Sierra Systems Group Inc.
TSX : SSG

Sierra Systems Group Inc.

February 03, 2006 15:00 ET

Sierra Systems Announces First Quarter Results

VANCOUVER, BRITISH COLUMBIA--(CCNMatthews - Feb. 3, 2006) - Sierra Systems Group Inc. (TSX:SSG) today reported financial results for the first quarter ended December 31, 2005. Material observations for the first quarter compared to the same quarter a year ago were as follows:

- Services revenue decreased 2% to $33.3 million

- Earnings from operations decreased 39% to $1.6 million

- Diluted earnings per share decreased 35% to $0.11 per share.

Iraj Pourian, Sierra Systems President & CEO, notes, "Consistent with our previous communication, quarter one was impacted by performance issues in one of our Canadian branches. As expected, this contributed to lower services revenue and earnings this quarter as compared to the same period last year.

We see 2006 as the foundation year of our strategic plan, and we are making a significant investment in our growth strategies this year. We have a strong leadership team in place to ensure our investments will build a solid foundation for greater market expansion in the coming years.

Looking forward, we are very optimistic. Despite considerable investment in our growth strategies, we anticipate a material improvement in sequential earnings next quarter and we expect this trend to continue in the second half of the year."



Amounts in tables are in thousands of Canadian dollars except
earnings per share.


3 months Ended
December 31
(unaudited)
--------------
Fiscal 2006 2005 2004
(in thousands, except earnings
per share amounts)

Services Revenue 33,281 34,068
Earnings from operations before
restructuring charge n/a 3,810
Earnings from Operations 1,567 2,561
Net earnings for the period 1,033 1,675
Earnings per share - basic & diluted 0.11 0.17


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FIRST QUARTER FISCAL 2006 RESULTS
Services revenue, the Company's primary business line, decreased by $0.8 million or 2% from the same quarter of fiscal 2005 to $33.3 million. The decrease was due primarily to $1.0 million lower revenues reported in our Canadian operations.

As noted last quarter, we are experiencing short-term performance issues in one Canadian Branch. This location had two significant projects complete in 2005, and the branch is working hard to replace that revenue. The loss of revenue associated with these two projects was the main reason for the decrease in Canadian Operations revenue in the quarter.

Our U.S. operations reported a 5% increase in US$ denominated revenue in the quarter as compared to the same period last year, although the strengthening Canadian dollar reduced this increase in Canadian dollar terms to 2% or $0.2 million.

Compensation costs include salaries, incentive compensation and benefits related to our billable and operations support headcount. These costs also include the expense associated with our use of subcontractors. Our compensation costs are our most significant expense, and on average comprise about 75% - 80% of the Company's operating expense.

In quarter one, compensation costs were $24.5 million. This represents a $1.6 million or 7% increase from the same period last year. The increase was mainly due to a higher usage of subcontractors to fulfill project deliverables. Subcontractor costs increased $1.2 million to $6.0 million this quarter. This represents a 24% increase as compared to the same period last year. Consistent with this increase, subcontractor costs were 25% of total compensation costs in quarter one of fiscal 2006 as compared to 21% in the same period last year.

Salary costs increased by $0.4 million as compared to quarter one of 2005. The increase was mainly attributable to higher variable compensation costs, as the cost of general salary increases was largely offset by a lower headcount in the quarter.

Additional variances as compared to the same period last year include an increase in benefits costs of $0.3 million, and a decrease in profit sharing costs of $0.2 million.

Compensation costs as a percentage of services revenue is a key performance indicator for our business. This indicator was weaker this quarter at 74% as compared to 67% in quarter one of fiscal 2005.

Utilization in the quarter continued to remain strong at 79%.

Other Costs include non-recoverable travel, promotion, education, and recruitment costs. In quarter one, these costs increased by 5% or $0.1 million to $2.0 million as compared to the same period last year. Higher promotion and travel costs were the significant contributors to the increase.

General and Administrative costs include administrative salaries, indirect overhead, rent and communication costs. G&A costs decreased 4% or $0.2 million to $4.4 million as compared to quarter one of fiscal 2005. Savings in rent costs due to rationalization of lease space in 2005 contributed to the positive variance. Additionally, lower administrative headcount resulted in reduced salary costs in the quarter.

