10-Q 1 tenq_q2-2003.txt 10-Q FOR PERIOD ENDED JUNE 30, 2003 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2003 OR [ ] 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 0-9722 INTERGRAPH CORPORATION ------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 63-0573222 ------------------------------- ---------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) Huntsville, Alabama 35894-0001 ---------------------------------------- ----------- (Address of principal executive offices) (Zip Code) (256) 730-2000 -------------------- (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 Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- ---- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No ---- ---- Common stock, par value $0.10 per share: 46,393,628 shares outstanding as of June 30, 2003 ====================================================================== INTERGRAPH CORPORATION FORM 10-Q* June 30, 2003 INDEX Page No. -------- PART I. FINANCIAL INFORMATION --------------------- Item 1. Financial Statements -------------------- Consolidated Balance Sheets at June 30, 2003, and December 31, 2002 2 Consolidated Statements of Income for the quarters and six months ended June 30, 2003, and 2002 3 Consolidated Statements of Cash Flows for the six months ended June 30, 2003, and 2002 4 Notes to Consolidated Financial Statements 5 - 11 Item 2. Management's Discussion and Analysis of Financial Condition ----------------------------------------------------------- and Results of Operations 12 - 18 ------------------------- Item 3. Quantitative and Qualitative Disclosures About Market Risk 19 ---------------------------------------------------------- Item 4. Controls and Procedures 19 ----------------------- PART II. OTHER INFORMATION ----------------- Item 1. Legal Proceedings 20 - 21 ----------------- Item 4. Submission of Matters to a Vote of Security Holders 21 --------------------------------------------------- Item 5. Other 21 ----- Item 6. Exhibits and Reports on Form 8-K 22 -------------------------------- SIGNATURES 23 * Information contained in this Form 10-Q includes statements that are forward- looking as defined in Section 21E of the Securities Exchange Act of 1934. Actual results may differ materially from those projected in the forward- looking statements. Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is described in the Company's filings with the Securities and Exchange Commission, including its most recent Annual Report on Form 10-K and this Form 10-Q. PART I. FINANCIAL INFORMATION --------------------- Item 1. Financial Statements -------------------- INTERGRAPH CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited) -------------------------------------------------------------------------------- June 30, December 31, 2003 2002 -------------------------------------------------------------------------------- (In thousands, except share and per share amounts) Assets Cash and cash equivalents $469,683 $490,097 Short-term investments 28,874 15,927 -------------------------------------------------------------------------------- Total cash and short-term investments 498,557 506,024 Accounts receivable, net 152,229 152,187 Inventories, net 17,931 19,397 Other current assets 39,184 39,795 -------------------------------------------------------------------------------- Total current assets 707,901 717,403 Investments in affiliates 10,043 20,700 Capitalized software development costs, net 30,989 29,830 Other assets, net 15,731 16,889 Property, plant, and equipment, net 50,365 50,818 -------------------------------------------------------------------------------- Total Assets $815,029 $835,640 ================================================================================ Liabilities and Shareholders' Equity Trade accounts payable $17,179 $17,850 Accrued compensation 30,610 31,541 Other accrued expenses 36,980 35,730 Billings in excess of sales 49,347 43,908 Income taxes payable 28,382 67,477 Short-term debt --- 169 -------------------------------------------------------------------------------- Total current liabilities 162,498 196,675 -------------------------------------------------------------------------------- Deferred income taxes 16,076 16,260 Other noncurrent liabilities 844 995 -------------------------------------------------------------------------------- Total noncurrent liabilities 16,920 17,255 -------------------------------------------------------------------------------- Shareholders' equity: Common stock, par value $0.10 per share - 100,000,000 shares authorized; 57,361,362 shares issued 5,736 5,736 Additional paid-in capital 203,198 206,888 Retained earnings 594,929 586,020 Accumulated other comprehensive income (loss) 6,247 (659) -------------------------------------------------------------------------------- 810,110 797,985 Less - cost of treasury shares (10,967,734 at June 30, 2003, and 11,198,767 at December 31, 2002) (174,499) (176,275) -------------------------------------------------------------------------------- Total shareholders' equity 635,611 621,710 -------------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $815,029 $835,640 ================================================================================ The accompanying notes are an integral part of these consolidated financial statements. INTERGRAPH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) -------------------------------------------------------------------------------- Quarter Ended June 30, Six Months Ended June 30, 2003 2002 2003 2002 -------------------------------------------------------------------------------- (In thousands, except per share amounts) Revenues Systems $ 72,819 $ 67,460 $143,225 $138,354 Maintenance 34,053 30,167 64,110 58,329 Services 20,475 24,943 40,565 48,983 -------------------------------------------------------------------------------- Total revenues 127,347 122,570 247,900 245,666 -------------------------------------------------------------------------------- Cost of revenues Systems 37,917 32,899 74,377 69,396 Maintenance 12,779 13,516 25,075 27,732 Services 15,066 17,312 30,262 33,875 -------------------------------------------------------------------------------- Total cost of revenues 65,762 63,727 129,714 131,003 -------------------------------------------------------------------------------- Gross profit 61,585 58,843 118,186 114,663 Product development 14,605 12,451 26,477 24,717 Sales and marketing 25,612 24,926 50,289 47,503 General and administrative 18,509 18,548 34,326 34,452 -------------------------------------------------------------------------------- Income from operations 2,859 2,918 7,094 7,991 Intellectual property income (expense), net (4,335) 293,320 995 290,166 Gains (losses) on sales of assets (65) 17,015 1,155 18,545 Interest income 1,676 1,665 3,599 2,661 Other income (expense), net (326) 804 (369) 1,449 -------------------------------------------------------------------------------- Income (loss) before income taxes and minority interest (191) 315,722 12,474 320,812 Income tax benefit (expense) 985 (35,100) (3,565) (35,750) -------------------------------------------------------------------------------- Income before minority interest 794 280,622 8,909 285,062 Minority interest in earnings of consolidated subsidiaries --- (35) --- (97) -------------------------------------------------------------------------------- Net income $ 794 $280,587 $ 8,909 $284,965 ================================================================================ Net income per share - basic $ 0.02 $ 5.67 $ 0.19 $ 5.73 - diluted $ 0.02 $ 5.37 $ 0.18 $ 5.44 ================================================================================ Weighted average shares outstanding - basic 46,275 49,506 46,238 49,729 - diluted 48,404 52,204 48,412 52,375 ================================================================================ The accompanying notes are an integral part of these consolidated financial statements. INTERGRAPH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) -------------------------------------------------------------------------------- Six Months Ended June 30, 2003 2002 -------------------------------------------------------------------------------- (In thousands) Cash Provided By (Used For): Operating Activities: Net income $ 8,909 $284,965 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 4,116 4,766 Amortization 8,192 7,303 Provisions for losses on accounts receivable 532 1,532 Noncurrent portion of deferred taxes (620) 19,192 Income taxes payable (38,975) 26,371 Gains on sales of assets (1,155) (18,545) Net changes in current assets and liabilities 8,190 (28,327) -------------------------------------------------------------------------------- Net cash provided by (used for) operating activities (10,811) 297,257 -------------------------------------------------------------------------------- Investing Activities: Net proceeds from sales of assets 3,490 18,798 Purchases of property, plant, and equipment (3,658) (4,656) Purchases of short-term investments (17,888) (254,197) Proceeds from maturities of short-term investments 16,857 11,035 Capitalized software development costs (5,691) (6,265) Business acquisitions (2,030) (981) Other (1,108) (1,394) -------------------------------------------------------------------------------- Net cash used for investing activities (10,028) (237,660) -------------------------------------------------------------------------------- Financing Activities: Gross borrowings 31 1,044 Debt repayment (200) (1,520) Purchase of treasury stock (9,341) (66,819) Proceeds of employee stock purchases and exercise of stock options 7,427 4,485 Other 9 --- -------------------------------------------------------------------------------- Net cash used for financing activities (2,074) (62,810) -------------------------------------------------------------------------------- Effect of exchange rate changes on cash 2,499 4,475 -------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (20,414) 1,262 Cash and cash equivalents at beginning of period 490,097 99,773 -------------------------------------------------------------------------------- Cash and cash equivalents at end of period $469,683 $101,035 ================================================================================ The accompanying notes are an integral part of these consolidated financial statements. INTERGRAPH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - BASIS OF PRESENTATION The unaudited consolidated financial statements include the accounts of Intergraph Corporation (the "Company" or "Intergraph") and its majority-owned subsidiaries. