Sierra Systems Group Inc.
TSX : SSG

Sierra Systems Group Inc.

August 04, 2005 15:00 ET

Sierra Systems Announces Record Q3 Results

VANCOUVER, BRITISH COLUMBIA--(CCNMatthews - Aug. 4, 2005) - Sierra Systems Group Inc. (TSX:SSG) today announced its most profitable quarter since becoming a public company in 1998 with earnings per share of $0.27 for the three months ended June 30, 2005. This represents the third quarter in a row the company has generated strong earnings and revenue growth after restructuring in fiscal 2004. Earnings per share for the nine months ended June 30, 2005 was $0.65 compared to a loss of $0.53 in the prior year.

"I am very pleased to announce such strong third quarter results," stated Iraj Pourian, Sierra Systems President & CEO. "Not only have we achieved continued growth while undergoing significant organizational changes, our earnings show consistent increases quarter-to-quarter. I am particularly pleased to announce that our revenue increased from the same period last year by 8%, and by 5% from the immediately preceding quarter. Despite the company's exit from the Washington D.C. marketplace at this time one year ago (as part of its organizational restructuring), Sierra Systems' revenue numbers continue to climb."

The Health practice continues to grow, with revenue up 23% from quarter two 2005. The Justice practice also remains a strong source of revenue for the company. Year-to-date, Enterprise Solutions Services remains a solid part of the business and contributed 23% to overall revenue. Our Managed Services (AMS, ITIL) also continue to present opportunities that are in line with our growth strategies.

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



Fiscal 2005 3 Months Ended June 30
(unaudited)
2005 2004
----------------------
Services revenue $ 39,093 $ 36,098
Earnings from operations $ 4,040 $ 266
Net earnings (loss) for the period $ 2,654 $ (230)
Earnings (loss) per share $ 0.28 $ (0.02)
Diluted earnings (loss) per share $ 0.27 $ (0.02)


Management's Discussion and Analysis of Third Quarter Fiscal 2005 Results

Results of Operations

Services revenue, the Company's primary business line, increased by $3.0 million or 8% from same quarter of fiscal 2004 to $39.1 million. The increase was due to higher revenues ($4.2 million) from the Canadian operations, offset by a decline of $0.4 million from the U.S. operations. The strengthening of the Canadian dollar reduced revenue by $0.8 million.

The impact from staff reductions implemented in fiscal 2004 will be experienced throughout fiscal 2005. The Company's average billable staff headcount decreased by 11% when compared to quarter three of 2004, and overall compensation costs decreased by 3% or $0.7 million. There were a number of offsetting factors; professional staff reductions and lower severance costs led to lower costs of $2.7 million. The strengthening of the Canadian dollar further reduced the Company's U.S. compensation costs by $0.5 million. These factors were offset by a $0.7 million increase in variable compensation plans, a $1.8 million increase in the usage of external subcontractors and modest annual salary increases of 2%.

Utilization was 85% in the current quarter (compared to 76% in the same quarter of last year). An increase in the Company's effective realized rate and the increased usage of external subcontractors, compensated for the lower capacity of the reduced headcount. The percentage of external subcontractors accounted for 26% of total compensation costs in the current quarter compared to 21% in the same period last year. The combination of the above factors improved the Company's most important performance indicator, compensation costs as a percentage of services revenue, to 69% in the current quarter from 76% in last year's third quarter.

Other costs increased by 11%, or $0.2 million from the same quarter in fiscal 2004, a result of higher project related travel costs. As a percentage of services revenue, other costs remained consistent at 6%.

General and administration costs decreased by 6% or $0.3 million in the current quarter compared to the same period last year. The decrease was a result of lower legal and professional fees ($0.4 million) and savings in rent expenses ($0.1 million) arising from the restructuring in 2004 of leased space (as described in note 2 of the financial statements). The decrease occurred despite inclusion in the current quarter of costs totaling $0.5 million to sub-lease excess space in the Vancouver office and realign space in the Victoria office. General and administration costs as a percentage of services revenue improved in the current quarter to 12% from 14%.

