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

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

                                   FORM 10-QSB

[X]   Quarterly Report under Section 13 or 15(d ) of the Securities Exchange Act
      of 1934 For the quarterly period ended: December 31, 2004

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

                         Commission file number: 1-12966

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

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

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

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

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

Yes [X]  No [ ]

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

TITLE OF EACH CLASS                                OUTSTANDING FEBRUARY 11, 2005
-------------------                                -----------------------------
Common Stock, par value $.10                                 5,992,287

Transitional Small Business Disclosure Format (check one)
Yes [ ]  No [X]
<PAGE>

                            CLEARSTORY SYSTEMS, INC.

                                      INDEX

                                                                            PAGE
                                                                            ----

PART I    FINANCIAL INFORMATION

Item 1. Financial Statements

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

Condensed Consolidated Statements of Operations for the Three and Nine
    Months Ended December 31, 2004 and 2003 (Unaudited)                       4

Condensed Consolidated Statements of Cash Flows for the Nine Months
    Ended December 31, 2004 and 2003 (Unaudited)                              5

Notes to Condensed Consolidated Financial Statements                          6

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

Item 3. Controls and Procedures                                              22

PART II   OTHER INFORMATION

Item 1. Legal Proceedings                                                    22

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

Item 6. Exhibits                                                             22

    Signature                                                                23

    Exhibit Index                                                            24


                                        2
<PAGE>

                            CLEARSTORY SYSTEMS, INC.
                      CONDENSED CONSOLIDATED BALANCE SHEET
                                DECEMBER 31, 2004
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                  DECEMBER 31,     MARCH 31,
                                                                      2004            2004
                                                                  ------------    ------------
<S>                                                               <C>             <C>
                               ASSETS                              (UNAUDITED)
Current assets:
    Cash and cash equivalents                                     $        155    $        751
    Accounts receivable, net of allowance for doubtful accounts          2,086           2,128
    Prepaid expenses and other current assets                              433             358
                                                                  ------------    ------------
       Total current assets                                              2,674           3,237
Property and equipment, net                                              1,798           1,479
Capitalized software                                                     1,365             242
Goodwill, net                                                            1,223           1,223
Other assets                                                               214             244
                                                                  ------------    ------------
                                                                  $      7,274    $      6,425
                                                                  ============    ============
               LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Accounts payable and accrued expenses                         $      2,606    $      1,975
    Advances against accounts receivable sold with recourse              1,824           1,412
    Deferred revenue                                                     2,359           2,374
    Capital leases, current portion                                        129              85
                                                                  ------------    ------------
          Total current liabilities                                      6,918           5,846
Long term liabilities:
    Deferred rent                                                          462             185
    Capital leases, net of current portion                                 144              42
                                                                  ------------    ------------
          Total long term liabilities                                      606             227
Commitments and contingencies
Stockholders' equity:
    Series C convertible preferred stock                                    31              27
    Series B convertible preferred stock                                     1               1
    8% convertible preferred stock                                           1               1
    Common stock                                                           599             599
    Additional paid-in capital                                          55,011          54,243
    Accumulated deficit                                                (55,893)        (54,519)
                                                                  ------------    ------------
          Total stockholders' equity                                      (250)            352
                                                                  ------------    ------------
                                                                  $      7,274    $      6,425
                                                                  ============    ============
</TABLE>

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


                                       3
<PAGE>

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

<TABLE>
<CAPTION>
                                                 THREE MONTHS ENDED         NINE MONTHS ENDED
                                                     DECEMBER 31,              DECEMBER 31,
                                                -----------------------------------------------
                                                  2004         2003         2004         2003
                                                -----------------------------------------------
<S>                                             <C>          <C>          <C>          <C>
Revenue:

    Product                                     $    861     $    603     $  3,031     $  2,153
    Services                                       1,843        1,626        5,233        3,944
                                                -----------------------------------------------
                                                   2,704        2,229        8,264        6,097
Cost of revenues:

    Product                                           12           34          138          115
    Services                                         841          743        2,604        1,428
                                                -----------------------------------------------
                                                     853          777        2,742        1,543
                                                -----------------------------------------------
Gross profit                                       1,851        1,452        5,522        4,554

Operating expenses:

    Sales and marketing                              802          873        2,260        2,167
    Product development                              659          958        1,862        2,268
    General and administrative                       717          775        2,168        1,649
    Non-recurring items                               --           --           --          380
                                                -----------------------------------------------
                                                   2,178        2,606        6,290        6,464
                                                -----------------------------------------------

Operating loss                                      (327)      (1,154)        (768)      (1,910)

Interest expense, net                                (94)        (130)        (148)        (338)
                                                -----------------------------------------------

Net loss before income taxes                        (421)      (1,284)        (916)      (2,248)

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

Net loss                                            (421)      (1,284)        (916)      (2,248)