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring items) necessary for a fair presentation of results for the interim periods presented. These unaudited interim financial statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2002 ("2002 Annual Report"). The operating results for the quarter and six months ended June 30, 2003, are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. The Company's operations are divided for operational and management purposes into four separate business segments, along with a corporate oversight function ("Corporate"): Intergraph Process, Power & Offshore ("PPO"), Intergraph Mapping and Geospatial Solutions ("IMGS"), Intergraph Solutions Group ("ISG"), and Intergraph Public Safety, Inc. ("IPS"). See Note 13 for a description of these business segments. Certain reclassifications have been made to the prior year amounts to provide comparability with the current year presentation. To provide consistency of reported results, all income and expenses associated with the intellectual property division, including related legal expenses, are now classified as "Intellectual property income (expense), net" in the consolidated statements of income. NOTE 2 - STOCK-BASED COMPENSATION In accordance with the disclosure provisions of Statement of Financial Accounting Standards ("SFAS") No. 123 "Accounting for Stock- Based Compensation," the Company has elected to apply Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its stock- based plans. Accordingly, the Company recognized no compensation expense for these plans during the quarter and six-month periods ended June 30, 2003, and 2002. Had the Company accounted for its stock-based compensation plans based on the fair value of awards at grant date consistent with the methodology of SFAS 123, the Company's reported net income and income per share for these periods would have been impacted as indicated below. The effects of applying SFAS 123 on a pro forma basis for the quarter and six-month periods ended June 30, 2003, and 2002, are not likely to be representative of the effects on reported pro forma net income for future periods as options vest over several years and as it is anticipated that additional grants will be made in future years. -------------------------------------------------------------------------------- Quarter Ended June 30, Six Months Ended June 30, 2003 2002 2003 2002 -------------------------------------------------------------------------------- (In thousands, except per share amounts) Net income As reported $ 794 $280,587 $8,909 $284,965 Deduct: Total stock-based employee compensation expense determined under fair-value-based method for all awards (net of income tax) (450) (498) (751) (1,000) -------------------------------------------------------------------------------- Pro forma $ 344 $280,089 $8,158 $283,965 ================================================================================ Basic income per share As reported $ 0.02 $ 5.67 $ 0.19 $ 5.73 Pro forma $ 0.01 $ 5.66 $ 0.18 $ 5.71 Diluted income per share As reported $ 0.02 $ 5.37 $ 0.18 $ 5.44 Pro forma $ 0.01 $ 5.37 $ 0.17 $ 5.42 ================================================================================ NOTE 3 - INVENTORIES Inventories are stated at the lower of average cost or market and are summarized as follows: -------------------------------------------------------------------------------- June 30, December 31, 2003 2002 -------------------------------------------------------------------------------- (In thousands) Raw materials $ 6,989 $7,011 Work-in-process 3,285 2,856 Finished goods 3,018 3,457 Service spares 4,639 6,073 -------------------------------------------------------------------------------- Totals $17,931 $19,397 ================================================================================ Inventories on hand at June 30, 2003, and December 31, 2002, relate primarily to continuing specialized hardware assembly activity in the Company's IMGS and ISG business segments, and to the Company's continuing warranty and maintenance obligations on computer hardware previously sold. Amounts reflected as work-in-process relate to sales contracts accounted for under the percentage-of-completion method. NOTE 4 - CAPITALIZED SOFTWARE DEVELOPMENT COSTS Product development costs are charged to expense as incurred; however, the costs incurred for the development of computer software that will be sold, leased, or otherwise marketed are capitalized when technological feasibility of the product has been established. Such capitalized costs are amortized on a straight-line basis over a period of two to seven years. Amortization of these capitalized costs, included in "Cost of revenues - Systems" in the consolidated statements of income, amounted to $2.6 million in second quarter 2003 compared to $1.3 million in second quarter 2002, and $4.5 million and $2.3 million in the first six months of 2003 and 2002, respectively. Due to net realizable value concerns, the Company did not capitalize product development expenses of $3.1 million and $2.6 million in second quarter 2003 and 2002, respectively, and $6 million and $5.1 million in the first six months of 2003 and 2002, respectively, for costs normally eligible for capitalization. See Note 5 for further information regarding capitalized software development costs and accumulated amortization. NOTE 5 - INTANGIBLE ASSETS The Company's intangible assets include capitalized software development costs (included as a separate line in the consolidated balance sheets) and other intangible assets (included in "Other assets, net" in the consolidated balance sheets). At June 30, 2003, and December 31, 2002, the Company's intangible assets and related accumulated amortization consisted of the following: -------------------------------------------------------------------------------- June 30, 2003 December 31, 2002 ------------------ -------------------- Accumulated Accumulated Gross Amortization Net Gross Amortization Net -------------------------------------------------------------------------------- (In thousands) Capitalized software development $50,082 $(19,093) $30,989 $44,417 $(14,587) $29,830 Other intangible assets 47,202 (36,193) 11,009 44,988 (32,522) 12,466 -------------------------------------------------------------------------------- Totals $97,284 $(55,286) $41,998 $89,405 $(47,109) $42,296 ================================================================================ The Company recorded amortization expense of $4.5 million and $3.8 million for second quarter 2003 and 2002, respectively, and $8.2 million and $7.3 million for first half 2003 and 2002, respectively. Based on the current intangible assets subject to amortization, the estimated amortization expense for the remainder of 2003 and each of the succeeding five years is as follows: $10 million in 2003, $14 million in 2004, $5 million in 2005, $3 million in 2006, $3 million in 2007, $3 million in 2008, and $4 million thereafter. NOTE 6 - PROPERTY, PLANT, AND EQUIPMENT, NET "Property, plant, and equipment, net" includes accumulated depreciation of approximately $114.3 million and $114.4 million at June 30, 2003, and December 31, 2002, respectively. NOTE 7 - SUPPLEMENTARY CASH FLOW INFORMATION Changes in current assets and liabilities, net of the effects of business acquisitions and divestitures, in reconciling net income to net cash provided by (used for) operations are as follows: -------------------------------------------------------------------------------- Six Months Ended June 30, 2003 2002 -------------------------------------------------------------------------------- (In thousands) (Increase) decrease in: Accounts receivable, net $ 5,256 $ 4,034 Inventories, net 1,880 1,952 Other current assets 247 (13,405) Increase (decrease) in: Trade accounts payable (353) (4,893) Accrued compensation and other accrued expenses (1,936) (13,319) Refundable income taxes (592) (627) Billings in excess of sales 3,688 (2,069) -------------------------------------------------------------------------------- Net changes in current