Resulting from the above noted factors, operating income decreased by $1.0 million to $1.6 million in the current quarter from $2.6 million last year.

The effective tax rate of 34.9% in the current quarter reflects a $0.1 million benefit of taxable income generated from the Company's U.S. operations not exposed to a current tax provision. Note 3 of the unaudited interim consolidated financial statements provides a detailed analysis of the difference from the statutory rate of 34.1%.

On a sequential quarterly basis, services revenue decreased by 9% or $3.3 million. The decrease resulted from a $2.1 million reduction in revenue from our Canadian operations and a $1.2 million reduction in revenue from our U.S. operations.

Compensation costs decreased 5% or $1.4 million from last quarter. Subcontractor costs decreased by $1.1 million, and salary costs decreased by $0.7 million largely due to lower severance and bonus costs in the current quarter. These reductions were offset by higher vacation costs in the quarter.

Other costs decreased 18% or $0.4 million as compared to the fourth quarter of 2005. Reduced spending on recruitment and education were the main contributors to the positive variance. General and Administrative costs increased 4% or $0.2 million from last quarter. Legal and regulatory costs were the most significant contributor to the increase.

Financial Capability

On December 31, 2005 the Company had cash on hand of $4.6 million, a $2.4 million decrease from the previous quarter. Several factors contributed to the decrease.

The company reported a $0.8 million use of cash from operations. There were two significant factors impacting this use of cash. First, variable compensation costs are accrued throughout the year, but are paid annually. This payment was made in the first quarter and consistent with increased profitability in fiscal 2005, was higher than in previous years. Additionally, in line with increased profitability in fiscal 2005, corporate income tax payments were higher in the quarter.

As noted in note 4(d) of the unaudited interim consolidated financial statements, on December 6, 2005 the Company amended the terms of its ongoing normal course issuer bid to permit additional shares in Sierra Systems' stock to be purchased for cancellation by the Company. During the quarter the Company acquired 69,147 shares for cancellation at an average cost of $9.41. This represented a $0.7 million use of cash in the quarter.

Additionally, as noted in note 4(e) of the unaudited interim consolidated financial statements, the Company made the first quarterly payment of the annual dividend announced last quarter. This represented a $0.7 million use of cash in the quarter.

A key performance measure of accounts receivable is days sales in trade accounts receivable. This measure weakened this quarter to 78 days as compared to 70 days last quarter, and 61 days in the same quarter last year. This increase was due mainly to the transfer of work-in-progress to accounts receivable through the billing process late in the quarter as opposed to a weakening of our accounts receivable.

Accounts receivable aging continued to remain strong in the quarter, with over 91% of accounts receivable less than 60 days old as at December 31, 2005.

Recent Accounting Changes

During the three months ended December 31, 2005, we did not adopt any new accounting policies or make changes to existing accounting policies that have a material impact on our consolidated financial statements.

Critical Accounting Estimates

The critical accounting estimates described in the Management's Discussion and Analysis presented in the 2005 Annual Report have not materially altered.

Business Risks

The business risks described in the Management's Discussion and Analysis presented in the 2005 Annual Report have not materially altered.

Disclosure Controls and Procedures

We maintain a set of disclosure controls and procedures designed to ensure that information required to be disclosed in filings made pursuant to Multilateral Instrument 52-109 is recorded, processed, summarized and reported within the time periods specified in the Canadian Securities Administrators' rules and forms. Our Chief Executive Officer and Chief Financial Officer have evaluated our disclosure controls and procedures as of December 31, 2005 and concluded that our current disclosure controls and procedures are effective.

Normal Course Issuer Bid

The Company intends to seek regulatory approval to renew the normal course issuer bid, which is due to expire on February 7, 2006.

Additional Information

Additional information relating to the Company, including the Company's most recently filed quarterly Management's Discussion and Analysis, can be found on SEDAR at www.sedar.com.

Caveat

The statements that are not historical facts contained in this release are forward-looking statements that involve risks and uncertainties. Sierra Systems' actual results could differ materially from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, technological shifts, employee retention, fixed price contract delivery, competition, general economic conditions, foreign exchange and other risks detailed in the Company's Annual Report and other filings with Canadian securities regulatory authorities.