Preferred stock dividends                           (162)         (83)        (458)        (167)
                                                -----------------------------------------------

Net loss attributable to common shareholders    $   (583)    $ (1,367)    $ (1,374)    $ (2,415)
                                                ===============================================

Net loss per share - basic and diluted          $  (0.10)    $  (0.23)    $  (0.23)    $  (0.43)
                                                ===============================================

Weighted average common shares outstanding -
    basic and diluted                              5,992        5,992        5,992        5,583
                                                ===============================================
</TABLE>

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


                                       4
<PAGE>

                            CLEARSTORY SYSTEMS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE NINE MONTHS ENDED DECEMBER 31, 2004 AND 2003
                                   (UNAUDITED)
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                    NINE MONTHS ENDED
                                                                       DECEMBER 31,
                                                                  ---------------------
                                                                     2004        2003
                                                                  ---------------------
<S>                                                               <C>          <C>
Cash flows from operating activities:
  Net loss                                                        $   (916)    $ (2,248)
  Reconciliation of net loss to net cash provided by (used in)
    operating activities:
  Depreciation and amortization                                        395          152
  Non-cash restructuring and other charges                              --         (180)
  Deferred rent                                                        277           --
  Changes in assets and liabilities:
      Accounts receivable                                               42          780
      Prepaid expenses and other current assets                        (75)          (6)
      Other assets                                                      30           31
      Accounts payable and accrued expenses                            495         (153)
      Deferred revenue                                                 (15)         (15)
                                                                  ---------------------
Net cash provided by (used in) operating activities                    233       (1,639)
Cash flows from investing activities:
  Capitalized software                                              (1,123)          --
  Capital expenditures                                                (714)        (207)
  Purchase of net assets of WebWare                                     --         (627)
                                                                  ---------------------
Net cash used in investing activities                               (1,837)        (834)

Cash flows from financing activities:
  Net advances (repayments) from sale of receivables                   412         (176)
  Proceeds from sale and leaseback                                     240           --
  Payments on capital leases                                           (94)         (33)
  Proceeds from issuance of Series C preferred stock                   450        3,500
  Series B Preferred dividends paid                                     --         (123)
  Repayments on long term convertible debt                              --         (252)
                                                                  ---------------------
Net cash provided by financing activities                            1,008        2,916
                                                                  ---------------------

Net increase (decrease) in cash                                       (596)         443
Cash, beginning of period                                              751          771
                                                                  ---------------------
Cash, end of period                                               $    155     $  1,214
                                                                  =====================
</TABLE>

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


                                       5
<PAGE>

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

NATURE OF BUSINESS AND BASIS OF PRESENTATION

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

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

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

      In the opinion of the management of the Company, the accompanying
unaudited financial statements reflect all adjustments that are necessary to
present fairly the financial position of the Company as of December 31, 2004 and
the results of operations for the three and nine months ended December 31, 2004
and 2003 and cash flows for the nine months ended December 31, 2004 and 2003.

      The accompanying consolidated financial statements for the nine months
ended December 31, 2004 and 2003 include the operations of the Company and its
wholly-owned subsidiaries, WCORP, Inc. ("WCORP") and Lognet 2000, Inc.
("Lognet"). WCORP was established August 26, 2003 to acquire certain assets and
liabilities of WebWare(R) Corporation ("WebWare"). WCORP acquired certain assets
and assumed certain liabilities of WebWare on September 5, 2003. Additional
subsidiaries of the Company are InfiniteSpace.com, Corp. ("InfiniteSpace"), The
Internet Broadcasting Company, Inc. ("IBC") and INSCI (UK) Limited, all of which
are no longer active. All significant intercompany transactions and balances
have been eliminated in the preparation of these financial statements.

RECENTLY ISSUED ACCOUNTING STANDARDS

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


                                       6
<PAGE>

ACQUISITION

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

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

Purchase price:
    Cash                                                               $    500
    716,204 shares of ClearStory common stock                               800
    Acquisition costs                                                       127
                                                                       --------
        Total consideration plus acquisition costs                     $  1,427
                                                                       ========
Allocation of purchase price:
    Fair value of assets acquired, net of $783 in liabilities
      assumed $204
    Purchase price in excess of fair value of net assets
      acquired allocated to goodwill                                      1,223
                                                                       --------
        Total                                                          $  1,427
                                                                       ========

      Goodwill, in accordance with SFAS No. 142, ACCOUNTING FOR THE IMPAIRMENT
OR DISPOSAL OF LONG-LIVED ASSETS, will be tested for impairment annually and
whenever there is an impairment indicator. No impairment charges have been
recorded as of December 31, 2004.