assets and liabilities $ 8,190 $(28,327) ================================================================================ Other non-cash investing and financing transactions in second quarter 2003 and the six months ended June 30, 2003, include favorable mark- to-market adjustments (net of tax) of $1.8 million and $812,000, respectively, on the Company's investment in Creative Technology Ltd. ("Creative"). Subsequent to June 30, 2003, all of the Company's 1.5 million shares of Creative were sold for $12.5 million, resulting in a $1.8 million gain. Significant non-cash investing and financing transactions in second quarter and first half 2002 include a net unfavorable adjustment of $19.4 million (net of tax) and a net favorable adjustment of $6.7 million (net of tax), respectively, primarily on the Company's investments in 3Dlabs Inc., Ltd. ("3Dlabs") and Creative. See Note 9 for detailed information regarding the Company's unrealized gains and losses on its investments. NOTE 8 - EARNINGS PER SHARE Basic income per share is computed using the weighted average number of common shares outstanding. Diluted income per share is computed using the weighted average number of common and equivalent common shares outstanding. Employee stock options are the Company's only common stock equivalent and are included in the calculation only if dilutive. For the quarters ended June 30, 2003, and 2002, these dilutive common stock equivalents were 2,129,000 and 2,698,000, respectively. For the six months ended June 30, 2003, and 2002, these dilutive shares were 2,174,000 and 2,646,000, respectively. NOTE 9 - COMPREHENSIVE INCOME Comprehensive income differs from net income due to non-equity items that include unrealized gains and losses on certain investments in debt and equity securities and foreign currency translation adjustments. Comprehensive income is as follows: -------------------------------------------------------------------------------- Quarter Ended June 30, Six Months Ended June 30, 2003 2002 2003 2002 -------------------------------------------------------------------------------- (In thousands) Net income $ 794 $280,587 $ 8,909 $284,965 Unrealized holding gains (losses) arising during the period 1,958 (2,742) 932 23,303 Reclassification adjustment for realized gains included in net income --- (16,632) --- (16,632) Translation adjustment for financial statements denominated in a foreign currency 5,681 6,110 5,974 6,312 -------------------------------------------------------------------------------- Comprehensive income $8,433 $267,323 $15,815 $297,948 ================================================================================ Second quarter and year-to-date 2003 unrealized holding gains are shown net of $974,000 and $437,000, respectively, of income taxes. Second quarter and year- to-date 2002 unrealized holding gains (losses) are both shown net of income taxes of $2.2 million. NOTE 10 - INTELLECTUAL PROPERTY INCOME (EXPENSE), NET In first quarter 2003, the Company recorded $10 million in income from International Business Machines Corporation ("IBM") as a balancing payment for future royalties in a full cross-licensing agreement that also resolved all outstanding patent infringement claims between IBM and the Company. A payment of $5 million was received in first quarter 2003, and the remainder was received in second quarter 2003. Netted against this income in first and second quarters were $4.7 million and $4.3 million, respectively, in legal fees and other related expenses associated with protecting and licensing the Company's intellectual property. Net intellectual property income was $1 million for the six months ended June 30, 2003. In second quarter 2002, Intergraph and Intel Corporation ("Intel") settled a patent infringement lawsuit filed in Alabama Federal Court in 1997 for $300 million, which the Company received in May 2002. Netted against this income in second quarter were $6.7 million in legal fees and other related expenses, for a total of $9.8 million in expenses during the first half of 2002. Net intellectual property income was $290.2 million for the six months ended June 30, 2002. For a complete discussion, see "Intellectual Property" and "Litigation" in the Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") section of this Form 10-Q. NOTE 11 - GAINS (LOSSES) ON SALES OF ASSETS During the six months ended June 30, 2003, IMGS reported a gain of approximately $1.2 million from the first quarter 2003 sale of its aeronautical intellectual property assets to Ingegneria Dei Sistemi S.p.a. in Rome, Italy. In second quarter 2003, IMGS incurred additional expenses of $65,000 related to this transaction. The Company reported gains of $18.5 million for first half 2002 and $17 million for second quarter 2002. For a complete discussion, see "Gains (Losses) on Sales of Assets" included in MD&A. NOTE 12 - ACQUISITIONS AND DIVESTITURES During the first half of 2003 there were no material acquisitions or divestitures. In second quarter 2002, the Company sold its ownership interest in 3Dlabs to Creative for approximately $40.2 million in cash and stock. The Company recorded a gain on this transaction of approximately $17 million, which is included in "Gains (losses) on sales of assets" in the 2002 consolidated statements of income. For a complete discussion, see the Company's 2002 Annual Report. NOTE 13 - SEGMENT REPORTING The Company's reportable segments are strategic business units that are organized by the types of products sold and the specific markets served. PPO supplies integrated lifecycle software solutions for the design, construction, and operation of process and power plants, offshore rigs, and ships. This division offers applications that span shipbuilding, plant design and visualization, materials procurement and management, plant operation, and engineering information management. IMGS is a leading geospatial solutions provider for the following markets: local, state, and federal government; transportation; utilities; communications; location-based services; photogrammetry; remote sensing; cartography; and military and intelligence. ISG provides professional services, specially developed software and hardware, and commercial off-the-shelf products to federal, state, and local governments, as well as to commercial customers. IPS develops computer graphics-based systems designed for public safety agencies, commercial fleet operations, campus, military base, and airport security. IPS systems are complete, integrated solutions for command and control, deployment, tracking, information gathering, analysis, and records management. The Corporate segment includes revenues and costs for Teranetix (a provider of computing support and hardware integration services), international hardware maintenance, and general corporate functions. Operating expenses for Corporate consist of general corporate expenses, primarily general and administrative expenses remaining after charges to the business segments based on usage of administrative services. The Company evaluates the performance of its business segments based on revenue and income from operations. The accounting policies of the reportable segments are consistent across segments and are the same as those used in preparation of the consolidated financial statements of the Company (see Note 1 of Notes to Consolidated Financial Statements included in the Company's 2002 Annual Report). Sales between the business segments are accounted for under a transfer pricing policy. Transfer prices approximate prices that would be charged for the same or similar products and services to unrelated buyers. The following table sets forth revenues and operating income (loss) by business segment for the quarters and six months ended June 30, 2003, and 2002. -------------------------------------------------------------------------------- Quarter Ended June 30, Six Months Ended June 30, 2003 2002 2003 2002 -------------------------------------------------------------------------------- (In thousands) Revenues: PPO: Unaffiliated customers $32,228 $29,667 $62,023 $57,882 Intersegment revenues 465 1,215 1,182 2,215 -------------------------------------------------------------------------------- 32,693 30,882 63,205 60,097 -------------------------------------------------------------------------------- IMGS: Unaffiliated customers 46,950 44,099 92,070 88,524 Intersegment revenues 1,592 2,424 3,235 4,295 -------------------------------------------------------------------------------- 48,542 46,523 95,305 92,819 -------------------------------------------------------------------------------- ISG: Unaffiliated customers 29,682 28,494 56,657 63,306 Intersegment revenues 396 2,028 898 3,079 -------------------------------------------------------------------------------- 30,078 30,522 57,555 66,385 -------------------------------------------------------------------------------- IPS: Unaffiliated customers 16,071 17,390 32,054 30,974 Intersegment revenues 784 347 1,325 669 -------------------------------------------------------------------------------- 16,855 17,737 33,379 31,643 -------------------------------------------------------------------------------- Corporate: Unaffiliated customers 2,416 2,920 5,096 4,980 Intersegment revenues 608 657 1,397 1,107 -------------------------------------------------------------------------------- 