**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

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**FORM 10-QSB**

 
| **ý** | ** ** | **Quarterly  Report pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934 For the quarterly period ended: December 31, 2005**                                                                                                                                                                                                                                                                                                                                                                     |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| **o**      | ** ** | **Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934 For the Transition period from                                  to                                 ** |

 

**Commissionfile number: 1-12966**

 

**ClearStory Systems, Inc.**

(Exact name of small businessissuer as specified in its charter)

 
| **Delaware**              | ** ** | **06-1302773**                        |
|---------------------------|------------|---------------------------------------|
| (State of  incorporation) |       | (IRS  employer identification number) |

 

**OneResearch Drive, Suite 200BWestborough, MA 01581**(Address of principal executive offices)

 

Issuer’s telephone number, includingarea code: **(508) 870-4000**

 

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

Yes  ý    No  o

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act)

Yes  o    No  ý

 

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

 
| **Title of Each Class**      | ** ** | **Outstanding February 10,  2006** |
|------------------------------|------------|-----------------------------------------|
| Common Stock, par value $.10 |       | 5,992,287                               |

 

Transitional Small Business Disclosure Format (check one)

Yes  o    No  ý

 

 

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**ClearStorySystems, Inc.**

 

###### **INDEX**

 
| **PART I**                                                                                                                        | **FINANCIAL INFORMATION**                                       | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------|------------|
|                                                                                                                              |                                                            |       |
| Item 1.                                                                                                                           | Financial Statements                                            |       |
|                                                                                                                              |                                                            |
| Condensed Consolidated Balance Sheet as of  December 31, 2005 (Unaudited) and March 31, 2005                            |                                                            |
|                                                                                                                              |                                                            |
| Condensed Consolidated Statements of  Operations for the Three and Nine Months Ended December 31, 2005 and  2004 (Unaudited) |                                                            |
|                                                                                                                              |                                                            |
| Condensed Consolidated Statements of Cash  Flows for the Nine Months Ended December 31, 2005 and 2004 (Unaudited)            |                                                            |
|                                                                                                                              |                                                            |       |
| Notes to Condensed Consolidated Financial Statements                                                                              |                                                            |
|                                                                                                                              |                                                            |       |
| Item 2.                                                                                                                           | Management’s Discussion and Analysis or  Plan of Operation |       |
|                                                                                                                              |                                                            |       |
| Item 3.                                                                                                                           | Controls and Procedures                                         |       |
|                                                                                                                              |                                                            |       |
|                                                                                                                              |                                                            |       |
| **PART II**                                                                                                                  | **OTHER  INFORMATION**                                          |       |
|                                                                                                                              |                                                            |       |
| Item 6.                                                                                                                           | Exhibits                                                        |       |
|                                                                                                                              |                                                            |       |
|                                                                                                                              | Signature                                                       |       |
|                                                                                                                                   |                                                                 |            |  |  |

 

2

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**ClearStory Systems, Inc.CONDENSED CONSOLIDATED BALANCE SHEET**

(Inthousands)

 
| ** **                                               | ** ** | **December 31,  2005** | ** ** | **March 31,  2005** | ** ** |
|----------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| **ASSETS**                                               | ** ** | ** **                  | ** ** | ** **               | ** ** |
| Current assets:                                          |       |                        |       |                     |       |
| Cash and cash equivalents                                |       | $                           | 55         |                     | $          | 849 |   |
| Accounts receivable, net                                 |       | 1,010                       |       | 917                      |       |
| Prepaid expenses and other current assets                |       | 473                         |       | 439                      |       |
| Total current assets                                     |       | 1,538                       |       | 2,205                    |       |
|                                                     |       |                        |       |                     |       |
| Property and equipment, net                              |       | 1,108                       |       | 1,439                    |       |
| Capitalized software, net                                |       | 1,608                       |       | 1,852                    |       |
| Goodwill                                                 |       | 1,223                       |       | 1,223                    |       |
| Other assets                                             |       | 631                         |       | 186                      |       |
|                                                     |       | $                           | 6,108      |                     | $          | 6,905 |   |
|                                                     |       |                        |       |                     |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**            | ** ** | ** **                  | ** ** | ** **               | ** ** |
| Current liabilities:                                     |       |                        |       |                     |       |
| Accounts payable and accrued expenses                    |       | $                           | 2,145      |                     | $          | 2,665 |   |
| Advances against accounts receivable sold  with recourse |       | 918                         |       | 606                      |       |
| Revolving credit facility                                |       | 1,500                       |       | —                   |       |
| Deferred revenue                                         |       | 2,590                       |       | 2,527                    |       |
| Capital leases, current portion                          |       | 141                         |       | 115                      |       |
| Total current liabilities                                |       | 7,294                       |       | 5,913                    |       |
|                                                     |       |                        |       |                     |       |
| Long term liabilities:                                   |       |                        |       |                     |       |
| Deferred rent                                            |       | 468                         |       | 494                      |       |
| Capital leases, net of current portion                   |       | 23                          |       | 112                      |       |
| Total long term liabilities                              |       | 491                         |       | 606                      |       |
|                                                     |       |                        |       |                     |       |
| Commitments and contingencies                            |       |                        |       |                     |       |
|                                                     |       |                        |       |                     |       |
| Stockholders’ equity:                               |       |                        |       |                     |       |
| Series B Convertible Preferred Stock                |       | 1                           |       | 1                        |       |
| Series C Convertible Preferred Stock                |       | 40                          |       | 37                       |       |
| 8% Convertible Preferred Stock                           |       | 1                           |       | 1                        |       |
| Common Stock                                             |       | 599                         |       | 599                      |       |
| Additional paid-in capital                               |       | 57,352                      |       | 56,139                   |       |
| Accumulated deficit                                      |       | (59,670                     | )          | (56,391                  | )          |
| Total stockholders’ equity (deficit)                |       | (1,677                      | )          | 386                      |       |
|                                                     |       | $                           | 6,108      |                     | $          | 6,905 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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**ClearStory Systems, Inc.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 

(In thousands,except per share amounts)

 
| ** **                                                       | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                                       | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue:                                                         |       |                                 |       |                                |       |   |   |   |   |
| Product                                                          |       | $                                    | 212        |                                | $          | 861 |   | $ | 1,318 |   | $ | 3,031 |   |
| Services                                                         |       | 1,900                                |       | 1,843                               |       | 4,782 |   | 5,233 |   |
|                                                             |       | 2,112                                |       | 2,704                               |       | 6,100 |   | 8,264 |   |
| Cost of revenues:                                                |       |                                 |       |                                |       |   |   |   |   |
| Product                                                          |       | 113                                  |       | 12                                  |       | 274 |   | 138 |   |
| Services                                                         |       | 737                                  |       | 841                                 |       | 2,203 |   | 2,604 |   |
|                                                             |       | 850                                  |       | 853                                 |       | 2,477 |   | 2,742 |   |
|                                                             |       |                                 |       |                                |       |   |   |   |   |
| Gross profit                                                     |       | 1,262                                |       | 1,851                               |       | 3,623 |   | 5,522 |   |
|                                                             |       |                                 |       |                                |       |   |   |   |   |
| Operating expenses:                                              |       |                                 |       |                                |       |   |   |   |   |
| Sales and marketing                                              |       | 524                                  |       | 802                                 |       | 1,838 |   | 2,260 |   |
| Product development                                              |       | 818                                  |       | 659                                 |       | 2,445 |   | 1,862 |   |
| General and administrative                                       |       | 522                                  |       | 717                                 |       | 1,727 |   | 2,168 |   |
|                                                             |       | 1,864                                |       | 2,178                               |       | 6,010 |   | 6,290 |   |
|                                                             |       |                                 |       |                                |       |   |   |   |   |
| Operating loss                                                   |       | (602                                 | )          | (327                                | )          | (2,387 | ) | (768 | ) |
|                                                             |       |                                 |       |                                |       |   |   |   |   |
| Interest expense, net                                            |       | (159                                 | )          | (94                                 | )          | (309 | ) | (148 | ) |
|                                                             |       |                                 |       |                                |       |   |   |   |   |
| Net loss                                                         |       | $                                    | (761       | )                                   | $          | (421 | ) | $ | (2,696 | ) | $ | (916 | ) |
|                                                             |       |                                 |       |                                |       |   |   |   |   |
| Net loss per share - basic and diluted                           |       | $                                    | (0.16      | )                                   | $          | (0.10 | ) | $ | (0.55 | ) | $ | (0.23 | ) |
|                                                             |       |                                 |       |                                |       |   |   |   |   |
| Weighted average common shares outstanding  -  basic and diluted |       | 5,992                                |       | 5,992                               |       | 5,992 |   | 5,992 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