Amortization expenses increased $0.1 million from the same quarter in fiscal 2004 due to the higher amortization of intangible assets, a result of an adjustment of the remaining economic life of the subcontract agreement with Donna Cona.

Operating income increased by $3.7 million to $4.0 million in the current quarter, from $0.3 million in the prior year.

The valuation allowance recorded in fiscal 2004 and disclosed in note 4 of the interim financial statements will make the tax rate in fiscal 2005 sensitive to profits from the Company's U.S. operations as no provision will be recorded relating to income generated from this tax jurisdiction. The effective rate for operating income earned in fiscal 2005 is expected to be in the range of 39-41% assuming the U.S. operations break even. The effective rate will decline from this range as the U.S. operating income increases.

The effective tax rate of 34.5% from earnings before taxes in the current quarter reflects a $0.3 million benefit of taxable income generated from the Company's U.S. operations not exposed to a current tax provision. Note 4 of the interim financial statements provides a detailed analysis of the difference from the statutory rate of 35.6%.

On a sequential quarterly basis, services revenue in quarter three compared to the immediately preceding quarter, increased by 4% or $1.6 million due to revenue growth from both the Company's Canadian and U.S. operations ($1.2 million and $0.2 million respectively). The weakening of the Canadian dollar in the quarter contributed another $0.2 million. Compensation costs increased 2% or $0.6 million due primarily to the higher usage of external subcontractors ($0.4 million) and increases to employee termination costs ($0.3 million). A lower expense for vacation pay of $0.2 million was in line with seasonal fluctuations. Compensation costs as a percentage of services revenue improved to 69% from 70%.

Other costs increased sequentially by 28%, or $0.5 million, due to higher education and travel costs. As a percentage of services revenue, other costs increased to the more sustainable level of 6%, from 5%. General and administration costs decreased by 5%, or $0.3 million, despite the space adjustment costs noted above. The decrease arose from lower professional fees associated with regulatory compliance. Expressed as a percentage of services revenue, the ratio of general and administration costs improved to 12% from 14%. Operating income increased $0.7 million from the prior quarter.



Fiscal 2005 9 Months Ended June 30
(unaudited)
2005 2004
----------------------
Services revenue $ 110,619 $ 106,470
Earnings (loss) from operations
before restructuring charge $ 11,150 $ (102)
Earnings (loss) from operations $ 9,901 $ (102)
Net earnings (loss) for the period $ 6,467 $ (5,092)
Earnings (loss) per share $ 0.67 $ (0.53)
Diluted earnings (loss) per share $ 0.65 $ (0.53)


Services revenue for the nine month period increased 4% or $4.1 million compared to the same period last year. The increase was attributable to two factors; organic revenue from Canadian operations grew by $5.6 million, and the acquisition completed in quarter two of fiscal 2004 contributed an estimated $1.6 million. Offsetting the increase was the impact of the strengthening of the Canadian dollar, reducing revenue from U.S. operations by $2.3 million, and a decline in services revenue from the Company's U.S. operations of $0.8 million. Compensation costs decreased by 8% or $6.4 million due primarily to headcount reductions stemming from the restructuring in fiscal 2004 and the strengthening of the Canadian dollar. The decrease was offset by increases in variable compensation plan costs and the higher usage of external consultants. Other costs decreased by 6% or $0.4 million due to reduced promotional and travel activities. General and administration costs decreased by 3%, or $0.4 million. Reductions experienced in rent, communications costs and administrative salaries were offset by exit costs associated with the sub-lease of the excess space in British Columbia.

Financial Capability

In the current quarter, net cash flow from operations was $0.6 million, an increase of $2.4 million from quarter three of fiscal 2004. The Company has generated net cash flow year to date from operations of $6.9 million, an increase of $8.5 million from the prior year.