Notice of no auditor review of interim consolidated financial statements

Under National Instrument 51-102, Part 4, subsection 4.3(3)(a), if an auditor has not performed a review of the interim financial statements, they must be accompanied by a notice indicating that the financial statements have not been reviewed by an auditor.

The accompanying unaudited, interim consolidated financial statements of the Company, as at and for the three months ended December 31, 2005 and December 31, 2004 have been prepared by and are the responsibility of the Company's management. The Company's independent auditor has not performed a review of these financial statements in accordance with standards established by the Canadian Institute of Chartered Accountants for a review of interim financial statements by an entity's auditor.

Conference Call Details

Date: February 3, 2006

Start time: 1:30 p.m. Pacific (4:30 p.m. Eastern)

Dial-in number: 1-866-321-6651

Live Web cast: www.SierraSystems.com

Presentation: A presentation to be viewed in conjunction with the conference call will be posted on the Company's website with a link on the home page to the presentation.

If you are unable to attend the conference call live, please call 800-374-1796 or 402-220-0876 through to Friday, February 17, 2006 to hear a digital playback. The Conference ID to be entered is 4589049. A playback of the call will be posted in the Investor Relations section of our Web site at www.SierraSystems.com approximately 24 hours after the call.

About Sierra Systems

Since 1966, Sierra Systems Group Inc. (TSX:SSG) has been improving the operational performance of our clients by delivering superior information technology and business consulting services. Through our extensive experience in Business Consulting, Solutions Delivery, and Managed Services, Sierra Systems has emerged as a trusted advisor to many leading private and public sector organizations across North America. With offices in Austin, Calgary, Dallas, Edmonton, Fredericton, Halifax, Hartford, Los Angeles, Olympia, Ottawa, Seattle, Toronto, Vancouver, Victoria, and Winnipeg, our consultants are never far from our clients. In Justice, Health, Government, and various other industries, Sierra Systems continues to win exciting engagements in the face of stiff competition. Visit us at www.SierraSystems.com.



SIERRA SYSTEMS GROUP INC.
CONSOLIDATED BALANCE SHEETS
(in thousands of Canadian dollars)

December 31 September 30
2005 2005
(unaudited)
----------- ------------
Assets
Current assets
Cash and cash equivalents $ 4,882 $ 7,017
Accounts receivable 28,340 28,470
Work-in-progress 6,815 8,078
Prepaid expenses 1,751 2,463
----------- ------------
41,788 46,028

Intangible assets (note 5) 412 514
Property and equipment 8,167 8,666
Goodwill 23,997 23,997
----------- ------------
$ 74,364 $ 79,205
----------- ------------
----------- ------------

Liabilities
Current liabilities
Bank indebtedness $ 260 $ -
Accounts payable and accrued
liabilities 11,327 15,110
Deferred revenue 1,371 1,706
Income taxes payable - 892
Dividend payable (note 4(e)) 1,975 -
----------- ------------
14,933 17,708
Future income taxes (note 3) 190 205
----------- ------------
15,123 17,913

Shareholders' Equity
Capital stock (note 4(a)) 42,597 43,192
Contributed surplus 1,353 1,224
Retained earnings 18,102 19,711
Cumulative translation adjustment (2,811) (2,835)
----------- ------------
59,241 61,292
----------- ------------
$ 74,364 $ 79,205
----------- ------------
----------- ------------


SIERRA SYSTEMS GROUP INC.
CONSOLIDATED STATEMENTS of RETAINED EARNINGS
(in thousands of Canadian dollars)

Three months ended
December 31
(unaudited)
2005 2004
----------- ------------

Retained earnings - Beginning of period $ 19,711 $ 14,544

Net earnings for the period 1,033 1,675

Dividend (note 4(e)) (2,642) -

Stock-based compensation
adjustment (note 4(b)) - (691)
----------- ------------

Retained earnings - End of period $ 18,102 $ 15,528
----------- ------------
----------- ------------


SIERRA SYSTEMS GROUP INC.
CONSOLIDATED STATEMENTS of EARNINGS
(in thousands of Canadian dollars except per share and share figures)

