenue gross margins are substantially higher than other revenue
sources. The percentage of license revenues to the overall revenues in a fiscal
period may materially change the overall gross margins and profitability for any
period. Variations in expense levels compared to other periods may result in
changes in operating income within a fiscal period.

BECAUSE WE HAVE EXPERIENCED LOSSES WE MAY NEED ADDITIONAL WORKING CAPITAL TO
IMPLEMENT OUR BUSINESS PLAN.

      In the fiscal year ended March 31, 2004, we experienced a net loss from
operations of $2,324,000 For the First Half of Fiscal 2005, we experienced a
loss from operations of $495,000. This loss was funded partially through
additional equity offerings. As of September 30, 2004, we had $694,000 of cash
and a working capital deficit of $3,337,000 in comparison to $751,000 of cash
and a working capital deficit of $2,609,000 as of March 31, 2004. In the future,
we may need additional financing to operate our business and implement our
business plan.

      If additional funds are raised by issuance of equity securities, dilution
to our stockholders will result. There can be no assurances, however, that we
will be successful in obtaining funds from any equity sources. If additional
funds are not available, we may be forced to eliminate or curtail certain of our
projects, sell assets, take additional steps to conserve cash and modify
execution of our business plan, actions that may adversely affect our
operations.

EXECUTION OF OUR BUSINESS PLAN WILL REQUIRE EXPANSION OF OUR DIRECT SALES.

      Historically we have significantly relied on the indirect sales channel
for sales leads and product revenues. We have invested, and expect to continue
to invest, in the development and growth of a direct sales channel. To the
extent that we are not successful in such efforts, future revenue growth and
operating margins may be adversely affected.

OUR BUSINESS GREATLY DEPENDS ON INDIRECT SALES.

      We depend upon introductions to potential customers by companies with
which we maintain strategic alliances for a significant percentage of our sales.
Although we have written agreements with UNISYS, Xerox Corporation, Fuji-Xerox,
PFPC, Agfa, AscentMedia Group and other value added resellers, the agreements do
not require customer introductions nor do they provide for minimum required
purchases of our products. If any of the companies with which we maintain
strategic alliances decide not to refer potential customers to us, our sales may
be reduced and operating losses increased. In addition, there is no assurance
that we will be able to maintain our strategic alliances on current terms.

WE ARE DEPENDENT ON LICENSED TECHNOLOGY.

      We depend on certain software products that are licensed from third
parties which are embedded and used in our products. We believe that there are
replacement alternatives for such third party products; however, the
interruption of the availability of such products may have an adverse impact on
the delivery of our products. Additionally, we expect our third party vendors to
maintain and continually improve their products. To the extent that such
products became obsolete or inoperable with other industry standard
applications, we may experience an adverse effect on revenues, operating results
and a decrease in customer satisfaction.


                                       18
<PAGE>

WE HAVE CHANGED THE NAME OF THE COMPANY.

      On October 28, 2004 at the Annual Stockholder Meeting, the stockholders
approved to change the name of the company to ClearStory Systems, Inc. effective
upon such approval. We believe that the name change better reflects our current
positioning within the Enterprise Content Management ("ECM") market. The name
change will require increased expense for legal matters, and promotional,
marketing and communication materials. To the extent that the name change causes
confusion within our target market or client base, we may experience a decrease
in revenues and/or an increase in overall expenses.

WE HAVE INITIATED A NEW PRODUCT BRANDING.

      We have initiated an effort to establish a common brand within the ECM
market. We plan to introduce an alternative naming convention and replace the
existing ESP and ActiveMedia names. The name change will require increased
expense for legal matters, and, promotional, marketing and communication
materials. To the extent that the name change causes confusion within our target
market or client base, we may experience a decrease in revenues and/or an
increase in overall expenses.

WE ARE OFFERING OUR CUSTOMERS A HOSTED SOLUTION.

      We market our digital asset management application in a hosted data
center. The market for success with this model is not clearly demonstrated, and
market acceptance of the hosted center is not ensured. To the extent that we
experience technological problems or challenges, certain of our customers may
seek a market alternative, which may limit market adoption of the hosted model.

      Furthermore, we have transitioned the hosted model from an outside third
party to an in-house solution. To the extent that the estimated cost savings are
not realized or difficulties arise from such a transition, the business may
suffer certain consequences.

OUR PRODUCTS AND SERVICES ARE DEPENDENT ON INTERNET ACCEPTANCE, ACCESSIBILITY,
INFRASTRUCTURE AND SECURITY.

      We have developed and realized revenues from our Internet-based products
and related services. The Internet is a recent product delivery platform, and as
such, is characterized by rapid technology changes, evolving standards and
adoption rates. Future revenues and services are dependent upon the acceptance
of the Internet as a recognized method of conducting business.