The key performance measure of accounts receivable is average days sales in trade accounts receivable calculated on quarterly trailing revenue. There was a slight improvement in this measure at the current quarter end to 72 days when compared to quarter three of fiscal 2004 of 73 days.

The contractual obligations and payments due for each of the next four years have not materially changed from the Management's Discussion and Analysis presented in the 2004 Annual Report.

Normal Course Issuer Bid

On February 8, 2005, the Company initiated its second normal course issuer bid. Under the bid, the Company had the right to purchase for cancellation up to a maximum of 491,707 common shares (representing approximately 5% of the Company's outstanding shares) over the following 12 months through the facilities of the Toronto Stock Exchange. During the three months ended June 30, 2005, the Company acquired 196,660 shares at an average cost of $10.80. For the nine months ended June 30, 2005, the Company has acquired 366,660 shares at an average cost of $9.44.

Recent Accounting Changes

As described in note 1 of the interim financial statements, on October 1, 2004, the Company adopted the recommendations of CICA Handbook Section 3870, Stock-based Compensation and Other Stock-based Payments with retroactive application. This required an adjustment to opening retained earnings of $691,000. This amount relates to stock-based compensation charges for stock-based awards granted on or after October 1, 2002 that were previously disclosed on a pro forma basis, and are now included in contributed surplus on the consolidated balance sheet. The impact for the three months (and nine months) ended June 30, 2005 was $0.02 and $0.04 respectively and is described in note 5(b) of the interim financial statements. The impact on earnings per share in fiscal 2005 from the expense related to stock-based compensation (granted October 1, 2002 to June 30, 2005) is expected to be $0.06.

In March 2003, the CICA issued Handbook Section 3110, "Asset Retirement Obligations". The new standard provides guidance for the recognition, measurement and disclosure of liabilities for asset retirement obligations and the associated retirement costs. It applies to legal obligations pertaining to the retirement of tangible long-lived assets from acquisition, construction, development or normal operations. The standard requires the Company to record the fair value of the liability for an asset retirement obligation in the year in which it is incurred and when a reasonable estimate of fair value can be made. The Company adopted this standard effective October 1, 2004 and has determined that it has a nominal liability relating to asset retirement obligations as at June 30, 2005.

In September 2004, the CICA finalized Accounting Guideline 15, "Consolidation of Variable Interest Entities", which provides clarification on the consolidation of variable interest entities. The Guideline defines variable interest entities ("VIE") and requires a VIE to be consolidated if the Company is at risk of absorbing the VIE's expected losses or is entitled to receive the majority of the VIE's residual returns. The Company adopted this Guideline effective January 1, 2005 and has determined that there is no impact.

Critical Accounting Estimates

The critical accounting estimates described in Management's Discussion and Analysis presented in the 2004 Annual Report have not materially altered.

Business Risks

The business risks described in the Management's Discussion and Analysis presented in the 2004 Annual Report have not materially altered.

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 and nine months ended June 30, 2005 and June 30, 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.

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.



Conference Call Details

Date: August 4, 2005
Start time: 1:30 p.m. Pacific (4:30 p.m. Eastern)
Dial-in number: 1.866.848.5070
Live webcast: 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.

A replay of the conference call is available through August 17, 2005,
by dialing 1.800.395.0403 or 1.402.220.2887 and entering the pass
code 7739254. The conference call and the presentation will be
archived in the Investor Relations section of the Company website at
www.SierraSystems.com.