Three months ended
December 31
(unaudited)
2005 2004
----------- ------------
Revenue
Services $ 33,281 $ 34,068
Product sales 141 164
Reimbursements 1,724 1,037
----------- ------------
35,146 35,269
----------- ------------

Expenses
Compensation costs 24,480 22,894
Other costs 1,984 1,889
Product costs 126 137
Reimbursable expenses 1,724 1,037
----------- ------------
28,314 25,957
----------- ------------

Gross profit 6,832 9,312

General and administration 4,355 4,554
Amortization (note 6) 910 948
Restructuring charge (note 2) - 1,249
----------- ------------
Earnings from operations 1,567 2,561
----------- ------------

Foreign exchange gain (loss) 1 (88)
Other income 20 1
----------- ------------
Earnings before income taxes 1,588 2,474

Provision for (recovery of)
income taxes (note 3)
Current 570 761
Future (15) 59
----------- ------------
555 820

Earnings before equity accounted investee 1,033 1,654

Equity earnings of Donna Cona Inc. - 21
----------- ------------
Net earnings for the period $ 1,033 $ 1,675
----------- ------------
----------- ------------

Earnings per share $ 0.11 $ 0.17
----------- ------------
----------- ------------
Diluted earnings per share $ 0.11 $ 0.17
----------- ------------
----------- ------------

Weighted average number of common
shares outstanding - basic 9,443,883 9,749,101
----------- ------------
----------- ------------
Weighted average number of common
shares outstanding - diluted 9,681,556 9,887,387
----------- ------------
----------- ------------


SIERRA SYSTEMS GROUP INC.
CONSOLIDATED STATEMENTS of CASH FLOWS
(in thousands of Canadian dollars)

Three months ended
December 31
(unaudited)
2005 2004
----------- ------------
Cash flows provided by (used in)

Operating activities
Net earnings for the period $ 1,033 $ 1,675
Items not affecting cash
Amortization 910 948
Future income taxes (15) 59
Stock-based compensation
charge (note 4(b)) 129 75
Net change in non-cash working capital
items relating to operations (2,874) 891
----------- ------------
(817) 3,648
Financing activities
Shares issued 50 52
Shares purchased and cancelled
(note 4(d)) (651) -
Shares purchased for Long-Term
Incentive Plan (17) (116)
Repayment of capital lease obligation - (6)
Dividend (note 4(e)) (667) -
----------- ------------
(1,285) (70)
Investing activities
Purchase of property and equipment (304) (430)
----------- ------------
(304) (430)

Effect of foreign exchange on translation 11 (75)

(Decrease) increase in cash and
cash equivalents (2,395) 3,073

Cash and cash equivalents -
Beginning of period 7,017 833
----------- ------------
Cash and cash equivalents -
End of period $ 4,622 $ 3,906
----------- ------------
----------- ------------

Represented by
Cash and cash equivalents $ 4,882 $ 3,906
Bank indebtedness (260) -
----------- ------------
$ 4,622 $ 3,906

Supplementary cash flow information (note 8)


Notes to Interim Consolidated Financial Statements (unaudited)

(Amounts in tables are in thousands of Canadian dollars except per share figures)

1. Basis of presentation

These unaudited interim consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles, using the same accounting policies as outlined in Note 2 to the most recent audited consolidated financial statements for the year ended September 30, 2005, except as noted below. These unaudited interim consolidated financial statements do not include all the disclosures required for annual financial statements and should be read in conjunction with the audited consolidated financial statements for the year ended September 30, 2005. Certain comparative figures in the unaudited interim consolidated financial statements have been reclassified to conform to the current period presentation.

In the opinion of management, all adjustments (which include reclassifications and normal recurring adjustments) necessary to present fairly the consolidated financial position, consolidated earnings, and consolidated cash flows as at December 31, 2005 and for all periods presented, have been made. All amounts herein are expressed in Canadian dollars unless otherwise noted.