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

                                                              NINE MONTHS ENDED
                                                              DECEMBER 31, 2003
                                                              -----------------
Revenue                                                                $  6,686
Net loss from continuing operations                                      (4,531)
Net loss attributable to common shareholders                             (4,698)
Basic and diluted loss per share attributable to
  common shareholders                                                  $  (0.84)

EARNINGS (LOSS) PER COMMON SHARE

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

      For the three and nine months ended December 31, 2004, approximately 17.1
million shares from stock options, warrants and convertible securities were
excluded due to their anti-dilutive effect. For the three months and nine months
ended December 31, 2003, approximately 19.2 million shares, respectively, from
stock options, warrants and convertible securities were excluded due to their
anti-dilutive effect.


                                       7
<PAGE>

GEOGRAPHIC INFORMATION

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

      Revenue was derived from customers in the following geographic areas:

                                     THREE MONTHS ENDED      NINE MONTHS ENDED
                                        DECEMBER 31,            DECEMBER 31,
                                    --------------------    --------------------
                                      2004        2003        2004        2003
                                    --------    --------    --------    --------
                                                   (IN THOUSANDS)
North America                       $  2,323    $  1,921    $  7,302    $  5,301
Europe                                   291         190         679         421
Other                                     90         118         283         375
                                    --------    --------    --------    --------
                                    $  2,704    $  2,229    $  8,264    $  6,097
                                    ========    ========    ========    ========

ADVANCES AGAINST RECEIVABLES SOLD WITH RECOURSE

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

SERIES C CONVERTIBLE PREFERRED STOCK

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

      On January 28, 2005, the Company entered into a Series C Convertible
Preferred Stock Purchase Agreements with SCP and CSSMK, whereby the Company sold
257,785 shares 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 to CSSMK at
$1.9396 per share for the sum of $100,000. Pursuant to the agreement, SCP, or at
the discretion of SCP, CIP Capital LP ("CIP"), has agreed to purchase a minimum
of 77,336 additional shares of Series C Preferred at $1.9396 per share for the
sum of $150,000, on or before April 15, 2005 (the "Second Closing"). In
addition, SCP may, at its sole discretion, expand the number of shares to be
purchased at the Second Closing to a maximum of 128,893 shares of Series C
Preferred at $1.9396 per share for a sum of $250,000.

      For the period ended December 31, 2004, the Company also issued a total of
166,350 shares of Series C Preferred in settlement of dividends of $122,000 on
its Series B Convertible Preferred Stock ("Series B Preferred") and $200,000 in
dividends on its Series C Preferred. The Company has recorded an additional
$160,000 in accrued dividends associated with its Series B Preferred and Series
C Preferred at December 31, 2004.

COMMITMENTS AND CONTINGENCIES

LEGAL PROCEEDINGS

      The Company was a defendant in an action commenced by one of its customers
for the return of certain pre-petition payments made prior to the customer's
bankruptcy petition in the amount of approximately $121,000. The Company was
contesting the action and is asserting a number of affirmative defenses on its
behalf. On February 08, 2005 the Company entered into a settlement agreement
whereby all claims regarding this action will be settled for $30,000. This
settlement has been accrued as of December 31, 2004 and reflected in the
Company's consolidated results of operations for the three and nine months ended
December 31, 2004.


                                       8
<PAGE>

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

<TABLE>
<CAPTION>
                                                                          NINE MONTHS ENDED
                                                                             DECEMBER 31,
                                                                        --------------------
                                                                          2004        2003
                                                                        --------    --------
                                                                           (IN THOUSANDS)
<S>                                                                     <C>         <C>
Non-cash investing and financing activities:
  Series C Preferred Stock issued in settlement of accrued dividends    $    322    $     --
  Common Stock issued in connection with the purchase of certain
    assets of WebWare                                                         --         800
  Capital lease obligations assumed with the purchase of certain
    assets of WebWare                                                         --         181
  Goodwill and other assets acquired in connection with the purchase
    of certain assets of WebWare                                              --       1,898
</TABLE>

STOCK-BASED COMPENSATION

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

      The Company computed the pro forma disclosures required under SFAS No. 123
for all stock options granted to employees and directors of the Company as of
December 31, 2004 and 2003, using the Black-Scholes option pricing model
prescribed by SFAS No. 123.

