Sierra Systems Group Inc.
TSX : SSG

Sierra Systems Group Inc.

November 21, 2005 01:26 ET

Sierra Systems Reports Fourth Quarter and Fiscal 2005 Results

VANCOUVER, BRITISH COLUMBIA--(CCNMatthews - Nov. 20, 2005) - Sierra Systems Group Inc.(TSX:SSG) today reported significantly improved financial results for the fiscal year ended September 30, 2005. Services revenue for the year was $147 million and net income for the year was $8.3 million. Earnings from operations increased substantially in fiscal 2005 to $12.7 million from a loss from operations of $1.2 million last year. Diluted earnings per share for the year were $0.84 as compared to a loss of $0.73 per share in fiscal 2004.

Our fourth quarter 2005 services revenue was $36.5 million, a 10% increase from the same period last year. Earnings from operations for the quarter grew to $2.8 million from a loss of $1.1 million in the same period last year. Diluted earnings per share for the quarter were $0.19 as compared to a loss of $0.20 per share in the fourth quarter of 2004.

Iraj Pourian, President and CEO of Sierra Systems Group Inc., commented on the Company's 2005 financial performance. "We are very pleased with our fiscal 2005 results. This has been a year of organizational change and I am proud to say that our company demonstrated an impressive level of maturity and remained focused on the business. I am delighted with the increase in earnings despite considerable changes in the year. In light of the Board's confidence in the future of the business, it has declared an annual dividend of $0.28 payable quarterly at $0.07 on each share." The dividend will be payable on the following dates to shareholders of record as at the close of business on the dates indicated.



------------------------------------------------------------
Shareholder Record Date Dividend Payment Date
------------------------------------------------------------
December 1, 2005 December 12, 2005
------------------------------------------------------------
March 1, 2006 March 13, 2006
------------------------------------------------------------
June 1, 2006 June 12, 2006
------------------------------------------------------------
September 1, 2006 September 12, 2006
------------------------------------------------------------


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



Fiscal 2005 3 Months Ended September 30
(unaudited)
2005 2004
---------------------------------
Services revenue $ 36,549 $ 33,241
Earnings from operations before
restructuring charge $ 2,837 $ 1,471
Earnings from operations $ 2,837 $ (1,109)
Net earnings (loss) for the period $ 1,847 $ (1,975)
Earnings (loss) per share $ 0.19 $ (0.20)
Diluted earnings (loss) per share $ 0.19 $ (0.20)


Management's Discussion and Analysis of Fourth Quarter Fiscal 2005 Results
Services revenue, the Company's primary business line, increased 10% or $3.3 million from the same period last year. The increase was driven primarily by $2.9 million growth in revenues reported in our Canadian operations. Our U.S. operations reported 14% growth in US$ denominated revenues in the quarter as compared to the same quarter last year, although the strengthening Canadian dollar reduced this increase in Canadian dollar terms to 4% or $0.4 million.

Compensation costs increased by $1.7 million or 7% as compared to the same quarter last year. The increase was due to increased salary costs of $1.6 million resulting mainly from higher variable compensation and severance costs. The Company also increased the use of subcontractors to fulfill project deliverables this quarter, which resulted in a $2.1 million increase. Consistent with this increase, subcontractor costs as a percentage of total compensation increased to 28%, from 22% in the same quarter last year. These increases were offset by the closure of the Washington D.C. operation in September 2004, which resulted in a $1.5 million savings as compared to the same period last year. Additionally, U.S. compensation costs were also $0.5 million lower due to the strengthening of the Canadian dollar.

Compensation costs as a percentage of services revenue improved slightly to 71% as compared to 73% in Q4 2004. Stronger utilization in the quarter was a key contributor to the improvement. Utilization this quarter was 77% as compared to 73% in Q4 2004.

General & Administration costs decreased by $0.7 million or 14% compared to last year. Lower rent costs resulting from a rationalization of space requirements contributed to this variance. Additional cost savings were also experienced in several of our indirect overhead costs. G&A costs as a percentage of services revenue improved significantly to 11% this quarter from 15% in 2004.

