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The Starting Line: Shoring up CA's vote

Charles Wang and Sanjay Kumar want to defeat the campaign by Texas billionaire Sam Wyly to wrest away control of Computer Associates. Now it's up to the shareholders.

The atrium lobby of Computer Associates' lush Long Island, N.Y., headquarters is a soaring, sky-lit space with balconies overlooking workers heading in and out of the company cafeteria.

On a recent day, a dozen or so signs were hanging from those balconies, giving the lobby the appearance of a college dorm before a pep rally: "Vote CA!" "Accounting/Finance supports CA," "You can't go wrong with Charles and Sanjay," "Read my lips: Vote for Charles and Sanjay."

Charles and Sanjay are Chairman Charles Wang and President and CEO Sanjay Kumar. And the votes that the employee-supporters are asking for are part of a proxy fight that is challenging their control over the fourth-largest software company in the world, amid accusations of accounting shenanigans, strong-arm sales tactics and shareholder dissatisfaction.

Texas billionaire businessman and investor Sam Wyly has launched a bid to take over the software company and replace current management with a new board.

Wyly charges CA management with "chronic abuse of customers and employees," and using accounting tricks to artificially boost sales figures.

Wyly, who has seen two of his companies, Sterling Software and University Computing, sold to CA, has proposed splitting the company into four divisions that would handle storage, security, systems management and knowledge management.

CA has fought back--hard. In addition to holding press conferences and issuing press releases fighting Wyly's claims, the company has filed suit against Wyly, arguing that his fight violates a non-compete contract he signed, as well as some proxy rules.

Wyly isn't alone in taking aim at CA's accounting methods.

The company recently switched to a new business model in which it books revenue from software licenses over the life of the contract, instead of up front. Although this will allow CA to level out its revenue over time, it also resulted in a sharp drop in sales.

To explain the difference to investors, CA began including "pro forma pro rata" results in its press releases, showing what the quarter's results would have been had they switched to the new business model years earlier.

While the company argues that this is intended to make comparisons easier for investors, critics charge that it artificially inflates CA's performance. Indeed, in the most recent quarter, the pro forma results were able to turn a net loss into a profit.

CNET spoke with Kumar and Wang last week at CA's headquarters.

Q: You have said that new bookings were $502 million, and that's a little lower than earlier predictions of $600 million. What's responsible for the slowdown?
A: Kumar: In aggregate numbers, the number is lower than $600 million. You also have to take into consideration the length of the contract. When we announced the new business model last year, the average length was right about six years. For the March quarter, it's a little over five years, and for the June quarter it's a little over four years. So there's a dramatic decrease by design. We have brought the number down by purpose. Because, especially in difficult economic times, we're at a major advantage to be able to sell shorter-term contracts.

So you're doing smaller contracts, but to balance out, don't you need to do more?

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  Billionaire Sam Wyly wrong?
Charles Wang, Computer Associates chairman, and Sanjay Kumar, Computer Associates CEO
Kumar: Volumes of contracts have gone way up. We did one deal greater than $30 million in the quarter, whereas last year we year did five worth more than $30 million. So we had to do much more smaller deals.

Were you surprised by the proxy fight?
Wang: We were notified when Sam Wyly first wrote to Walter Haefner (who is the largest individual shareholder and has said he will support the current board), and we were surprised. We never thought that somebody, especially somebody who doesn't understand the business and our industry, would attempt this.

Kumar: And we hadn't heard from him; I hadn't heard from him in over a year.

What do you think his chances are?
Wang: We're very confident. We're going to fight this thing to get to every shareholder, large and small, and make sure they understand what we've done in the last 25 years, and why we're very confident of what we're going to achieve in the next 25 years.

You said he doesn't understand the industry, and you obviously don't think much of his proposal.
Wang: I don't think he understands what our customers are asking us to do and why it's so important, as Sanjay just said, to reduce the number of vendors. They want integrated solutions, and they want less vendors and less people calling on them.

Kumar: I haven't seen him give an industry keynote at Comdex or Networld+Interop or Java One talking about the technology and relevant issues to our industry.

The way Sterling was organized was across four divisions. Our customers would view that as absolutely a negative thing to do and going back to something they don't want. We ourselves were organized across four divisions in Europe, and our performance, which is public record, was not good for two years, and (so)...we went the other way to reflect a more consolidated face to our customers.

So what he's...suggesting has been relatively vague other than the fact that he says he's going to break it up into four businesses: There will be four people to run the four businesses; no one person other than him would be in charge of all the pieces. Today our largest customers insist on meeting somebody who's responsible for the business. I don't think they're going to enjoy the idea, and they won't put up with the idea of going to four different companies.

