SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended March 31, 2005

Commission File Number 1-5620

SAFEGUARD SCIENTIFICS, INC.

(Exact name of registrant as specified in its charter)

(610) 293-0600
Registrant’s telephone number, including area code

     Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes  þ     No  o

     Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes  þ     No  o

Number of shares outstanding as of May 6, 2005:
Common Stock 119,890,738

SAFEGUARD SCIENTIFICS, INC.
QUARTERLY REPORT FORM 10-Q
INDEX

PART  I  -  FINANCIAL INFORMATION

2

SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED BALANCE SHEETS

See Notes to Consolidated Financial Statements.

3

SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS

See Notes to Consolidated Financial Statements.

4

SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

See Notes to Consolidated Financial Statements.

5

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004

1.  GENERAL

     The accompanying unaudited interim Consolidated Financial Statements were prepared in accordance with accounting principles generally accepted in the United States of America and the interim financial statements rules and regulations of the SEC. In the opinion of management, these statements include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the Consolidated Financial Statements. The interim operating results are not necessarily indicative of the results for a full year or for any interim period. 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 financial statements. The Consolidated Financial Statements included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Form 10-Q and included together with the Company’s Consolidated Financial Statements and Notes thereto included in the Company’s 2004 Annual Report on Form 10-K.

2. BASIS OF PRESENTATION

     The Consolidated Financial Statements include the accounts of the Company and all subsidiaries in which it directly or indirectly owns more than 50% of the outstanding voting securities.

     The Company’s Consolidated Statements of Operations, Comprehensive Loss and Cash Flows include the following subsidiaries:

     The Company’s Consolidated Balance Sheets include the following majority-owned subsidiaries:

     Alliance operates on a 52 or 53-week fiscal year, ending on the Saturday closest to the end of the fiscal period. The Company and all other subsidiaries operate on a calendar year. Alliance’s first quarter ended on April 2, 2005, a period of 13 weeks, and April 3, 2004, a period of 14 weeks.

     CompuCom Systems, Inc., previously a majority-owned subsidiary, is accounted for as a discontinued operation (see Note 3). Accordingly, for financial statement purposes, the assets, liabilities, results of operations and cash flows of this business have been segregated from those of continuing operations for all periods presented.

6

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
MARCH 31, 2005

     Tangram was consolidated through February 20, 2004 at which time it was sold to Opsware, Inc. in a stock and debt for stock exchange. The Company recorded an $8.5 million gain on the transaction, which is included in Other Income (Loss), Net on the Consolidated Statements of Operations for the three months ended March 31, 2004.

     Certain prior year amounts have been reclassified to conform to the current year presentation including the reclassification of CompuCom, previously a majority owned subsidiary, as discontinued operations as a result of the sale of the Company’s interest in October 2004. The impact of these changes did not affect the Company’s net loss.

3.  DISCONTINUED OPERATIONS

     On October 1, 2004, the Company completed the sale of its interest in CompuCom.

Results of the discontinued operation are as follows:

4.  MARKETABLE SECURITIES

     Marketable securities include the following:

7

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
MARCH 31, 2005

     As of March 31, 2005, the contractual maturities of securities are as follows:

     As of March 31, 2005 and December 31, 2004, the Company’s investment in available-for-sale securities had a carrying value of zero and unrealized gains of $6.4 million and $ 12.0 million, respectively, which are reflected in Accumulated Other Comprehensive Income on the Consolidated Balance Sheets.

5.  GOODWILL AND OTHER INTANGIBLE ASSETS

     The following is a summary of changes in the carrying amount of goodwill by segment:

     As discussed in Note 18, certain purchase price adjustments are not final.

     Intangible assets with definite useful lives are amortized over their respective estimated useful lives to their estimated residual values. The following table provides a summary of the Company’s intangible assets with definite and indefinite useful lives:

8

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
MARCH 31, 2005

     Amortization expense related to intangible assets was $0.9 million and $0.8 million for the three months ended March 31, 2005, and 2004, respectively. The following table provides estimated future amortization expense related to intangible assets:

6.  RECENT ACCOUNTING PRONOUNCEMENTS

     In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), “Share-Based Payment” (“SFAS No.123(R)”). SFAS No. 123(R) will require companies to measure all employee stock-based compensation awards using a fair value method and record such expense in its consolidated financial statements. In addition, the adoption of SFAS No. 123(R) requires additional accounting and disclosure related to the income tax and cash flow effects resulting from share-based payment arrangements. SFAS No. 123(R) is effective beginning as of the first annual reporting period beginning after June 15, 2005. The Company is required to adopt SFAS No. 123 (R) on January 1, 2006. This new standard may be adopted in one of two ways – the modified prospective transition method or the modified retrospective transition method. The Company is in the process of determining the impact of the requirements of SFAS No. 123(R), which will have a material impact on its consolidated financial statements. See the pro forma disclosures currently provided under SFAS No. 123 in Note 10.

     In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets,” an amendment of Accounting Principles Board (APB) Opinion No. 29, “Accounting for Nonmonetary Transactions.” SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS No. 153 is effective for nonmonetary asset exchanges beginning in our third quarter of 2005. We do not believe adoption of SFAS No. 153 will have a material effect on our consolidated financial position, results of operations or cash flows.

9

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
MARCH 31, 2005

7.  COMPREHENSIVE LOSS

     Comprehensive loss is the change in equity of a business enterprise from transactions and other events and circumstances from non-owner sources. Excluding net loss, the Company’s sources of comprehensive loss are from net unrealized depreciation on its holdings classified as available-for-sale and foreign currency translation adjustments, which have been negligible to date.