4

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**ClearStory Systems, Inc.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                             | ** ** | **Nine Months Ended  December 31,** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                             | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| Cash flows from operating activities:                                  |       |                                |       |   |   |
| Net loss                                                               |       | $                                   | (2,696     | ) | $ | (916 | ) |
| Reconciliation of net loss to net cash  provided operating activities: |       |                                |       |   |   |
| Depreciation and amortization                                          |       | 736                                 |       | 395 |   |
| Deferred rent                                                          |       | (26                                 | )          | 277 |   |
| Changes in assets and liabilities:                                     |       |                                |       |   |   |
| Accounts receivable                                                    |       | (93                                 | )          | 42 |   |
| Prepaid expenses and other current assets                              |       | (34                                 | )          | (75 | ) |
| Other assets                                                           |       | 18                                  |       | 30 |   |
| Accounts payable and accrued expenses                                  |       | (681                                | )          | 495 |   |
| Deferred revenue                                                       |       | 63                                  |       | (15 | ) |
| Net cash provided by (used in) operating                               |       | (2,713                              | )          | 233 |   |
|                                                                   |       |                                |       |   |   |
| Cash flows from investing activities:                                  |       |                                |       |   |   |
| Capitalized software                                                   |       | —                              |       | (1,123 | ) |
| Capital expenditures                                                   |       | (40                                 | )          | (714 | ) |
| Net cash used in investing activities                                  |       | (40                                 | )          | (1,837 | ) |
|                                                                   |       |                                |       |   |   |
| Cash flows from financing activities:                                  |       |                                |       |   |   |
| Net advances from sale of receivables                                  |       | 312                                 |       | 412 |   |
| Proceeds from Revolving Credit Facility                                |       | 1,500                               |       | — |   |
| Proceeds from issuance of Note                                         |       | 750                                 |       | — |   |
| Repayment of Note                                                      |       | (750                                | )          | — |   |
| Proceeds from sale and leaseback of  equipment                         |       | —                              |       | 240 |   |
| Payments on capital leases                                             |       | (103                                | )          | (94 | ) |
| Proceeds from issuance of Series C  Preferred                          |       | 250                                 |       | 450 |   |
| Net cash provided by financing activities                              |       | 1,959                               |       | 1,008 |   |
|                                                                   |       |                                |       |   |   |
| Net decrease in cash                                                   |       | (794                                | )          | (596 | ) |
| Cash, beginning of period                                              |       | 849                                 |       | 751 |   |
| Cash, end of period                                                    |       | $                                   | 55         |   | $ | 155 |   |
|                                                                   |       |                                |       |   |   |
| Supplemental Disclosure of Cash Flow  Information:                     |       |                                |       |   |   |
| Series C Preferred Stock issued in  settlement of dividends            |       | $                                   | 421        |   | $ | 322 |   |
| Series C Preferred Stock warrants issued                               |       | 544                                 |       | — |   |
| Equipment purchased under capital leases                               |       | 40                                  |       | — |   |
| Cash interest paid                                                     |       | 222                                 |       | 111 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

5

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**ClearStory Systems, Inc.****Notes to Condensed Consolidated FinancialStatements****(Unaudited)**

 

**Nature of Business and Basis of Presentation**

 

ClearStory Systems, Inc. (the “Company” or “ClearStory”) is a provider of integrated enterprise contentmanagement (“ECM”) solutions.  ClearStory’sproven technology provides a solid foundation for managing the full spectrum ofenterprise content, from documents to e-mail, and graphics to video.  By bringing digital assets and businesscontent together with a unified Web services platform, ClearStory readilyenables content use in e-commerce, customer service, marketing content managementand regulatory compliance applications.

 

The consolidated financial statementsincluded in this report have been prepared by the Company, without audit,pursuant to the rules and regulations of the Securities and ExchangeCommission regarding interim financial reporting.  In addition, certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of Americahave been condensed or omitted pursuant to such rules and regulationsrelating to interim condensed financial statements.  However, the Company believes that thedisclosures contained herein are adequate to make the information presented notmisleading.  The financial statementsshould be read in conjunction with the financial statements and notes theretoincluded in the Company’s Annual Report on Form 10-KSB for the fiscal yearended March 31, 2005.  The resultsfor the three and nine months ended December 31, 2005 may not beindicative of the results that may be expected for the year ending March 31,2006 or for any other future period.

 

In the opinion of the management of theCompany, the accompanying unaudited financial statements reflect alladjustments that are necessary to present fairly the financial position of the Companyas of December 31, 2005 and the results of operations for the three andnine months ended December 31, 2005 and 2004 and cash flows for the ninemonths ended December 31, 2005 and 2004.

 

***Recently Issued Accounting Standards***

*** ***

In December 2004, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial Standards (“SFAS”)No. 123 (revised 2004), *Share-BasedPayment* (“SFAS No. 123(R)”), which is a revision of SFAS No. 123,Accounting for Stock-based Compensation (“SFAS No. 123”). SFAS No. 123(R)supersedes Accounting Principle Board Opinion (“APB”) No. 25, *Accounting for Stock Issued to Employees*,and amends FASB Statement No. 95, *Statementof Cash Flows.* Generally, the approach to accounting for share-basedpayments in SFAS No. 123(R) is similar to the approach described in SFAS No. 123.  However, SFAS No. 123(R) requires allshare–based payments to employees, including grants of employee stock options,to be recognized in the financial statements based on their fair values.  Pro forma disclosure of the fair value ofshare-based payments is no longer an alternative to financial statementrecognition.  SFAS No. 123(R) iseffective for small business issuers at the beginning of the first fiscal yearbeginning after December 15, 2005, or effective April 1, 2006 for theCompany.

 

The Company expects the adoption of SFAS No. 123(R)to have a material effect on its financial statements, in the form ofadditional compensation expense, on a quarterly and annual basis.  It is not possible to precisely determine theexpense impact of adoption since a portion of the ultimate expense that isrecorded will likely relate to awards that have not yet been granted, but arelikely to be granted prior to our April 1, 2006 adoption date.  The expense associated with these futureawards can only be determined based on factors such as the price for theCompany’s common stock, volatility of the Company’s stock price and risk freeinterest rates as measured at the grant date. However, the pro forma disclosures related to SFAS No. 123 includedin the Company’s historical financial statements are relevant data points forgauging the potential level of expense that might be recorded in futureperiods.

** **

**Earnings (Loss) Per Common Share**

 

Basic and diluted net earnings (loss) per share arepresented in conformity with SFAS No. 128, *Earnings PerShare*(“SFAS No. 128”),for all periods presented. In accordance with SFAS No. 128, basicnet earnings (loss)

 

6

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per common share was determinedby dividing net earnings (loss) applicable to common stockholders by theweighted average common shares outstanding during the period. Basic and dilutednet earnings (loss) per share are the same because all outstanding common stockequivalents have been excluded as they are anti-dilutive.

 

Reconciliation of the Company’s net loss tonet loss attributable to common shareholders is as follows:

 
| ** **                                    | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                    | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss -  as reported                       |       | $                                    | (761       | )                                   | $          | (421 | ) | $ | (2,696 | ) | $ | (916 | ) |
| Preferred  stock dividends                    |       | (200                                 | )          | (162                                | )          | (583 | ) | (458 | ) |
| Net loss  attributable to common shareholders |       | $                                    | (961       | )                                   | $          | (583 | ) | $ | (3,279 | ) | $ | (1,374 | ) |

 

## ** **

For the three and nine months ended December 31,2005 and 2004, approximately 20.9million and 17.1 million shares, respectively, from stock options, warrants andconvertible securities were excluded due to their anti-dilutive effect.

 

## **Stock-Based Compensation**

## ** **

The Company has elected to follow 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 exerciseprice of employee stock options is equal to or greater than the market price ofthe underlying stock on the date of grant no compensation expense isrecorded.  The Company disclosesinformation relating to the fair value of stock-based compensation awards inaccordance with SFAS No. 123.

 

The Company computed the pro forma disclosuresrequired under SFAS No. 123 for all stock options granted to employees anddirectors of the Company as of December 31, 2005 and 2004, using the Black-Scholesoption pricing model prescribed by SFAS No. 123.

 

## **The effect of applying SFAS No. 123 would be asfollows:**

 
| ** **                                     | ** ** | **Three Months Ended  December 31,**      | ** ** | **Nine Months Ended  December 31,** | ** ** |
|------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                  | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                     | ** ** | **(In thousands, except per share data)** | ** ** |
| Net loss  attributable to common shareholders: |       |                                      |       |                                |       |   |   |   |   |
| As reported                                    |       | $                                         | (961       | )                                   | $          | (583 | ) | $ | (3,279 | ) | $ | (1,374 | ) |
| Pro forma - SFAS 123                           |       | $                                         | (1,031     | )                                   | $          | (648 | ) | $ | (3,537 | ) | $ | (1,701 | ) |
|                                           |       |                                      |       |                                |       |   |   |   |   |
| Basic and  diluted net loss per share:         |       |                                      |       |                                |       |   |   |   |   |
| As reported                                    |       | $                                         | (0.16      | )                                   | $          | (0.10 | ) | $ | (0.55 | ) | $ | (0.23 | ) |
| Pro forma - SFAS 123                           |       | $                                         | (0.17      | )                                   | $          | (0.11 | ) | $ | (0.59 | ) | $ | (0.28 | ) |

 

## **Advances against Receivables Sold with Recourse**

 

On November 2, 2004,the Company entered into a factoring agreement (“Factoring Agreement”) withBenefactor Funding Corporation (“Benefactor”), which replaced its existingfinancing agreement with another financing company.  Pursuant to the Factoring Agreement, theCompany sells certain accounts receivable to Benefactor at a purchase price,for each accepted account, equal to (i) 98.75% of the face amount of theapplicable account receivable less (ii) Benefactor’s fees and the amountof any trade or cash discounts, credits or allowances, set-offs or any otherapplicable reductions or adjustments. The Company has also granted Benefactor asecurity interest in all of the Company’s assets to secure the payment andperformance of all obligations under the Factoring Agreement.