3,024 3,577 6,493 6,087 -------------------------------------------------------------------------------- 131,192 129,241 255,937 257,031 -------------------------------------------------------------------------------- Eliminations (3,845) (6,671) (8,037) (11,365) -------------------------------------------------------------------------------- Total revenues $127,347 $122,570 $247,900 $245,666 ================================================================================ -------------------------------------------------------------------------------- Operating income (loss): PPO $ 4,306 $ 5,012 $ 8,475 $ 9,247 IMGS (1,232) (1,221) (1,046) (1,256) ISG 2,844 1,865 3,980 4,438 IPS 3,562 3,466 7,031 6,423 Corporate (6,621) (6,567) (11,346) (11,275) Eliminations --- 363 --- 414 -------------------------------------------------------------------------------- Total $ 2,859 $ 2,918 $ 7,094 $ 7,991 ================================================================================ Significant profit and loss items that were not allocated to the segments and not included in the analysis above include gains and losses on sales of assets and intellectual property income and expense. See Notes 10 and 11 for comparative details of these items. The Company does not evaluate performance or allocate resources based on assets. For further information see "Results by Operating Segment" in MD&A. NOTE 14 - LETTERS OF CREDIT In September 2002, the Company established a credit line with Wells Fargo Bank to cover its outstanding letters of credit. In order to reduce the cost of issuing letters of credit, the Company secured the credit line with $15 million of interest-bearing securities. Under this arrangement, the Company earns interest on the securities and withdrawal of securities is allowed, but the Company is required to maintain a level of securities sufficient to cover total outstanding letters of credit (which totaled $10 million at June 30, 2003, and $10.9 million at December 31, 2002). NOTE 15 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In November 2002, the Financial Accounting Standards Board ("FASB") issued Interpretation No. ("FIN") 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," which is effective for guarantees issued or modified after December 31, 2002. FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under the guarantee and must disclose that information in its interim and annual financial statements. The provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor's obligations does not apply to product warranties or to guarantees accounted for as derivatives. The adoption of FIN 45 in first quarter 2003 did not have a significant impact on the Company's consolidated operating results or financial position. The Company has not incurred costs to settle claims or pay awards under the patent infringement indemnity provisions of some of our sales agreements with customers; therefore, the Company has recorded no liabilities for these agreements as of June 30, 2003. In January 2003, FASB issued FIN 46, "Consolidation of Variable Interest Entities," an interpretation of Accounting Research Bulletin 51 "Consolidation of Financial Statements," which addresses consolidation of variable interest entities ("VIE") by business enterprises. FIN 46 requires immediate consolidation of VIEs created after January 31, 2003, and the compliance of older entities in the first fiscal year or interim period beginning after June 15, 2003. The Company is still evaluating the impact, if any, that adoption of FIN 46 may have on its consolidated results of operations or financial position. On April 30, 2003, FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities," in order to provide for more consistent reporting of contracts as either freestanding derivative instruments subject to SFAS No. 133 in its entirety, or as hybrid instruments with debt host contracts and embedded derivative features. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The adoption of this statement is not expected to have a significant impact on the Company's consolidated results of operations or financial position. On May 15, 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," which establishes standards for classifying and measuring as liabilities certain freestanding financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. The statement defines an obligation as "a conditional or unconditional duty or responsibility on the part of the issuer to transfer assets or to issue its equity shares." SFAS No. 150 is effective for all financial instruments created or modified after May 31, 2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this statement is not expected to have a significant impact on the Company's consolidated results of operations or financial position. NOTE 16 - LITIGATION As further described in the Company's 2002 Annual Report, the Company continues to protect its intellectual property portfolio by engaging in both licensing discussions and patent infringement litigation. See MD&A for a discussion of 2003 developments. INTERGRAPH CORPORATION AND SUBSIDIARIES Item 2. Management's Discussion and Analysis of Financial Condition ----------------------------------------------------------- and Results of Operations ------------------------- Cautionary Note Regarding Forward-Looking Statements This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements including, but not limited to, projections about revenue, operating income levels, margins, and market conditions and their anticipated impact on the Company; expectations regarding future results and cash flows; information regarding the development, timing of introduction, and performance of new products; any statements of the plans, strategies, and objectives of management for future operations; and expectations regarding the Company's various ongoing litigation proceedings. These forward- looking statements are subject to known or unknown risks and uncertainties (some of which are beyond the Company's control) that could cause actual results to differ materially from those anticipated in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, worldwide political and economic conditions and changes, the ability to attract or retain key personnel, increased competition, rapid technological change, unanticipated changes in customer requirements, the ability to protect the Company's intellectual property rights, the ability to access the technology necessary to compete in the markets served, the ability to complete certain sales and lease transactions as planned, risks associated with doing business internationally (including foreign currency fluctuations), risks associated with various ongoing litigation proceedings, and other risks detailed in our annual and quarterly filings with the Securities and Exchange Commission ("SEC"). RESULTS OF OPERATIONS Earnings In second quarter 2003, the Company earned net income of $794,000 on revenues of $127.3 million, compared to second quarter 2002 net income of $280.6 million on revenues of $122.6 million. Income from operations was $2.9 million for both second quarter 2003 and second quarter 2002. For the first half of 2003, the Company earned net income of $8.9 million on revenues of $247.9 million, compared to the first half of 2002, where the Company earned net income of $285 million on revenues of $245.7 million. Income from operations for the first half of 2003 was $7.1 million compared to $8 million for the first half of 2002. See "Intellectual Property" and "Gains (Losses) on Sales of Assets" for a discussion of non-operating items included in net income. Also see "Item 3. Quantitative and Qualitative Disclosures About Market Risk" for a discussion of the currency impact on earnings. Revenues Total revenues for second quarter and first half 2003 were $127.3 million and $247.9 million, respectively, up 4% and 1% from the comparable prior-year periods. Sales outside the United States represented approximately 46% of total revenues in first half 2003, up from 42% for the comparable period in 2002. European revenues were 30% of total revenues for first half 2003, up from the first half 2002 level of 26%. Systems. Systems revenues for second quarter and first half 2003 were $72.8 million and $143.2 million, respectively, up 8% and 4% from the comparable prior-year periods. The increase in revenues for second quarter 2003 over the prior-year period is due primarily to an estimated $2.6 million currency impact and to an increase in new business in the IPS and PPO business segments. The increase in revenues for the first half of 2003 over the prior-year period is due primarily to an estimated $6.4 million currency impact and to an increase in new business in the IPS and PPO business segments, offset by a decrease of approximately $6 million in the ISG business segment as several contracts were completed or neared completion in the first half of 2002. Maintenance. Maintenance revenues totaled $34.1 million in second quarter 2003 and $64.1 million for first half 2003, up 13% and 10% from comparable prior-year periods. The increase for both comparable periods is attributable to larger installed customer bases for IPS and PPO. These increases in revenues were offset by a decrease in ISG maintenance revenues as more hardware continued to be removed from maintenance