      The accessibility of the Internet has expanded over the last several
years. Technology enhancements and improvements have accelerated the
availability of Internet access. To the extent that continued developments in
communications, communication standards, availability and accessibility do not
continue to expand, the rate of adoption may decline. Additionally, the
expansion of the Internet as a commercial communications platform typically
requires continued capital investment and infrastructure support. To the extent
that capital investment declines or funding for Internet-based programs is
reduced, the accessibility and necessary supporting infrastructure may reduce
the adoption and performance of the Internet.

      If there is an increase in the use of the Internet, or no increase in
bandwidth, the infrastructure may not be able to effectively support demand and
result in a degradation of commercial acceptance. Reduced response times may
also affect the acceptance of the Internet.

RAPID TECHNOLOGY CHANGES IN OUR INDUSTRY MAY ADVERSELY AFFECT OUR BUSINESS.

      Our business is subject to technological advances and possible product
obsolescence. The market for our products is characterized by rapidly changing
technology, intense competition, technological complexity and evolving industry
standards. We must insure that our products are compatible with those products
offered by third-party vendors, including server platforms for our software and
various storage devices and platforms. We have no contracts with third-party
vendors; therefore, there is no assurance that we will be able to make our
software products compatible with new products that are introduced by others.


                                       19
<PAGE>

WE HAVE RECENTLY RELEASED THE NEXT GENERATION OF OUR PRODUCT.

      We recently announced the release of a next generation of applications
based upon a J2EE three-tier architecture. We have also embraced a Web services
technology model for the user interfaces and API. There can be no assurance that
such technologies will not be replaced by more contemporary offerings in the
marketplace.

      The market acceptance of the architecture and related applications cannot
be ensured. To the extent that we experience certain product issues or that
acceptance is limited, we may incur increased expense to maintain additional
product lines and may not realize anticipated savings with the technology model.
The performance and market adoption of this platform may alter future product
development strategies which may result in delays to subsequent product
introductions. In addition, customers may delay upgrading and migrating to new
products. As a result of the above, we may experience reduced revenues and
increased expenses in future periods.

QUALITY ASSURANCE AND PRODUCT STABILITY.

      We have invested to establish a Quality Assurance function to limit
certain errors, omissions and support incidents. While we believe that we have
implemented industry standards and procedures to minimize issues, there can be
no assurance that released versions of the product will not contain certain
issues, the consequence of which cannot be fully determined.

WE DEPEND ON PROPRIETARY TECHNOLOGY, WHICH IS NOT PROTECTED BY PATENTS.

      Our business depends on proprietary software technology for which we have
no patent protection. Although we require our employees and others to whom we
disclose proprietary information to sign non-disclosure agreements, this
protection may not be sufficient. Our business will be adversely affected if
anyone improperly uses or discloses our proprietary software or other
proprietary information.

      We do not hold any patents and rely on copyright and trade secret laws,
non-disclosure agreements and contractual provisions to protect our proprietary
technology. These methods afford only limited protection. Despite the
precautions we take, unauthorized parties may attempt to copy or otherwise
obtain and use our proprietary technologies, ideas, know-how and other
proprietary information without authorization or may independently develop
technologies similar or superior to our technologies. Policing unauthorized use
of our products may be difficult and costly. Also, the laws of some foreign
countries do not protect our proprietary rights as much as the laws of the
United States. We are unable to predict whether our means of protecting our
proprietary rights will be adequate.

      We believe that our technologies have been developed independent of
others. Nevertheless, third parties may assert infringement claims against us
and our technologies may be determined to infringe on the intellectual property
rights of others. We could become liable for damages, be required to modify our
technologies or obtain a license if our technologies are determined to infringe
upon the intellectual property rights of others. We may not be able to modify
our technologies or obtain a license in a timely manner, if required, or have
the financial or other resources necessary to defend an infringement action. We
would be materially adversely affected if we fail to do any of the foregoing.

AS WE MIGRATE OUR BUSINESS MODEL TO A RECURRING REVENUE STREAM WE MAY EXPERIENCE
CERTAIN QUARTERLY REVENUE DEGRADATION.

      As we attempt to expand the hosting model we may experience certain
increased costs to establish the hosting services center. Furthermore there can
be no assurance that market adoption and revenue realization will cover such
costs. As a consequence, we may experience negative cash flows from the
establishment and implementation of such a strategy. The establishment of such a
strategy is capital intensive and requires certain management skills that we
must develop or acquire.


