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Intergraph Reports Second Quarter 2002 Results

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 � Intergraph

All Core Businesses Are Profitable; Patent Settlement Boosts EPS to $5.37

HUNTSVILLE, Ala., July 31, 2002--Intergraph Corporation today reported operating results for its second quarter ended June 30, 2002.

For the quarter, Intergraph reported operating income of $2.7 million and net income of $280.6 million on revenues of $122.6 million. Net income per share was $5.37 (diluted), including $5.29 per share earned from the sale of assets and settlement of a patent infringement lawsuit. Revenues were slightly below expectations, but income from operations increased 39% over operating income of $1.9 million in Q1 2002.

In comparison to second quarter last year, income from operations increased substantially over the $1.4 million reported in 2001, even though revenue declined 4% from $127.8 million. The revenue decline is due primarily to less hardware maintenance and to Z/I Imaging and Intergraph Public Safety (IPS) being below Q2 2001 levels because of less capital spending by their customers in the earth imaging and utilities and communications markets.

Gross margins improved almost 3 percentage points over Q2 2001 because of an improved product mix and several non-recurring transactions. The Company expects gross margins to return to the 44% to 46% range in Q3 2002.

Operating expenses: In order to remain profitable on weak revenues, the Company continues to monitor expenses closely. Operating expenses were slightly higher than Q1 2002 but flat with Q2 2001. Sales and marketing expenses were higher in second quarter 2002 because the Company attended more trade shows, and three of the divisions held user group conferences during the quarter.

In Q2, legal expenses, along with other costs associated with the patent litigation, were offset against the gain from the patent settlement that is shown in other income. Ignoring legal expenses, G&A was slightly higher than Q1 2002 because of higher medical benefits, costs associated with the annual shareholders meeting, and additional bad debt reserves. The Company expects G&A expenses other than legal fees to decline slightly in Q3.

Research and Development expenses were basically flat with Q1 2002 amounts. R&D expenses are below prior-year levels because more software development costs have been capitalized in 2002 than were capitalized in the first six months of 2001. Most of Intergraph's business units have announced new products that will soon be released. The technological feasibility of the products has been established, and the costs of performing certification and producing documentation before general release to customers are being capitalized in accordance with generally accepted accounting principles.

Other income for the quarter totaled $313.1 million, primarily from the settlement of a patent infringement lawsuit. The Company has requested that the SEC staff concur with this financial statement presentation of the patent settlement. The Company also recognized a gain of $17 million on the sale of Intergraph's interest in 3Dlabs to Creative Technology Ltd. Interest income was higher than in the prior quarter because the additional cash from these transactions was invested during the quarter.

Income Tax expense was $35.1 million for the quarter. The effective tax rate was approximately 11% due to the utilization of net operating loss carryforwards in the U.S. Since the income in Q2 utilized all the available net operating loss carryforwards in the U.S., the estimated tax rate on future earnings should be in the 40% to 45% range. The actual tax rate will depend upon the countries in which profits are earned.

The Balance Sheet is in excellent shape. Cash and short-term investments increased from $102 million at the end of the first quarter to $355.8 million at June 30. This increase of $253.8 million was due primarily to the proceeds from the patent settlement and the asset sale, which were offset by $66.8 million the Company spent during the quarter to repurchase stock. Total debt was approximately $3.3 million at the end of Q2 2002.

Intergraph Chairman and CEO Jim Taylor said of the results, "The current economy remains a problem, but I'm pleased that for the sixth consecutive quarter each of our five core businesses was profitable."

Again this quarter, the Company will use the quarterly results news release as a public forum for management's comments on financial results and review of the core businesses. This detailed disclosure of information should enable participants on the quarterly conference call to focus on questions not answered in the news release.

Business Outlook

Information contained in this news release (including this Business Outlook) includes statements that are forward-looking as defined in Section 21E of the Securities Exchange Act of 1934. Readers are cautioned against placing undue reliance on any forward-looking statements. Please refer to "Cautionary Note Regarding Forward-Looking Statements."

"The outlook for next quarter and for the remainder of the year continues to be similar to what we have seen during the first half of the year," CEO Taylor said. "We are committed to remaining profitable, but we continue to forecast that revenues and profits will remain flat until the economy improves. Although some economic indicators suggest that the recession is nearing an end, the effects continue to be felt in some of our business sectors. We see improvements in our divisions that focus on public safety and on the process, power and offshore industry. However, our businesses that target state and local governments, utilities and communications, mapping/GIS, and earth imaging are still encountering reluctance from their customers to spend and invest in information technology (IT). We believe that our continued investment in R&D, which was again around 10% of total revenues for the quarter, combined with close monitoring of expenses, will enable us to end this recession in a stronger competitive position."