contracts because of the Company's exit from the hardware business. Services. Services revenues, consisting primarily of revenues from implementation and consulting services, totaled $20.5 million for the second quarter and $40.6 million for the first half of 2003, down 18% and 17% from comparable prior-year periods. The decrease in services revenues is due primarily to the completion of a large IPS project in late 2002 and is partially offset by increased revenues for IMGS on several new projects in 2003. Gross Margin The Company's total gross margin for second quarter 2003 was 48%, flat compared to second quarter 2002. For the first half of 2003, total gross margin was 48% compared to 47% for the first half of 2002. Systems margin was 48% for second quarter 2003, down from 51% in second quarter 2002. First half 2003 systems margin was 48%, down from 50% in the first half of 2002. The decline in gross margin percentages for both comparable periods was caused mainly by a $1.3 million non-recurring adjustment in the IMGS business segment, primarily due to physical inventory adjustments. Excluding this adjustment, systems margin was 50% and 49% for second quarter and first half 2003, respectively. In general, the Company's systems margin may be lowered by price competition, a higher hardware content in the product mix, a stronger U.S. dollar in international markets, and a higher mix of federal government sales, which generally produce lower margins than commercial sales. Systems margins may be improved by higher software content in the product mix, a weaker U.S. dollar in international markets, and a higher mix of international systems sales to total systems sales when the dollar is weaker in international markets. Maintenance margin for second quarter 2003 was 63%, improving from 55% in second quarter 2002. For the first half of 2003, maintenance margin was 61%, up from 53% for the comparable prior-year period. The improvement in margin is mainly due to higher software content in new maintenance contracts, revenue from retroactively renewed contracts, and Company-wide headcount reductions from 2002 to 2003 as a result of the Company's exit from the hardware business. Services margin was 26% for second quarter 2003, down from 31% in second quarter 2002. For the first half of 2003, services margin was 25%, down from 31% in the first half of 2002. Second quarter and first half 2002 included positive non-recurring transactions, without which services margin would have been 29% and 28%, respectively. The decline for the six-month comparison was also affected by a shift in the ISG business segment's contract mix to lower-margin contracts than in the prior year. Significant fluctuations in services revenues and margins from period to period are not unusual. Operating Expenses Operating expenses for the second quarter and first half of 2003 were $58.7 million and $111.1 million, respectively, up 5% from second quarter 2002 and up 4% from the first half of 2002. Product development expenses were $14.6 million for second quarter 2003, up 17% from the second quarter 2002 level. This increase was primarily the result of shipbuilding product development costs of $1.3 million in the PPO business segment, combined with an increase of $1.4 million due to fewer costs qualifying for capitalization in the PPO and IMGS business segments. Product development expenses were $26.5 million for the first half of 2003, up 7% from the first half of 2002. This increase was also a result of the $1.3 million shipbuilding product development costs mentioned above, combined with an increase of $1.1 million due to fewer costs qualifying for capitalization. Sales and marketing expenses were $25.6 million for second quarter 2003, up 3% from $24.9 million in second quarter 2002. This increase was primarily due to an estimated $1.7 million currency impact of the U.S. dollar weakening against international currencies in the second quarter of 2003 compared to the second quarter of 2002. This was partially offset by a reduction in compensation expenses in the ISG business segment and cost savings resulting from the combination of the Z/I Imaging and Utilities & Communications divisions into the IMGS business segment. Sales and marketing expenses were $50.3 million for the first half of 2003, up 6% compared to $47.5 million in the first half of 2002. This increase was primarily due to an estimated $3.6 million currency impact of the U.S. dollar weakening against international currencies during the first half of 2003, compared to the first half of 2002, partially offset by a reduction in compensation and consulting expenses in the ISG business segment. General and administrative expenses were $18.5 million for second quarter 2003 and $34.3 million for the first half of 2003, relatively flat with the comparable periods in 2002. For first half 2003, an unfavorable currency impact of $1.6 million and retention bonuses for Z/I Imaging employees of $433,000 were offset by lower legal fees of $1.5 million and a reversal of bad debt reserve of $500,000. To provide consistency of reported results, all income and expenses associated with the former intellectual property division, including legal expenses, are classified and reported in the other income section of the income statement. Prior period amounts have been reclassified to conform to the current period presentation. Restructuring Charges In fourth quarter 2002, the Company recorded $2.1 million in restructuring charges as a result of combining the Utilities & Communications business with the IMGS business segment. Cash outlays related to this restructuring approximated $236,000 and $1.3 million for second quarter and first half 2003, respectively. At June 30, 2003, the total remaining accrued liability for restructuring was approximately $698,000 compared to approximately $2.1 million at December 31, 2002. These liabilities are reflected in "Other accrued expenses" in the Company's consolidated balance sheets. The related costs are expected to be paid during 2003 and relate to severance liabilities in European countries (where typically several months are required for settlement) and to liabilities for idle building space in Europe and Asia. For a complete discussion, see the Company's 2002 Annual Report. Non-Operating Income and Expense Intellectual Property. "Intellectual property income (expense), net" in the consolidated statements of income consists of income resulting from protection and licensing of the Company's intellectual property, net of legal fees and other expenses associated with maintaining and defending the Company's intellectual property. To provide better consistency of reported results, all income and expenses associated with the intellectual property division, including related legal expenses, are classified and reported in this section of the consolidated statements of income. In first quarter 2003, the Company recorded income of $10 million due to a balancing payment from IBM for future royalties in a full cross- licensing agreement that also resolved all outstanding patent infringement claims between IBM and the Company. In the first six months of 2003, $9 million in legal fees and other related expenses associated with protecting and licensing the Company's intellectual property were netted against this income, including $4.3 million in second quarter. In April 2002, Intergraph and Intel settled a patent infringement lawsuit filed in 1997 for $300 million, which the Company received in May 2002. Netted against this income in second quarter 2002 were $6.7 million in legal fees and other related expenses, for a total of $9.8 million in expenses during the first half of 2002. (See "Litigation" for further discussion on this transaction.) Gains (Losses) on Sales of Assets. In first quarter 2003, IMGS reported a gain of approximately $1.2 million from the March 14, 2003, sale of its aeronautical intellectual property assets to Ingegneria Dei Sistemi S.p.a. in Rome, Italy. This gain was offset slightly by a $65,000 loss in second quarter 2003. In March 2002, the Company reported a gain of approximately $2 million as escrowed shares of 3Dlabs were released. The Company also recognized a loss of approximately $455,000 on the sale of its Greek subsidiary in first quarter 2002. In May 2002, the Company recognized a gain of $17 million on the sale of its shares of 3Dlabs to Creative. See the Company's 2002 Annual Report for further discussion of these transactions. See Note 12 of Notes to Consolidated Financial Statements contained in this Form 10-Q for further information regarding the 3Dlabs transaction. Interest Income. Interest income was $1.7 million in second quarter of both 2003 and 2002. For the first six months of 2003, interest income was $3.6 million, compared to $2.7 million for the same period 2002. Interest income from short-term investments increased during 2003 due to proceeds from patent litigation, but was offset by a decline in interest rates and a decrease in the amount of interest earned on notes receivable. Other. "Other income (expense), net" in the consolidated statements of income consists of interest expense, foreign exchange gains and losses, and other miscellaneous items of non-operating income and expense. No significant items were included in these amounts for the periods presented. Income Taxes Income