 

7

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**10%Convertible Promissory Note**

 

On June 16, 2005, the Company, issued a 10%Convertible Promissory Note (the “Note”) to SCP Private Equity Partners II,L.P. (“SCP”). The Note was issued in the amount of $750,000, and was payable ondemand at any time. Pursuant to the terms of the Note, the Note was convertibleupon demand into up to 386,678 shares of the Company’s Series CConvertible Preferred Stock, par value $.01 per share (“Series C Preferred”)or other equity securities of the Company. The Note could be pre-paid by theCompany at any time without penalty.  On September 8,2005, the Company utilized borrowings from its Revolving Credit Facility torepay the Note.

 

**RevolvingCredit Facility**

 

On August 25, 2005,the Company entered into a Loan and Security Agreement (“Revolver’) withSilicon Valley Bank (“SVB”) which provided for the Company to borrow up to$1,500,000 for general corporate purposes for two years at the prime interestrate plus 0.5%, payable monthly.  TheCompany granted SVB a third security interest in all of the Company’s assets tosecure the payment and performance of all of its obligations under theRevolver. The Revolver also contains certain financial covenants and wasguaranteed by SCP.  In consideration forthe guarantee by SCP, the Company issued a warrant to SCP to purchase 232,007shares of Series C Preferred at $1.9396 per share. The term of the warrantexpires on August 25, 2015.  The Companyhas valued the warrant at $408,000 utilizing the Black-Scholes option pricingmodel.  The Company will amortize thiscost along with $41,000 of legal and other fees incurred over the term of theRevolver.  On September 8, 2005, theCompany utilized borrowings under the Revolver to repay its Note with SCP.

 

Based upon the results for the three months ended September 30,2005 and its outlook for the remainder of the year, the Company was inviolation of its financial covenants set forth in the Revolver.  On November 28, 2005, the Company andSVB entered into an amendment (the “Amendment”) to the Revolver to increase theCompany’s maximum borrowing amount under the line of credit to $2,000,000 andto eliminate the financial covenants from the Revolver. The Company’s obligations under the expandedRevolver continue to be guaranteed by SCP. Inconsideration for the expanded guarantee by SCP, the Company issued anadditional warrant to SCP to purchase 77,336 shares of Series CPreferred at $1.9396 per share. The term of the warrant expires on November 28,2015.  The Company has valued thiswarrant at $136,000 utilizing the Black-Scholes option pricing model.  The Company will amortize this cost over theremaining term of the Revolver.

 

**Series C****Convertible Preferred Stock**

 

On January 28, 2005,the Company entered into a Series C Convertible Preferred Stock PurchaseAgreement with SCP and CSSMK, LLC (“CSSMK”), whereby the Company sold 257,785shares of Series C Preferred at $1.9396 per share to SCP for the sum of$500,000 and sold an additional 51,557 shares of Series C Preferred toCSSMK at $1.9396 per share for the sum of $100,000.  Pursuant to the agreement, SCP, or at thediscretion of SCP, CIP Capital LP (“CIP”), agreed to purchase a minimum of77,336 additional shares of Series C Preferred at $1.9396 per share forthe sum of $150,000, on or before April 15, 2005 (the “Second Closing”).  In addition, SCP could, at its solediscretion, expand the number of shares to be purchased at the Second Closingto a maximum of 128,893 shares of Series C Preferred for $250,000.  SCP elected to purchase 128,893 shares of Series CPreferred for $250,000 on April 15, 2005.

 

For the nine months endedDecember 31, 2005, the Company issued a total of 63,146 shares of Series CPreferred in settlement of dividends of $122,000 on its Series BConvertible Preferred Stock (“Series B Preferred”).  The Company also issued 154,261 shares of Series CPreferred in settlement of dividends of $299,000 on its Series C PreferredStock.  The Company has recorded anadditional $208,000 in accrued dividends associated with its Series BPreferred and Series C Preferred at December 31, 2005.

 

**Liquidity**

 

As of December 31, 2005, the Company hada cash balance of $55,000, the ability to sell certainaccounts receivable for additional funds of approximately $146,000pursuant to its Factoring Agreement and $500,000 of available funds under itsRevolver.  Based upon the Company’scurrent operating outlook for the remainder of the

 

8

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current fiscal year and thefirst half of fiscal 2007, the Company needs additional financial resources tomeet its short term liquidity requirements, especiallyfor intra-quarter liquidity requirements that depend on the timing and amountof monthly cash receipts that are anticipated by its current operating outlook.Additionalfinancing could take the form of equity or debt offerings, spin-offs, jointventures or other collaborative relationships that may require the Company toissue shares or share revenue.  Since its acquisition of WebWare in September 2003, theCompany has incurred operating losses and negative cash flows which havehistorically been funded through the issuance of additional capital from itsmajor stockholders. Based upon its latest operating outlook, the Companyexpects to incur losses for the remaining quarter of the current fiscal yeardue in part to significant investments in its direct sales and marketingefforts, the establishment of new sales distribution channels and thedevelopment and release of its products. There can be no assurances that the Company will be able to achieverevenue levels or sufficiently reduce expenses to allow the Company to becomeprofitable without detrimentally affecting its long-term revenues or marketposition.  Additionally, the Companyalready has a working capital deficit of $5,756,000 as of December 31,2005, compared to a working capital deficit of $3,708,000 as of March 31,2005, which increases the need for the Company to successfully execute anddeliver on its current business plan. The Company expects its working capital deficit to increase, as theCompany anticipates incurring operating losses for the remaining quarter offiscal 2006 and the first half of fiscal 2007. In the event that the Company’splans or assumptions change or prove to be inaccurate (due to revenueshortfalls, unanticipated expenses, difficulties, delays or otherwise), theCompany may have insufficient funds to support its operations. Over the pastseveral years, the Company has been successful in raising additional funds fromits major shareholders, and these funds have allowed the Company to continue tomake certain strategic investments. However, the Company’s ability to garner continued financial supportfrom these, or other investors, should the need arise, cannot be assured.

 

**Geographic Information**

 

The Company operates as a single reportable segment asa developer and distributor of software solutions for the ECM market.

 

Revenue was derived from customers in thefollowing geographic areas:

 
| ** **     | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,** | ** ** |
|----------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **     | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| North  America |       | $                                    | 1,844      |                                | $          | 2,323 |   | $ | 5,372 |   | $ | 7,302 |   |
| Europe         |       | 122                                  |       | 291                                 |       | 405 |   | 679 |   |
| Other          |       | 146                                  |       | 90                                  |       | 323 |   | 283 |   |
|           |       | $                                    | 2,112      |                                | $          | 2,704 |   | $ | 6,100 |   | $ | 8,264 |   |

 

9

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**Item 2.****    Management’sDiscussion and Analysis or Plan of Operations**

 

***The following discussion ofresults of operations for the three months (“Third Quarter of Fiscal 2006”) andthe nine months (“First Three Quarters of Fiscal 2006”) ended December 31,2005 and the three months (“Third Quarter of Fiscal 2005”) and the nine months(“First Three Quarters of Fiscal 2005”) ended December 31, 2004 and thediscussion of the Company’s financial condition at December 31, 2005should be read in conjunction with the financial statements and the relatednotes thereto included elsewhere in this Form 10-QSB and the auditedfinancial statements and notes thereto and Management’s Discussion and Analysisof Financial Condition and Results of Operations included in our Annual Reporton Form 10-KSB for the year ended March 31, 2005, which has beenfiled with the Securities and Exchange Commission (the “SEC”).  The following discussion containsforward-looking statements that reflect our business, plans, estimates andbeliefs.  Our results could differmaterially from those discussed in the forward-looking statements***.