The above factors increased earnings from operations (before restructuring charge) in Q4 2004 by $1.4 million to $2.8 million this quarter.

The tax valuation allowance recorded in fiscal 2004 will make the tax rate in future periods sensitive to profits from the Company's U.S. operations as no provision will be recorded relating to income generated from our U.S. operations. The effective tax rate of 32.9% from earnings before taxes in the current quarter reflects a $0.2 million benefit from income generated in the Company's U.S. operations not exposed to a current tax provision.



Fiscal 2005 12 Months Ended September 30
2005 2004
---------------------------------
Services revenue $ 147,168 $ 139,711
Earnings from operations before
restructuring charge $ 13,987 $ 1,367
Earnings (loss) from operations $ 12,738 $ (1,213)
Net earnings (loss) for the period $ 8,314 $ (7,067)
Earnings (loss) per share $ 0.86 $ (0.73)
Diluted earnings (loss) per share $ 0.84 $ (0.73)


Management's Discussion & Analysis of Fiscal 2005 Results

Services revenues increased by 5% to $147 million for the fiscal year ended September 30, 2005. Our Canadian operations generated a 10% growth in services revenues as compared to the prior year. Our U.S. operations reported nominal services revenue growth in the year, although the strengthening Canadian dollar resulted in a 7% reduction in revenues from our U.S. operations as reported in Canadian dollars. Our Washington D.C. location ceased operations in the fourth quarter of 2004. The loss of this revenue in 2005 was replaced largely by the growth of our Managed Services business in our Austin, Texas location.

Compensation costs decreased by 4% as compared to the prior year. The closure of our Washington D.C. branch, and the lower average headcount in 2005 were the major contributors to this decrease. These saving were offset by higher subcontractor costs, which increased 16% from fiscal 2004. Compensation costs as a percentage of services revenue improved in 2005 to 69% from 76% last year. A significant contributing factor to this improvement was the high utilization for the year, which was 81% as compared to 75% last year. Subcontractor costs as a percentage of total compensation costs increased to 25% in 2005 from 21% last year.

Other costs increased 4% from last year. The increase was due mainly to increased recruiting efforts in the year. Other costs as a percentage of services revenue remained constant at 6% of services revenue in both 2005 and 2004.

Our general and administrative costs decreased by 6% in relation to the prior year. Lower facility rent costs were a significant contributor to the positive variance this year, and were a result of rationalization of space requirements in certain locations. Additional cost savings were also experienced in our indirect overhead costs. Our general and administrative costs as a percentage of services revenue improved this year to 13% from 14% in 2004.

Earnings from operations in 2005 increased to $12.7 million from a loss of $1.2 million in 2004.

The effective tax rate of 34.3% from earnings before taxes in the current year reflects a $0.9 million benefit from income generated in the Company's U.S. operations which is not exposed to a current tax provision.

In the first quarter of 2005 the former Chief Executive Officer left the Company and a charge of $960,000 was incurred in connection with the termination of his employment. Additionally, in the same quarter a charge of $289,000 was incurred due to further changes to the executive team.

Financial Capability

In the current quarter, net cash flow from operations was $6.5 million, an increase of $2.4 million from quarter four of fiscal 2004. On a year-to-date basis, the Company has generated cash flow from operations of $13.7 million, an increase of $11.2 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 significant improvement in this measure as at the quarter end to 70 days when compared to 85 days reported in quarter four of 2004. It should be noted that this measure was negatively impacted in the fourth quarter of 2004 by the conversion of $5.8 million in Work In Process to accounts receivable.

The Company's contractual obligations and payments have increased to $11.2 million as of September 2005 from $9.4 million in 2004. This increase results from new facility lease contracts entered into during the year.

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 month period ended September 30, 2005, the Company acquired and cancelled 105,900 shares at an average cost of $10.77. For the year ended September 30, 2005, the Company has acquired and cancelled 472,560 shares at an average cost of $9.74.