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

<TABLE>
<CAPTION>
                                                    THREE MONTHS ENDED           NINE MONTHS ENDED
                                                        DECEMBER 31,                 DECEMBER 31,
                                                 -------------------------------------------------------
                                                     2004          2003           2004           2003
                                                 ----------     ----------     ----------     ----------
                                                          (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                              <C>            <C>            <C>            <C>
Net loss attributable to common shareholders:
     As reported                                 $     (583)    $   (1,367)    $   (1,374)    $   (2,415)
                                                 ==========     ==========     ==========     ==========
     Pro forma - SFAS 123                        $     (648)    $   (1,367)    $   (1,701)    $   (2,415)
                                                 ==========     ==========     ==========     ==========

Basic and diluted net loss per share:
     As reported                                 $    (0.10)    $    (0.23)    $    (0.23)    $    (0.43)
                                                 ==========     ==========     ==========     ==========
     Pro forma - SFAS 123                        $    (0.11)    $    (0.23)    $    (0.28)    $    (0.43)
                                                 ==========     ==========     ==========     ==========
</TABLE>


                                       9
<PAGE>

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

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

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

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

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

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


                                       10
<PAGE>

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

SIGNIFICANT ACCOUNTING POLICIES

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

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

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

COMPARISON OF RESULTS OF OPERATIONS

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

THREE MONTHS ENDED DECEMBER 31:                    2004       2003     % CHANGE
                                                 --------   --------   --------
     Product revenues                            $    861   $    603         43%
     Professional services                            436        346         26%
     Maintenance and hosting contract revenues      1,407      1,280         10%
                                                 --------   --------   --------
          Total revenues                         $  2,704   $  2,229         21%
                                                 ========   ========   ========

NINE MONTHS ENDED DECEMBER 31:

     Product revenues                            $  3,031   $  2,153         41%
     Professional services                          1,187        670         77%
     Maintenance and hosting contract revenues      4,046      3,274         24%
                                                 --------   --------   --------
          Total revenues                         $  8,264   $  6,097         36%
                                                 ========   ========   ========


                                       11
<PAGE>

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

REVENUES

      Revenues for the Third Quarter of Fiscal 2005 increased by $475,000, or
21%, to $2,704,000 as compared to revenues of $2,229,000 for the Third Quarter
of Fiscal 2004. Product revenues increased by $258,000, or 43%, to $861,000 in
the Third Quarter of Fiscal 2005 as compared to $603,000 in the Third Quarter of
Fiscal 2004. Professional service revenues increased $90,000, or 26%, to
$436,000 in the Third Quarter of Fiscal 2005 as compared to $346,000 in the
Third Quarter of Fiscal 2004. The increase in professional services revenues was
due to increased product revenues. Maintenance and hosting revenues increased
$127,000, or 10%, to $1,407,000 in the Third Quarter of Fiscal 2005 as compared
to $1,280,000 in the Third Quarter of Fiscal 2004. Maintenance contract revenues
are earned ratably over the term of the contract commencing upon receipt of
payment or when other acceptance is received. Hosting contract revenues are
earned ratably over the period invoiced, typically monthly or quarterly.

GROSS PROFIT

      Gross profit for the Third Quarter of Fiscal 2005 increased $399,000 or
27% to $1,851,000 as compared to gross profit of $1,452,000 for the Third
Quarter of Fiscal 2004. The increase in gross profit is related to the increase
in product and service revenue as previously discussed. Gross margin percentage
increased to 68% for the Third Quarter of Fiscal 2005 from 65% for the Third
Quarter of Fiscal 2004. The increase in gross margin was primarily the result of
the higher product revenue, which have higher gross profit margins.

SALES AND MARKETING

      Sales and marketing expenses for the Third Quarter of Fiscal 2005
decreased $71,000, or 8%, to $802,000, as compared to $873,000 for the Third
Quarter of Fiscal 2004. The decrease of $71,000 is primarily due to the
integration of our sales and marketing efforts in connection with our
acquisition of WebWare, partially offset by the strategic investment in our
direct sales force.

      Sales and marketing expenses expressed as a percentage of sales decreased
to 30% in the Third Quarter of Fiscal 2005 compared to 39% in the Third Quarter
of Fiscal 2004 primarily due to the increase in revenue and the reduction in
overall sales and marketing costs.

PRODUCT DEVELOPMENT

      Product development expenses, net of capitalized software, for the Third
Quarter of Fiscal 2005 decreased by $299,000, or 31%, to $659,000 as compared to
$958,000 for the Third Quarter of Fiscal 2004. We capitalized $357,000 of
product development costs associated with the development of our next generation
platform in the Third Quarter of Fiscal 2005 as compared to none in the Third
Quarter of Fiscal 2004. This application achieved technological feasibility in
the fourth quarter of Fiscal 2004 and is expected to be made commercially
available in the fourth quarter of Fiscal 2005. Excluding the impact of the
software capitalization, total product development expenses for the Third
Quarter of Fiscal 2005 would have increased by $58,000, or 6%, to $1,016,000 as
compared to $958,000 for the Third Quarter of 2004. The increase in product
development costs is attributable to the product development efforts associated
with our next generation application mentioned above and the further development
of formalized quality assurance and documentation procedures.

      Product development expenses, excluding the impact of the software
capitalization, expressed as a percentage of revenues was 38% in the Third
Quarter of Fiscal 2005, compared to 43% in the Third Quarter of Fiscal 2004.