Also, how is it that (they will) set this up to go to our 1,000 largest customers who have businesses across the supposed four divisions that Mr. Wyly is suggesting they be broken up into? (They'd) have one contract to support all four. The company can't arbitrarily go to customers that we have this long-term contract with and say, "We're going to break it up. We're going to arbitrarily assign different products to different companies." They won't put up with that.

Wyly's arguing that splitting the company up would have the potential to create more shareholder value, possibly through spinoffs.
Kumar: The management team and employees are shareholders. We have their interests in mind. If we thought it was a better way in the medium term and beyond to increase shareholder value, we would do that. The fact of the matter remains that's not what customers are asking for. I don't think you spur innovation by breaking it up; I don't think you make it simpler by breaking it up; and I don't think you expand shareholder value by breaking it up.

He's been able to do this because your board all comes up for

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  Computer Associates CEO against breakup
Sanjay Kumar, CEO, Computer Associates
re-election at the same time. Are you planning on keeping it like that, or will you switch to a staggered board?
Kumar: (Not having a staggered board is) considered the best shareholder practice.

He's not the only one to have issues with your accounting methods. There have been articles criticizing some of your business methods, and there are still some questions among analysts. For instance, J.P. Morgan in a recent report said, "We're still getting our arms around (the new business model)." How do you respond to that?
Kumar: To be fair and provide a balanced perspective, I'd point out that more analysts like it than don't; and our share price has improved since last October to outperform Microsoft, Intel and just about every other tech giant in the marketplace. On balance, investors and institutional holders understand the model and like it. If they didn't...our share price wouldn't have improved 70-plus percent in a very difficult marketplace.

We had been candid last year to talk about how difficult it is at the end of the quarter. Companies who have good expectations, for good reasons, about making a quarter don't make it because so much happens at the end of the quarter. The that the first day of the quarter and the last day of the quarter are even under GAAP (generally accepted accounting principles).

Under GAAP, when you have a multiyear transaction, you have to book the revenue up front if you satisfy certain criteria. CA, like our peers and competitors, used to act under that business model. For the most part, our peers and competitors still operate under that model. We figured there was a much, much better way to work with our customers to build partnerships and get our products in the door. And that was to offer our customers the choice of long-term licenses and short-terms licenses, subscription licenses and month-to-month licenses.

It would be a competitive advantage to go up against a competitor who's asking for a big five-year deal and for us to say (to a customer), "Try us month to month. If we don't perform in six months, you're going to throw us out." The risk is diminished, and the returns are much greater with CA.

The back end of the change is really very simple...We go ratable. Every single thing should be taken month to month to month. So if it's a three-year deal, we'll recognize it in 36 installments.

The confusion, if any, stems from our desire to respond to the needs of the market by providing comparability to our old numbers. Under the old business model, like everybody else, the revenue came in up front, so the numbers were big. In the new model we take it in over time, so the numbers, by their nature, will be smaller. This pro forma methodology...simply allows people to compare what it would have been before ratable to what it would be like today if it was ratable all along.

The expense numbers, while they've been trimmed, haven't been trimmed to the same degree as the revenue numbers.
Kumar: Expenses pro forma or under GAAP are identical. There is absolutely no change. We 're not in any way going to change expenses to make the

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  CA says analysts keen on business model
Sanjay Kumar, CEO, Computer Associates
numbers look better.

The reported revenue numbers start to catch up over time, and they start to accelerate mathematically, because...every quarter we add more in deferred revenue.

Our expenses are primarily people, the cost of developing software, and the cost of taking care of our customers. We're committed to continuing all of that stuff. The reported revenue catches up down the road in three years.

What are some of the things you've done to get your message to shareholders?
Wang: We're continuing to meet with institutions. Also, we have a proxy solicitation firm, and they're working to make sure every shareholder gets our message.

Have you run any numbers on how much this proxy fight has cost, in terms of extra mailings, things like that?
Wang: We've budgeted around $10 million.

What's the feedback you've gotten from within the company?
Wang: It's tremendous. We have the best people in the industry. These people have grown up through the company. Sanjay's from an acquisition--to give you an idea--(and) he runs the business today. We've given people here an opportunity to do something they never thought they'd do in their lives--build a business together--and they're very proud of it.

Kumar: And I think they see it from two very unique fronts. They know what customers are asking for today because they're in the front lines. They're developing the technology, they're selling it, they're serving and supporting it. So they realize that what Mr. Wyly is suggesting really has no merit in the eyes of the customer.

The second and very fortunate thing we have is lots and lots and lots of ex-Sterling employees running around the company at many different levels. And there is no greater vote of confidence than for a Sterling employee to tell his peers that the way Sterling was organized was a disaster and (that) this is a much better place to work and for employees to function.