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 negative impact on earnings per share for the three months and twelve months ended September 30, 2005 from the expense related to stock-based compensation (granted October 1, 2002 to September 30, 2005) was $0.02 and $0.06 respectively.

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

In September 2004, the CICA finalized Accounting Guideline 15, "Consolidation of Variable Interest Entities," which establishes a new consolidation model to determine whether interests an enterprise holds in a variable interest entity ("VIE") should be consolidated. The guideline defines a VIE and requires a VIE to be consolidated if the enterprise is at risk of absorbing the majority of 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 determined it has no variable interest entities, therefore there is no impact for fiscal 2005.

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.

Outlook

Sierra Systems has developed a strategic plan to drive revenue and earnings growth in excess of the industry average. The Company's results can vary considerably from quarter to quarter. The results of our first quarter will be negatively impacted by short-term performance issues in one Canadian branch.
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 September 30, 2005 and concluded that our current disclosure controls and procedures are effective.

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 year ended September 30, 2005 and September 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: November 21, 2005

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

Dial-in number: 1.866.322.3032

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.

If you are unable to attend the conference call live, please call 888-562-2819 or 402-220-7737 through to Sunday, December 4, 2005 to hear a digital playback. The Conference ID to be entered is 1685889. 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.



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


September 30 September 30
2005 2004
--------------- ---------------
--------------- ---------------
Assets
Current assets
Cash and cash equivalents $ 7,017 $ 973
Accounts receivable 28,470 31,109
Work-in-progress 8,078 6,067
Prepaid expenses 2,463 2,184
--------------- ---------------
46,028 40,333

Intangible assets (note 6) 514 1,131
Property and equipment 8,666 8,703
Goodwill (note 3) 23,997 24,179
--------------- ---------------
$ 79,205 $ 74,346
--------------- ---------------
--------------- ---------------
Liabilities
Current liabilities
Bank Indebtedness $ - $ 140
Accounts payable and accrued
liabilities 15,110 14,212
Deferred revenue 1,706 1,911
Income taxes payable 892 670
--------------- ---------------
17,708 16,933
--------------- ---------------

Future income taxes (note 4) 205 352
--------------- ---------------
17,913 17,285

Shareholders' Equity
Capital stock (note 5 (a)) 43,192 44,191
Contributed surplus (note 5(b)) 1,224 -
Retained earnings 19,711 14,544
Cumulative translation adjustment (2,835) (1,674)
--------------- ---------------
61,292 57,061
--------------- ---------------
$ 79,205 $ 74,346
--------------- ---------------
--------------- ---------------


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

Three months ended Year ended
September 30 September 30
(unaudited)
2005 2004 2005 2004
-------------------- -------------------
-------------------- -------------------

Retained earnings -
Beginning of period $ 18,520 $ 16,519 $ 14,544 $ 21,611

Shares purchased and
cancelled (note 5(d)) (656) - (2,456) -

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

Net earnings (loss) for
the period 1,847 (1,975) 8,314 (7,067)

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


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

Three months ended Year ended
September 30 September 30
(unaudited)
2005 2004 2005 2004
-------------------- -------------------
-------------------- -------------------
Revenue
Services $ 36,549 $ 33,241 $ 147,168 $ 139,711
Product sales 175 63 933 1,166
Reimbursements 878 916 3,852 5,054
-------------------- -------------------
37,602 34,220 151,953 145,931
-------------------- -------------------
Expenses
Compensation costs 25,873 24,192 101,867 106,617
Other costs 2,429 1,727 8,490 8,154
Product costs 163 15 817 970
Reimbursable expenses 878 916 3,852 5,054
-------------------- -------------------
29,343 26,850 115,026 120,795
-------------------- -------------------

