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Regulatory Announcement

RNS Number:3903Z
SQS Software Quality Systems AG
07 March 2006

SQS Software Quality Systems AG

Maiden Preliminary Results
For the full year ended 31st December 2005

SQS Software Quality Systems AG (AIM:SQS.L) the leading independent pan-European provider of quality management and testing services for software development, today announces its maiden preliminary results for the full year ended 31st December 2005.

Financial Highlights:

• Turnover up by 12.5% to €54.7m (2004: €48.7m)
• Profit before tax up 38.5% to €3.7m (2004: €2.7m)
• BITDA up 18% to €6.8m (2004: €5.8m)
• Adjusted earnings per share up 66% to €0.22 (2004: €0.13)
• Improved gross margin
• Continued strong underlying cash flow; borrowings decreased by 57% to €6.7m
  (2004: €15.8m)

• Successful AIM flotation raising €16m on September 20, 2005, followed by a secondary listing on the new German Entry Standard on December 2, 2005
• Grew recurring revenues - secured significant contract renewals with existing client base
• Improved sales capabilities - to further grow the business and establish the framework for long term outsourcing contracts
• Invested in growth markets - increased activity in embedded systems by successfully securing a sizeable contract with a leading aircraft manufacturer; finished a major Mercury tool integration project at a telecom carrier by providing high tech software engineering services

Commenting on the results, Rudolf van Megen, CEO, said:

"During the year, SQS strengthened its position as the leading independent pan-European provider of quality management and testing services for software development and once again grew at almost three times the rate of the European IT service market."
"In 2006, we will concentrate on both acquisitive and organic growth, focusing on expanding markets such as outsourcing and embedded systems. Trading has been encouraging in the first two months of 2006, and as expected, growth is well ahead of the comparable period last year. The pipeline remains strong."

For further information please contact:

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Notes to Editors

SQS is the leading independent pan-European provider of quality management and testing services for software development. SQS consultants design and oversee quality management processes during software and systems development, and test the resulting products for errors and omissions.

Headquartered in Cologne, Germany, SQS now has operations across Europe with offices in seven countries and has over 470 employees. SQS has a strong presence in Germany (Cologne, Munich, Frankfurt, Stuttgart and Hamburg) with subsidiaries in the UK, Netherlands, Switzerland and Austria. SQS also has a minor stake in an operation in Portugal and a partnership operation in Spain.

With over 3,000 completed projects under its belt, SQS has a strong customer base including half of the DAX 30 companies and 30% of the STOXX-50. They include names like Dresdner Bank, Lloyds TSB, Deutsche Telekom, Vodafone, Daimler Chrysler, and Airbus spread across the full range of industries.

SQS is the first German company to have a primary listing on AIM, completing its IPO on 20 September 2005 raising £10.8m before expenses at an issue price of 190p. SQS is included in the Software and Computer Services sector (9530) within the Computer Services subsector (9533) and has a RIC code of SQS.L. SQS completed a secondary listing on the Deutsche Boerse in Frankfurt on 2nd December 2005. For further information, please visit www.sqs-uk.com.

Chief Executive's Statement

Introduction

I am pleased to present SQS's maiden preliminary results following its admission to AIM in September 2005. SQS had an excellent year, recording a material increase in both profit and revenues. This improvement resulted from an excellent underlying performance in our core businesses. During the year we also invested in three growth markets by developing our long term software testing outsourcing business, increasing our presence in the software testing of embedded systems, and building technical test frameworks that support automation of software testing. Business remained strong within our existing client base and we also secured a number of additional new projects which provide the platform for further growth in the current year.

Results

Turnover from continuing operations rose 12.5% to €54.7m (2004: €48.7m). Underlying profit before tax increased 38.5% to €3.7m (2004: €2.7m) benefitting from improved margins. EBITDA rose by 18% to €6.8m (2004: €5.8m).

Margins improved despite continuing price pressure as a result of improving utilisation of billable consultants throughout the Group.

Turnover growth was highest in Other European Countries (Switzerland, Austria and the Netherlands), especially Switzerland, where turnover grew by 67%, and in the United Kingdom where turnover grew by 18.2%.

Adjusted earnings per share (adjusted to add back deferred taxes and IFRS tax differences) of €0.22 rose by 66 % (2004: €0.13).