tax was a benefit of $1 million for second quarter 2003 and an expense of $3.6 million for first half 2003, compared to expenses of $35.1 million for second quarter 2002 and $35.8 million for first half 2002. The Company had income (loss) before taxes and minority interest of ($200,000) and $12.5 million in the second quarter and first half of 2003, respectively, compared to $315.7 million in the second quarter of 2002 and $320.8 million for the first half of 2002. Income tax expense for the first half of 2003 is attributable to both taxes on individually profitable majority-owned subsidiaries and patent litigation income partially offset by the second quarter tax benefit, which was primarily the result of a favorable resolution of a disputed issue with the Internal Revenue Service. Income tax expense for the quarter and six months ended June 30, 2002, was largely a result of the patent litigation gain and the gains on sales of assets offset by the utilization of the Company's U.S. net operating loss and tax credit carryforwards. See the Company's 2002 Annual Report for details of the Company's tax position, including its net operating loss and tax credit carryforwards. Results By Operating Segment In second quarter 2003, PPO reported operating income of $4.3 million on revenues of $32.7 million, compared to second quarter 2002 operating income of $5 million on revenues of $30.9 million. The decrease in operating income is primarily the result of increased shipbuilding product development costs of $1.3 million in the second quarter of 2003, offset somewhat by higher maintenance gross margins. For the first half of 2003, operating income was $8.5 million on revenues of $63.2 million, compared to operating income of $9.2 million on revenues of $60.1 million for the first half of 2002. The 8% decrease in operating income is due to increased shipbuilding product development costs, as mentioned above, and an increase in sales and marketing expenses primarily due to currency fluctuations. The increase in operating expenses is partially offset by an 11% increase in maintenance margin, mainly due to lower amortization and royalty costs as a result of renegotiated contracts with vendors. In second quarter 2003, IMGS reported an operating loss of $1.2 million on revenues of $48.5 million, compared to second quarter 2002 operating loss of $1.2 million on revenues of $46.5 million. Although revenues increased, operating loss remained flat primarily due to a non-recurring adjustment of $1.3 million (most of which related to an inventory write-off as a result of physical inventory). Operating loss for the first half of 2003 was $1 million on revenues of $95.3 million, compared to the first half 2002 loss of $1.3 million on revenues of $92.8 million. The increase in 2003 revenues occurred mainly in maintenance (due to a larger installed base) and professional services (due to several new contracts in Europe). The year-to-date 2003 operating loss resulted primarily from the $1.3 million non-recurring inventory adjustment mentioned above. In second quarter 2003, ISG earned operating income of $2.8 million on revenues of $30.1 million, compared to operating income of $1.9 million on revenues of $30.5 million in second quarter 2002. The 52% increase in operating income is primarily due to higher maintenance gross margins as a result of headcount reductions. Also improving operating income is a reduction of operating expense as outsourced consulting and compensation expense declined. In first half 2003, ISG earned operating income of $4 million on revenues of $57.6 million, compared to first half 2002 operating income of $4.4 million on revenues of $66.4 million. The decrease in operating income is a direct result of lower revenues (due to fewer contracts and programs delayed from fourth quarter 2001 to first quarter 2002 in the aftermath of the September 11, 2001, terrorist attacks), mitigated by lower operating expenses, as mentioned above. In second quarter 2003, IPS earned operating income of $3.6 million on revenues of $16.9 million, 3% higher than second quarter 2002 operating income of $3.5 million on revenues of $17.7 million. Although revenues decreased 5% from second quarter 2002 (due primarily to the loss of revenues from a large services contract in Australia that ended in third quarter 2002), operating income increased due to higher gross margins. IPS reported operating income of $7 million on revenues of $33.4 million for the first half of 2003, compared to operating income of $6.4 million on revenues of $31.6 million for the same period in 2002. Revenues and gross margin dollars increased from the first half of 2002 level mainly due to new projects and additional maintenance contracts with higher gross margins. These improvements were partially offset by higher operating expenses due primarily to increased headcount. In second quarter 2003, Corporate reported an operating loss of $6.6 million on revenues of $3 million, compared to a second quarter 2002 operating loss of $6.6 million on revenues of $3.6 million. For the first six months of 2003, Corporate reported an operating loss of $11.3 million on revenues of $6.5 million compared to an operating loss of $11.3 million on revenues of $6.1 million in the first half of 2002. Revenues are primarily associated with hardware repair, logistics, and maintenance services. Operating expenses include costs associated with worldwide corporate oversight functions, including those related to being a publicly held company, and management of residual hardware functions. See Note 13 of Notes to Consolidated Financial Statements contained in this Form 10-Q for further explanation of the Company's segment reporting. Litigation As further described in the Company's 2002 Annual Report, the Company continues to protect its intellectual property portfolio by engaging in both licensing discussions and patent infringement litigation. The following is a discussion of the 2003 developments for patent and other litigation. Intel. The Company has had ongoing litigation with Intel since 1997. In July 2002, the Company filed a patent infringement case against Intel pertaining to the Company's parallel instruction computing ("PIC") patents and went to trial in July 2002. In October 2002, the judge ruled that the PIC patents were valid, enforceable, and infringed by Intel's Itanium and Itanium 2 products. Based upon the trial court's decision and the parties' prior settlement agreement, Intel paid $150 million to the Company in November 2002. Although Intel appealed this ruling in November 2002, the $150 million payment is non-refundable, regardless of the outcome on appeal. Intel will be obligated to pay an additional $100 million in damages to the Company if the trial court's decision is affirmed on appeal. The parties have completed the briefing process, and oral argument is tentatively scheduled for the first week of December 2003. The final decision from the appeal court is not expected until after February 2004. Original Equipment Manufacturers ("OEM"). On December 16, 2002, the Company filed a patent infringement action against Dell Computer Corporation TM ("Dell"), Gateway Inc. TM ("Gateway"), and Hewlett-Packard Co. TM ("HP") (including the former Compaq Computer Corporation TM) in the U.S. District Court for the Eastern District of Texas ("the Texas court") claiming that products from these computer vendors infringe three computer system ("Clipper") patents (related to memory management technology) owned by the Company. The OEM action seeks an unspecified amount of damages for past infringement, plus a statutory patent injunction. The Company delayed serving the defendants with the lawsuit and engaged each defendant in licensing discussions. These licensing discussions were not successful, and the defendants were served on April 1, 2003. The trial judge has set a scheduling conference for August 20, 2003, and has issued a tentative trial schedule for August 2004. A final trial schedule will be issued by the Texas court following the August 20 scheduling conference. On May 28, 2003, HP filed a patent countersuit against the Company in the Northern District of California, and has asked the Texas court to transfer the OEM case to the Northern District of California for consolidation with their countersuit. The countersuit did not specify any accused infringing products or resulting damages, and the Company has challenged the validity of HP's complaint. The Company has not determined what impact, if any, HP's countersuit may have on the Company's results of operations and cash flows. The Company has also responded to HP's motion to transfer. The Company will vigorously defend against HP's countersuit, and aggressively oppose HP's motion to transfer. On June 21, 2003, Dell filed a counterclaim against Intel, adding them as a party to the OEM case. Intel filed a general denial to Dell's counterclaim. It is currently unclear what role Intel will play as a party in the OEM action. Texas Instruments TM ("TI"). On January 30, 2003, the Company filed a patent infringement action against TI in the Texas court. This action is directed at the TI family of Digital Signal Processors (marketed under the name TMS320C6000 TM), which employs the same PIC technology described by the Company's PIC patents. TI filed a general response to the