The following summarizes the components of comprehensive loss:

8.  LONG-TERM DEBT AND CREDIT ARRANGEMENTS

     Consolidated long-term debt consists of the following:

     In May 2005, the Company renewed its revolving credit facility that provides for borrowings and issuances of letters of credit and guarantees of up to $55 million. Borrowing availability under the facility is reduced by the face amount of outstanding letters of credit, guarantees and all other loan facilities between the same lender and our controlled companies. This credit facility matures in May 2006 and bears interest at the prime rate (5.75% at March 31, 2005) for outstanding borrowings. The credit facility is subject to an unused commitment fee of 0.0125%, which is subject to reduction based on deposits maintained at the bank. The facility requires cash collateral equal to one times any amounts outstanding under the facility.

10

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
MARCH 31, 2005

     Availability under our revolving credit facility at March 31, 2005 is as follows (in millions):

     (a) Of the total guarantees of $34.0 million, $15.5 million is outstanding under these facilities at March 31, 2005 and included as debt on the Consolidated Balance Sheet.

     As part of the May 2005 amendment, the revolving credit facility was amended such that the remaining $3.7 million available under the letters of credit is now classified as available under the revolving credit bringing the total to $48.7 million under revolving credit and $6.3 million under letter of credit facility. The total facility remained unchanged at $55 million.

     Five consolidated companies maintain separate revolving credit facilities which provide for aggregate borrowings of $37.5 million, of which $34.0 million is guaranteed by the Company under its credit facility as noted above. As of March 31, 2005, outstanding borrowings under these facilities were $15.5 million. Borrowings are secured by substantially all of the assets of the respective subsidiaries. These obligations bear interest at variable rates ranging between the prime rate minus 0.5% and the prime rate plus 1.0%. These facilities contain financial and non financial covenants and expire at various points in the first quarter of 2006. During the first quarter of 2005, two subsidiaries did not comply with certain financial covenants and subsequently received waivers from the lender.

     Debt as of March 31, 2005 bears interest at fixed rates ranging between 4.0% and 22.0% and variable rates indexed to the prime rate plus 1.25% and variable rates indexed to the 3 Year Treasury rate. Debt as of December 31, 2004 bore interest at fixed rates between 4.0% and 22.0% and variable rates indexed to the prime rate plus 1.5%.

9.  CONVERTIBLE SUBORDINATED NOTES AND CONVERTIBLE SENIOR DEBENTURES

     In June 1999, the Company issued $200 million of 5% convertible subordinated notes due June 15, 2006 (2006 Notes). During 2004, the Company repurchased or redeemed all of the 2006 Notes for an aggregate cost of $201.4 million, including transaction costs. During the three months ended March 31, 2004, the Company recorded $0.9 million of expense related to the acceleration of deferred debt costs associated with the 2006 Notes, which is included in Other Income (Loss), Net on the Consolidated Statements of Operations.

11

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
MARCH 31, 2005

     In February 2004, the Company completed the sale of $150 million of 2.625% convertible senior debentures with a stated maturity of March 15, 2024. Interest on the 2024 Debentures is payable semi-annually. At the debenture holders’ option, the debentures are convertible into our common stock through March 14, 2024, subject to certain conditions. The conversion rate of the debentures at March 31, 2005 was $7.2174 of principal amount per share. The closing price of the Company’s common stock at March 31, 2005 was $1.42. The Debenture holders may require repurchase of the debentures on March 21, 2011, March 20, 2014 or March 20, 2019 at a repurchase price equal to 100% of their respective face amount plus accrued and unpaid interest. The Debenture holders may also require repurchase of the debentures upon certain events, including sale of all or substantially all of our common stock or assets, liquidation, dissolution or a change in control. Subject to certain conditions, we may redeem all or some of the debentures commencing March 20, 2009.

     As required by the terms of the 2024 Debentures, after completing the sale of CompuCom, the Company escrowed $16.7 million on October 8, 2004 for interest payments through March 15, 2009 on the 2024 Debentures. These amounts are included in Restricted Marketable Securities on the Consolidated Balance Sheet at March 31, 2005 and December 31, 2004.

10.  STOCK-BASED COMPENSATION

     As permitted by SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company accounts for employee stock-based compensation in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, no compensation expense is recorded for stock options issued to employees at fair market value. Stock options issued to non-employees are measured at fair value on the date of grant using the Black-Scholes model and are expensed over the vesting period.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” – an amendment to SFAS 123.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also amended the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.

12

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
MARCH 31, 2005

     The Company elected to continue to account for stock-based compensation in accordance with APB Opinion No. 25. Had compensation cost been recognized consistent with SFAS No. 123 and 148, the Company’s consolidated net income (loss) from continuing operations and discontinued operations and income (loss) per share from continuing operations and from discontinued operations would have been as follows:

13

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
MARCH 31, 2005

     The following ranges of assumptions were used by the Company, its subsidiaries and its companies accounted for under the equity method to determine the fair value of stock options granted during the three months ended March 31, 2005 and 2004 using the Black-Scholes option-pricing model for public companies and subsidiaries and the minimum value method for private equity method companies:

     No options were granted by the Company during the three months ended March 31, 2005 and 2004.

11.  INCOME TAXES

     The Company’s consolidated income tax benefit recorded for the three months ended March 31, 2005 was $0.2 million, net of a recorded valuation allowance of $5.7 million. The Company recorded a valuation allowance against its deferred tax assets based on management’s determination that it is more likely than not that these assets will not be realized in future years.