Gross profit 8,259 7,370 36,927 25,136

General and administration 4,200 4,901 18,697 19,789
Amortization (note 7) 1,222 998 4,243 3,980
Restructuring charge
(note 2) - 2,580 1,249 2,580
-------------------- -------------------
Earnings (loss) from
operations 2,837 (1,109) 12,738 (1,213)

Foreign exchange loss (140) (56) (226) (49)
Other income (expense) 54 (1) 69 (7)
-------------------- -------------------
Earnings (loss) before
income taxes 2,751 (1,166) 12,581 (1,269)
-------------------- -------------------

Provision for (recovery of)
income taxes (note 4)
Current 1,038 957 4,456 2,799
Future (134) (103) (147) 3,181
-------------------- -------------------
904 854 4,309 5,980

Earnings (loss) before
equity accounted investee 1,847 (2,020) 8,272 (7,249)
Equity earnings of Donna
Cona Inc. (note 8) - 45 42 182
-------------------- -------------------
Net earnings (loss) for
the period $ 1,847 $ (1,975) $ 8,314 $ (7,067)
-------------------- -------------------
-------------------- -------------------
Basic earnings (loss)
per share $ 0.19 $ (0.20) $ 0.86 $ (0.73)
-------------------- -------------------
-------------------- -------------------
Diluted earnings (loss)
per share $ 0.19 $ (0.20) $ 0.84 $ (0.73)
-------------------- -------------------
-------------------- -------------------
Weighted average number
of common shares
outstanding - basic 9,492,656 9,751,131 9,626,311 9,642,694
-------------------- -------------------
-------------------- -------------------
Weighted average number
of common shares
outstanding - diluted 9,788,110 9,751,131 9,872,126 9,642,694
-------------------- -------------------
-------------------- -------------------


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

Three months ended Year ended
September 30 September 30
(unaudited)
2005 2004 2005 2004
-------------------- -------------------
-------------------- -------------------

Cashflows provided by
(used in)

Operating activities
Net earnings (loss)
for the period $ 1,847 $ (1,975) $ 8,314 $ (7,067)
Items not affecting cash
Amortization 1,222 998 4,243 3,980
Future income taxes (134) (103) (147) 3,181
Loss on disposal of
property and equipment 9 221 130 324
Stock-based compensation
charge (note 5(b)) 145 - 533 -
Net change in non-cash
working capital items
relating to operations 3,431 5,024 664 2,169
-------------------- -------------------
6,520 4,165 13,737 2,587
Financing
Shares issued 604 54 1,283 288
Shares purchased and
cancelled (note 5(d)) (1,141) - (4,604) -
Shares purchased for
Long-Term Incentive Plan (5) (35) (345) (35)
Repayment of capital lease
obligation - (6) (9) (36)
-------------------- -------------------
(542) 13 (3,675) 217
Investing
Purchase of property
and equipment (1,210) (547) (3,854) (2,110)
Business acquisitions - - - (3,517)
-------------------- -------------------
(1,210) (547) (3,854) (5,627)

Effect of foreign exchange
on translation (64) (66) (24) (137)

Increase (decrease) in cash
and cash equivalents 4,704 3,565 6,184 (2,960)

Cash and cash equivalents
- Beginning of period 2,313 (2,732) 833 3,793
-------------------- -------------------
Cash and cash equivalents -
End of period $ 7,017 $ 833 $ 7,017 $ 833
-------------------- -------------------
-------------------- -------------------
Represented by
Cash and cash
equivalents $ 7,017 $ 973
Bank indebtedness - (140)
--------------------
$ 7,017 $ 833
--------------------
--------------------

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 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 September 30, 2005 and for all periods presented, have been made. All amounts herein are expressed in Canadian dollars unless otherwise noted.

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 the third quarter, the Company performed its annual impairment test of goodwill for each reporting unit to which goodwill applies, 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 option is 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 September 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 a variable interest entity ("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 the Company has no variable interest entities therefore there is no impact for fiscal 2005.