Patent settlement

The Alabama Clipper patent case was filed in Federal Court in Alabama in 1997. Intergraph and Intel settled the Alabama case on April 14 for $300 million, which the Company received on May 1. Taylor said of the settlement, "We believe that the $300 million settlement validates the value of Intergraph's patents and will assist our efforts to license others to use Intergraph's patented technology. The settlement specifically preserves our rights to license others, including vendors at the computer system level."

Update on the Bentley Systems Inc. IPO

On April 22, 2002, Bentley Systems Inc. filed documents with the SEC for an initial public offering. Because of the uncertainty in the equity markets, however, Bentley has decided not to file an amendment to its registration statement until the IPO market improves. Intergraph owns approximately 7.8 million shares of Bentley stock and currently plans to sell some portion of its holdings in the initial public offering.

Creative Technology Ltd. completes its purchase of 3Dlabs

In July 2000, Intergraph sold its Intense3D graphics division to 3Dlabs for approximately 11.2 million shares of 3Dlabs common stock. In May 2002, Creative Technology Ltd. purchased all the outstanding shares of 3Dlabs for $3.60 per share, paying one-third in cash and two-thirds in Creative Technology common stock. The Company recognized a gain of $17 million from this transaction. At June 30, the Company owned approximately 2.3 million shares of Creative Technology common stock with a market value of approximately $20.6 million.

Stock repurchase program

The Company's cash position increased substantially with the patent settlement and the sale of the 3Dlabs shares. Also, there continues to be the possibility of additional cash from the Bentley IPO and the Texas patent suit described below. Because of the large influx of cash, the Board of Directors hired an investment-banking firm to help determine the best use of the excess cash to maximize shareholder value. The initial recommendation was to increase the existing stock repurchase plan from $30 million to $75 million and wait until the conclusion of the Bentley IPO and the Texas court case to take further action. However, it is now clear that both events will be delayed by several months. Therefore, the Board of Directors, as an interim step, has increased funding for the Company's stock repurchase plan from $75 million to $100 million. During Q2, the Company repurchased approximately 3.7 million shares at a cost of $66.8 million.

Patent infringement suit against Intel in Texas

The Texas PIC patent infringement suit was included in the mediation that led to the Clipper patent settlement, but the Texas PIC case was not settled. The parties did, however, agree to set a value for the Texas case. Under the agreement, if Intel is found not to have infringed Intergraph's PIC patents, they will pay nothing. If there is a finding of infringement, Intel will pay Intergraph $150 million, which is non-refundable, regardless of any outcome on appeal. Intel then has three options: (1) Intel may pay an additional $100 million to Intergraph, and the suit will be dropped and Intel will receive a license to the Texas patents. (2) Intel may appeal the district court decision. If Intel loses on appeal, they will pay Intergraph an additional $100 million. (3) Intel may try to design around the infringement. This design-around would have to be confirmed by the Texas Federal District Court and implemented in the next version of the product. If Intel can successfully design around the infringement, no additional payment is required.

The courtroom portion of the trial began on July 2 and concluded on July 12, 2002. The judge requested that the parties file post-trial briefs by August 2 and set final closing arguments for August 29. Originally, the parties were directed to submit briefs on both validity and infringement. However, on July 19, the judge sent a letter to the parties stating his opinion that Intel has not met its burden to prove that the claims of either of the patents-in-suit are invalid. Further, the judge indicated that he would issue more detailed findings of fact at a later date. Based on this, the issue of validity will not be included in the parties' briefs. On August 29, each side will make final oral arguments before the judge, after which the judge will deliberate. The Company does not anticipate a verdict before mid-September.

Update on the Employee Stock Bonus Plan

In 2001, Intergraph petitioned the IRS and SEC with a plan to terminate the Company's stock bonus plan and allow participants to receive money or stock, or rollover their accounts into an IRA or an existing 401(k) program. In March and May of 2002, the IRS and SEC, respectively, completed their reviews and gave permission to begin distribution to Plan participants. During the second quarter, slightly more than 2.5 million shares of Intergraph stock were sold in the open market or transferred to participants of the plan. At the end of June, 2.1 million shares of Intergraph stock remained in the plan. Participants have until mid-September to take distribution of their shares.