 

We were founded to capture andpreserve high volumes of mission critical business information.  Our product offering includes web-basedpresentment capabilities for documents such as bank statements, 401(k)statements, customer and vendor statements, explanation of benefits (“EOB”)statements, and transaction confirmation documents.  We have expanded our product offerings toinclude e-mail archiving and notification capabilities as well as the abilityto capture, store and deliver high value digital assets such as video, voice ondemand, graphics and presentations subsequent to our acquisition of certainassets and liabilities of WebWare Corp. on September 5, 2003.  These offerings provide our customers withthe ability to improve internal communication, enhance productivity andincrease customer satisfaction and communication.  With the March 2005 release of RadiantEnterprise Media Server (“Radiant EMS”), our next generation software platform,coupled with our ActiveMedia product offerings, we have substantially expandedour digital archive and rich media asset management capabilities and supportbusiness efforts such as video and voice on demand, and brand and channelmanagement.

 

We distribute our products through a combination ofour direct sales force and through our Alliance Partners.  Revenue is net of discounts and allowancesgiven to our Alliance Partners.  Wealso market and license our products on an international basis through ourAlliance Partners.  We havereseller relationships with Unisys, and Xerox Global Services, and originalequipment manufacturer (“OEM”) agreements with Agfa Corporation and SunguardShareholder Systems, Inc. In addition, on March 30, 2005, we signedan agreement with IBM, representing a new distribution opportunity for ourrecently released platform, Radiant EMS. We considerthe development of a successful Alliance Partner program as a key element forour future growth. In Fiscal 2005, we derived approximately 46% of our totalrevenues from our Alliance Partners.  Salesto new end-users generally include a software license, professional services,and maintenance contracts.  Additionally,our Radiant EMS and Active Media products are also offered under a hostingcontract pursuant to which we are an application service provider (“ASP”).  ASP sales typically include monthly recurringrevenues that are recognized as earned.

 

## **Significant Accounting Policies**

## ** **

Financial Reporting Release No. 60,which was recently issued by the SEC, requires all registrants to discusscritical accounting policies or methods used in the preparation of the financialstatements. The notes to the consolidated financial statements included in ourAnnual Report on Form 10-KSB for the year ended March 31, 2005includes a summary of the significant accounting policies and methods used inthe preparation of our consolidated financial statements, the most significantof which are revenue recognition, capitalization of software, and income taxes.

 

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

 

10

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

 

**RESULTS OF OPERATIONS**

 

**Third Quarter of Fiscal 2006 Compared toThird Quarter of Fiscal 2005:**

 

**Revenues**

 

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

 
| ** **                                 | ** ** | **Three Months Ended December 31,** | ** ** |
|--------------------------------------------|------------|-------------------------------------|------------|
| ** **                                 | ** ** | **2005**                            | ** ** | **2004** | ** ** | **% Change** | ** ** |
| Product  revenues                          |       | $                                   | 212        |   | $ | 861 |   | -75 | % |
| Professional  services                     |       | 661                                 |       | 436 |   | 52 | % |
| Maintenance  and hosting contract revenues |       | 1,239                               |       | 1,407 |   | -12 | % |
| Total revenues                             |       | $                                   | 2,112      |   | $ | 2,704 |   | -22 | % |

 

Revenues for the Third Quarter of Fiscal 2006decreased by $592,000, or 22%, to $2,112,000 as compared to revenues of$2,704,000 for the Third Quarter of Fiscal 2005.  Product revenues decreased by $649,000, or 75%,to $212,000 in the Third Quarter of Fiscal 2006 as compared to $861,000 in theThird Quarter of Fiscal 2005.  Thedecrease in product revenues was primarily attributable to lower revenueassociated with Radiant BDS as well as a decrease in our ActiveMedia andRadiant EMS products primarily as a consequence of our product transition fromActiveMedia 5.5  to ActiveMedia 7.0.Professional service revenues increased by $225,000, or 52%, to $661,000 in theThird Quarter of Fiscal 2006 as compared to $436,000 in the Third Quarter ofFiscal 2005.  An increase in professionalservice revenue was due to the completion of several projects with both new andexisting customers.  Maintenance andhosting revenues decreased by $168,000, or 12%, to $1,239,000 in the ThirdQuarter of Fiscal 2006 as compared to $1,407,000 in the Third Quarter of Fiscal2005. The decrease in maintenance and hosting revenues was due primarily to adecline in hosting revenues as a large hosting customer moved its applicationin-house.

 

**Gross Profit**

 

Gross profit for the Third Quarter of Fiscal 2006decreased by $589,000, or 32%, to $1,262,000 as compared to gross profit of$1,851,000 for the Third Quarter of Fiscal 2005.  The decrease in gross profit is related tothe decrease in product and service revenue as discussed above.  Gross margin percentage decreased to 60% forthe Third Quarter of Fiscal 2006 from 68% for the Third Quarter of Fiscal 2005.The decrease in the gross margin percentage was primarily the result of lowerproduct revenue, which has higher gross profit margins, and the amortization ofsoftware development costs of $79,000 primarily associated with the developmentof the Radiant EMS product we recently released.  The gross profit decrease was offset byhigher margins associated with professional services.

 

**Sales and Marketing**

 

Sales and marketing expenses for the Third Quarter ofFiscal 2006 decreased by $278,000, or 35%, to $524,000, as compared to $802,000for the Third Quarter of Fiscal 2005. The decrease is primarily due to lowercommissions earned due to the decline in revenues and in lower marketing costsfrom those incurred in the Third Quarter of Fiscal 2005 associated with there-branding of our suite of products along with our company name change toClearStory.

 

Sales and marketing expenses expressed as a percentageof sales decreased to 25% in the Third Quarter of Fiscal 2006 compared to 30%in the Third Quarter of Fiscal 2005, primarily due to a decrease in marketingrelated costs.

 

11

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**Product Development**

 

Product developmentexpenses, net of capitalized software, for the Third Quarter of Fiscal 2006increased by $159,000, or 24%, to $818,000 as compared to $659,000 for theThird Quarter of Fiscal 2005.  Wecapitalized $357,000 of product development costs associated with thedevelopment of our next generation platform, Radiant EMS, in the Third Quarterof Fiscal 2005 with no capitalization occurring in the Third Quarter of Fiscal2006. Radiant EMS achieved technological feasibility in the fourth quarter ofFiscal 2004 and was released in March 2005. Excluding the impact of thesoftware capitalization, total product development expenses for the ThirdQuarter of Fiscal 2006 would have decreased by $198,000, or 19%, to $818,000 ascompared to $1,016,000 for the Third Quarter of Fiscal 2005.  The decrease in product development costs isattributable to reduced costs associated with Radiant BDS and a reduction inexternal development costs associated with the development of Radiant EMS.

 

Product development expenses, excluding theimpact of the software capitalization, expressed as a percentage of revenueswas 39% in the Third Quarter of Fiscal 2006, compared to 38% in the ThirdQuarter of Fiscal 2005.

 

## **General and Administrative**

## ** **

General and administrative expense for theThird Quarter of Fiscal 2006 decreased by $195,000, or 27%, to $522,000 ascompared to $717,000 for the Third Quarter of Fiscal2005.  Generaland administrative expense decreased primarily as a result of reduced insurance and personnel-related expenses.

 

General andadministrative expense, expressed as a percentage of revenues, was 25% for theThird Quarter of Fiscal 2006, compared to 27% in the Third Quarter of Fiscal2005.

 

**Interest Expense, net**

 

Interest expense,net for the Third Quarter of Fiscal 2006 increased by $65,000 to $159,000 ascompared to $94,000 for the Third Quarter of Fiscal2005.  The increase in interestexpense, net was primarily due to the outstanding borrowings under our Revolverand the amortization of deferred financing costs, primarily the value assignedto Series C Preferred Stock Warrants issued to SCP for its guaranty of ourobligations under the Revolver.

 

**Provision for Taxes**

 

No provisionfor or benefit from federal, state or foreign income taxes was recorded for theThird Quarter of Fiscal 2006 or for the Third Quarter of Fiscal 2005 because weincurred net operating losses and fully reserved our deferred tax assets astheir future realization could not be determined.

 

**First Three Quarters of Fiscal 2006 Comparedto First Three Quarters of Fiscal 2005:**

 

**Revenues**

 
| ** **                                 | ** ** | **Nine Months Ended December 31,** | ** ** |
|--------------------------------------------|------------|------------------------------------|------------|
| ** **                                 | ** ** | **2005**                           | ** ** | **2004** | ** ** | **% Change** | ** ** |
| Product  revenues                          |       | $                                  | 1,318      |   | $ | 3,031 |   | -57 | % |
| Professional  services                     |       | 1,056                              |       | 1,187 |   | -11 | % |
| Maintenance  and hosting contract revenues |       | 3,726                              |       | 4,046 |   | -8 | % |
| Total revenues                             |       | $                                  | 6,100      |   | $ | 8,264 |   | -26 | % |

 

Revenues for the First Three Quarters of Fiscal 2006decreased by $2,164,000, or 26%, to $6,100,000 as compared to revenues of$8,264,000 for the First Three Quarters of Fiscal 2005.  Product revenues decreased by $1,713,000, or57%, to $1,318,000 in the First Three Quarters of Fiscal 2006 as compared to$3,031,000 in the First Three Quarters of Fiscal 2005.  The decrease in product revenues wasprimarily attributable to lower product revenue associated with Radiant BDS andwith longer sales cycles associated with our Radiant EMS product. Professionalservice revenues decreased by $131,000, or 11%, to $1,056,000 in the FirstThree Quarters of Fiscal 2006 as compared to $1,187,000 in the First ThreeQuarters of Fiscal 2005. The decrease in professional services

 

12

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revenues was due to the decline in product revenueswhich have historically resulted in the initiation of service engagements.  Maintenance and hosting revenues decreased by$320,000, or 8%, to $3,726,000 in the First Three Quarters of Fiscal 2006 ascompared to $4,046,000 in the First Three Quarters of Fiscal 2005. The decreasein maintenance and hosting revenues was due primarily to a decline in hostingrevenues as a large hosting customer moved its application in-house.