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

June 30 September 30
2005 2004
(unaudited)
------------ ------------
------------ ------------
Assets
Current assets
Cash and cash equivalents $ 2,313 $ 973
Accounts receivable 31,674 31,109
Work-in-progress 8,165 6,067
Prepaid expenses 2,920 2,184
------------ ------------
45,072 40,333

Intangible assets (note 6) 735 1,131
Property and equipment 8,583 8,703
Goodwill (note 3) 23,997 24,179
------------ ------------
$ 78,387 $ 74,346
------------ ------------
------------ ------------

Liabilities
Current liabilities
Bank Indebtedness $ - $ 140
Accounts payable and accrued
liabilities 14,808 14,212
Deferred revenue 1,780 1,911
Income taxes payable 856 670
------------ ------------
17,444 16,933

Future income taxes (note 4) 339 352
------------ ------------
17,783 17,285

Shareholders' Equity

Capital stock (note 5(a)) 43,057 44,191
Contributed surplus (note 5(b)) 1,079 -
Retained earnings 18,520 14,544
Cumulative translation adjustment (2,052) (1,674)
------------ ------------
60,604 57,061
------------ ------------
$ 78,387 $ 74,346
------------ ------------
------------ ------------


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

Three months ended Nine months ended
June 30 June 30
(unaudited) (unaudited)
2005 2004 2005 2004
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------

Retained earnings
- Beginning of
period $ 17,098 $ 16,749 $ 14,544 $ 21,611

Shares purchased
and cancelled
(note 5(d)) (1,232) - (1,800) -

Stock-based
compensation
adjustment
(note 5(b)) - - (691) -

Net earnings (loss)
for the period 2,654 (230) 6,467 (5,092)

---------- ---------- ---------- ----------
Retained earnings
- End of period $ 18,520 $ 16,519 $ 18,520 $ 16,519
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------


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

Three months ended Nine months ended
June 30 June 30
(unaudited) (unaudited)
2005 2004 2005 2004
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Revenue
Services $ 39,093 $ 36,098 $ 110,619 $ 106,470
Product sales 434 87 758 1,103
Reimbursements
(note 1) 916 1,366 2,974 4,138
---------- ---------- ---------- ----------
40,443 37,551 114,351 111,711
---------- ---------- ---------- ----------

Expenses
Compensation costs 26,832 27,577 75,994 82,425
Other costs 2,340 2,107 6,061 6,425
Product costs 366 85 654 955
Reimbursable
expenses (note 1) 916 1,366 2,974 4,138
---------- ---------- ---------- ----------
30,454 31,135 85,683 93,943
---------- ---------- ---------- ----------

Gross profit 9,989 6,416 28,668 17,768

General and
administration 4,845 5,172 14,497 14,887
Amortization (note 7) 1,104 978 3,021 2,983
Restructuring
charge (note 2) - - 1,249 -
---------- ---------- ---------- ----------
Earnings (loss)
from operations 4,040 266 9,901 (102)
---------- ---------- ---------- ----------

Foreign exchange
(loss) gain (27) (13) (86) 6
Other income
(expense) 6 (18) 15 (7)
---------- ---------- ---------- ----------
Earnings (loss)
before income taxes 4,019 235 9,830 (103)

Provision for
(recovery of)
income taxes
(note 4)
Current 1,423 470 3,418 1,842
Future (38) 30 (13) 3,284
---------- ---------- ---------- ----------
1,385 500 3,405 5,126

Earnings (loss)
before equity
accounted investee 2,634 (265) 6,425 (5,229)
Equity earnings of
Donna Cona Inc.
(note 8) 20 35 42 137
---------- ---------- ---------- ----------
Net earnings
(loss) for the
period $ 2,654 $ (230) $ 6,467 $ (5,092)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------

Earnings (loss)
per share $ 0.28 $ (0.02) $ 0.67 $ (0.53)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------

Diluted earnings
(loss) per share $ 0.27 $ (0.02) $ 0.65 $ (0.53)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------

Weighted average
number of common
shares outstanding
- basic 9,573,174 9,741,233 9,671,352 9,606,316
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------

Weighted average
number of common
shares outstanding
- diluted 9,910,168 9,741,233 9,940,276 9,606,316
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------


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

Three months ended Nine months ended
June 30 June 30
(unaudited) (unaudited)
2005 2004 2005 2004
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------