GENERAL AND ADMINISTRATIVE

      General and administrative expenses for the Third Quarter of Fiscal 2005
decreased $58,000, or 7%, to $717,000 as compared to $775,000 for the Third
Quarter of Fiscal 2004. General and administrative expenses decreased primarily
as a result of reduced facility costs as we moved into a new corporate facility
in March 2004.


                                       12
<PAGE>

      General and administrative expense, expressed as a percentage of revenues,
was 27% for the Third Quarter of Fiscal 2005, compared to 35% in the Third
Quarter of Fiscal 2004.

INTEREST EXPENSE, NET

      Interest expense for the Third Quarter of Fiscal 2005 decreased $36,000,
or 28%, to $94,000 as compared to $130,000 for the Third Quarter of Fiscal 2004.
The decrease was due to the lower level of borrowings as $1.9 million of
convertible debt was converted to Series C Convertible Preferred Stock as of
March 31, 2004, which was partially offset, by higher borrowings, fees, and
interest under our Factoring Agreement.

PROVISION FOR TAXES

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

FIRST THREE QUARTERS OF FISCAL 2005 AS COMPARED TO FIRST THREE QUARTERS OF
FISCAL 2004:

REVENUES

      Revenues for the First Three Quarters of Fiscal 2005 increased by
$2,167,000, or 36%, to $8,264,000 as compared to revenues of $6,097,000 for the
First Three Quarters of Fiscal 2004. The revenue increase was attributable to
the inclusion of WebWare for the entire First Three Quarters of Fiscal 2005.
Product revenues increased by $878,000, or 41%, to $3,031,000 in the First Three
Quarters of Fiscal 2005 as compared to $2,153,000 in the First Three Quarters of
Fiscal 2004. The product revenue increase was attributable to the inclusion of
WebWare product revenues for the entire First Three Quarters of Fiscal 2005.
Professional service revenues increased $517,000, or 77%, to $1,187,000 in the
First Three Quarters of Fiscal 2005 as compared to $670,000 in the First Three
Quarters of Fiscal 2004 due to increased product installations and inclusion of
WebWare included in the operations for the entire First Three Quarters of Fiscal
2005. Maintenance and hosting revenues increased $772,000, or 24%, to $4,046,000
in the First Three Quarters of Fiscal 2005 as compared to $3,274,000 in the
First Three Quarters of Fiscal 2004. The increase in maintenance and hosting
revenues was primarily due to the inclusion of WebWare hosting and maintenance
revenue for the entire First Three Quarters in Fiscal 2005.

GROSS PROFIT

      Gross profit for the First Three Quarters of Fiscal 2005 increased
$968,000, or 21%, to $5,522,000 as compared to gross profit of $4,554,000 for
the First Three Quarters of Fiscal 2004. The increase in gross profit is related
to the increase in product and service revenue as previously noted. Gross margin
decreased to 67% for the First Three Quarters of Fiscal 2005 as compared to 75%
for the First Three Quarters of Fiscal 2004. The decline in gross margins was
primarily the result of the inclusion of service and maintenance revenues
associated with WebWare, which operate at lower gross margins than our
historical gross margins and additional costs associated with our hosting center
as we continue to invest in this solution.

SALES AND MARKETING

      Sales and marketing expenses for the First Three Quarters of Fiscal 2005
increased $93,000, or 4%, to $2,260,000 as compared to sales and marketing
expenses of $2,167,000 for the First Three Quarters of Fiscal 2004. The increase
in sales and marketing expenses was attributable to higher commissions as a
result of the increase in revenues, an increase in marketing costs associated
with the re-branding of our suite of products along with our Company name change
to ClearStory Systems, Inc. and our strategic investment in our direct sales
force.

      Sales and marketing expenses expressed as a percentage of sales decreased
to 27% in the First Three Quarters of Fiscal 2005 compared to 36% in the First
Three Quarters of Fiscal 2004.


                                       13
<PAGE>

PRODUCT DEVELOPMENT

      Product development expenses, net of capitalized software, for the First
Three Quarters of Fiscal 2005 decreased by $406,000, or 18%, to $1,862,000 as
compared to $2,268,000 for the First Three Quarters of Fiscal 2004. We
capitalized $1,123,000 of product development costs associated with the
development of its next generation application for the First Three Quarters of
Fiscal 2005 as compared to no costs being capitalized for the First Three
Quarters of Fiscal 2004. This application achieved technological feasibility in
the fourth quarter of Fiscal 2004. Excluding the impact of the software
capitalization, total product development expenses for the First Three Quarters
of Fiscal 2005 would have increased by $717,000, or 32%, to $2,985,000 as
compared to $2,268,000 for the First Three Quarters of Fiscal 2004. The increase
in product development costs is attributable to the product development efforts
associated with our next generation application mentioned above and the
development of formalized quality assurance and documentation procedures.