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<PAGE>

AS A CONSEQUENCE OF THE REVERSE STOCK SPLIT WE MAY EXPERIENCE SHAREHOLDER
LIQUIDITY ISSUES.

      We implemented a reverse stock split of 1:10 on January 2, 2004. As a
result, the freely traded number of shares on the OTC bulletin board has been
substantially reduced. This may give rise to certain liquidity issues relative
to the freely traded common stock. This may impair the ability to achieve
liquidity within certain periods of trading. The average daily trading volume
for the 30-day trading period ended November 1, 2004 is 4,163 shares of common
stock.

BECAUSE OF THE HIGH COST, WE LACK PRODUCT LIABILITY INSURANCE.

      We develop, market, install and service electronic information and
document management systems. Failure of our products may result in a claim
against us. Because of the high cost of product liability insurance, we do not
maintain insurance to protect against claims associated with the use of our
products. Any claim against us may result in costs to us in defending
litigation. Further, any claim may require management's time and the use of our
resources.

WE DEPEND UPON CERTAIN KEY EMPLOYEES TO DEVELOP OUR PRODUCTS.

      We do not have the financial resources to compete with larger more
established companies to attract and retain certain key technological employees.
The loss of current technological employees or our inability to recruit and
retain employees with certain key technology skills will have an adverse effect
on product development and our business.

THE MEMBERS OF OUR BOARD OF DIRECTORS OWN A SIGNIFICANT PERCENTAGE OF OUR COMMON
STOCK AND CAN INFLUENCE MATTERS REQUIRING THE VOTE OF SHAREHOLDERS.

      As of September 15, 2004, our directors and officers beneficially owned,
as defined by the SEC, approximately 16.8 million shares of common stock,
representing 78.3% of the outstanding common stock. Based on their ownership,
our directors and officers have the ability to influence matters requiring a
stockholder vote, including the election of directors, the amendment of charter
documents, the merger or dissolution of our Company and the sale of all or
substantially all of our assets. Their voting power also may discourage or
prevent any proposed takeover.

OUR INABILITY TO RAISE ADDITIONAL CAPITAL ON ACCEPTABLE TERMS IN THE FUTURE MAY
LIMIT OUR GROWTH.

      If our capital resources become insufficient to meet future requirements,
we will have to raise additional funds to continue the operations, development
and commercialization of our technologies. Our inability to raise capital would
seriously harm our business and development efforts. In addition, we may choose
to raise additional capital due to market conditions or strategic considerations
even if we believe we have sufficient funds for our current or future
operations. These funds may not be available on favorable terms, or at all. If
adequate funds are not available on attractive terms, we may have to restrict
our operations significantly or obtain funds by entering into agreements on
unattractive terms. Further, to the extent that additional capital is raised
through the sale of equity or convertible debt securities, the issuance of these
securities could result in dilution to our stockholders.

OUR EXISTING COMMON STOCK SHAREHOLDERS FACE SUBSTANTIAL DILUTION UPON THE
CONVERSION OF OUR OUTSTANDING SERIES B CONVERTIBLE PREFERRED STOCK AND SERIES C
CONVERTIBLE PREFERRED STOCK.

      Our stock is traded on the Over the Counter Bulletin Board (OTCBB) under
the symbol "CSYS". As of October 22, 2004 we have 5,992,287 common shares
outstanding. The Company's Series B Convertible Preferred Stock is convertible
into approximately 8,634,000 shares of common stock. The Company's Series C
Convertible Preferred Stock is convertible into approximately 6,120,000 shares
of common stock.


                                       21
<PAGE>

THE POTENTIAL ISSUANCE OF ADDITIONAL SHARES OF PREFERRED STOCK MAY NEGATIVELY
AFFECT THE MARKET PRICE OF OUR COMMON STOCK AND SHAREHOLDER RIGHTS.

      Our certificate of incorporation empowers the board of directors with the
right to determine the designations, rights, preferences and privileges of the
holders of one or more series of preferred stock. The board of directors can
issue, without stockholder approval, preferred stock with voting, dividend,
conversion, liquidation or other rights, which could adversely affect the voting
power and equity interest of common stock holders.

BECAUSE OF CERTAIN PROVISIONS IN OUR BY-LAWS, CHANGE IN CONTROL MAY BE
DIFFICULT.

      Our by-laws and the Delaware General Corporation Law contain provisions
including a shareholders rights plan that may make a change in control more
difficult or delay attempts by others to obtain control of us, even when this
may be in the interests of stockholders. The Delaware General Corporation Law
also imposes conditions on certain business combinations with "interested
stockholders", as defined by Delaware law. Under certain agreements with key
personnel, we also have provided stock options in the event of a change of
control and a termination of those employment agreements without cause.
Additionally, we have provided that if a change of control occurs, certain
directors will receive immediate vesting of stock options granted under our 1992
Directors Option Plan. Change of control shall occur, in this instance, if a
majority of the directors elected at any Annual Meeting are persons other than
those nominated by management in the proxy statement distributed for such Annual
Meeting.