Cashflows provided
by (used in)

Operating activities
Net earnings (loss)
for the period $ 2,654 $ (230) $ 6,467 $ (5,092)
Items not affecting
cash
Amortization 1,104 978 3,021 2,983
Future income taxes (38) 30 (13) 3,284
Loss on disposal
of property and
equipment 44 - 121 -
Stock-based
compensation
charge (note 5(b)) 172 - 388 -
---------- ---------- ---------- ----------
3,936 778 9,984 1,175

Net change in
non-cash working
capital items
relating to
operations (3,122) (2,616) (2,767) (2,816)
Shares purchased
for long-term
incentive plan (209) - (340) -
---------- ---------- ---------- ----------
605 (1,838) 6,877 (1,641)
Financing
Shares purchased
and cancelled
(note 5(d)) (2,125) - (3,463) -
Shares issued 418 38 679 233
Repayment of capital
lease obligation (1) (10) (9) (30)
---------- ---------- ---------- ----------
(1,708) 28 (2,793) 203
Investing
Purchase of
property and
equipment (1,730) (1,007) (2,644) (1,460)
Business
acquisitions - - - (3,555)
---------- ---------- ---------- ----------
(1,730) (1,007) (2,644) (5,015)

Effect of foreign
exchange on
translation 80 (2) 40 (72)

(Decrease) increase
in cash and cash
equivalents (2,753) (2,819) 1,480 (6,525)

Cash and cash
equivalents -
Beginning of
period 5,066 87 833 3,793
---------- ---------- ---------- ----------

Cash and cash
equivalents - End
of period $ 2,313 $ (2,732) $ 2,313 $ (2,732)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------

Represented by
Cash and cash
equivalents $ 2,313 $ 387
Bank indebtedness - (3,119)
---------- ----------
$ 2,313 $ (2,732)

Supplementary cash flow information (note 10)


Notes to Interim Consolidated Financial Statements (unaudited)
(Amounts in tables are in thousands of Canadian dollars
except per share figures)


1. Summary of significant accounting policies

General

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, 2004, 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, 2004. Certain comparative figures in the 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 June 30, 2005 and for all periods presented, have been made. The earnings for the three and nine months ended June 30, 2005 are not necessarily indicative of the earnings for the full year ending September 30, 2005. All amounts herein are expressed in Canadian dollars unless otherwise noted.

Revenue recognition

As part of the Company's ongoing operations to provide services to its customers, out-of-pocket expenses, which are reimbursable under the terms of the contract, are billed to the customer. Previously, these amounts were treated as pass-through costs, and were not reflected as revenue and a corresponding cost on the consolidated statement of earnings.

During the second quarter of 2004, the Company changed its method of recording reimbursements received for out-of-pocket expenses. These reimbursements are now reflected as "Reimbursements" revenue on the consolidated statement of earnings and the corresponding expense is now included as a separate component of expenses. As such, there is no effect on earnings for the period.

The Company also provides Application Maintenance Services ("AMS") which include the operation, support, and optimization of business applications subsequent to the applications' development. Services revenue related to AMS under fixed price contracts is recognized on a straight-line basis over the term of the arrangement, regardless of the timing of the amounts billed.

Goodwill

Goodwill is not amortized but is tested for impairment on an annual basis, or more frequently if events or circumstances indicate that the asset might be impaired. During this quarter, the Company performed its annual impairment test of goodwill based on (a) the market capitalization of the Company, and (b) an analysis of valuation metrics of comparable companies, and determined that no goodwill impairment charge was required.

Capital Stock and Stock Options

In November 2003, the Canadian Institute of Chartered Accountants ("CICA") re-issued Handbook Section 3870, Stock-based Compensation and other Stock-based Payments. The revised standard requires the adoption of the fair value based method for all stock-based awards effective for fiscal years beginning on or after January 1, 2004. The Company adopted this new standard for its current fiscal year beginning October 1, 2004, with retroactive application for stock-based awards granted to employees on or after October 1, 2002. As permitted by the standard prior period financial statements have not been restated. The application of the standard resulted in a $691,000 first quarter adjustment to opening retained earnings.