12.  NET LOSS PER SHARE

     The calculations of net loss per share were:

14

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
MARCH 31, 2005

     If a consolidated or equity method company has dilutive stock options, unvested restricted stock, warrants or securities outstanding, diluted net loss per share is computed by first deducting from net loss the income attributable to the potential exercise of the dilutive securities of the company. This impact is shown as an adjustment to net loss for purposes of calculating diluted net loss per share.

     The following potential shares of common stock and their effects on income were excluded from the diluted net loss per share calculation because their effect would be anti-dilutive:

	•	At March 31, 2005 and 2004, options to purchase 8.8 million and 9.8 million shares of common stock at prices ranging from $1.25 to $50.98 per share, were excluded from the 2005 and 2004 calculations, respectively.
	•	At March 31, 2005 and 2004, restricted stock units convertible into 0.1 million and 0.2 million shares of stock and deferred stock units convertible into 0.6 million and 1.2 million shares were excluded from the calculations.
	•	At March 31, 2004, 7.2 million shares related to the Company’s 2006 Notes (See Note 9) representing the weighted average effect of assumed conversion of the 2006 Notes were excluded from the calculation.
	•	At March 31, 2005 and 2004, a total of 20.8 million and 9.8 million shares, respectively, related to the Company’s 2024 Debentures (See Note 9) representing the weighted average effect of assumed conversion of the 2024 Debentures were excluded from the calculation.

13.  PARENT COMPANY FINANCIAL INFORMATION

     Parent company financial information is provided to present the financial position and results of operations of the Company as if the consolidated companies (see Note 2) were accounted for under the equity method of accounting for all periods presented during which the Company owned its interest in these companies.

15

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
MARCH 31, 2005

16

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
MARCH 31, 2005

14.  OPERATING SEGMENTS

     Management evaluates segment performance based on segment revenue, operating income (loss) and income (loss) before income taxes, which reflects the portion of income (loss) allocated to minority shareholders.

     Other Items includes certain corporate expenses, which are not identifiable to the operations of the Company’s operating business segments. Other Items primarily consists of general and administrative expenses related to employee compensation, insurance and professional fees including legal, finance and consulting. Other Items also includes interest income, interest expense and income taxes, which are reviewed by management independent of segment results.

     The following tables reflect the Company’s consolidated operating data by reportable segments. Each segment includes the results of the consolidated companies and records the Company’s share of income or losses for entities accounted for under the equity method. Segment results also include impairment charges, gains or losses related to the disposition of the companies and the mark to market of trading securities. All significant intersegment activity has been eliminated in consolidation. Accordingly, segment results reported by the Company exclude the effect of transactions between the Company and its subsidiaries and among the Company’s subsidiaries.

     Revenue is attributed to geographic areas based on where the services are performed or the customer’s shipped to location. A majority of the Company’s revenue is generated in the United States.

     As of March 31, 2005 and December 31, 2004, the Company’s assets were primarily located in the United States.

     The following represents the segment data from continuing operations:

17

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
MARCH 31, 2005

Other Items

18. BUSINESS COMBINATIONS

Acquisitions by the Company – 2004

     In 2004, the Company completed the following acquisitions:

	•	Acquired substantially all of the assets comprising the business of Laureate Pharma L.P.
	•	Acquired additional shares of Pacific Title from minority interest shareholders for a total of $1.8 million, increasing its ownership in Pacific Title from 84% to 93%.
	•	Acquired additional shares of Mantas for a total of $10 million, increasing its ownership in Mantas to 88%.
	•	Acquired additional shares of Clarient for $12.5 million

     The Company has not completed the allocation of purchase price for Laureate. Therefore, the allocation of purchase price could be adjusted when the valuation of assets acquired and liabilities assumed is completed.

     The following unaudited pro forma financial information presents the combined results of operations of the Company as if the acquisitions had occurred as of the beginning of the periods presented, after giving effect to certain adjustments, including amortization of intangibles with definite useful lives. The pro forma results of operations are not indicative of the actual results that would have occurred had the acquisitions been consummated at the beginning of the period presented and are not intended to be a projection of future results.

19.  RELATED PARTY TRANSACTIONS

     In October 2000, the Company guaranteed certain margin loans advanced by a third party to Mr. Musser, then the Chief Executive Officer of the Company. The securities subject to the margin account included shares of the Company’s common stock. The Company entered into this guarantee arrangement to maintain an orderly trading market for its equity securities, to maintain its compliance posture with the Investment Company Act of 1940, and to avoid diversion of the attention of a key executive from the performance of his responsibilities to the Company. In May 2001, the Company entered into a $26.5 million loan agreement with Mr. Musser. The proceeds of the loan were used to repay the margin loans guaranteed by Safeguard in October 2000. The purpose of the May 2001 loan agreement was to eliminate the guarantee obligations and to provide for direct and senior access to Mr. Musser’s assets as collateral for the loan.

18

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
MARCH 31, 2005

     The loan bears interest at the default annual rate of 9% and became payable on a limited basis on January 1, 2003. The Company sent Mr. Musser a demand notice in January 2003 and, when no payment was received, a default notice. In conjunction with the original loan, Mr. Musser granted the Company security interests in securities and real estate as collateral. Based on the information available to us, the Company also concluded that Mr. Musser may not have sufficient personal assets to satisfy the outstanding balance due under the loan when the loan becomes full recourse against Mr. Musser on May 18, 2006. To date the Company has impaired the loan by $15.7 million, including $0.2 million in the first quarter of 2005, to the estimated value of the collateral that the Company held at each respective date. The Company’s carrying value of the loan at March 31, 2005 is $1.2 million. The Company will continue to evaluate the value of the collateral to the carrying value of the note on a quarterly basis.