The balance sheet has been considerably strengthened during the year reflecting the benefit of the €14.1m net proceeds from our admission to AIM and the positive net income in 2005. We reduced our borrowings by €9.0m to €6.7m (2004: €15.8m). Cash balances and marketable securities at the year end stood at €6.5m (2004: cash €1.5m).

Dividend

As SQS was quoted for only three months of the year the Board is not proposing a dividend in respect of 2005. Moreover, the Directors consider that at this time it is more appropriate to reinvest funds in the development of the Company's growing businesses.

However, the Board intends to pursue a progressive dividend policy in future and therefore intends to pay a final dividend for the year ending 31st December 2006.

The Board

There has been one change to our supervisory board in preparation for our admission to AIM last year. There were no changes to our management board. We are pleased to welcome Jeremy Hamer who joined our supervisory board on August 25, 2005. Mr Hamer is also a director of a number of other quoted and unquoted companies including Inter Link Foods plc and Avingtrans plc, and he is non-executive chairman of Glisten plc. With over ten years experience as a board member of various UK quoted companies, his appointment is a significant step for SQS as a public company. Mr Hamer has replaced Hartmut Voss who had served on our supervisory board since 2000. We thank him for his valuable contribution and commitment.

Strategy

Our strategy is to strengthen our market position as the leading independent pan-European provider of quality management and testing services for software development. We aim to grow our business with long term outsourcing contracts and investment in expanding markets such as embedded systems in the aircraft manufacturing and automotive industries. We intend to strengthen our position in a number of key European markets and will actively look for acquisitions to support and accelerate this strategy.

Employees

On behalf of the board, I would like to thank all our employees for their contribution, hard work, and excellent support during the last year. I am confident that we have the team in place to capitalise on the opportunities available and to enable us to deliver long term shareholder value.

Outlook

During the year, SQS strengthened its position as the leading independent pan-European provider of quality management and testing services for software development and once again grew at almost three times the rate of the European IT service market.
In 2006, we will concentrate on both acquisitive and organic growth, focusing on expanding markets such as outsourcing and embedded systems. Trading has been encouraging in the first two months of 2006, and as expected, growth is well ahead of the comparable period last year. The pipeline remains strong.

Rudolf van Megen
Chief Executive Officer
7th March 2006

Review of Business

During 2005, we continued to strengthen our business by improving utilisation rates and overheads, and increasing the number of clients to over 300. We achieved this by increasing the number of projects staffed with international teams and by hiring 37 additional employees, mainly consultants, with strong software engineering backgrounds as well as senior project management skills. As a service company helping its clients to improve the quality of their software and IT systems, our commitment to quality is paramount.

Strategic Update

Market drivers
Software quality management and testing constitutes a segment of the IT services market and therefore growth in the IT services market closely correlates with growth in software quality management and testing. Research conducted by the European Information Technology Observatory ("EITO") showed the European growth rate for IT services to be approximately 4.7% in 2005. In 2005, SQS achieved growth at almost three times that rate.
Market drivers include the increasing complexity of software and IT systems, higher regulatory demands imposed on IT systems by requirements such as the Sarbanes Oxley Act, and the high number of IT projects that either fail or are out of budget and/or time.
In addition, continuing return on investment (ROI) pressures, coupled with increasing "industrialisation" of the software engineering process has led to an increased demand for outsourced software testing as well as better quality management of embedded systems.

Strategic Goals
The SQS Group strategy builds on five strategic goals which all contribute to market leadership as a service company and resulting shareholder value. They are:

• to extend leadership in independent quality management and testing by delivering added value to our customers in order to achieve their goals
• to grow the business significantly above the market growth rate for IT services
• to remain the financially strongest independent quality service company in Europe
• to extend and retain a strong base of highly motivated, skilled, and best performing employees
• to spot and anticipate trends in IT quality management and testing and use them for the benefit of our clients.

• IT professional services: within its broad range of software testing and quality management services, SQS has enhanced its offerings in the fields of code quality management, assessments of software development and IT organisations, quality management in standard software package projects, and outsourcing.
• Tools, licences, and maintenance: SQS's specialist range of software testing tools which work in conjunction with the tools available from competitors has been enhanced by Version 8.0 of our SQS-Test Professional product. The first press release for this product was presented to the market in December 2005.
• IT training and IT events: The training business was extended. ISTQB and ISEB courses were updated for the new versions of the syllabus.