The Company accounts for its stock-based compensation using the fair value method. The fair value of an award is determined using the Black-Scholes option pricing model on the date the award is granted and is amortized over the vesting period. In the event an option expires or is cancelled unvested, any previously recorded expense is reversed in the period when the unvested options are cancelled.

Asset Retirement Obligation

In March 2003, the CICA issued Handbook Section 3110, "Asset Retirement Obligations". The new standard provides guidance for the recognition, measurement and disclosure of liabilities for asset retirement obligations and the associated retirement costs. It applies to legal obligations pertaining to the retirement of tangible long-lived assets from acquisition, construction, development or normal operations. The standard requires the Company to record the fair value of the liability for an asset retirement obligation in the year in which it is incurred and when a reasonable estimate of fair value can be made. The Company adopted this standard effective October 1, 2004 and has determined that it has a nominal liability relating to asset retirement obligations as at June 30, 2005.

Variable Interest Entities

In September 2004, the CICA finalized Accounting Guideline 15, "Consolidation of Variable Interest Entities", which provides clarification on the consolidation of variable interest entities. The guideline defines variable interest entities ("VIE") and requires a VIE to be consolidated if the Company is at risk of absorbing the VIE's expected losses or is entitled to receive the majority of the VIE's residual returns. The Company adopted this Guideline effective January 1, 2005 and has determined that there is no impact.



2. Restructuring charge

Charged during the three Payable at
months ended June 30 June 30, September 30,
2005 2004 2005 2004
-----------------------------------------------

Workforce reduction $ - $ - $ - $ 1,075

Lease termination - - - 463

Other - - - 64
-----------------------------------------------
$ - $ - $ - $ 1,602


In the fourth quarter of fiscal 2004, the Company restructured its operations to improve its financial performance. The restructuring activities included closing the Washington D.C. branch, reducing the workforce and rationalizing its office space in California. The workforce reduction charge consists primarily of severance and other related benefits resulting from the termination of employees. No further terminations in connection with this restructuring are expected.

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 this quarter.

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 are expected, and as at June 30, 2005 all amounts have been paid.

3. Business acquisitions

Pursuant to the acquisition of Eastbridge Consulting Incorporated ("Eastbridge") and its subsidiary, Eastech Advanced Development Incorporated ("Eastech") on January 1, 2004, consideration of $1,167,000 in cash and 164,528 shares are held in escrow with scheduled release dates to certain vendors contingent upon their employment with the Company; January 1, 2006 - $632,000 (89,182 shares), and January 1, 2007 - $535,000 (75,346 shares).

During the second quarter of fiscal 2005, the Company modified the purchase price allocation, and made adjustments relating to the acquisition of Eastbridge / Eastech completed in fiscal 2004. The finalization of the acquisition resulted in a net increase in working capital items and a corresponding decrease in goodwill of $182,000.



4. Income taxes

Three months Three months Nine months Nine months
ended ended ended ended
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
(unaudited) (unaudited) (unaudited) (unaudited)
----------------------------------------------------
Earnings before
income taxes $ 4,019 $ 235 $ 9,830 $ (103)
Expected
provision
based on a
tax rate of
35.62% (2004
- 36.1%) 1,432 85 3,501 (37)
Increase
(decrease)
resulting from
Non-deductible
expenses 268 75 525 253
Foreign tax
differential 14 (171) 61 9
Canadian
statutory
rate
differential 12 6 49 67
Change in
valuation
allowance
for U.S.
net operating
loss
carry-forwards (288) 456 (707) 4,751

Other (53) 49 (24) 83
----------------------------------------------------
Income tax
provision $ 1,385 $ 500 $ 3,405 $ 5,126
----------------------------------------------------