Company's allegations, and the PIC case has been set for trial in October 2004. The parties are currently engaged in the discovery process. In May 2003, TI filed two patent countersuits against the Company in the Texas court. The countersuits have been assigned to two separate judges; however, both cases will be governed by the local patent rules for the Eastern District. A tentative scheduling order has been issued for the countersuit pending in the Paris Division, which sets a tentative trial date of September 20, 2004. No schedule has been issued for the countersuit pending in the Marshall Division. The countersuits include a total of eight patents, which target a variety of products in each of the Company's business units. The Company has responded to both countersuits, and plans to vigorously defend both actions. The Company has not determined what impact, if any, this lawsuit may have on the Company's results of operations and cash flows. Bentley Systems, Inc. ("BSI"). In December 2002, the Company filed a declaratory judgment action in Madison County, Alabama ("the Alabama court"), against BSI. The action requests the Alabama court to interpret the parties' asset purchase agreement and promissory note, and require BSI to specifically perform the repayment of the same. The asset purchase agreement and note were executed in conjunction with the sale of the Company's civil, plotting, and raster software product lines to BSI in 2000. BSI subsequently filed an initial action against the Company in Philadelphia, Pennsylvania, and thereafter filed a second action in Delaware alleging that the Company breached certain terms of the asset purchase agreement. BSI's Pennsylvania action was dismissed in March 2003, and a Motion to Dismiss BSI's Delaware action is still pending. In response to these dismissals, BSI has now asserted certain counterclaims against the Company in the pending Alabama action. These counterclaims are substantially the same as those claims asserted in its Delaware action. As with its prior actions, BSI did not specify an amount of damages in its Alabama counterclaims. The Company does not believe that BSI's claims are likely to be of a size or nature that would impact the operations of the Company. The Company intends to vigorously pursue its claims against BSI and defend the claims asserted by BSI. Other. The Company has other ongoing litigation, none of which is considered to represent a material contingency for the Company at this time; however, any unanticipated unfavorable ruling in any of these proceedings could have an adverse impact on the Company's results of operations and cash flows. Remainder of the Year The Company expects that the markets in which it competes will continue to be characterized by intense competition, rapidly changing technologies, and shorter product cycles. Further improvement in the Company's operating results will depend on further market penetration achieved by accurately anticipating customer requirements and technological trends, and rapidly and continuously developing and delivering new products that are competitively priced, offer enhanced performance, and meet customers' requirements for standardization and interoperability. Better operating results will also depend on global political events and worldwide economic improvement in the markets served. To increase operating profitability, the Company must achieve revenue growth and continue to align operating expenses with the projected level of revenue. In addition, the Company continues to face legal expenses of unknown duration and amount as it licenses its intellectual property and otherwise asserts its intellectual property rights. The ultimate impact of these initiatives is subject to known and unknown risks and uncertainties. See "Cautionary Note Regarding Forward-Looking Statements." LIQUIDITY AND CAPITAL RESOURCES In September 2002, the Company established a credit line with Wells Fargo Bank to cover its outstanding letters of credit. In order to reduce the cost of issuing the letters of credit, the Company secured the credit line with $15 million of interest-bearing securities. Under this arrangement, the Company earns interest on the securities and withdrawal of securities is allowed, but the Company is required to maintain a level of securities sufficient to cover total outstanding letters of credit (which totaled $10 million at June 30, 2003, and $10.9 million at December 31, 2002). At June 30, 2003, the Company had no debt. In second quarter 2003, the Company spent approximately $4.7 million to repurchase 211,500 shares of its common stock under a stock repurchase program. As of June 30, 2003, the Company had repurchased approximately 5.4 million shares since the program was initiated in late 2001, and total expenditures were $94.8 million. The Company believes that existing cash balances will substantially exceed cash requirements for 2003 operations. The Company does not anticipate significant non-operating events that will require the use of cash, with the exception of its stock repurchase program. In first quarter 2003, the Company's board of directors authorized an increase in the funding for the stock repurchase program from $175 million to $250 million. The board also extended the termination date for the program from December 31, 2004, to December 31, 2005, and approved privately negotiated transactions in addition to open market purchases of the Company's stock. CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires that management use judgments to make estimates and assumptions that affect the amounts reported in the financial statements. As a result, there is some risk that reported financial results could have been materially different had different methods, assumptions, and estimates been used. The Company believes that of its significant accounting policies, those related to revenue recognition, capitalized software, deferred taxes, bad debt reserves, and inventory may involve a higher degree of judgment and complexity as used in the preparation of its consolidated financial statements. Management believes there have been no significant changes during the three months ended June 30, 2003, to the items disclosed as "Critical Accounting Policies" in MD&A in the Company's 2002 Annual Report. Item 3. Quantitative and Qualitative Disclosures About Market Risk ---------------------------------------------------------- The Company has experienced no material changes in market risk exposures that affect the quantitative and qualitative disclosures presented in the Company's 2002 Annual Report. Impact of Currency Fluctuations and Currency Risk Management Fluctuations in the value of the U.S. dollar in international markets can have a significant impact on the Company's results of operations. For first half 2003, approximately 46% of the Company's revenues were derived from customers outside the United States, primarily through subsidiary operations, compared to 42% for first half 2002. Most subsidiaries sell to customers and incur and pay operating expenses in local currencies. These local currency revenues and expenses are translated into U.S. dollars for reporting purposes. A weaker U.S. dollar increases the level of reported U.S. dollar orders and revenues, increases the dollar gross margin, and increases reported dollar operating expenses of the international subsidiaries. The Company estimates that the weakening of the U.S. dollar in its international markets, primarily in Europe, improved its first half 2003 results of operations by approximately $0.10 per share (basic and diluted) in comparison to first half 2002 results. The Company conducts business in all major markets outside the United States, but the most significant of these operations with respect to currency risk are located in Europe and Asia. Local currencies are the functional currencies for the Company's European and Canadian subsidiaries. The U.S. dollar is the functional currency for all other international subsidiaries. The Company had no forward contracts outstanding at June 30, 2003, or December 31, 2002, and does not currently hedge any of its foreign currency risks. Impact of Interest Rates on Investment Earnings The Company's excess funds are generally invested in short-term, highly liquid, interest-bearing securities which may include short- term municipal bonds, time deposits, money market funds, repurchase agreements, short-term corporate obligations, commercial paper, and U.S. government securities. The Company limits the amount of credit exposure from any single issuer of securities. The Company is subject to earnings fluctuations due to market changes in interest rates. Should interest rates of invested funds change by 0.5%, the Company estimates that pre-tax earnings could be affected by approximately $0.05 per share (diluted) on an annualized basis. Item 4. Controls and Procedures ----------------------- The Company, under the direction of the Chief Executive Officer ("CEO") and the Chief Financial Officer ("CFO"), has established disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms. The disclosure controls and procedures are also intended to ensure that such information is accumulated and communicated to the Company's management, including the CEO and the CFO, as appropriate to allow timely decisions regarding required disclosures. The