ITEM 3. CONTROLS AND PROCEDURES

      As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer who also serves as President and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures, as defined in Exchange Act Rule 15(d)-15(e).
Based upon that evaluation, we believe that our disclosure controls and
procedures are effective in enabling us to record, process, summarize and report
information required to be included in our periodic SEC filings within the
required time period. Our disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed by us in the periodic reports filed with the SEC is accumulated
and communicated to our management, including our principal executive and
financial officers, or persons performing similar functions, as appropriate to
allow timely decisions regarding required disclosure.

      During the fiscal quarter covered by this report, there have been no
significant changes in internal control over financial reporting that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.


PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

      The Company is a defendant in an action commenced on May 16, 2003 by
Lason, Inc. ("Lason") in the United States Bankruptcy Court for the District of
Delaware. The Lason action is seeking the return of certain pre-petition
payments made prior to the bankruptcy petition of Lason in the amount of
approximately $121,000. The Company is contesting the action and has asserted a
number of affirmative defenses to the action.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

      On September 22, 2004, the Company amended its Series C Convertible
Preferred Stock Purchase Agreements dated as of September 9, 2003 and December
31, 2003 with SCP Private Equity Investors II, LP ("SCP") and CSSMK, LLC
("CSSMK"), respectively, whereby the Company sold an additional 180,450 shares
of Series C Convertible Preferred Stock ("Series C Preferred") at $1.9396 per
share to SCP for the sum of $350,000 and sold an additional 51,557 shares of
Series C Preferred to CSSMK at $1.9396 per share for the sum of $100,000.


                                       22
<PAGE>

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

      On October 28 2004, at our annual meeting of stockholders, the
stockholders elected as directors, each to serve until the next annual meeting
of stockholders, the following individuals: Yaron I, Eitan (15,399,994 shares
for; 250,823 shares withheld) Henry F. Nelson (15,399,994 shares for; 250,823
shares withheld) Francis X. Murphy (15,399,994 shares for; 250,823 shares
withheld) Derek Dunaway (15,399,994 shares for; 250,823 shares withheld)
Mitchell Klein (15,399,994 shares for; 250,823 shares withheld) Amit Avnet
(15,399,994 shares for; 250,823 shares withheld) Steven Morgenthal (15,399,994
shares for; 250,823 shares withheld) Adi Raviv (15,399,994 shares for; 250,823
shares withheld) George Calhoun (15,399,994 shares for; 250,823 shares withheld)
and Thomas G. Rebar (15,399,994 shares for; 250,823 shares withheld).

      A proposal to ratify Goldstein & Morris, Certified Public Accountants, PC
as the Company's independent auditors for the fiscal year ended March 31, 2004
was approved (12,461,638 shares for, 6,215 shares against, 3,182,964 withheld).

      A proposal to approve the 2004 Directors' Option Plan authorizing 800,000
shares of common stock was approved (12,682,355 shares for, 358,238 shares
against, 33,010 withheld).

      A proposal to amend the Company's Article of Incorporation to change its
corporate name to ClearStory Systems, Inc. was approved (15,624,588 shares for,
13,489 shares against, 12,740 withheld).


ITEM 6. EXHIBITS

      (A) EXHIBITS

            Exhibit 31.1 *    Certification pursuant to 18 U.S.C. Section 1350
                              as adopted pursuant to Section 302 of the
                              Sarbanes-Oxley Act of 2002
            Exhibit 32.1 *    Certification pursuant to 18 U.S.C. Section 1350
                              as adopted pursuant to Section 906 of the
                              Sarbanes-Oxley Act of 2002

* Annexed hereto


                                    SIGNATURE

      Pursuant to the requirements 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.

                                         CLEARSTORY SYSTEMS, INC.


Date:  December 13, 2004             By: /S/ HENRY F. NELSON
                                         --------------------------------------
                                         Henry F. Nelson
                                         Chief Executive Officer, President and
                                         Chief Financial Officer


                                       23
<PAGE>

                                  EXHIBIT INDEX

EXHIBIT
NUMBER                                  DESCRIPTION
-------     --------------------------------------------------------------------

31.1        Certification Pursuant to Rule 13(a)-14(a) or Rule 15d-14(a).

32.1        Certification Pursuant to 18 U.S.C Section 1350, as Adopted Pursuant
            to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished
            herewith).


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