Harvard Business School

9-279-074
April 1, 1979

Systems Engineering Laboratories, Inc.

In early 1978, Systems Engineering Laboratories, Inc. was considering how to raise $10 to $15
million of new capital to finance its rapid growth. Systems was incorporated in 1961. At first the firm
produced components for data acquisition systems. Later the firm began to produce digital
computers for the high-speed acquisition and control of real-time data. The company's sales grew
rapidly from $1.0 million in 1962 to $6.2 million by 1966.
In March 1966, Systems first sold stock publicly through an offering of 240,000 shares at $4.50
per share. In a second public offering in November 1967, the firm sold 100,000 shares at $22.00 per
share. Two years later the firm sold stock in a third public offering. The sale of 250,000 shares at a
price of $40.25 per share raised approximately $10 million in this public offering.
In the decade following its initial public offering, Systems' financial record was somewhat
erratic. The firm's progress was interrupted twice (Exhibit 1). Sales declines and major losses were
sustained in 1971 and again in 1974. In 1971, a soft economy, several disastrous acquisitions, and a
significant write down of obsolete inventory resulted in a sales decline from $21 to $13 million, and a
loss exceeding $10 million. This loss eliminated almost one-half of the firm's net worth.
In 1972, Systems introduced three new major products which helped to rebuild the
company's sales. Progress continued until 1974 when sales declined from $17 million to $15 million,
and a net loss of $3.8 million was incurred (Exhibit 1). The loss in 1974 consisted of $2.6 million from
operations, $1.2 million from the writeoff of obsolete inventory, and $1.3 million from the
discontinuation of an obsolete product line. This $5.1 million loss was reduced by a $1.3 million gain
on the sale of land.
In 1974 Systems commenced a major new product development effort. This effort was quite
successful and the first models of a newly developed computer series were shipped in October 1975.
Shipments of this equipment had a major impact on Systems' sales, profits, and financing
requirements (Exhibit 2).
Systems felt that its new products represented a significant improvement in machine
performance/price ratios. An improvement of substantial magnitude was usually necessary to
prompt users to consider changing their computer vendor, since "computer users characteristically
become attached to computer suppliers because of their extensive investments in applications
software operable only on the machines for which it is written."1 In Systems' view, opportunities of
the type presented by its new products "do not occur often in the computer industry, and we intend
to focus resources to benefit from this situation."2 In this effort, Systems would be facing some
competitors with substantially greater financial resources. Indeed all of Systems' principal

1
2

Systems Engineering Laboratories, Inc., Annual Report1977, p. 2.

Ibid., p. 2.

This case was prepared as the basis for class discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.
Copyright 1979 by the President and Fellows of Harvard College. Distributed by HBS Case Services, Harvard
Business School, Boston, Mass. 02163. All rights reserved to the contributors. Printed in the USA.
1

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279-074

Systems Engineering Laboratories, Inc.

competitors were larger firms. These competitors included Digital Equipment Corp., Data General
Corp., Prime Computer, Inc., and Perkin-Elmer Corp. (Exhibit 3).
The bulk of Systems' computer sales were to manufacturers whose products served three
markets. These markets were (1) energy monitoring and control systems (primarily for electric
utilities): (2) flight training simulators; and (3) laboratory and computation uses. Systems' 1977 share
of market and the growth in the computer segment of these markets between 1977 and 1981 was
estimated as shown below.

Energy Monitoring and Control

Flight Training Simulators
Laboratory and Computation

Systems' 1977
Share of
Market (%)
35
25
5

Size of Market
in 1977 ($
millions)
25
30
195

Estimated Size
of Market in
1981 ($
millions)
65
60
300

Estimated
Annual Market
Growth 1977
1981 (%)
27
19
16

Revolving Credit Financing Arrangement

Through June of 1977, Systems had been able to finance its operations through the use of a
revolving credit agreement which the firm had established with two banks in 1972. This agreement
allowed Systems to borrow (on a fully secured basis) amounts which had, in the past, adequately met
the firm's operating needs. Southeast First National Bank of Miami was the lead bank in the credit,
and the Chemical Bank joined in the credit with a 50% participation. The revolving credit agreement
had been modified many times in the past in order to meet the needs of both Systems and its lenders
(Exhibit 4). By year-end 1977, however, it was clear that Systems would very soon encounter a level
of funds needs that would exhaust the desires of the firm's lenders for granting additional credit. The
various markets served by Systems had been growing at annual rates of 18% to 40% in fiscal 1978, a
rate somewhat higher than the longer-run average forecasted above. These growth rates were not
expected to diminish in the immediate future. Systems would thus easily require $10 million to $15
million of new externally supplied capital over the next two years to simply keep pace with the
growth in its markets, even ignoring the financing requirements associated with Systems' increased
market share objective. As the need for additional funds grew, Systems began encountering difficulty
meeting the restrictive covenants on its existing debt.
Indeed, Systems had been unable to fulfill the loan restriction relating to the ratio of total
liabilities to tangible net worth as of September 23, 1977, and had to obtain a waiver of this restriction
from its bankers. At December 23, 1977, Systems was in default of two covenants (i.e. those relating to
debt to worth and inventory turnover) and had received waivers. During December 1977, the
Chemical Bank dropped out of the credit agreement after declining to increase Systems' line of credit,
and the First National Bank of Boston became the lead bank in the loan. The maximum loan limit was
raised from $6.5 million to $8.5 million. On March 3, 1978, this loan limit was raised to $10.0 million.
By March 24, 1978, Systems was in default of three covenants (i.e. those relating to debt to worth,
inventory turnover, and current ratio) and had again received waivers. On May 8, 1978, the
Continental Illinois National Bank joined in the credit agreement, raising Systems' maximum credit
limit to $12.0 million.

A Need for New Financing

Systems' lenders were endeavoring to assist the firm in achieving its full growth potential.
Nonetheless, by 1978 Systems' lenders were insistent that the firm either had to seek new long-term
financing or find a way to live within its existing credit limits. The latter choice would require
Systems to forego highly profitable sales, an outcome that the firm was unwilling to accept. Systems
simply had to find one or more new sources of financing, and the firm was exploring all available
options. By the end of March 1978, it was clear that the sale of two quite different financing

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