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

June 30, 2005 September 30, 2004
U.S. Canadian U.S. Canadian
companies companies companies companies
(unaudited)
-------------------- ---------------------
Differences in working
capital deductions for
tax and accounting
purposes $ (2,235) $ 56 $ (1,727) $ 61

Property and equipment 140 (344) 248 (432)

Goodwill - (51) - 19

Loss carry-forwards 8,036 - 8,307 -

Valuation allowance (5,941) - (6,828) -
-------------------- ---------------------

Total net future tax
liabilities $ - $ (339) $ - $ (352)
-------------------- ---------------------

Comprising

Non-current liability $ (339) $ (352)
--------- ---------

$ (339) $ (352)
--------- ---------

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

Expiry date Loss carry-forwards
US$
2020 1,879
2021 681
2022 3,988
2023 5,009
2024 4,889


5. Capital stock and stock options

a) Capital stock

As at June 30, 2005 As at September 30, 2004
(unaudited)
------------------------------------------------
Issued
Common shares 9,468,032 9,746,842
Amount $ 43,057 $ 44,191


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 June 30, 2005 the total stock-based compensation charge was $172,000, which has been included in compensation cost on the consolidated statement of earnings. Of this cost, $24,000 relates to the granting of 84,000 (2004 - 30,000) options to employees during this quarter, $90,000 relates to options granted in the first and second quarter, and the balance is the amortization of previous awards granted prior to October 1, 2004.

For the nine months ended June 30, 2005 the total stock-based compensation charge was $388,000, which has been included in compensation cost on the consolidated statement of earnings. Of this cost, $218,000 relates to the granting of 352,000 (2004 - 94,200) options to employees during this nine months period, and the balance is the amortization of previous awards granted prior to October 1, 2004.

The retroactive application of CICA Handbook Section 3870 in the first quarter required an adjustment to opening retained earnings of $691,000. This amount relates to stock-based compensation charges for stock-based awards granted to employees on or after October 1, 2002 to September 30, 2004, that were previously only disclosed on a pro forma basis, and are now included in contributed surplus on the consolidated balance sheet.



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

Three months ended Nine months ended
June 30 June 30
(unaudited) (unaudited)
2005 2004 2005 2004
------------------ --------------------
Dividend yield 0.0% 0.0% 0.0% 0.0%

Expected volatility 31% 37% - 39% 31% - 36% 37% - 43%

Risk free interest rate 2.7% 2.5% 2.7% - 2.9% 2.5%

Expected life (years) 4 4 4 4

Weighted average grant
date fair value $ 11.00 $ 6.27 $ 7.76 $ 7.34


Pro forma net earnings (loss) related to stock options:

Three months ended Nine months ended
June 30 June 30
(unaudited) (unaudited)
2005 2004 2005 2004
------------------ ------------------
Net earnings (loss)
as reported $ 2,654 $ (230) $ 6,467 $ (5,092)

Adjustment relating to
stock options - 139 - 377

Pro forma earnings (loss) $ 2,654 $ (369) $ 6,467 $ (5,469)

Diluted earnings (loss)
per share $ 0.27 $ (0.02) $ 0.65 $ (0.53)
Pro forma diluted
earnings (loss)
per share $ 0.27 $ (0.04) $ 0.65 $ (0.56)


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

Three months ended Nine months ended
June 30, 2005 June 30, 2005
(unaudited) (unaudited)
------------------ -----------------
Balance - beginning of period 891,500 850,300

Options granted in period 84,000 352,000

Options exercised in period (58,000) (80,800)

Options expired in period (20,000) (152,000)

Options cancelled in period - (72,000)
------------------ -----------------

Balance - end of period 897,500 897,500


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. During the three months ended June 30, 2005, the Company contributed $16,000 (2004 - $19,000) and issued 3,120 shares (2004 - 5,402) pursuant to this plan. For the nine months ended June 30, 2005, the Company contributed $43,000 (2004 - $57,000) and issued 21,336 shares (2004 - 25,494) 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 February 8, 2005, the Company initiated its second normal course issuer bid. Under the bid, the Company has the right to purchase for cancellation up to a maximum of 491,707 common shares (representing approximately 5% of the Company's outstanding shares) over the following 12 months through the facilities of the Toronto Stock Exchange.