20.  COMMITMENTS AND CONTINGENCIES

     The Company and its subsidiaries are involved in several pending legal actions including the Safeguard Securities litigation and the CompuCom Securities litigation, as described in the Company’s 2004 Annual Report on Form 10-K. There were no material developments in these actions during the quarter ended March 31, 2005.

     As previously reported, the outcome of the above litigation matters are uncertain, and while we believe that we have valid defenses to plaintiffs’ claims and intend to defend the lawsuits vigorously, no assurance can be given as to the outcome of these lawsuits. An adverse outcome could have a material adverse effect on our consolidated financial statements and results of operations.

     The Company and its subsidiaries are involved in various other claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s consolidated financial position or results of operations.

     In connection with its ownership interests in certain affiliates, the Company has guarantees of $45 million at March 31, 2005, of which $41 million relates to guarantees of the Company’s consolidated companies (and $34 million of which is guaranteed under the Company’s revolving credit facility (See Note 8)).

     Additionally, we have committed capital of approximately $20.5 million related to commitments made in prior years to various private equity funds and a private company, to be funded over the next several years, including approximately $7.9 million which is expected to be funded during the next twelve months.

     Under certain circumstances, the Company may be required to return a portion or all the distributions it received as a general partner to the certain private equity funds (the “clawback”). Assuming the funds in which we are a general partner are liquidated or dissolved on March 31, 2005 and assuming for these purposes the only distributions from the funds are equal to the carrying value of the funds on the March 31, 2005 financial statements, the maximum clawback we would be required to

19

SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
MARCH 31, 2005

return for our general partner interest is approximately $7 million. Management estimates its liability to be approximately $4 million. This amount is reflected in “Other Long-Term Liabilities” on the Consolidated Balance Sheets.

     The Company’s ownership in the general partner of the funds which have potential clawback liabilities range from 19-30%. The clawback liability is joint and several, such that the Company may be required to fund the clawback for other general partners should they default. The funds have taken several steps to reduce the potential liabilities should other general partners default, including withholding all general partner distributions in escrow and adding rights of set-off among certain funds. The Company believes its liability due to the default of other general partners is remote.

     In October 2001, the Company entered into an agreement with Mr. Musser, its former Chairman and Chief Executive Officer, to provide for annual payments of $650,000 per year and certain health care and other benefits for life. The related current liability of $0.5 million is included in Accrued Expenses and the long-term portion of $4.2 million is included in Other Long-Term Liabilities on the Consolidated Balance Sheets at March 31, 2005.

     The Company has employment agreements with certain executive officers that provide for severance payments to the executive officer in the event the officer is terminated without cause or the officer terminates their employment for “good reason”.

     Certain employees of our subsidiaries have the right to require the respective subsidiary to purchase shares of common stock of the subsidiary received by the employee pursuant to the exercise of options. The employee must hold the shares for at least six months prior to exercising this right. The required purchase price is 75% — 100% of the fair market value at the time the right is exercised, and in some cases is subject to a floor of $1.58. At March 31, 2005, a subsidiary may be required to purchase up to 361,250 shares based on options exercised to date, for an aggregate value of $0.6 million.

21.  SUBSEQUENT EVENT

     On May 2, 2005, the Company amended its credit facility to extend the maturity date to May 2006 (See Note 8).

20

Item 2.          Management’s Discussion and Analysis of Financial Condition and Results of Operations

     Cautionary Note concerning Forward-Looking Statements

     This report contains forward-looking statements that are based on current expectations, estimates, forecasts and projections about us, the industries in which we operate and other matters, as well as management’s beliefs and assumptions and other statements regarding matters that are not historical facts. These statements include, in particular, statements about our plans, strategies and prospects. For example, when we use words such as “projects,” “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “should,” “would,” “could,” “will,” “opportunity,” “potential” or “may,” variations of such words or other words that convey uncertainty of future events or outcomes, we are making forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Our forward-looking statements are subject to risks and uncertainties. Factors that could cause actual results to differ materially, include, among others, managing rapidly changing technologies, limited access to capital, competition, the ability to attract and retain qualified employees, the ability to execute our strategy, the uncertainty of the future performance of our companies, acquisitions and dispositions of companies, the inability to manage growth, compliance with government regulation and legal liabilities, additional financing requirements, labor disputes and the effect of economic conditions in the business sectors in which our companies operate, all of which are discussed below under the caption “Factors that May Affect Future Results.” Many of these factors are beyond our ability to predict or control. In addition, as a result of these and other factors, our past financial performance should not be relied on as an indication of future performance.

     All forward-looking statements attributable to us, or to persons acting on our behalf, are expressly qualified in their entirety by this cautionary statement. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

     In light of these risks and uncertainties, the forward-looking events and circumstances discussed in this report might not occur.

Overview

     We are focused on owning and operating growth businesses engaged in a number of diverse business activities. We focus primarily on companies in the Time-To-Volume stage of development. Time-to-Volume companies generally are generating revenues from commercially viable products or services and are facing new challenges as they scale their businesses to take advantage of market opportunities. We seek to create long-term shareholder value by helping companies primarily in the information technology and life sciences industries develop through superior operations and management. Our primary focus is on the operations of our consolidated, majority-owned companies and helping them increase market penetration, grow revenue and improve cash flow in order to create long-term value.

     We see growing market opportunities for companies that operate in the following two categories:

	•	Information Technology. Including companies focused on complex information technology, software and service solutions; and
	•	Life Sciences. Including companies focused on drug formulation or delivery techniques, specialty pharmaceuticals, diagnostics or devices.