CEO and the CFO have reviewed and evaluated the Company's disclosure controls and procedures as of the end of the period covered by this report. Based on, and as of the effective date of, that review and evaluation, the CEO and the CFO have concluded that the Company's disclosure controls and procedures are effectively serving the stated purposes. In addition, there have been no changes in the Company's internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART II. OTHER INFORMATION ----------------- Item 1. Legal Proceedings ----------------- As further described in the Company's 2002 Annual Report, the Company continues to protect its intellectual property portfolio by engaging in both licensing discussions and patent infringement litigation. The following is a discussion of the 2003 developments of patent and other litigation. Intel. The Company has had ongoing litigation with Intel since 1997. In July 2002, the Company filed a patent infringement case against Intel pertaining to the Company's PIC patents and went to trial in July 2002. In October 2002, the judge ruled that the PIC patents were valid, enforceable, and infringed by Intel's Itanium and Itanium 2 products. Based upon the trial court's decision and the parties' prior settlement agreement, Intel paid $150 million to the Company in November 2002. Although Intel appealed this ruling in November 2002, the $150 million payment is non-refundable, regardless of the outcome on appeal. Intel will be obligated to pay an additional $100 million in damages to the Company if the trial court's decision is affirmed on appeal. The parties have completed the briefing process, and oral argument is tentatively scheduled for the first week of December 2003. The final decision from the appeal court is not expected until after February 2004. OEM. On December 16, 2002, the Company filed a patent infringement action against Dell, Gateway, and HP in the Texas court claiming that products from these computer vendors infringe three Clipper patents (related to memory management technology) owned by the Company. The OEM action seeks an unspecified amount of damages for past infringement, plus a statutory patent injunction. The Company delayed serving the defendants with the lawsuit and engaged each defendant in licensing discussions. These licensing discussions were not successful, and the defendants were served on April 1, 2003. The trial judge has set a scheduling conference for August 20, 2003, and has issued a tentative trial schedule for August 2004. A final trial schedule will be issued by the Texas court following the August 20 scheduling conference. On May 28, 2003, HP filed a patent countersuit against the Company in the Northern District of California, and has asked the Texas court to transfer the OEM case to the Northern District of California for consolidation with their countersuit. The countersuit did not specify any accused infringing products or resulting damages, and the Company has challenged the validity of HP's complaint. The Company has not determined what impact, if any, HP's countersuit may have on the Company's results of operations and cash flows. The Company has also responded to HP's motion to transfer. The Company will vigorously defend against HP's countersuit, and aggressively oppose HP's motion to transfer. On June 21, 2003, Dell filed a counterclaim against Intel, adding them as a party to the OEM case. Intel filed a general denial to Dell's counterclaim. It is currently unclear what role Intel will play as a party in the OEM action. TI. On January 30, 2003, the Company filed a patent infringement action against TI in the Texas court. This action is directed at the TI family of Digital Signal Processors (marketed under the name TMS320C6000 TM), which employs the same PIC technology described by the Company's PIC patents. TI filed a general response to the Company's allegations, and the PIC case has been set for trial in October 2004. The parties are currently engaged in the discovery process. In May 2003, TI filed two patent countersuits against the Company in the Texas court. The countersuits have been assigned to two separate judges; however, both cases will be governed by the local patent rules for the Eastern District. A tentative scheduling order has been issued for the countersuit pending in the Paris Division, which sets a tentative trial date of September 20, 2004. No schedule has been issued for the countersuit pending in the Marshall Division. The countersuits include a total of eight patents, which target a variety of products in each of the Company's business units. The Company has responded to both countersuits, and plans to vigorously defend both actions. The Company has not determined what impact, if any, this lawsuit may have on the Company's results of operations and cash flows. BSI. In December 2002, the Company filed a declaratory judgment action in the Alabama court against BSI. The action requests the Alabama court to interpret the parties' asset purchase agreement and promissory note, and require BSI to specifically perform the repayment of the same. The asset purchase agreement and note were executed in conjunction with the sale of the Company's civil, plotting, and raster software product lines to BSI in 2000. BSI subsequently filed an initial action against the Company in Philadelphia, Pennsylvania, and thereafter filed a second action in Delaware alleging that the Company breached certain terms of the asset purchase agreement. BSI's Pennsylvania action was dismissed in March 2003, and a Motion to Dismiss BSI's Delaware action is still pending. In response to these dismissals, BSI has now asserted certain counterclaims against the Company in the pending Alabama action. These counterclaims are substantially the same as those claims asserted in its Delaware action. As with its prior actions, BSI did not specify an amount of damages in its Alabama counterclaims. The Company does not believe that BSI's claims are likely to be a size or nature that would impact the operations of the Company. The Company intends to vigorously pursue its claims against BSI and defend the claims asserted by BSI. Other. The Company has other ongoing litigation, none of which is considered to represent a material contingency for the Company at this time; however, any unanticipated unfavorable ruling in any of these proceedings could have an adverse impact on the Company's results of operations and cash flow. Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- Intergraph Corporation's Annual Meeting of Shareholders was held May 15, 2003. The results of the meeting follow. (1)Eight directors were elected to the Board of Directors to serve for the ensuing year and until their successors are duly elected and qualified. All nominees were serving as Directors of the Company at the time of their nomination for the current year. Votes ------------------------------ For Against/Withheld ---------- ---------------- James F. Taylor, Jr. 33,599,606 4,642,105 Larry J. Laster 33,610,340 4,631,371 Sidney L. McDonald 33,615,291 4,626,420 Thomas J. Lee 33,155,262 5,086,449 Lawrence R. Greenwood 33,173,940 5,067,771 Joseph C. Moquin 33,634,924 4,606,787 Linda L. Green 33,241,455 5,000,256 Richard W. Cardin 33,242,267 4,999,444 (2)Ratification of the appointment of Ernst & Young LLP as the Company's independent auditors for the current fiscal year was approved by a vote of 35,534,574 for, 1,170,501 against, and 1,536,636 abstentions. Item 5. Other ----- Effective July 28, 2003, Mr. Halsey Wise was selected as the Company's President and Chief Executive Officer, and immediately joined the Intergraph Board of Directors. Mr. Wise succeeds Mr. Jim Taylor, who announced last fall his intention to retire. Mr. Taylor also retired from the Company's Board of Directors, but will continue to consult with management of the Company with the primary responsibility of managing its intellectual property litigation. Mr. Sid McDonald, a director since 1997, has been elected Chairman of the Intergraph Board of Directors. Mr. McDonald served previously as the lead outside director and Chairman of the Compensation Committee. Item 6. Exhibits and Reports on Form 8-K -------------------------------- (a)Exhibits Exhibit Number Description ------- ----------- 10(g) Employment Contract of R. Halsey Wise dated June 12, 2003 10(h) Employment Contract of Graeme J. Farrell dated July 1, 2003 31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by R. Halsey Wise dated August 13, 2003 31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by Larry J. Laster dated August 13, 2003 32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by R. Halsey Wise dated August 13, 2003 32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Larry J. Laster dated August 13, 2003 (b) Reports on Form 8-K: o Form 8-K dated July 30, 2003, reporting the Company's second quarter earnings INTERGRAPH CORPORATION AND SUBSIDIARIES SIGNATURES 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. INTERGRAPH CORPORATION ---------------------- (Registrant) By: /s/ R. Halsey Wise By: /s/ Larry J. Laster ------------------ ------------------- R. Halsey Wise Larry J. Laster President and Executive Vice President and Chief Executive Officer Chief Financial Officer (Principal Financial and Accounting Officer) Date: August 13, 2003 Date: August 13, 2003