 

**Gross Profit**

 

Gross profit for the First Three Quarters of Fiscal2006 decreased by $1,899,000, or 34%, to $3,623,000 as compared to gross profitof $5,522,000 for the First Three Quarters of Fiscal 2005.  The decrease in gross profit is related tothe decrease in product and service revenue as previously discussed.  Gross margin percentage decreased to 59% forthe First Three Quarters of Fiscal 2006 from 67% for the First Three Quartersof Fiscal 2005. The decrease in the gross margin percentage was primarily theresult of lower product revenue, which has higher gross profit margins, theamortization of software development costs of $197,000 primarily associatedwith the development of the Radiant EMS product we recently released, partiallyoffset by an improvement in service margins.

 

**Sales and Marketing**

 

Sales and marketing expenses for the First ThreeQuarters of Fiscal 2006 decreased by $422,000, or 19%, to $1,838,000, ascompared to $2,260,000 for the First Three Quarters of Fiscal 2005. Thedecrease is primarily due to lower commissions earned due to the decline inrevenues and a decrease in marketing costs incurred in the Third Quarter of Fiscal2005 associated with the re-branding of our suite of products, along with ourcompany name change to ClearStory.

 

Sales and marketing expenses expressed as a percentageof sales increased to 30% in the First Three Quarters of Fiscal 2006 comparedto 27% in the First Three Quarters of Fiscal 2005, primarily due to thedecrease in revenues.

 

**Product Development**

 

Product developmentexpenses, net of capitalized software, for the First Three Quarters of Fiscal2006 increased by $583,000, or 31%, to $2,445,000 as compared to $1,862,000 forthe First Three Quarters of Fiscal 2005. We capitalized $1,123,000 of product development costs associated withthe development of our next generation platform, Radiant EMS, in the FirstThree Quarters of Fiscal 2005 with no capitalization occurring in the FirstThree Quarters of Fiscal 2006. Radiant EMS achieved technological feasibilityin the fourth quarter of Fiscal 2004 and was released in March 2005.Excluding the impact of the software capitalization, total product developmentexpenses for the First Three Quarters of Fiscal 2006 would have decreased by$540,000, or 18%, to $2,445,000 as compared to $2,985,000 for the First ThreeQuarters of Fiscal 2005.  The decrease inproduct development costs is attributable to reduced costs associated withRadiant BDS and a reduction in external development costs associated with thedevelopment of Radiant EMS.

 

Product development expenses, excluding theimpact of the software capitalization, expressed as a percentage of revenueswas 40% in the First Three Quarters of Fiscal 2006, compared to 36% in theFirst Three Quarters of Fiscal 2005.

 

## **General and Administrative**

## ** **

General and administrative expenses for theFirst Three Quarters of Fiscal 2006 decreased by $441,000, or 20%, to $1,727,000as compared to $2,168,000 for the First Three Quartersof Fiscal 2005.  General and administrative expensesdecreased primarily as a result of reduced facilitycosts as we moved into a new corporate facility on March 1, 2004 butcontinued to be obligated on our prior facility through September 2004.

 

General andadministrative expense, expressed as a percentage of revenues, was 28% for theFirst Three Quarters of Fiscal 2006, compared to 26% in the First ThreeQuarters of Fiscal 2005.

 

13

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**Interest Expense, net**

 

Interest expense,net for the First Three Quarters of Fiscal 2006 increased by $161,000 to$309,000 as compared to $148,000 for the First ThreeQuarters of Fiscal 2005.  Theincrease in interest expense, net was primarily due to the outstandingborrowings under our Note and Revolver and the amortization of deferredfinancing costs, primarily the value assigned to Series C Preferred StockWarrants issued to SCP for its guaranty of our obligations under the Revolver.

 

**Provision for Taxes**

 

No provisionfor or benefit from federal, state or foreign income taxes was recorded for theFirst Three Quarters of Fiscal 2006 or for the First Three Quarters of Fiscal2005 because we incurred net operating losses and fully reserved our deferredtax assets as their future realization could not be determined.

 

## **Liquidity and CapitalResources**

## ** **

As of December 31,2005, we had a cash balance of $55,000, the ability tosell certain accounts receivable for additional funds of approximately$146,000 pursuant to our Factoring Agreement and $500,000 of available fundsunder our Revolver.  Based upon ourcurrent operating outlook for the remainder of the current fiscal year and thefirst half of fiscal 2007, we need additional financial resources to meet ourshort term liquidity requirements, especially forintra-quarter liquidity requirements that depend on the timing and amount ofmonthly cash receipts that are anticipated by our current operating outlook. Additionalfinancing could take the form of equity or debt offerings, spin-offs, jointventures or other collaborative relationships that may require us to issueshares or share revenue.  Since ouracquisition of WebWare in September 2003, we have incurred operatinglosses and negative cash flows which have historically been funded through theissuance of additional capital from our major stockholders. Based upon ourlatest operating outlook, we expect to incur losses for the remaining quarterof the current fiscal year due in part to significant investments in our directsales and marketing efforts, the establishment of new sales distributionchannels and the development and release of our products.  There can be no assurances that we will beable to achieve revenue levels or sufficiently reduce expenses to allow us tobecome profitable without detrimentally affecting our long-term revenues ormarket position.  Additionally, wealready have a working capital deficit of $5,756,000 as of December 31,2005, compared to a working capital deficit of $3,708,000 as of March 31,2005, which increases the need for us to successfully execute and deliver onour current business plan.  We expect ourworking capital deficit to increase, as we anticipate incurring operatinglosses for the remaining quarter of fiscal 2006 and the first half of fiscal2007. In the event that our plans or assumptions change or prove to beinaccurate (due to revenue shortfalls, unanticipated expenses, difficulties,delays or otherwise), we may have insufficient funds to support our operations.Over the past several years, we have been successful in raising additionalfunds from our major shareholders, and these funds have allowed us to continueto make certain strategic investments. However, our ability to garner continued financial support from these,or other investors, should the need arise, cannot be assured.

 

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

 
| ** **                   | ** ** | **Nine Months Ended December 31,** | ** ** |
|------------------------------|------------|------------------------------------|------------|
| ** **                   | ** ** | **2005**                           | ** ** | **2004** | ** ** | **Delta** | ** ** |
| Cash  provided by (used in): |       |                               |       |   |   |   |   |
| Operating activities         |       | $                                  | (2,713     | ) | $ | 233 |   | $ | (2,946 | ) |
| Investing activities         |       | (40                                | )          | (1,837 | ) | 1,797 |   |
| Financing activities         |       | 1,959                              |       | 1,008 |   | 951 |   |
| Net decrease  in cash        |       | (794                               | )          | (596 | ) | (198 | ) |
| Cash,  beginning of period   |       | 849                                |       | 751 |   | 98 |   |
| Cash, end of  period         |       | $                                  | 55         |   | $ | 155 |   | $ | (100 | ) |

 

Net cash used inoperating activities was $2,713,000 in the First Three Quarters of Fiscal 2006 compared to net cash provided byoperating activities of $233,000 in the prior comparable period.  The decrease in cash from

 

14

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operations is primarilydue to our higher net loss for the First Three Quarters of Fiscal 2006, adecrease in accounts payable and accrued expenses due to the timing of paymentsand an increase in accounts receivable.  For the Third Quarter of Fiscal 2006, the day’ssales outstanding (“DSO”) was 43 compared to a DSO of 69 for the Third Quarterof Fiscal 2005.

 

Net cash used ininvesting activities was $40,000 in the First Three Quarters of Fiscal 2006compared to $1,837,000 in the prior comparable period.  For the First Three Quarters of 2005, weutilized funds of $1,123,000 for capitalized software development costs and$714,000 of funds for capital expenditures for the completion of our hosteddata center, other equipment relating to the relocation of corporate facilitiesand computer equipment and software associated with our product developmentactivities.