     Our strategy is to acquire majority ownership positions in companies through expansion capital, buyouts, carve-outs, recapitalizations or other structures. In general, we hold our ownership interest in a company as long as we believe that we can leverage our resources to assist the company in achieving superior growth in financial performance and value. On an ongoing basis, we review the current value and prospects of each of our companies in order to determine whether our long-term interests can best be served by holding the company or by realizing the value (or a portion of the value) of the company. As a result, from time-to-time, we may sell an entire company or some or all of our interests in a company and redeploy the capital realized in other opportunities. We may achieve these liquidity events through private transactions with strategic buyers, initial public offerings or other means. In the case of our public companies, we may sell our interests from time to time in the open market, in privately negotiated sales or in public offerings. Consistent with that strategy, during 2005, we will continue to assess our companies, consider the strategy of each company, its fit within our strategic focus and its opportunities for growth. As a result of these assessments, we may undertake liquidity events during the course of the year.

21

     During 2005, we intend to focus our resources on the operations of our consolidated companies — Alliance Consulting, Clarient (formerly ChromaVision), Laureate Pharma, Mantas and Pacific Title. In addition, we will continue to pursue potential acquisitions and business combinations. We anticipate that any new acquisitions will involve companies that are either in the information technology or life sciences industries or are complementary to our existing companies.

     In addition, we hold interests in a number of other companies, that do not currently operate in the categories described above or that operate in these categories but in which we generally own less than a majority interest. We also participate in earlier stage technology development through our interests in several private equity funds.

     Many of our companies are technology-related companies that have incurred substantial losses in first quarter of 2005, and in prior periods. We expect some of these losses to continue as we move further into 2005. In addition, we expect to continue to acquire interests in more technology-related companies that may have operating losses when we acquire them. We also expect certain of our existing companies to continue to invest in their products and services and to recognize operating losses related to those activities. As a result, our operating losses attributable to our corporate operations and our companies could continue to be significant. Our financial results also are affected by acquisitions or dispositions of companies or equity or debt interests in companies. These transactions have resulted in significant volatility in our financial results, which we expect will continue.

Critical Accounting Policies and Estimates

     Accounting policies, methods and estimates are an integral part of consolidated financial statements prepared by management and are based upon management’s current judgments. These judgments are normally based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods and estimates are particularly important because of their significance to the financial statements and because of the possibility that future events affecting them may differ from management’s current judgments.

     On an ongoing basis, we evaluate our estimates. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. There can be no assurance that actual results will not differ from those estimates.

     While there are a number of accounting policies, methods and estimates affecting our financial statements, areas that are particularly significant include the following:

	•	Revenue recognition
	•	Recoverability of goodwill
	•	Recoverability of long-lived assets
	•	Recoverability of ownership interests in and advances to companies
	•	Recoverability of notes receivable — related party
	•	Income taxes
	•	Allowance for doubtful accounts
	•	Commitments and contingencies

     Revenue Recognition

     During 2005, our revenue from continuing operations was primarily attributable to Alliance, Clarient, Laureate Pharma, Mantas and Pacific Title and during 2004, Alliance, Clarient, Mantas and Pacific Title.

     Alliance generates revenue primarily from consulting services. Revenue is generally recognized upon the performance of services. Certain services are performed under fixed-price service contracts related to discrete projects. Revenue from these contracts is recognized using the percentage-of-completion method, primarily based on the actual labor hours incurred to date compared to the estimated total hours of the project. Any losses expected to be incurred on jobs in process are charged to income in the period such losses become known.

     Clarient generates revenue from lab services, instrument sales and fee-per-use charges. Clarient recognizes revenue for lab services at the time of completion of services at amounts equal to those amounts expected for collection from third

22

parties including Medicare, insurance companies and, to a small degree, private patients. These expected amounts are based both on Medicare allowable rates and Clarient ‘s collection experience with other third party payors.

     Clarient places most of its ACIS^® units with users on a “fee-per-use” basis. Clarient recognizes revenue based on the greater of actual usage fees or the minimum monthly rental fee. Under this pricing model, Clarient owns most of the ACIS^® instruments that are engaged in service and, accordingly, all related depreciation and maintenance and service costs are expensed as incurred. For those instruments that are sold, Clarient recognizes and defers revenue using the residual method pursuant to the requirements of Statement of Position No. 97-2, “Software Revenue Recognition” (SOP 97-2), as amended by Statement of Position No. 98-9, “Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Arrangements.” At the outset of the arrangement with the customer, Clarient defers revenue for the fair value of its undelivered elements (e.g., maintenance) and recognizes revenue for the remainder of the arrangement fee attributable to the elements initially delivered in the arrangement (e.g., software license) when the basic criteria in SOP 97-2 have been met. Maintenance revenue is recognized ratably over the term of the maintenance contract, typically twelve months. Revenue on system sales is recognized upon acceptance by the customer, often subsequent to a testing and evaluation period.

     Mantas recognizes revenue from software licenses, related consulting services and post contract customer support (PCS). Revenue from software license agreements and product sales is recognized upon delivery, provided that all of the following conditions are met: a non-cancelable license agreement has been signed; the software has been delivered; no significant production, modification or customization of the software is required; the vendor’s fee is fixed or determinable; and collection of the resulting receivable is deemed probable. In software arrangements that include rights to software products, hardware products, specified upgrades, PCS, and/or other services, Mantas allocates the total arrangement fee among each deliverable based on vendor-specific objective evidence. Revenue from maintenance agreements is recognized ratably over the term of the maintenance period, generally one to five years. Consulting and training services provided by Mantas that are not considered essential to the functionality of the software products are recognized as the respective services are performed.