2. Restructuring charge

Charged during the three
months ended September 30, Payable at September 30,
2005 2005 2005 2004
(unaudited) (unaudited)
--------------------------- ------------------------
Workforce
reduction $ - $ 1,341 $ - $ 1,075
Lease
termination - 973 - 463
Other - 266 - 64
--------------------------- ------------------------
$ - $ 2,580 $ - $ 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 occurred, and all amounts were paid during fiscal 2005. 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.

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 have been paid as at September 30, 2005.

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). These share are included in the calculation of issued and outstanding shares.

During the second quarter of fiscal 2005, the Company determined that it was entitled to a reduction of the purchase price of the acquired entities based on certain working capital requirements. The Company received a return of the purchase consideration in the amount of $182,000 which was recorded as a reduction of goodwill.



4. Income taxes

Three Three
months months
ended ended Year Year
September September ended ended
30, 30, September September
2005 2004 30, 30,
(unaudited) (unaudited) 2005 2004
-----------------------------------------------------

Earnings before
income taxes $ 2,751 $ (1,166) $ 12,581 $ (1,269)
Expected provision
based on a tax
rate of 35.25%
(2004 - 36.1%) 970 (421) 4,435 (458)
Increase (decrease)
resulting from
Non-deductible
expenses 126 69 650 322
Foreign tax
differential 14 181 74 192
Canadian statutory
rate differential 45 92 94 92
Change in valuation
allowance for
U.S. net operating
loss carry-forwards (236) 1,091 (929) 5,712
Other (15) (158) (15) 120
-----------------------------------------------------
Income tax
provision $ 904 $ 854 $ 4,309 $ 5,980
-----------------------------------------------------


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

September 30, 2005 September 30, 2004
U.S. Canadian U.S. Canadian
companies companies companies companies
------------------------- -----------------------

Differences in
working capital
deductions for tax
and accounting
purposes $ (2,444) $ 164 $ (1,727) $ 61
Property and equipment (12) (309) 248 (432)
Goodwill - (60) - 19
Loss carry-forwards 7,838 - 8,307 -
Valuation allowance (5,382) - (6,828) -
------------------------- -----------------------
Total net future
tax liabilities $ - $ (205) $ - $ (352)
------------------------- -----------------------
Comprising
Non-current
liability $ (205) $ (352)
----------- ----------
$ (205) $ (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
2025 439


5. Capital stock and stock options

a) Capital stock


As at September 30, 2005 As at September 30, 2004
---------------------------------------------------
Issued
Common shares 9,449,787 9,746,842
Amount $ 43,192 $ 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 September 30, 2005 the total stock-based compensation charge was $145,000, which has been included in compensation cost on the consolidated statement of earnings. Of this cost, $12,000 relates to the granting of 60,000 (2004 - 52,000) options to employees during this quarter, $102,000 relates to options granted in the previous three quarters, and the balance is the amortization of previous awards granted prior to October 1, 2004.

For the twelve months ended September 30, 2005 the total stock-based compensation charge was $533,000 (2004 - $nil) which has been included in compensation cost on the consolidated statement of earnings. Of this cost, $301,000 relates to the granting of 412,000 (2004 - 146,200) options to employees during this twelve 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 Year ended
September 30, September 30,
2005 2004 2005 2004
(unaudited) (unaudited)
----------------------- -------------------

Dividend yield 0.0% 0.0% 0.0% 0.0%

Expected volatility 32% 35% 31%-36% 35%-43%

Risk free interest rate 3.3% 2.7% 3.2%-3.8% 2.3%-3.2%

Expected life (years) 3 4 1-4 1-4

Weighted average grant
date fair value $ 2.55 $ 1.83 $ 2.58 $ 2.41




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

Three months ended Year ended
September 30, September 30,
2005 2004 2005 2004
(unaudited) (unaudited)
----------------------- -------------------

Net earnings (loss)
as reported $ 1,847 $ (1,975) $ 8,314 $ (7,067)

Adjustment relating
to stock options - $ 126 - $ 503

Pro forma earnings
(loss) $ 1,847 $ (2,101) $ 8,314 $ (7,570)