The successful SQC conferences (Software and Systems Quality Conferences), held in Germany and the UK are two of the largest quality management and software testing events in Europe. We plan to expand these into one further country in 2006. SQS has been investigating partnership opportunities for these conferences, and is pleased to have formed a media alliance with one of Europe's most influential publishers, IDG Communications (e.g. "Computerwoche" in Germany). The partnership with IDG is expected to increase the number of delegates, exhibitors, and sponsors attending our conferences in 2006.

Geographic review

Germany
Revenue in Germany, our traditional home market, was €34.2m (2004: €34.1m) contributing 63% to the Group's total revenue compared with 70% in the prior year. This reflects the increase in services rendered for Group companies in other territories as well as the fact that our growth in Germany was limited by the number of available skilled consultants. Services sold within the Group (mainly to Switzerland and the UK) increased by 59% to €3.9m (2004: €2.4m). We intensified our hiring activities and skills training in the second half of 2005 in order to be able to grow the local business in Germany significantly in 2006. During the year, we secured key contract renewals with our largest client (a public service organisation in Germany) and other major customers, all of which provide a solid base for the current year. We have also increased the business base in embedded systems by securing extended contracts with our largest aircraft manufacturing client. We have successfully finished the first major Mercury tool integration project at a telecom carrier by providing high tech software engineering services. Mercury is the worldwide leading company in the field of software testing tools. We have hired a number of high calibre sales managers, some with extensive experience in outsourcing projects and global account development, who will enable SQS to grow its business with international clients.

United Kingdom
In the United Kingdom, which is our second largest regional segment and the largest European market for IT services in general, we generated revenues of €9.2m (2004: €7.8m), 17% of the Group's total. This represented an 18% increase year on year. While business with existing and new clients increased, professional training revenue grew by 17% and SQS conference revenue grew by 23%. We also achieved above average market growth in our services with logo certification for telecommunication applications. To improve earnings we have initiated measures for improving profits in the UK operation such as improving utilisation of billable staff and reducing overheads.

The UK market continues to be very fragmented as a handful of similar and larger sized pure play testing services companies serve this market. We continue to focus on further consolidation.

Other European Countries (Switzerland, Austria, and the Netherlands) Switzerland, Austria and the Netherlands contributed aggregate revenue of €11.3m (2004: €6.8m), or 21% of the Group's total turnover. This strong year on year increase of 67% predominantly came from our Swiss operation due to successful wins of recurring project business with major Swiss clients in financial services and telecommunications. During the year we doubled the number of local Swiss consultants to 16, and as we continue to add local staff we expect this to reduce the demand on our German operation, which limited our sales growth in Germany in 2005.

Summary

We aim to grow organically by adding more consultants and offering a greater range of services to our existing client base. In particular, we will look to increase our market presence in test outsourcing, software testing of embedded systems as well as building technical test frameworks that support test automation. The existing client relationships, of which we have over 300, are the backbone to our future growth.

Where appropriate, we will also seek to consolidate other specialists in our field and pursue infill acquisitions to further establish or strengthen our market position in selected European countries.

Finance Director's Review

Results

Total revenue for the year grew by 12.5% to €54.7m (2004: €48.7m). IT Professional Services was the major contributor with revenues of €50.7m (2004: €44.9m) a 13% increase year on year. Revenue from tool licenses and maintenance was €2.1m (2004: €2.2m), with IT training and IT events contributing €1.9m (2004: €1.6m).

Earnings before interest, tax, depreciation, and amortisation (EBITDA) was up 18% year on year to €6.8m (2004: €5.8m). Profit before tax was €3.7m (2004: €2.7m), up 38.5%. The improved result was based on improved gross margins and relatively reduced administrative expenses and research & development overheads, while sales & marketing expenses increased in order to foster future revenue growth.

Adjusted* earnings per share improved to €0.22 (2004: €0.13).