     For Mantas’ software installations or implementations that include significant production, development or customization, revenue is recognized using the percentage of completion method. Mantas measures progress toward completion by reference to total costs incurred compared to total estimated costs to be incurred in completing the development effort. Mantas’ revenue calculated using the percentage completion method is limited by the existence of customer acceptance provisions of contractually defined milestones and corresponding customer rights to refund for certain portions of the fee. In cases where acceptance provisions exist, Mantas defers revenue recognition until Mantas has evidence that the acceptance provisions have been met. When current analysis of cost estimates indicate a loss is expected to be incurred, the entire loss is recorded in the period in which it is identified.

     Pacific Title’s revenue is primarily derived from providing post-production services to the motion picture and television industry. Laureate’s revenue is generated by sale of contract manufacturing services to support the development and commercialization of pharmaceutical products. Revenue is generally recognized upon the performance of services. Certain services are performed under fixed-price contracts. Revenue from these contracts is recognized on a percentage of completion basis based on costs incurred to total estimated costs to be incurred. Any anticipated losses on contracts are expensed when identified.

     Recoverability of Goodwill

     We conduct a review for impairment of goodwill at least annually. Additionally, on an interim basis, we assess the impairment of goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that we consider important which could trigger an impairment review include significant underperformance relative to historical or expected future operating results, significant changes in the manner or use of the acquired assets or the strategy for the overall business, significant negative industry or economic trends or a decline in a company’s stock price for a sustained period.

     We test for impairment at a level referred to as a reporting unit (same as or one level below an operating segment as defined in SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information”). If we determine that the fair value of a reporting unit is less than its carrying value, we assess the recoverability of these assets. To determine fair value, we use a number of valuation methods including quoted market prices, discounted cash flows and revenue and acquisition multiples. Depending on the complexity of the valuation and the significance of the carrying value of the goodwill

23

to the financial statements, we may engage an outside valuation firm to assist us in determining fair value. As an overall check on the reasonableness of the fair values attributed to our reporting units, we will consider comparing and contrasting the aggregate fair values for all reporting units with our average total market capitalization for a reasonable period of time.

     The carrying value of goodwill at March 31, 2005 was $93 million.

     We operate in industries which are rapidly evolving and extremely competitive. It is reasonably possible that our accounting estimates with respect to the ultimate recoverability of the carrying value of goodwill could change in the near term and that the effect of such changes on our Consolidated Financial Statements could be material. While we believe that the current recorded carrying values of our companies are not impaired, there can be no assurance that a significant write-down or write-off will not be required in the future.

     Recoverability of Long-Lived Assets

     We test long-lived assets, including property and equipment and amortizable intangible assets, for recoverability whenever events or changes in circumstances indicate that we may not be able to recover the asset’s carrying amount. When events or changes in circumstances indicate an impairment may exist, we evaluate the recoverability by determining whether the undiscounted cash flows expected to result from the use and eventual disposition of that asset cover the carrying value at the evaluation date. If the undiscounted cash flows are not sufficient to recover the carrying value, we measure any impairment loss as the excess of the carrying amount of the asset over its fair value.

     The carrying value of net intangible assets at March 31, 2005 was $10 million. The carrying value of net property and equipment at March 31, 2005 was $46 million.

     Recoverability of Ownership Interests In and Advances to Companies

     On a continuous basis, but no less frequently than at the end of each quarterly period, we evaluate the carrying value of our companies for possible impairment based on achievement of business plan objectives and milestones, the fair value of each company relative to its carrying value, the financial condition and prospects of the company and other relevant factors. We then determine whether there has been an other than temporary decline in the carrying value of our ownership interest in the company. Impairment to be recognized is measured by the amount by which the carrying value of the assets exceeds the fair value of the assets.

     The fair value of privately held companies is generally determined based on the value at which independent third parties have invested or have committed to invest in these companies. The fair value of our ownership interests in private equity funds is generally determined based on the value of our pro rata portion of the funds’ net assets and estimated future proceeds from sales of investments provided by the funds’ managers.

     The new cost basis of a company is not written-up if circumstances suggest the value of the company has subsequently recovered.

     We operate in industries which are rapidly evolving and extremely competitive. It is reasonably possible that our accounting estimates with respect to the ultimate recoverability of the carrying value of ownership interests in and advances to companies, including goodwill, could change in the near term and that the effect of such changes on our Consolidated Financial Statements could be material. While we believe that the current recorded carrying values of our companies are not impaired, there can be no assurance that our future results will confirm this assessment or that a significant write-down or write-off of the carrying value will not be required in the future.

     Recoverability of Notes Receivable — Related Party

     A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. In May 2001, we entered into a $26.5 million loan agreement with Mr. Musser, our former CEO. On a quarterly basis, we assess the recoverability of the loan, by reviewing the fair value of the liquid collateral supporting the loan and estimating future cash flows discounted at the loan’s effective rate, as well as determining whether there have been any significant, adverse, other than temporary changes in the estimated fair value of other collateral that does not have readily available fair values. We do not accrue interest when a note

24

is considered impaired. All cash receipts from impaired notes are applied to reduce the principal amount of such note until the principal has been fully recovered, and is recognized as interest income thereafter.