Diluted earnings
(loss) per share $ 0.19 $ (0.20) $ 0.86 $ (0.73)

Pro forma diluted
earnings (loss)
per share $ 0.19 $ (0.22) $ 0.84 $ (0.79)


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

Three months ended
September 30, 2005 Year ended
(unaudited) September 30, 2005
-------------------------------------------
Balance - beginning of
period 897,500 850,300
Options granted in
period 60,000 412,000
Options exercised
in period (80,500) (161,300)
Options expired
in period (13,000) (165,000)
Options cancelled
in period (38,000) (98,000)
-------------------------------------------
Balance - end
of period 826,000 838,000


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 September 30, 2005, the Company contributed $15,000 (2004 - $18,000) and issued 4,782 shares (2004 - 8,981) pursuant to this plan. For the year ended September 30, 2005, the Company contributed $58,000 (2004 - $74,000) and issued 26,118 shares (2004 - 39,881) 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 September 30, 2005, the Company acquired 105,900 shares at an average cost of $10.77. These shares were cancelled on September 30, 2005, with an average assigned value $4.58. 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 472,560 shares.



6. Intangible assets

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

Customer relationships
with an economic life
of 44 months $ 683 $ 322 $ 361

Sub-contracting
agreement from
Donna Cona Inc. 856 703 153
--------------------------------------------
$ 1,539 $ 1,025 $ 514

Accumulated Net book value at
Cost amortization September 30, 2004
--------------------------------------------

Customer relationships
with an economic life
of 44 months $ 683 $ 138 $ 545
Sub-contracting
agreement from
Donna Cona Inc. 813 227 586
--------------------------------------------
$ 1,496 $ 365 $ 1,131


7. Amortization

Three months ended Year ended
September 30, September 30,
2005 2004 2005 2004
(unaudited) (unaudited)
----------------------- -------------------

Amortization of
property and equipment $ 1,001 $ 899 $ 3,583 $ 3,654
Amortization of
customer relationships 46 46 184 138
Amortization of
sub-contracting
agreement from
Donna Cona Inc. 175 53 476 188
----------------------- -------------------
$ 1,222 $ 998 $ 4,243 $ 3,980


8. Investment in Donna Cona Inc. ("DC")

In August 2002 the Company entered into an agreement with DC (formerly Donna Cona II Inc.) to relinquish its 49% interest in DC 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. The final installment was due on July 1, 2006.

In September 2005, the Company returned its remaining interest in Donna Cona Inc. for a nominal value, as it was determined that the investment in DC was non-core to Sierra Systems' business. Effective September 30, 2005 the Company held a 0% interest (2004 - 32%) in Donna Cona Inc.

For the three and twelve months ended September 30, 2005, the Company recorded revenues from DC of $468,000 and $1,847,000 respectively (2004 - $497,000 and $2,140,000), of which $348,000 (2004 - $366,000) was included in accounts receivable at September 30, 2005.

9. 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
September 30, 2005 $ 28,057 $ 9,545 $ 37,602
For the three months ended
September 30, 2004 $ 25,083 $ 9,137 $ 34,220

For the year ended September
30, 2005 $ 115,784 $ 36,169 $ 151,953
For the year ended September
30, 2004 $ 106,595 $ 39,336 $ 145,931

Property, equipment,
and goodwill:
As at September 30, 2005 $ 30,884 $ 1,779 $ 32,663
As at September 30, 2004 $ 30,837 $ 2,045 $ 32,882


10. Supplementary cash flow information

Three months ended Year ended
September 30, September 30,
2005 2004 2005 2004
(unaudited) (unaudited)
----------------------- -------------------
Interest and income
taxes:
Interest paid $ 56 $ 22 $ 10 $ 78
Interest received $ 10 $ 19 $ 79 $ 68
Income taxes paid $ 1,003 $ 750 $ 4,273 $ 3,050
Income taxes refunded $ - $ 1,191 $ 225 $ 1,191


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