Excess real estate put on the market

Intergraph has approximately 570,000 sq. ft. of excess space and 600 acres of excess land that the Company intends to sell. At the end of the second quarter, about 411,000 sq. ft. (72%) of the excess space was under lease. The Company has engaged two brokers to lease the remaining 160,000 square feet and sell the excess land, although Company officials believe that the economic environment makes a near-term sale unlikely. Intergraph values these facilities at approximately $27 million ($19 million for the buildings and $8 million for the land).

Review of Intergraph's Vertically Focused Businesses

Intergraph consists of five core business segments, along with an Intellectual Property division and a corporate oversight function. The five core businesses and the Intellectual Property division are managed as independent businesses. The Company believes that providing the following level of detail about each business will help investors make informed decisions.

Process, Power & Offshore (PP&O)

For Q2, PP&O is reporting revenue of $30.9 million and operating income of $5 million. This reflects a 6% increase in revenue and an 18% increase in operating income compared to Q1 2002 earnings of $29.2 million in revenue and $4.2 million in operating income. In comparison to the same quarter last year, revenue increased 11% from $27.9 million, and operating income is substantially higher than the $1.3 million reported in Q2 2001.

Comparing the first six months of 2001 and 2002, PP&O revenue increased 4% from $57.8 million in 2001 to $60.1 million in 2002, and operating income increased substantially from $2.6 million in 2001 to $9.2 million in 2002. The increase in operating income is due to increased revenues, cost reductions, improved product mix (growth in higher-margin products), and several non-recurring transactions that positively impacted operating income.

From a geographical perspective, revenue in the second quarter increased in North America, Asia Pacific, the Middle East and Europe. South America reported flat revenues compared to the first quarter. From an industry perspective, the oil and gas industry (on- and offshore) and the pharmaceutical industry were strong. The power plant industry was stable, but the chemical industry remains weak. PP&O believes this will continue for the remainder of the year.

From a software and services perspective, the number of Plant Design System (PDS) lease licenses increased by 20% in the first half of 2002 compared to the same period in 2001, reaching a new all-time high in Q2. Revenues from services increased 11% compared to the first six months of last year. Among the products, revenue from MARIAN showed the highest rate of growth. This Material and Supply Chain Management software has enjoyed increasing acceptance in the customer base, as shown by the increase in sales since last year. In Q2, PP&O launched SmartPlant Electrical, a new product for schematic layout of electrical systems, and released Version 3.0 of SmartPlant P&ID, a major new version of PP&O's software for creating intelligent Piping & Instrumentation Diagrams.

Overall, PP&O feels well positioned for the remainder of the year and beyond. Development of important new products is on target, and significant investments are being made to further extend product offerings and market leadership. PP&O is fully focused on growing core software and services in the industries it serves.

For Q3, PP&O forecasts revenues of $30 million with operating income of $3.5 million.

Intergraph Public Safety and Utilities & Communications (IPS)

The IPS business covers three primary markets: Public Safety, Utilities and Communications. For Q2, IPS is reporting revenue of $26.8 million and operating income of $1.9 million. This represents a 28% increase over the $20.9 million in revenue reported in Q1 2002 and a substantial increase over the $122,000 in operating income. In comparison to second quarter of 2001, revenue decreased 11% from $30.1 million, while operating income increased 58% from $1.2 million.

The increase in revenue and profits over Q1 2002 is the result of continued strong performance from the Public Safety division and better performance from the Utilities and Communications division. In Q2, IPS reduced costs (primarily headcount) in the Utilities and Communications division.

For the first six months of 2002, revenue declined 20% from $59.8 million in 2001 to $47.7 million in 2002. Income from operations declined 12% during the same period, from $2.3 million to $2 million. The decline in revenue and income was in the Utilities and Communications division.

Public Safety has approximately 45 ongoing projects in North America and continues to win additional business in this region.

Both the Utilities and Communications markets are in an economic slump that is unlikely to improve significantly for the rest of the year. However, Utilities and Communications is seeing some demand for its Workforce Management solution as utility companies focus more on customer satisfaction and improved utilization of their field personnel. The geospatial market for utilities continues to be depressed, however, and competition for the few opportunities that arise is fierce and very price-competitive.

The current IPS backlog is $65 million, which represents more than six months of revenue. For Q3, IPS is forecasting revenue of $27 million and operating income of $1.5 million.