2. Restructuring charge

Charged during the
three months ended
December 31, Payable at December 31,
2005 2004 2005 2004
(unaudited) (unaudited) (unaudited) (unaudited)
---------------------- ----------------------
Workforce
reduction $ - $ 1,249 $ - $ 488
Lease
termination - - - 441
Other - - - -
---------------------- ----------------------
$ - $ 1,249 $ - $ 929
---------------------- ----------------------


On November 15, 2004, the Chief Executive Officer ("CEO") left the Company. A charge of $960,000 was incurred in connection with the termination of his employment. An interim CEO was appointed, who undertook further changes in the executive team. No further terminations in connection with this restructuring occurred, and all amounts were paid as at September 30, 2005.

In the fourth quarter of fiscal 2004, the Company gave notice to terminate its Los Angeles lease space and incurred a termination fee of US$733,678 (CA$973,003) of which 50%, or US$366,839 (CA$486,502), was paid upon notice to the landlord. The termination fee was fully expensed in fiscal 2004, and the balance was paid during the third quarter of fiscal 2005.



3. Income taxes

Three months ended Three months ended
December 31, 2005 December 31, 2004
(unaudited) (unaudited)
--------------------------------------
Earnings before income taxes $ 1,588 $ 2,474
Expected provision based on
a tax rate of 34.1%
(2004 - 35.6%) 542 881
Increase (decrease)
resulting from
Non-deductible expenses 128 129
Foreign tax differential 7 49
Canadian statutory rate
differential 22 16
Change in valuation allowance
for net operating loss
carry-forwards (144) (337)
Other - 82
--------------------------------------
Income tax provision $ 555 $ 820
--------------------------------------


The Company's future tax assets and liabilities are as follows:



December 31, 2005 September 30, 2005
U.S. Canadian U.S. Canadian
companies companies companies companies
(unaudited)
-------------------- --------------------
Differences in
working capital
deductions for tax
and accounting
purposes $ (1,825) $ 149 $ (2,444) $ 164
Property and equipment (12) (272) (12) (309)
Goodwill - (67) - (60)
Loss carry-forwards 7,742 - 7,838 -
Valuation allowance (5,905) - (5,382) -
-------------------- --------------------
Total net future tax
liabilities $ - $(190) $ - $(205)
-------------------- --------------------

Comprising
Non-current
liability $(190) $(205)
-------- ---------
$(190) $(205)
-------- ---------


The following table provides details of net operating loss carry-forwards of Sierra Systems Inc.:



Loss carry-forwards
Expiry date US$

2020 1,879
2021 681
2022 3,988
2023 5,009
2024 4,889
2025 439


4. Capital stock and stock options

a) Capital stock



Authorized
100,000,000 common shares without par value
50,000,000 preferred shares without par value

Issued
Three months ended Twelve months ended
December 31, 2005 September 30, 2005
(unaudited)
--------------------- ----------------------
Common Amount Common Amount
shares $ shares $

Balance - Beginning
of period 9,449,787 43,192 9,746,842 44,191

Issued pursuant to
the ESOP 4,380 49 26,118 182
Exercise of options 250 1 161,300 1,101
Shares purchased for
Long-Term Incentive
Plan (1,545) (17) (40,053) (345)
Long-Term Incentive
Plan shares vested 3,000 23 28,140 211
Shares purchased for
cancellation (69,147) (651)
Shares purchased and
cancelled - - (472,560) (2,148)
--------------------- ----------------------

Balance - End of
period 9,386,725 44,192 9,449,787 43,192


b) Options

The Company has a stock option plan that grants to directors and certain employees of the Company the option to purchase up to 1,312,900 common shares of the Company. The exercise price of each option is determined by the market price of the Company's stock on the date of the grant and an option's maximum term is 10 years. Options generally vest over three to five years.

For the three months ended December 31, 2005, the total stock-based compensation charge was $129,000, which has been included in compensation cost on the consolidated statement of earnings. All of this cost relates to the amortization of previous stock option awards granted prior to October 1, 2005.