      Product development expense, excluding the impact of software
capitalization, expressed as a percentage of revenues, for the First Three
Quarters of Fiscal 2005 would have been 36%, compared to 37% of revenues for the
First Three Quarters of 2004.

GENERAL AND ADMINISTRATIVE

      General and administrative expenses for the First Three Quarters of Fiscal
2005 increased $519,000, or 31%, to $2,168,000 as compared to $1,649,000 for the
First Three Quarters of Fiscal 2004. The increase in general and administrative
expense is primarily attributable to an increase in rent expense, the inclusion
of WebWare general and administrative expense for the entire First Three
Quarters of Fiscal 2005 and a provision of $80,000 for state and local taxes
associated with previous years. We moved to a new corporate facility that
includes our data hosting facility on March 1, 2004. While the new lease
provided for a rent abatement through February 2005, we continued to be
obligated for rent on our previous facility through September 2004. Accordingly,
we recorded rent expense for both facilities for the First Three Quarters of
Fiscal 2005.

      General and administrative expense, expressed as a percentage of revenues,
was 26% for the First Three Quarters of Fiscal 2005 as compared to 27% for the
First Three Quarters of Fiscal 2004.

NON-RECURRING ITEMS

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

INTEREST EXPENSE, NET

      Interest expense for the First Three Quarters of Fiscal 2005 decreased
$190,000, or 56%, to $148,000 as compared to $338,000 for the First Three
Quarters of Fiscal 2004. The decrease was due to the lower level of borrowings
as $1.9 million of convertible debt was converted to Series C Convertible
Preferred Stock as of March 31, 2004, which was partially offset, by higher
borrowings, fees and interest under our Factoring Agreement.

PROVISION FOR TAXES

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


                                       14
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

      We anticipate, based upon our current operating outlook, that our cash
balance of approximately $155,000 as of December 31, 2004, the proceeds of
$600,000 from the issuance of Series C Preferred Stock, which was completed on
January 28, 2005, along with the additional minimum funding commitment of
$150,000 expected to be completed by April 15, 2005, supplemented by additional
advances under our Factoring Agreement will be sufficient to satisfy our
operations and capital requirements for the next twelve months. There can be no
assurance, however, that such funds will not be expended prior thereto. In the
event our plans change, or our assumptions change, or prove to be inaccurate
(due to revenue shortfalls, unanticipated expenses, difficulties, delays or
otherwise), we may have insufficient funds to support our operations.

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

                                                            NINE MONTHS ENDED
                                                               DECEMBER 31,
                                                           --------------------
                                                             2004        2003
                                                           --------    --------
Cash provided by (used in):
   Operating activities                                    $    233    $ (1,639)
   Investing activities                                      (1,837)       (834)
   Financing activities
                                                              1,008       2,916
                                                           --------    --------
Net decrease in cash                                           (596)        443
Cash, beginning of period                                       751         771
                                                           --------    --------
Cash, end of period                                        $    155    $  1,214
                                                           ========    ========

      Net cash provided by operating activities was $233,000 in the First Three
Quarters of Fiscal 2005 compared to net cash used in operating activities of
$1,639,000 in the prior year period. The increase in cash from operations is
primarily due to our lower net loss for the First Three Quarters of 2005,
increased non-cash expenses and an increase in accounts payable and accrued
expenses. As of December 31, 2004, the Company had a working capital deficit of
$4,244,000 compared to a working capital deficit of $2,609,000 as of March 31,
2004. For the Third Quarter of Fiscal 2005, the days sales outstanding (DSO) was
69 days compared to a DSO of 70 days for the quarter ended March 31, 2004 and 63
days for the quarter ended December 31, 2003.

      Net cash used in investing activities was $1,837,000 in the First Three
Quarters of Fiscal 2005 compared to $834,000 in the prior year period. For the
First Three Quarters of 2005, we utilized funds of $1,123,000 for capitalized
software development costs and $714,000 of funds for capital expenditures
primarily attributable to the completion of our hosted data center, other
equipment relating to the relocation of corporate facilities and for computer
equipment and software associated with our product development activities.
During the First Three Quarters of Fiscal 2004, we utilized $627,000 of funds
for the acquisition of the assets and certain liabilities of WebWare and
$207,000 of funds for capital expenditures primarily attributable to computer
equipment and software associated with our product development activities.
Additionally, we issued 716,204 shares of our common stock in connection with
the WebWare acquisition, which we valued at $800,000.

      Net cash provided by financing activities was $1,008,000 in the First
Three Quarters of Fiscal 2005 compared to net cash provided by financing
activities of $2,916,000 in the prior year period. Cash provided in the First
Three Quarters of Fiscal 2005 was a result of the proceeds from the issuance of
preferred stock of $450,000, proceeds from a capital lease of $240,000 and
$412,000 of advances against accounts receivable partially offset by $94,000 of
payments on capital leases.