During the three month period ended June 30, 2005, the Company acquired 196,660 shares at an average cost of $10.80. 74,000 of these shares were cancelled on May 30, 2005 and the balance was cancelled on June 10, 2005. The average assigned value of these shares at each of the cancellation dates was $4.53 and $4.54 respectively. For each cancelled share, the amount by which cost exceeded the assigned value has been recorded as an adjustment to retained earnings. For the year to date, the Company has acquired and cancelled 366,660 shares.



6. Intangible assets

Net book value at
Accumulated June 30, 2005
Cost Amortization (unaudited)
--------------------------------------

Customer relationships with
an economic life of
45 months $ 683 $ 276 $ 407

Sub-contracting agreement
from Donna Cona Inc. 856 528 328
--------------------------------------
$ 1,539 $ 804 $ 735

Net book value at
Cost Accumulated September 30,
Amortization 2004
--------------------------------------
Customer relationships with
an economic life of
45 months $ 683 $ 138 $ 545

Sub-contracting agreement
from Donna Cona Inc. 813 227 586
--------------------------------------
$ 1,496 $ 365 $ 1,131


7. Amortization

Three months ended Nine months ended
June 30 June 30
(unaudited) (unaudited)
2005 2004 2005 2004
---------------------- ------------------------
Amortization of
property and
equipment $ 862 $ 884 $ 2,582 $ 2,756

Amortization of
customer
relationships 46 46 138 92

Amortization of
sub-contracting
agreement from
Donna Cona Inc. 196 48 301 135
---------------------- ------------------------
$ 1,104 $ 978 $ 3,021 $ 2,983


8. Investment in Donna Cona Inc. (DC)

The Company entered into an agreement in August 2002 to relinquish its 49% interest in DC (formerly Donna Cona II Inc.) through four equal installments over a four-year period. The installments commenced on July 1, 2003, at which time the Company began using the equity method to account for its remaining interest. Prior to this, the proportionate consolidation method was used to account for the investment in DC, as joint control existed. At June 30, 2005, the Company held a 32% interest (2004 - 42%) in DC.

For the three and nine months ended June 30, 2005, the Company recorded revenues from DC of $450,000 and $1,379,000 respectively (2004 - $483,000 and $1,643,000), of which $339,000 (2004 - $524,000) was included in accounts receivable at June 30, 2005.

9. Business segment information

The Company operates in one operating segment - providing IT services. The Company operates primarily in Canada and the United States. 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
June 30, 2005 $ 31,099 $ 9,344 $ 40,443
For the three months ended
June 30, 2004 $ 26,924 $ 10,627 $ 37,551

For the nine months ended
June 30, 2005 $ 87,727 $ 26,624 $ 114,351
For the nine months ended
June 30, 2004 $ 81,515 $ 30,196 $ 111,711

Property, equipment, and goodwill:

As at June 30, 2005 $ 30,709 $ 1,871 $ 32,580
As at September 30, 2004 $ 30,837 $ 2,045 $ 32,882


10. Supplementary cash flow information

Three months ended Nine months ended
June 30 June 30
(unaudited) (unaudited)
2005 2004 2005 2004
---------------------------------------------
Interest and income
taxes:
Interest paid $ 3 $ 19 $ 8 $ 56
Interest received $ 10 $ 1 $ 23 $ 49
Income taxes paid $ 870 $ 936 $ 3,270 $ 2,300
Income taxes refunded $ 225 $ 0 $ 225 $ 0



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