Intergraph Solutions Group (ISG)

In May 2002, Intergraph Government Solutions formally changed its name to Intergraph Solutions Group to reflect a migration into commercial markets as well as government markets. In Q2 2002, ISG is reporting revenue of $30.5 million and operating income of $1.9 million. This reflects a 15% decrease in revenue and a 28% decrease in operating income from Q1 2002 revenues of $35.9 million and operating income of $2.6 million. In comparison to Q2 2001, revenue declined 4% from $31.7 million, and operating income is down 22% from $2.4 million.

On a year-to-date basis, ISG is reporting revenues of $66.4 million, which is 5% less than the $69.9 million reported in the first six months of 2001. Operating income for the first half of 2002 is $4.4 million, 22% less than the $5.7 million in operating income in the first half of 2001. The reduction in operating income is a direct result of reduced revenue. The impact of lower revenues on operating income was mitigated by the fact the revenue reductions were largely in third-party products where gross margins are smaller than in the core services business. In addition, overhead rates in the services business were lower than planned, again lessening the impact of the decline in revenue on operating income.

Overall, total systems and services backlog grew by approximately $3 million during the second quarter. Ending backlog is $71 million for Q2, which represents more than six months of revenue.

Delays in the funding of programs related to IT improvements have affected the award of new contracts. These delays are directly related to September 11 and the government's change in priorities in response to this event. Much of ISG's funding is derived from Operations and Maintenance (O&M) budgets within the Department of Defense. However, non-mission-critical O&M funds have been diverted to pay for the war effort. ISG believes that when funding returns to normal levels and priorities, more money will go into IT systems and ISG will be well positioned within its major accounts. In comparison to last year, ISG should see an increase in orders in the second half. The second half of 2001 was weak in new orders ($24 million) as many of the IT-related new programs were cancelled in response to the events of September 11.

To counter the affects of reduced spending in ongoing IT infrastructure programs, ISG has promoted its capabilities in such high priority national security initiatives as IT assurance, information and asset security, and Homeland Security. So far, the focus of Homeland Security has not been on IT solutions. Most of the efforts and funds are focused on physical security requirements such as airport detection equipment and extra security personnel. Although progress in funding IT solutions has been slow, the investments made to date are beginning to show results in terms of contract awards. System and services bookings year-to-date in 2002 have exceeded bookings in the same period in 2001 by $8.1 million or 16%.

In 2002, ISG has also attempted to counter the affects of the changing government spending priorities by targeting selected commercial markets for its IT services expertise. However, on the commercial side, economic conditions continue to constrain industry spending. IT improvements that can be delayed without dramatically affecting ongoing operations are being postponed, as the commercial sector continues to show the effects of the slow economic recovery.

As the economy improves and national spending priorities get better defined, ISG will continue to grow its already profitable services business. Until these industry conditions change, however, ISG will focus on managing its costs to ensure profitability in an environment of stagnant growth.

For the remainder of 2002, ISG is forecasting that total revenue will remain flat at levels consistent with Q2. This assumes that core services business will grow somewhat to offset expected continued declines in the hardware maintenance business. ISG expects to remain profitable, although some decline from the current level of income can be expected as contract billable resources are balanced and cost control measures are implemented.

For Q3, ISG is forecasting revenues of $30.8 million and operating income of $1.3 million.

Intergraph Mapping and GIS Solutions (IMGS)

For Q2, IMGS is reporting revenue of $31.2 million and operating income of $25,000. In comparison to Q1 2002, which saw increased revenue and operating income from map production, current quarter results represent a decrease of 8% from the $33.8 million revenue and a substantial decrease over first quarter operating income of $2.1 million. Comparing Q2 2002 to Q2 2001, revenue increased 8% over the $29 million reported in Q2 2001, while operating income declined from $317,000 reported in Q2 2001. On a year-to-date basis, IMGS revenue is at $65 million, with operating income of $2.2 million, an increase of 2% over first-half 2001 revenue of $63.5 million, and a decrease of 35% over first-half 2001 operating income of $3.3 million.

IMGS has experienced the effects of a downturn in the economy, particularly in the commercial, state and local government businesses. The U.S. federal mapping business remains strong, and IMGS has experienced positive effects in its map production outsourcing business in support of national security efforts. In the short-term, IMGS will focus on balancing these industries and strengthening its commercial position in key target markets. IMGS will continue to invest in its technology to strengthen its competitive position.