 

Net cash providedby financing activities was $1,959,000 in the First Three Quarters of Fiscal2006 compared to net cash provided by financing activities of $1,008,000 in theprior comparable period.  Cash provided by financing activities in the First ThreeQuarters of Fiscal 2006 was a result of the proceeds from the issuance of$250,000 of Series C Preferred, the proceeds of $1,500,000 under our newRevolver and $312,000 of advances against accounts receivable under ourFactoring Agreement.  Cash provided byfinancing activities in the First Three Quarters of Fiscal 2005 was a result ofthe proceeds from an increase in advances against accounts receivable under ourFactoring Agreement of $412,000, the issuance of $450,000 of Series CPreferred and the proceeds of $240,000 under a sale and leaseback transaction.

 

**Quarterly Results**

 

# Quarterly revenues and results of operations may fluctuate as theresult of a variety of factors, including the lengthy sales cycle for ourproducts, the proportion of revenues attributable to software license feesversus services, the amount of revenue generated by alliances with othercompanies distributing our products, demand for our products and services, thesize and timing of individual license transactions, the introduction of newproducts and product enhancements by us or our competitors, changes in customerbudgets and capital expenditures, competitive conditions in the industry andgeneral economic conditions. Additionally, the sale of our products generally involves a significantcommitment of capital by our customers and may be delayed due to time-consumingauthorization procedures within an organization.  Other factors affecting our operating resultsinclude our ability to design and introduce on a timely basis new productswhich compete effectively on the basis of price and performance, product obsolescence,technological changes, competition and competitive pressures on price, theability to hire and retain qualified personnel and general economic conditionsaffecting the investment by potential customers in technology basedinvestments.  There is no assurance thatwe can maintain or increase our sales volume going forward or that we will beable to achieve a profit in the marketing of our products.

#  

#### **Off-BalanceSheet Arrangements**

#### ** **

The Company does not have any off-balancesheet arrangements that have not been disclosed.

 

**“Forward-Looking” Statements Under ThePrivate Securities Litigation Reform Act**

 

This Quarterly Report on Form 10-QSB containsstatements which constitute forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. These statements appear in a number of places in this Quarterly Reportand include all statements that are not statements of historical fact regardingthe intent, belief or expectations of theCompany and its management.  Thesestatements are based upon a number of assumptions and estimates, which aresubject 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 toidentify such forward-looking statements. Such forward-looking statements are not guarantees and actual resultsmay differ materially from those expressed or implied by such forward-lookingstatements.  Factors that could causeactual results to differ materially include, but are not limited to, ourability to achieve or maintain growth or profitability, our ability to executeour business strategy successfully, our ability to obtain financing and to payoff our existing liabilities and to fund our working capital needs, ourrelationship with our existing lenders, our relationship with our customers andsuppliers, increased competition, possible system failures and rapid changes intechnology and other factors discussed in this Quarterly Report on Form 10-QSBand in our other filings with the SEC.

 

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**Business Risks**

 

An investment in ourcommon stock involves a high degree of risk. Current and potential investors should carefully consider the followingrisks, and consult with their legal, tax and financial advisors whenconsidering an investment in the Company.

 

*We Need Additional Financing To Fund Our Operations.*

 

We are activelyexploring alternative sources of capital, which could result in additionalfinancing arrangements. The opinion of our independent auditors on our auditedfinancial statements for the year ended March 31, 2005 is subject to a “goingconcern” qualification and states that our accumulated deficit resulting fromrecurring losses from operations and a working capital deficiency raisessubstantial doubt about our ability to continue as a going concern.    If we are unable to obtain additionalfinancing or attain profitability within the next three to nine months, we maybe unable to continue operating as an independent entity.  There is no assurance that we will besuccessful. Further, additional financing could take the form of equity or debtofferings, spin-offs, joint ventures or other collaborative relationships thatmay require us to issue shares or share revenue.  Any such financing strategies would likelyimpose operating restrictions on us and be dilutive to holders of our commonstock, and may not be available on attractive terms or at all.  Further, any additional financing we enterinto would be subject to approval by SCP.

 

*We Have AHistory Of Losses And Our Ability To Be Profitable Depends On A Number OfFactors That We May Be Unable To Control.*

 

We have incurred substantial operating lossessince our inception, which has resulted in an accumulated deficit of$59,670,000, as of December 31, 2005. For the years ended March 31,2005 and March 31, 2004, we incurred net losses of $1,242,000 and $2,324,000,respectively, and we incurred additional net losses of $2,696,000 for the ninemonths ended December 31, 2005.  We expect this working capital deficit to further increase aswe anticipate incurring additional losses for the remainder of fiscal 2006. Sinceour acquisition of certain assets and liabilities of WebWare on September 3,2003, we have experienced operating losses as we focused our efforts onintegration and market enhancement initiatives and the development of our nextgeneration platform, Radiant EMS.  Therecan be no assurance that revenues will continue to increase from current levelsto allow us to become profitable or that any expense reduction actions we maytake will allow us to become profitable, or not affect our future revenues ormarket position.

 

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

 

•      Size and timingof software license orders

•      Adoption ofrecently introduced products

•      Sales mix ofinstalled versus hosted license revenues

•      Licenserevenues as a percentage of our revenues

•      Completion ofbacklog orders

•      Successfulimplementation of a direct sales model

•      Acceptance andsign off of service contracts

•      Maintenancecontract renewal rates

•      Seasonality

•      Customerbudgetary constraints and timelines

•      Availability ofembedded third party products or tool sets

•      Availability ofAlliance Partner products

•      Financialcondition of Alliance Partners

•      Variations ofAlliance Partner strategies

•      Competitivepricing

•      Changes inproduct distribution channels

•      Execution of adirect sales strategy

•      Variations inexpense levels

•      Generaltechnology trends

 

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•      Change ofbusiness strategy

•      Generaleconomic conditions

•      Changes inaccounting pronouncements

 

A significant amount of our license and servicerevenues are derived from a limited number of customers.  Such orders are typically placed within thespecific financial quarter when revenue is recognized, and we expect this trendto continue.  The placement of suchorders is typically at the end of a fiscal quarter requiring shipment.  The sales cycle is typically lengthy for anew licensed customer and shorter for an existing customer.  Revenue recognition for service contractsrequires the acceptance and sign off from a customer.  The amount of licensed product and servicebacklogs at the end of a quarter is typically immaterial.  We experience variations in product demanddue to customer budgetary constraints that may be imposed within a fiscalyear.  Additionally, we may experiencechanges in product demand due to changes in budgetary timelines.  As a consequence, we experience difficulty inforecasting license and service revenues, particularly at the beginning of thefiscal quarter.

 

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

 

*Because We HaveExperienced Losses We May Need Additional Working Capital To Implement OurBusiness Plan.*

 

We experienced losses from operations of $1,242,000and $2,324,000 for the fiscal years ended March 31, 2005 and 2004,respectively, and weincurred additional net losses of $2,696,000 for the nine months ended December 31,2005. These losses were funded partially through additional equityofferings and most recently debt offerings. Based upon our current operating outlook for the remainder of thecurrent fiscal year and the first half of fiscal 2007, we need additionalfinancial resources to meet our short term liquidityrequirements.  Additional financing couldtake the form of equity or debt offerings, spin-offs, joint ventures or othercollaborative relationships that may require us to issue shares or sharerevenue.  As of December 31, 2005, we had a working capitaldeficit of $5,756,000 compared to a working capital deficit of $3,708,000 as ofMarch 31, 2005.

 

Ifadditional funds are raised by issuance of equity securities, dilution to ourstockholders will result.  There can beno assurances, however, that we will be successful in obtaining funds from anyequity sources.  If additional funds arenot available, we may be forced to eliminate or curtail certain of ourprojects, sell assets, take additional steps to conserve cash and modify theexecution of our business plan. These actions may adversely affect our resultsof operations.

 

*We Have Recently Released The Next Generation OfOur Product.*

 

We recently announced the release of our nextgeneration software platform, Radiant EMS, based upon a pure J2EEarchitecture.  We have also embraced aWeb services technology model for the user and application programinterface.  There can be no assurancethat such technologies will not be replaced by more contemporary offerings inthe marketplace.

 

The market acceptance of the architecture and relatedapplications cannot be ensured. To the extent that we experience certainproduct issues or that acceptance is limited, we may incur increased expense tomaintain additional product lines and may not realize anticipated savings withthe technology model. The performance and market adoption of this platform mayalter future product development strategies, which may result in delays tosubsequent product introductions. In addition, customers may delay upgrading andmigrating to new products. As a result of the above, we may experience reducedrevenues and increased expenses in future periods.