*based on net income increased by €1.1m deferred taxes and IFRS tax differences on capitalised R&D and IPO costs but including actual profit taxes of €0.2m payable under local GAAP

Costs

Administrative costs of €8.5m (2004: €7.9m) were 15.5% of sales (2004:16.3%), increased in absolute terms because of the improvement of local infrastructure in Switzerland and hiring costs. Sales & marketing costs of €3.5m increased relative to sales (to 6.4% from 5.8%), as we continued to invest in additional sales resources to support current and future organic growth of the business. Research and development costs of €2.7m were marginally reduced relative to sales (to 4.9% from 5.0%), reflecting a peak in efforts for Version 8.0 of the SQS-TEST Professional tool and course development for our training products.

Taxation

The Group tax charge of €1.3m has two components; one is tax on profits payable under local GAAP of €0.2m, and the other is the deferred tax and tax differences that we are required to show under IFRS of €1.1m. Due to tax breaks and a tax effective expensing of the IPO costs under German local GAAP, SQS will pay no or negligible tax on profits in Germany, Austria and the Netherlands. The remaining €0.2m tax on profits arose in the UK and Switzerland. Deferred tax and IFRS tax differences were €1.1m on capitalised R&D and IPO costs.

Cash Flow and Financing

The group generated operating cash inflow of €2.8m (2004: €4.4m). Although operating profits have risen, operating cash flow was impacted by an €0.9m increase in receivables and tax payments of €0.6m (2004: €-0.2m). Cash flow from financing activities was €5.1m (2004: €-1.9m) and includes a positive cash flow from the net proceeds of the IPO of €14.1m and the pay back of loans and convertible bonds of €-9.0m (2004: €-1.6m). Cash flow from investments was €-8.5m (2004: €-1.7m), including €-2.7m for capitalised R&D for products and investments in intangible assets (2004: €-1.4m), and an additional €-5.6m in marketable securities. In total, cash and marketable securities were €6.5m (2004: €1.5m) at the year end.

Foreign Exchange

Approximately 70% of the Group's turnover is generated in Euros. With the exception of SQS UK Group Ltd and Software Quality Systems (Schweiz) AG, all subsidiaries of SQS are located in the currency area of the Euro. For the conversion of the local currency into Euros, the official fixed exchange rate was chosen. For the conversion of the balance sheet items from foreign currency into Euros, the official mean rate as at 31st December 2005 was used.

The Group's exposure to foreign exchange risks is negligible as more than 90% of the business is billed and served locally.

Amortisation

Amortisation of goodwill is no longer carried out due to the changed IFRS accounting rules. On account of the high amortisation of these goodwill values in previous years, their book values today lie considerably below the original acquisition costs. No reductions in value were necessary by reason of the impairment tests carried out in accordance with IAS 36.

International Financial Reporting Standards (IFRS)

The Consolidated Financial Statements of SQS and its subsidiary companies ("SQS Group") are prepared in accordance with all IFRS Standards, as has been the case since 2001. In addition, they conform with the Interpretations of the IASB (International Accounting Standards Board) applied to those financial statements which have reporting periods starting on or after 1st January 2005.

The SQS Group Consolidated Financial Statements for the business year 2005 were prepared in accordance with uniform accounting and valuation principles in Euros.

First-time application of new standards; change in the accounting policy and adjustment of figures from the previous year

SQS has applied standards of the Improvements Project of the IASB and other changed standards which are binding for the business year commencing 1 January 2005. The changes have led to some additional details but they did not have any effect on the approach and valuation.

Since 1 January 2004, SQS applies IFRS 3 and IAS 36 and 38 in the version of 2004. As a result, the scheduled amortisation of goodwill is no longer carried out. SQS performs annual intrinsic value tests for each cash generating unit.

Further, in 2004 SQS altered the presentation of minority interests in accordance with IAS 1 in the version of 2003. This item is now shown under equity. The accounting and valuation methods correspond to the methods applied in the previous year.

SQS does not apply any further changed or newly passed standards prior to the binding date stipulated. Nor, according to the assessment of SQS, would the application of these standards have any effects on the financial statements.

Rene Gawron
Chief Financial Officer
7th March 2006

Consolidated Profit and Loss Account
for the business year ended 31st December 2005 (IFRS)

Consolidated Balance Sheet as at 31st December 2005 (IFRS)

Consolidated Cash Flow Statement as at 31st December 2005 (IFRS)