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

      This Quarterly Report contains statements which constitute forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
These statements appear in a number of places in this Quarterly Report and
include all statements that are not statements of historical fact regarding the
intent, belief or expectations of ClearStory and its management. These
statements are based upon a number of assumptions and estimates, which are
subject to significant uncertainties, many of which are beyond our control.
Words such as "may," "would," "could," "will," "expect," "anticipate,"
"believe," "intend," "plan" and "estimate" are meant to identify such


                                       15
<PAGE>

forward-looking statements. Such forward-looking statements are not guarantees
and actual results may differ materially from those expressed or implied by such
forward-looking statements. Factors that could cause actual results to differ
materially include, but are not limited to our ability to achieve or maintain
growth or profitability, our ability to execute our business strategy
successfully, our ability to obtain financing and to pay off our existing
liabilities and fund our working capital needs, our relationship with our
existing lenders, our relationship with our customers and suppliers, increased
competition, possible system failures and rapid changes in technology and other
factors discussed in this Quarterly Report and in our other filings with the
Securities and Exchange Commission.

QUARTERLY RESULTS

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

BUSINESS RISKS

      An investment in our common stock involves a high degree of risk. Current
and potential investors should carefully consider the following risks, and
consult with their legal, tax and financial advisors when considering an
investment in the Company.

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

      We have incurred substantial operating losses since our inception, which
has resulted in an accumulated deficit of $55,893,000, as of December 31, 2004.
For the year ended March 31, 2004 and the nine months ended December 31, 2004,
we incurred net losses of $2,324,000 and $916,000, respectively. Through our
wholly owned subsidiary, WCORP, we acquired certain assets and liabilities of
WebWare and as a result, we experienced operating losses in the fiscal year
March 31, 2004 while we focused our efforts on integration and market
enhancement initiatives. There can be no assurance that that revenues will
continue to increase from current levels to allow us to become profitable or
that any expense reduction actions we may take, will allow us to become
profitable, or not affect future revenues or our market position.

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

      o     Size and timing of software license orders
      o     Sales mix of installed versus hosted licenses
      o     Introduction and market acceptance of new products
      o     Completion of backlog orders
      o     Acceptance and sign off of service contracts
      o     Maintenance contract renewal rates
      o     Regulatory compliance
      o     Seasonality


                                       16
<PAGE>

      o     Customer budgetary constraints and timelines
      o     Availability of embedded third party products or tool sets
      o     Availability of Alliance Partner products
      o     Financial condition of Alliance Partners
      o     Variations of Alliance Partner strategies
      o     Competitive pricing
      o     License revenues as a percentage of our revenues
      o     Changes in product distribution channels
      o     Execution of a direct sales strategy
      o     Variations in expense levels
      o     Change of business strategy
      o     General economic conditions
      o     International exchange rates
      o     Changes in accounting pronouncements

      A significant amount of our license and service revenues are derived from
a limited number of customers. Such orders are typically placed within the
specific financial quarter when revenue is recognized, and we expect this trend
to continue. The placement of such orders is typically at the end of a fiscal
quarter requiring shipment, and if related to a new customer, the implementation
of the licensed product. The sales cycle is typically lengthy for a new licensed
customer and less time for an existing customer. Revenue recognition for service
contracts requires the acceptance and sign off from a customer. The amount of
licensed product and service backlogs at the end of a quarter is typically
immaterial. We have historically experienced increased revenues in the third
fiscal quarter compared to the preceding fiscal quarters. We also experience
variations in product demand due to customer budgetary constraints that may be
imposed within a fiscal year. Additionally, we may experience changes in product
demand due to changes in budgetary timelines. As a consequence, we experience
difficulty in forecasting license and service revenues, particularly at the
beginning of the fiscal quarter.

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

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

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

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

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

      We experienced losses from operations of $916,000 for the First Three
Quarters of Fiscal 2005 and $2,324,000 for the fiscal year ended March 31, 2004.
These losses were funded partially through additional equity offerings. In the
future, we may need additional financing to operate our business and implement
our business plan beyond the $600,000 of funds raised in connection with the
issuance of Series C Preferred on January 28, 2005, along with the additional
minimum funding commitment of $150,000 expected to be completed by April 15,
2005.

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


                                       17
<PAGE>

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

      As of January 31, 2005, our directors and officers, assuming the
conversion of all outstanding preferred stock into common stock, owned
approximately 16.6 million shares of common stock, representing approximately
77% of the outstanding common stock. Based on their ownership, our directors and
officers have the ability to influence matters requiring a stockholder vote,
including the election of directors, the amendment of charter documents, the
merger or dissolution of our Company and the sale of all or substantially all of
our assets. Their voting power also may discourage or prevent any proposed
takeover.