 

*We Have Recently Begun Efforts To Transition OurExisting Customer Base To Our Next Generation Product.*

 

We recently began contacting certain of our existingcustomers, both installed and hosted clients, regarding upgrading toActiveMedia 7.0 from previous versions of ActiveMedia, specifically thosesupported by a WebObjects operating system. The upgrade to ActiveMedia 7.0 requires implementing our next generationsoftware platform, Radiant EMS, a pure J2EE architecture.  In certain instances, this upgrade mayrequire the re-development

 

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of custom code and user interfaces that may have beendeveloped and employed specifically for that customer.  As we have not yet specifically addressed allof the transition issues that may be required for each of our customers, norhave we yet successfully migrated a client from an previous version ofActiveMedia to ActiveMedia 7.0, we can give no assurance that we will be ableto successfully and efficiently migrate our existing customers withoutexperiencing reduced revenues and increased expenses in future periods.  Furthermore, if a significant amount of ourcustomers demand to be upgraded to the newest version of our software, we maybe unable to accommodate them in a timely manner without potentially incurringadditional costs.

 

*Execution Of Our Business PlanWill Require The Successful Implementation Of Our Direct Sales Strategy.*

 

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

 

*Our Inability To RaiseAdditional Capital On Acceptable Terms In The Future May Limit Our Growth.*

 

If our capital resources become insufficientto meet future requirements, we will have to raise additional funds to continuethe operations, development and commercialization of our technologies. Ourinability to raise capital would seriously harm our business and developmentefforts. In addition, we may choose to raise additional capital due to marketconditions or strategic considerations even if we believe we have sufficientfunds for our current or future operations. These funds may not be available onfavorable terms, or at all. If adequate funds are not available on attractiveterms, we may have to restrict our operations significantly or obtain funds byentering into agreements on unattractive terms. Further, to the extent thatadditional capital is raised through the sale of equity or convertible debtsecurities, the issuance of these securities could result in dilution to ourstockholders.

 

*Our ExistingCommon Stock Shareholders Face Substantial Dilution Upon the Conversion of OurOutstanding Series B Convertible Preferred Stock and Series CConvertible Preferred Stock.*

 

Our stock is traded on the Over the Counter BulletinBoard (OTCBB) under the symbol “CSYS”. As of December 31, 2005, we have 5,992,287 common sharesoutstanding.  As of December 31,2005, the Company’s Series B Convertible Preferred Stock is convertibleinto 8,634,080 shares of common stock while the Company’s Series CConvertible Preferred Stock is convertible into approximately 8,024,450 sharesof common stock.

 

*The Members OfOur Board Of Directors Own A Significant Percentage Of Our Common Stock And CanInfluence Matters Requiring The Vote Of Shareholders.*

 

As of December 31, 2005, our directors andofficers, assuming the conversion of all outstanding preferred stock intocommon stock, owned approximately 17.8 million shares of common stock,representing approximately 78% of the outstanding common stock.  Based on their ownership, our directors andofficers have the ability to influence matters requiring a stockholder vote,including the election of directors, the amendment of charter documents, themerger or dissolution of the Company and the sale of all or substantially allof its assets.  Their voting power alsomay discourage or prevent any proposed takeover.

 

*Our Preferred Stockholders Have Senior Rights In The Event Of OurLiquidation, Dissolution Or Winding-Up.*

 

Our preferred stockholders have senior rightsin the event of our liquidation, dissolution or winding-up, including our saleto a third party.  In the event that anyliquidation, dissolution or winding-up occurs, our common stockholders wouldnot be entitled to any proceeds of such liquidation, dissolution or winding-upuntil the liquidation preference of our preferred stockholders is fullysatisfied.  As a result, we can provideno assurances that our common stockholders will receive any proceeds in theevent of our liquidation, dissolution or winding-up to the extent that theliquidation preference of our preferred stockholders is not fullysatisfied.  As of December 31, 2005,the aggregate liquidation preference for all series of preferred stock,excluding the conversion of the outstanding Series C Preferred warrantsissued in connection with the guarantee by SCP of our obligations under theRevolver, was approximately $19.9 million.

 

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*The PotentialIssuance Of Additional Shares Of Preferred Stock May Negatively Affect TheMarket Price Of Our Common Stock And Shareholder Rights.*

 

 Our certificateof incorporation empowers the board of directors with the right to determinethe designations, rights, preferences and privileges of the holders of one ormore series of preferred stock.  Theboard of directors can issue, without stockholder approval, preferred stockwith voting, dividend, conversion, liquidation or other rights, which couldadversely affect the voting power and equity interest of common stockholders.

 

*Because OurCommon Stock Has Historically Had Limited Trading Volumes, Our Shareholders May ExperienceLiquidity Issues.*

 

The average daily trading volume for the three-monthtrading period ended December 31, 2005 on the OTC bulletin board wasapproximately 12,000 shares of common stock. This may impair the ability of our shareholders to achieve liquiditywithin certain periods of trading.

 

*Our Former Independent PublicAccountants, Goldstein & Morris PC, Resigned Effective October 20,2004.*

 

On October 20,2004, Goldstein & Morris PC (“Goldstein & Morris”) informedus that they were resigning as our independent registered public accountingfirm.  Prior to October 20, 2004,Goldstein & Morris had not previously advised management or our auditcommittee of its intention to resign its engagement as our independentregistered public accounting firm.  Theresignation was not sought or recommended by our audit committee.

 

Following thisresignation, the Company’s audit committee engaged a new independent publicaccounting firm.

 

On May 25,2005, the Public Company Accounting Oversight Board took action againstGoldstein & Morris by revoking its registration and barring itsmanaging partner, Edward B. Morris, from associating with a registeredaccounting firm for violating the auditor independence rules of theSarbanes-Oxley Act with respect to two public companies unrelated to theCompany.

 

SEC rules require the Company topresent historical audited financial statements in various SEC filings, such asregistration statements, along with Goldstein & Morris’s consent tothe inclusion of their audit report in those filings. Despite our best efforts,we have not been able to obtain the consent of Goldstein & Morris tothe inclusion of their audit report in the Company’s current filing and, mostlikely, future filings. In certain circumstances, the SEC has allowed a companyto file reports without requiring it to file a consent of its former independent registered public accounting firm butpurchasers of securities sold under such company’s registration statements,which were not filed with the consent of such company’s former independent registered public accounting firm’saudit report, would not be able to sue the formerindependent registered public accounting firm pursuant to Section 11(a)(4) ofthe Securities Act.  Therefore, apurchasers’ right of recovery under that section may be limited as aresult of the Company’s inability to obtain Goldstein & Morris’sconsent.

 

Our business and our results of operationsmay be adversely impacted by Goldstein & Morris’s resignation in that:

 

•      We have and expect to continue to incursubstantial additional legal and accounting fees relating to disclosure andother regulatory compliance matters associated with the resignation ofGoldstein & Morris; and

 

•      Our managementhas already spent, and is expected to continue to spend, considerable time andeffort on matters related to the resignation of Goldstein & Morris.

 

*Our BusinessGreatly Depends On Indirect Sales.*

 

We depend upon introductions to potential customers bycompanies with which we maintain strategic alliances for a significantpercentage of our sales.  Although wehave written agreements with our Alliance Partners and other value addedresellers, the agreements do not require customer introductions nor do theyprovide for minimum required purchases of our products. If any of the companieswith which we maintain strategic alliances

 

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decide not to refer potential customers to us, oursales may be reduced and operating losses increased.  In addition, there is no assurance that wewill be able to maintain our strategic alliances on current terms.  If our Alliance Partners’ strategy, productofferings or financial condition change, or if there are material changes intheir sales force or customer support, or if their hardware or softwareproducts are unavailable, our revenues may be affected.

 

*We AreDependent On Licensed Technology.*

 

We depend on certain software products that arelicensed from third parties, which are embedded and used in our products.  We believe that there are replacementalternatives for such third party products; however, the interruption of theavailability of such products may have an adverse impact on the delivery of ourproducts.  Additionally, we expect ourthird party vendors to maintain and continually improve their products.  To the extent that such products becameobsolete or inoperable with other industry standard applications, we mayexperience an adverse effect on revenues, operating results and a decrease incustomer satisfaction.

 

*We Changed The Name Of The Company And InitiatedA New Product Branding.*

 

At the AnnualStockholder Meeting held on October 28, 2004, our stockholders approved aproposal to change the name of the Company to ClearStory Systems, Inc.from INSCI Corp.  We believe that thename change better reflects our current positioning within the ECM market. Thename change has required and may continue to require increased expense forlegal matters, as well as promotional, marketing and communication materials.We have also initiated an effort to establish a common brand for our productswithin the ECM market with a new naming convention for certain of our products.To the extent that the name change and product branding cause confusion withinour target market or client base, we may experience a decrease in revenuesand/or an increase in overall expenses.

 

*We Are OfferingOur Customers A Hosted Solution.*

 

We host certain of our applications in our hosted datacenter. The success of the hosted application business model has not beenclearly demonstrated, and market acceptance of the hosted center is notensured.  To the extent that weexperience technological problems or challenges, certain of our customers mayseek a market alternative, which may limit market adoption of the hosted model.

 

*Our ProductsAnd Services Are Dependent On Internet Acceptance, Accessibility,Infrastructure And Security.*

 

We have developed and realized revenues from ourInternet-based products and related services. The Internet is a recent product delivery platform, and as such, ischaracterized by rapid technology changes, evolving standards and adoptionrates.  Future revenues and services aredependent upon the acceptance of the Internet as a recognized method ofconducting business.