Assumptions used in the Black-Scholes option-pricing model:



Three months ended
December 31,
2005 2004
(unaudited) (unaudited)
-----------------------
Dividend yield 0.7% 0.0%
Expected volatility 32% - 33% 35% - 36%
Risk free interest rate 3.6% 2.7% - 2.9%
Expected life (years) 3 4
Weighted average grant date fair value $ - $ 1.81


The following table summarizes the movement in options under this
Plan:



Three months ended Twelve months ended
December 31, 2005 September 30, 2005
(unaudited)
----------------------------------------
Balance - beginning of
period 826,000 897,500

Options granted in period 0 60,000

Options exercised in period (250) (80,500)

Options expired in period (30,000) (13,000)

Options cancelled in period (4,000) (38,000)
----------------------------------------

Balance - end of period 791,750 826,000


c) Employee share ownership plan (ESOP)

The ESOP permits all full-time employees of the Company to purchase common shares through payroll deductions. Shares are purchased quarterly at prevailing market prices with a 15% subsidy from the Company via funds paid into a trust account. During the three months ended December 31, 2005, the Company contributed $15,000 (2004 - $17,000) and issued 4,380 shares (2004 - 10,725) pursuant to this plan. The contributed amount has been included in compensation expense in the consolidated statement of earnings.

d) Shares purchased and cancelled

On December 6, 2005, the Company amended the terms of its ongoing normal course issuer bid, which was initiated on February 8, 2005 and is scheduled to terminate on February 7, 2006. Prior to the amendment, the Company was permitted to purchase up to 491,707 common shares of the Company, representing approximately 5% of the issued and outstanding common shares at the time of the commencement of the bid. With the amendment, the Company is now permitted to purchase up to 657,999 common shares of the Company representing approximately 10% of the public float of the Company at the time of the commencement of the bid. Sierra Systems has received approval from the TSX to amend this bid. Purchases will continue to be made on the TSX at the market price at the time of acquisition.

During the quarter the Company acquired 69,147 shares for cancellation, at an average cost of $9.41. These shares were not yet cancelled as at December 31, 2005.

e) Dividend

On November 20, 2005, the Company declared an annual dividend of $0.28 on each outstanding common share, payable at $0.07 quarterly. On this date, the Company recorded a "Dividend payable" on the consolidated balance sheet and made a corresponding adjustment to retained earnings for the total dividend liability of $2,642,000. The first quarter's payment of $667,000 was made on December 12, 2005, to all shareholders of record as at the close of business on December 1, 2005.

5. Intangible assets



Accumulated Net book value at
Cost amortization December 31, 2005
-----------------------------------------

Customer relationships
with an economic life of
44 months at inception $ 683 $ 368 $ 315
Sub-contracting agreement
from Donna Cona Inc. 856 759 97
-----------------------------------------
$ 1,539 $ 1,127 $ 412


Accumulated Net book value at
Cost amortization September 30, 2005
-----------------------------------------

Customer relationships
with an economic life of
44 months at inception $ 683 $ 322 $ 361
Sub-contracting agreement
from Donna Cona Inc. 856 703 153
-----------------------------------------
$ 1,539 $ 1,025 $ 514


6. Amortization



Three months ended
December 31,
2005 2004
(unaudited) (unaudited)
----------------------

Amortization of property and equipment $ 808 $ 853
Amortization of customer relationships 46 46
Amortization of sub-contracting agreement
from Donna Cona Inc. 56 49
----------------------
$ 910 $ 948


7. Business segment information

The Company has twelve branches that operate in two geographical regions, Canada and the United States. Each branch engages in business activities and generates its own discrete financial information. As all branches operate in one segment, the provision of IT services, they qualify for aggregation into one operating segment. Geographical information is based upon the country in which the Company's operations are located.



Canada U.S. Total
(unaudited)
-----------------------------
Revenue:
For the three months ended
December 31, 2005 $ 26,260 $ 8,886 $ 35,146
For the three months ended
December 31, 2004 $ 26,909 $ 8,360 $ 35,269

Property, equipment, and goodwill:
As at December 31, 2005 $ 30,524 $ 1,640 $ 32,164
As at September 30, 2005 $ 30,884 $ 1,779 $ 32,663


8. Supplementary cash flow information



Three months ended
December 31,
2005 2004
(unaudited) (unaudited)
----------------------
Interest and income taxes:
Interest paid $ 4 $ 2
Interest received $ 24 $ 3
Income taxes paid $1,470 $ 965



Contact Information