The majority of IMGS software solution sales are to governments at all levels around the world, primarily as a combination of geospatial software and professional services. At the local and state government level, the weakened economy, combined with lower budgets in general, has either slowed or reduced purchases in IT, including GIS. The Company believes that this will continue in the short to medium term. At the federal and national levels, the situation is improving in areas pertaining to national security. IMGS is well positioned here with solutions in map production and data management. However, some of the larger government projects this quarter experienced a delay in starting, either due to budget shortfalls or longer approval cycles. IMGS management sees these issues as delays in the expected pipeline rather than the cancellation of planned projects or funding by government customers. IMGS began shipping the next major release, Version 5, of its GeoMedia product suite in Q2.

IMGS ended the quarter with a backlog of approximately $37 million, level with last quarter. In Q3, IMGS expects revenue and operating income to remain flat with Q2 results.

Z/I Imaging

For Q2, Z/I Imaging is reporting revenue of $7 million and operating income of $310,000. This compares to $7.7 million in revenue and $501,000 in operating income from the prior quarter, and represents decreases of 9% in revenue and 38% in operating income. Comparing results to the second quarter of 2001, Z/I Imaging is reporting a decrease of 41% from the $12 million in revenue reported and a substantial decline from the $2.2 million in operating income. On a year-to-date basis, both revenue and operating income have declined from first half 2001 levels. Z/I Imaging's revenue is at $14.8 million with operating income of $811,000 compared to $23.1 million in revenue and $3.8 million in operating income in the comparable six-month period of 2001.

Z/I Imaging is one of the world leaders in the earth imaging market, producing hardware and software solutions for infrastructure mapping, engineering and image data management. These solutions involve capital-intensive components such as aerial cameras, photogrammetric scanners, stereo mapping workstations, and engineering software applications. As reported in Q1 of this year, the economic slow-down has caused customers to delay their capital investments. However, Z/I Imaging has not seen its customer base turning to competitors. Shortfalls in state sales tax revenues continue to negatively impact spending within the state Departments of Transportation, who represent a significant customer segment within Z/I Imaging's U.S. customer base.

Despite the revenue shortfall, however, Z/I Imaging has remained profitable by carefully controlling expenses and slowing down the rate of growth of international operations. Despite the current economic climate, Z/I Imaging has continued to aggressively pursue a strategy of new product development, as shown by the successful completion of three flight tests of the new Digital Mapping Camera with truly stunning image quality. The first production system will be shipped in Q3. Z/I Imaging expects a continued ramp-up in software sales. The new TerraShare Enterprise software family is picking up momentum, as shown by three recent software wins in the U.S. and Europe totaling $300,000. Overall, the company is well positioned to respond to an improving economy.

Z/I Imaging ended the quarter with a backlog of $3.1 million. For the third quarter of 2002, Z/I Imaging is projecting revenue of $8 million and operating income of $500,000.

Intellectual Property (IP) Division

Intergraph has created an Intellectual Property division to maximize the value of the Company's portfolio of patents, copyrights and trademarks. The new division will have responsibility for its own P&L and will manage all aspects of Intergraph's intellectual property with the goal of identifying, protecting and profiting from the Company's intellectual capital. The Company has retained a consultant to assist in the formulation and implementation of its licensing program. The Company has also begun its evaluation of technology sectors, companies, and products that may benefit from the licensing of Intergraph technology.

For the second quarter, the IP division is reporting an operating loss of $381,000 and for the first half of 2002, an operating loss of $3.5 million. These losses are the expenses associated with the patent lawsuits in Q1 2002 and other Intellectual Property costs in Q2 2002. As mentioned earlier, the costs of the patent lawsuits in Q2 2002 were offset against the gain from the Intel settlement and shown as other income. The division had no revenue for the first six months of the year. For Q3, the IP division is forecasting an operating loss of $300,000.

Corporate holding company

The corporate holding company carries costs that are not the result of providing direct services to the vertical businesses. These charges include:

Costs that are directly the result of Intergraph being a publicly held company.
Oversight costs associated with the offices of CEO, CFO and Treasurer, and corporate oversight costs in Europe and Asia. These costs would likely not be incurred by the vertical businesses if they were truly separate and independent companies.

Residual effects of exiting the hardware business, including management of warranty reserves and management of a repair depot.

Fees for outside legal services other than Intellectual Property-related legal services.
Revenues and expenses associated with the rental and management of excess facilities on the Huntsville campus.

For Q2, Corporate had revenues of $3.6 million and an operating loss of $6.4 million, as compared to Q1 2002 revenues of $2.5 million and an operating loss of $4.7 million. For the first six months of 2002, revenue totaled $6.1 million with an operating loss of $11.1 million.

In Q3, the corporate vertical expects revenue of $4.5 million and an operating loss of $4.1 million.

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