 

The accessibility of the Internet has expanded over thelast several years.  Technologyenhancements and improvements have accelerated the availability of Internetaccess.  To the extent that continueddevelopments in communications, communication standards, availability andaccessibility do not continue to expand, the rate of adoption may decline.  Additionally, the expansion of the Internetas a commercial communications platform typically requires continued capitalinvestment and infrastructure support. To the extent that capital investment declines or funding forInternet-based programs is reduced, the accessibility and necessary supportinginfrastructure may reduce the adoption and performance of the Internet.

 

If there is an increase in the use of the Internet, orno increase in bandwidth, the infrastructure may not be able to effectivelysupport demand and result in a degradation of commercial acceptance.  Reduced response times may also affect theacceptance of the Internet.

 

*RapidTechnology Changes In Our Industry May Adversely Affect Our Business.*

 

Our business is subject to technological advances andpossible product obsolescence.  Themarket for our products is characterized by rapidly changing technology,intense competition, technological complexity and evolving industrystandards.  We must ensure that ourproducts are compatible with those products offered by third-party

 

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vendors, including serverplatforms for our software and various storage devices and platforms.  We have no contracts with third-partyvendors; therefore, there is no assurance that we will be able to make oursoftware products compatible with new products that are introduced by others.

 

*Quality Assurance And Product Stability.*

 

We have invested to establish a quality assurancefunction to limit certain errors, omissions and support incidents. While webelieve that we have implemented industry standards and procedures to minimizeissues, there can be no assurance that released versions of the product willnot contain certain issues, the consequence of which cannot be fullydetermined.

 

*We Depend On Proprietary Technology,Which Is Not Protected By Patents.*

 

Our business depends on proprietary softwaretechnology for which we have no patent protection.  Although we require our employees and othersto 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 ordiscloses our proprietary software or other proprietary information.

 

We do not hold any patents and rely on copyright andtrade secret laws, non-disclosure agreements and contractual provisions toprotect our proprietary technology. These methods afford only limited protection.  Despite the precautions we take, unauthorizedparties may attempt to copy or otherwise obtain and use our proprietarytechnologies, ideas, know-how and other proprietary information withoutauthorization or may independently develop technologies similar or superior toour technologies. Policing unauthorized use of our products may be difficultand costly.  Also, the laws of someforeign countries may not protect our proprietary rights to the same extent asthe laws of the United States. Therefore, we are unable to predict whether our means of protecting ourproprietary rights will be adequate.

 

We believe that our technologies have beendeveloped independent of others. Nevertheless, third parties may assert infringement claims against usand our technologies may be determined to infringe on the intellectual propertyrights of others.  We could become liablefor damages, or be required to modify our technologies or obtain a license ifour technologies are determined to infringe upon the intellectual propertyrights of others.  We may not be able tomodify our technologies or obtain a license in a timely manner, if required, orhave the financial or other resources necessary to defend an infringementaction.  We would be materially adverselyaffected if we fail to do any of the foregoing.

 

*Because Of TheHigh Cost, We Lack Product Liability Insurance.*

 

We develop, market, install and service enterprisecontent management and digital asset management systems.  Failure of our products may result in a claimagainst us.  Because of the high cost ofproduct liability insurance, we do not maintain insurance to protect againstclaims 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’stime and the use of certain of our resources.

 

*We Depend UponCertain Key Employees To Develop Our Products.*

 

We do not have the financial resources to compete withlarger more established companies to attract and retain certain keytechnological employees.  The loss ofcurrent technological employees or our inability to recruit and retainemployees with certain key technology skills could have an adverse effect onproduct development and our business.

 

*Because OfCertain Provisions In Our By-Laws, Change In Control May Be Difficult.*

 

Our by-laws and the Delaware GeneralCorporation Law contain provisions that may make a change in control of theCompany 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 alsoimposes conditions on certain business

 

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combinations with “interested stockholders”, as defined by Delawarelaw.  Under certain agreements with keypersonnel, we also have provided the acceleration of vesting of stock optionsin the event of a change of control and severance payments in the event thatthe employment of such personnel is terminated without cause following a changein control.  Additionally, we haveprovided that if a change of control occurs, certain directors will receiveimmediate vesting of stock options granted under our 1992 and 2004 DirectorsOption Plans.

 

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**Item 3.****    Controls and Procedures**

 

As of the end of the period covered by this report, wecarried out an evaluation, under the supervision and with the participation ofour management, including our President and Chief Executive Officer and ourChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures, as defined in Exchange Act Rule 15(d)-15(e).Based upon that evaluation, we believe that our disclosure controls andprocedures are effective in enabling us to record, process, summarize andreport information required to be disclosed in our periodic SEC filings withinthe required time periods.  Ourdisclosure controls and procedures include, without limitation, controls andprocedures designed to ensure that information required to be disclosed by usin the periodic reports filed with the SEC is accumulated and communicated toour management, including our principal executive and principal financialofficers, or persons performing similar functions, as appropriate to allowtimely decisions regarding required disclosure.

 

During the period covered by this report, there havebeen no changes in our internal control over financial reporting that havematerially affected, or are reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**PART II****         OTHERINFORMATION**

 

**Item 4 Rider**

 

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

 

The Annual Meeting of Stockholders ofthe Company was held on November 16, 2005. The matters voted on by the stockholders and the voting results are asfollows:

 

(1)           Proposal to elect ten (10) directorsto serve until the next Annual Meeting of Stockholders and until theirsuccessors are elected and qualified.

 
| **Nominee**          | ** ** | **For**   | ** ** | **Withheld** |   |
|----------------------|------------|-----------|------------|--------------|--------|
| Yaron I. Eitan       |       | 4,468,136 |       | 156,509      |   |
| Henry F. Nelson      |       | 4,468,635 |       | 156,010      |   |
| Francis X. Murphy    |       | 4,468,635 |       | 156,010      |   |
| Derek Dunaway        |       | 4,468,635 |       | 156,010      |   |
| Mitchell Klein       |       | 4,468,635 |       | 156,010      |   |
| Amit Avnet           |       | 4,468,635 |       | 156,010      |   |
| Steven Morgenthal    |       | 4,468,635 |       | 156,010      |   |
| Adi Raviv            |       | 4,468,635 |       | 156,010      |   |
| George Calhoun       |       | 4,468,635 |       | 156,010      |   |
| Thomas G. Rebar |       | 4,468,635 |       | 156,010      |   |

 

Therewere no abstentions with respect to this matter.

 

(2)           Proposal to ratify the appointmentof Miller, Ellin & Company, LLP as the Company’s independentaccountants for the fiscal year ending March 31, 2006.

 
| **For**   | ** ** | **Against** | ** ** | **Abstain** |   |
|-----------|------------|-------------|------------|-------------|--------|
| 4,623,575 |       | 990         |       | 80          |   |

 

(3)           Proposal to ratify and approve theAmended and Restated Certificate of Incorporation of the Company.

 
| **For**   | ** ** | **Against** | ** ** | **Abstain** |   |
|-----------|------------|-------------|------------|-------------|--------|
| 4,463,661 |       | 150,100     |       | 1,884       |   |

 

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**Item 6.****            Exhibits**

 

**(a)****   Exhibits**

 
| 3.1  |   | Amended and Restated Certificate of Incorporation of the Company.*                                                                                                                                                                                                                      |
|------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1 |   | First Loan Modification Agreement, dated as of November 28, 2005, by and between the Company and Silicon Valley Bank (incorporated by reference to the Company’s Current Report on Form 8-K dated as of November 28, 2005).                                         |
| 10.2 |   | Series C  Convertible Preferred Stock Purchase Warrant, dated as of November 28,  2005, issued by the Company to SCP Private Equity Partners II, L.P.  (incorporated by reference to the Company’s Current Report on Form 8-K  dated as of November 28, 2005). |
| 31.1 |   | Certificate pursuant  to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.*                                                                                                                                                       |
| 31.2 |   | Certificate pursuant  to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.*                                                                                                                                                       |
| 32.1 |   | Certificate pursuant  to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.**                                                                                                                                                      |
| 32.2 |   | Certificate pursuant  to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.**                                                                                                                                                      |

 

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*      Filedherewith.

**   Furnishedherewith.

 

 

**SIGNATURE**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this Report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                          | **ClearStory Systems, Inc.**                            |
|-------------------------------|--------------------------------------------------------------|
|                          |                                                         |
|                          |                                                         |
| Dated: February 10, 2006 | By:                                                          | /s/ HENRY F. NELSON |   |
|                          | Henry F. Nelson, President and Chief Executive  Officer      |
|                          |                                                         |
|                          |                                                         |
| Dated: February 10, 2006 | By:                                                          | /s/ STEPHEN A. READ |   |
|                          | Stephen A. Read, Vice President and Chief Financial  Officer |

 

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