     As of March 31, 2005, the value of the collateral pledged by Mr. Musser to secure the loan had an approximate value of $1.2 million compared to the loan’s carrying value of $1.2 million after giving effect to a $0.2 million impairment charge in the first quarter of 2005. The collateral pledged includes $0.4 million of publicly traded securities, $0.3 million of privately held securities, and $0.5 million of private equity fund interests. The publicly traded securities are valued using quoted market prices, the privately held securities have been valued based on the price at which the privately held company has offered to pay shareholders to acquire the shares and the private equity fund interests are valued based upon the estimated fair value of the net assets of the fund. We will continue to evaluate the value of the collateral compared to the carrying value of the note on a quarterly basis.

     Income Taxes

     We are required to estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our Consolidated Balance Sheet. We must assess the likelihood that the deferred tax assets will be recovered from future taxable income and to the extent that we believe recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance in a period, we must include an expense within the tax provision in the Consolidated Statements of Operations. We have recorded a valuation allowance to reduce our deferred tax asset to an amount that is more likely than not to be realized in future years. If we determine in the future that it is more likely than not that the net deferred tax assets would be realized, then the previously provided valuation allowance would be reversed.

     Allowance for Doubtful Accounts

     The allowance for doubtful accounts is an estimate prepared by management based on identification of the collectibility of specific accounts and the overall condition of the receivable portfolios. When evaluating the adequacy of the allowance for doubtful accounts, we specifically analyze trade receivables, historical bad debts, customer credits, customer concentrations, customer credit-worthiness, current economic trends and changes in customer payment terms. If the financial condition of customers or vendors were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Likewise, should we determine that we would be able to realize more of our receivables in the future than previously estimated, an adjustment to the allowance would increase income in the period such determination was made. The allowance for doubtful accounts is reviewed on a quarterly basis and adjustments are recorded as deemed necessary.

     Commitments and Contingencies

     From time to time, we are a defendant or plaintiff in various legal actions which arise in the normal course of business. Additionally, we have received distributions as both a general partner and a limited partner from certain private equity funds. Under certain circumstances, we may be required to return a portion or all the distributions we received as a general partner to the fund for a further distribution to the fund’s limited partners (the “clawback”). We are also a guarantor of various third-party obligations and commitments, and are subject to the possibility of various loss contingencies arising in the ordinary course of business. We are required to assess the likelihood of any adverse outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of provision required for these commitments and contingencies, if any, which would be charged to earnings, is made after careful analysis of each matter. The provision may change in the future due to new developments or changes in circumstances. Changes in the provision could increase or decrease our earnings in the period the changes are made.

  Results of Operations

     Management evaluates segment performance based on segment revenue, operating income (loss) and income (loss) before income taxes, which reflects the portion of income (loss) allocated to minority shareholders.

     Other items include certain expenses which are not identifiable to the operations of the Company’s operating business segments. Other items primarily consists of general and administrative expenses related to employee compensation,

25

insurance and professional fees, including legal, finance and consulting. Other items also includes interest income, interest expense and income taxes, which are reviewed by management independent of segment results.

     The following tables reflect our consolidated operating data by reportable segments. Each segment includes the results of our consolidated companies and records our share of income or losses for entities accounted for under the equity method. Segment results also include impairment charges, gains or losses related to the disposition of the companies and the mark to market of trading securities. All significant intersegment activity has been eliminated in consolidation. Accordingly, segment results reported by us exclude the effect of transactions between us and our subsidiaries and among our subsidiaries.

     The Company’s operating results by segment are as follows:

     There is intense competition in the markets in which these companies operate, and we expect competition to intensify in the future. Additionally, the markets in which these companies operate are characterized by rapidly changing technology, evolving industry standards, frequent introduction of new products and services, shifting distribution channels, evolving government regulation, frequently changing intellectual property landscapes and changing customer demands. Their future success depends on each company’s ability to execute its business plan and to adapt to its respective rapidly changing markets.

Alliance

     Alliance operates on a 52 or 53-week fiscal year, ending on the Saturday closest to the end of the fiscal period. Alliance’s first quarter ended on April 2, 2005, a period of 13 weeks and April 3, 2004, a period of 14 weeks.

     Alliance is an information technology services and consulting firm that provides custom software solutions and IT consulting services to clients in the Fortune 2000 market. Alliance’s business-driven solutions enable corporate performance

26

management through the delivery of business intelligence and data warehousing, custom application development and outsourcing, packaged software integration and strategic consulting services. Over its ten-year history, Alliance has developed considerable domain expertise in the pharmaceutical, financial services, manufacturing, healthcare and distribution industries.

     While global economic conditions continue to cause companies to be cautious about increasing their use of consulting and IT services, Alliance continues to see growing demand for its services. However, Alliance continues to experience pricing pressure from competitors as well as from clients facing pressure to control costs. In addition, the growing use of offshore resources to provide lower cost service delivery capabilities within the industry continues to place pressure on pricing and revenue. Alliance expects to continue to focus on maintaining and growing its blue chip client base and providing high quality solutions and services to its clients.

     In October 2004, Alliance acquired Mensamind, (now Alliance India) a software development company based in Hyderabad, India. This acquisition enables Alliance to provide offshore capabilities to its existing and new clients. Since the transaction was completed in October 2004, the acquisition did not have a material effect on the consolidated operating results of Alliance for 2004. Alliance expects that revenue from off-shore operations will increase substantially as compared to 2004, but will account for less than five percent of total revenue in 2005.

     At March 31, 2005, we owned 99% of Alliance.