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

      We implemented a reverse stock split of 1:10 on January 2, 2004. As a
result, the freely traded number of shares on the OTC bulletin board has been
substantially reduced. This may give rise to certain liquidity issues relative
to the freely traded common stock. This may impair the ability to achieve
liquidity within certain periods of trading. The average daily trading volume
for the 3-month trading period ended January 30, 2005 is 10,000 shares of common
stock.

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

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

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

      Our stock is traded on the Over the Counter Bulletin Board (OTCBB) under
the symbol "CSYS". As of January 31, 2005 we have 5,992,287 common shares
outstanding. The Company's Series B Convertible Preferred Stock is convertible
into 8,634,080 shares of common stock. The Company's Series C Convertible
Preferred Stock is convertible into approximately 6,781,300 shares of common
stock.

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

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


                                       18
<PAGE>

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

      On October 20, 2004, Goldstein & Morris PC informed us that they were
resigning as our independent registered public accounting firm. Prior to October
20, 2004, Goldstein & Morris PC had not previously advised management or our
audit committee of its intention to resign its engagement as our independent
registered public accounting firm. The resignation was not sought or recommended
by our audit committee. Our business and our results of operations may be
adversely impacted by Goldstein & Morris PC's' resignation in that:

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

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

OUR BUSINESS GREATLY DEPENDS ON INDIRECT SALES.

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

WE ARE DEPENDENT ON LICENSED TECHNOLOGY.

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

WE HAVE CHANGED THE NAME OF THE COMPANY.

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

WE HAVE INITIATED A NEW PRODUCT BRANDING.

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

WE ARE OFFERING OUR CUSTOMERS A HOSTED SOLUTION.

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


                                       19
<PAGE>

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

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

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

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

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

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

WE HAVE RECENTLY RELEASED THE NEXT GENERATION OF OUR PRODUCT.

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

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

QUALITY ASSURANCE AND PRODUCT STABILITY.

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


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<PAGE>

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

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

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

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

AS WE MIGRATE OUR BUSINESS MODEL TO INCLUDE A HOSTED MODEL, WE MAY EXPERIENCE
CERTAIN QUARTERLY REVENUE DEGRADATION.

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

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

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

WE DEPEND UPON CERTAIN KEY EMPLOYEES TO DEVELOP OUR PRODUCTS.

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

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

      Our by-laws and the Delaware General Corporation Law contain provisions
that may make a change in control more difficult or delay attempts by others to
obtain control of us, even when this may be in the interests of stockholders.
The Delaware General Corporation Law also imposes conditions on certain business
combinations with "interested stockholders", as defined by Delaware law. Under
certain agreements with key personnel, we also have provided the acceleration of
vesting of stock options in the event of a change of control and severance
payments in the event that the employment of such personnel is terminated
without cause following a change in control. Additionally, we have provided that
if a change of control occurs, certain directors will receive immediate vesting
of stock options granted under our 1992 Directors Option Plan.


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<PAGE>

ITEM 3. CONTROLS AND PROCEDURES

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

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

PART II  OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

      The Company is a defendant in an action commenced on May 16, 2003 by
Lason, Inc. ("Lason") in the United States Bankruptcy Court for the District of
Delaware. The Lason action is seeking the return of certain pre-petition
payments made prior to the bankruptcy petition of Lason in the amount of
approximately $121,000. The Company was contesting the action and is asserting a
number of affirmative defenses on its behalf. On February 08, 2005, the Company
entered into a settlement agreement whereby all claims regarding this action
will be settled for $30,000.

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

      On January 28, 2005, the Company entered into a Series C Convertible
Preferred Stock Purchase Agreements dated as of September 9, 2003 and December
31, 2003 with SCP Private Equity Investors II, LP ("SCP") and CSSMK, LLC
("CSSMK"), respectively, whereby the Company sold an additional 257,785 shares
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 to CSSMK at $1.9396 per
share for the sum of $100,000. Pursuant to the agreement, SCP, or at the
discretion of SCP, CIP Capital LP ("CIP"), has agreed to purchase a minimum of
77,336 additional shares of Series C Preferred at $1.9396 per share for the sum
of $150,000, on or before April 15, 2005 (the "Second Closing"). In addition,
SCP may, at its sole discretion, expand the number of shares to be purchased at
the Second Closing to a maximum of 128,893 shares of Series C Preferred at
$1.9396 per share for a sum of $250,000.

ITEM 6. EXHIBITS

      (A) EXHIBITS

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

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

* Annexed hereto


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<PAGE>

                                    SIGNATURE

      Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.

                                          CLEARSTORY SYSTEMS, INC.


Date:  February 11, 2005              By: /S/ HENRY F. NELSON
                                          --------------------------------------
                                          Henry F. Nelson

                                          Chief Executive Officer, President and
                                          Chief Financial Officer


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<PAGE>

                                  EXHIBIT INDEX


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

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

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


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