Revenue. Revenue, including reimbursement of expenses, decreased $1.7 million, or 7.2%, to $21.8 million in 2005 as compared to $23.5 million in 2004. This decrease is due to the prior year including a substantial acquisition-related integration project for Alliance’s largest customer, continued consolidation within the pharmaceutical sector, and the fact that the first quarter of 2004 contained one more week (since 2004 had 14 fiscal weeks compared to 13 weeks in 2005). Revenue in 2005 is expected to benefit from continued growth in two new service offerings – Master Data Management and Global Delivery – which were introduced during 2004. Master Data Management includes business intelligence and data management as well as corporate performance management. Global Delivery is Alliance Consulting’s low cost, high quality offshore delivery and support service. These new services generated an aggregate of $1.4 million in 2005 revenue and provided increased gross profit of $60 thousand as compared to other services due to their lower cost of delivery. Revenue growth continues to be impacted by general economic uncertainty, causing many clients to delay project starts or award projects in multiple stages instead of one large project.

     Alliance’s top ten customers accounted for approximately 62% of total revenue in 2005 as compared to approximately 55% of total revenue in 2004. Two customers in the first quarter of 2005 individually had revenue greater than 10% of total revenue.

Cost of Sales. Cost of sales decreased $1.3 million, or 8.1%, to $15.0 million in 2005 as compared to $16.3 million in 2004. This decrease was a direct result of the decrease in revenue. Gross Margin remained relatively flat year over year. The increase in overall pricing pressures within the industry and increased employee and contractor costs as competition for talent has increased with declines in unemployment levels and pricing concessions made to customers in exchange for greater volume were offset by the introduction of higher margin service offerings during the quarter and internal improvements surrounding project management that prevented cost overruns during the delivery process. In 2005, gross margins are expected to continue to be impacted by general economic uncertainty, pricing pressures both with the client and the consultant, resource availability and efficiency in project management.

Selling, General and Administrative. Selling, general and administrative expenses decreased $0.2 million or 2.7% in 2005. Selling, general and administrative expenses were 32.7% of revenue in 2005 as compared to 31.2% of revenue in 2004. The increase as a percentage of revenue was directly due to the decrease in revenue against a semi-variable cost structure. Costs are expected to increase as the business grows; however, as a percentage of revenue, costs are expected to decrease as sales force headcount additions made during 2004 begin to generate a return on investment.

Amortization. Amortization expense associated with amortizable intangible assets increased $0.1 million to $0.3 million in 2005. The increase was due to higher intangible assets as a result of Alliance’s acquisition of Mensamind.

Net Loss Before Income Taxes. Net loss increased $0.4 million to $0.7 million in 2005. The increase in net loss is primarily attributable to the decline in revenue in 2005.

27

Clarient

     Clarient is an advanced diagnostics technology and services company focused on improving the quality of patient care while reducing medical costs and speeding the discovery of new drugs to treat cancer. Clarient’s proprietary Automated Cellular Imaging System (ACIS^Ò) is a versatile automated microscope system that greatly improves the accuracy and reproducibility of cell imaging through its unique patented technology. Clarient also provides comprehensive laboratory services ranging from in-house pathology testing using the ACIS^Ò to other diagnostic technologies that assist physicians in managing cancer. In addition, Clarient develops ACIS^Ò-based tools for academic and biopharmaceutical company researchers, allowing them to perform cellular-level analyses much faster and with improved accuracy.

     The decision to provide in-house laboratory services was made in 2004 to give Clarient an opportunity to capture a significant service-related revenue stream over the much broader and expanding cancer diagnostic testing marketplace while also optimizing the level of service and accuracy provided to remote pathology customers. Clarient believes that they are positioned to participate in this growth because of their proprietary analysis capabilities, depth of experience of the staff in their diagnostic laboratory, relationships with the pharmaceutical companies and demonstrated ability to develop unique assays to support new diagnostic tests.

     As of March 31, 2005, we owned a 57% voting interest in Clarient.

Revenue. Total revenue increased $2.1 million or 107.5% in the first quarter of 2005 as compared to 2004. Lab services revenue was $1.9 million in the first quarter of 2005, with no comparable figure for the prior year as these services commenced in the second quarter of 2004. Revenue generated from system sales increased $0.4 million in the first quarter of 2005 as compared to 2004. These increases were partially offset by a decline in fee-per-use revenue of $0.2 million, which was caused by a reduction in the aggregate number of ACIS^Ò placements and a significant decline in the average monthly revenue for ACIS^Ò placements and remote viewing stations.

Cost of Sales. Cost of sales increased $1.5 million or 165.2% in the first quarter of 2005 as compared to 2004. Cost of sales related to lab services was $1.8 million in the first quarter of 2005. These costs were relatively high compared to lab services revenue because these operations have not yet achieved economies of scale. Cost of sales related to systems sales and fee-per-use declined in the first quarter of 2005. Gross margins for systems sales was 70% in 2005 as compared to 52% in 2004. The improvement was due primarily to lower costs of sale for sold systems, which in many cases were refurbished older systems, and lower costs of field service.

Selling, General and Administrative. Selling, general and administrative expenses increased $1.2 million or 34.8% in the first quarter of 2005 as compared to 2004. Clarient attributes the increase primarily to lab services administration costs, which included the costs of senior medical staff, senior operations personnel, collection costs, consultants and legal resources to facilitate implementation of this new operation.

Research and Development. Research and development costs declined $0.1 million in the first quarter of 2005 as compared to 2004. Clarient attributes the decline to a reduction in personnel as a result of a fourth quarter 2004 workforce reduction.

28

Net Loss Before Income Taxes. Net loss remained constant in the first quarter of 2005 as compared to 2004 for the reasons discussed above.

Laureate Pharma

     We acquired 100% of Laureate Pharma in December 2004. As a result, there is no comparative financial information for the prior year period.