Final Results

6 March 2013

SQS Software Quality Systems AG

("SQS" or the "Company")

Results for the year ended 31 December 2012

SQS Software Quality Systems AG (AIM: SQS.L), the world's leading specialist in software quality services, today announces its results for the year ended 31 December 2012.

Financial Highlights:

·; Turnover increased by 11.1% to €210.1 million (FY 2011: €189.1 million)

·; Gross margin up to 31.2% (FY 2011: 30.5%)

·; Adjusted* PBT up by 26.6% to €9.2 million (FY 2011: €7.3 million)

·; Adjusted** EPS up by 33.3% to €0.24 (FY 2011: €0.18)

·; Operating cash flow*** improved to €14.1 million (FY 2011: €10.2 million)

·; Net debt as at 31 December 2012 reduced by 36% to €7.9 million (FY 2011: €12.3 million)

·; Proposed dividend of €0.07 per share (FY 2011: €0.05 per share)

* Adjusted to add back IFRS effect of €1.3 million of amortisation of intangible assets of acquired companies in 2012

** Includes adjustments above and local GAAP tax rate which is €0.6 million higher than under IFRS because of €0.5 million deferred taxes, other tax assets under IFRS and minority interests

*** Debtor days reduced to 58 (2011: 64) with cash conversion above 100%

Operational Highlights:

·; Managed Services contracts accounted for 34% of total full year revenues (FY 2011: 22%)

·; Managed Services gross margins improved by 3.2 percentage points to 32.7% (FY 2011: 29.5%) and positively contributed to EBIT

·; Improved visibility with order intake of €101 million during the period (FY 2011: €67 million) and order backlog (revenues still to be delivered over the next three years) at 31 December 2012 of €98 million

·; Successfully began programme to move Regular Testing business to higher profit contribution through higher margin contracts and reduced overheads

·; Successfully renewed all Managed Services contracts due to end

Diederik Vos, Chief Executive Officer of SQS, commented, "During the period we made considerable progress regarding our stated strategic move away from the provision of short-term contracts for regular testing services while simultaneously delivering above-market growth in revenues and profits mainly through Managed Services. Together these developments have enabled us to increase our overall margins while providing greater revenue visibility. In addition, we completed the first phase of our investment programme in the test centre in India and greatly improved cash collection during the year, enabling us to substantially reduce our net debt position.

Going forward we will continue to extend our US presence and invest in the build out of our test centre infrastructure in India in order to satisfy the growing demand generated from managed services.

We continue to work toward these goals and, although we maintain caution regarding the wider economic outlook, indications for the first quarter of 2013 give us confidence that we will be able to report further progress going forward."

Enquiries:

About SQS Software Quality Systems

SQS is the world's leading specialist in software quality. This position stems from over 30 years of successful consultancy operations. SQS consultants provide solutions for all aspects of quality throughout the whole software product lifecycle driven by a standardised methodology, high offshore automation processes and deep domain knowledge in various industries. Headquartered in Cologne, Germany, the company employs approximately 2,300 staff. SQS has offices in Germany, the UK, Egypt, Finland, France, India, Ireland, the Netherlands, Norway, Austria, Sweden, Switzerland, South Africa and the US. In addition, SQS maintains a minority stake in a company in Portugal. In 2012, SQS generated revenues of 210.1 million Euros.

SQS is the first German company to have a primary listing on the AIM (Alternative Investment Market) in London. In addition, SQS shares are also traded on the German Stock Exchange in Frankfurt am Main.

With over 7,000 completed projects under its belt, SQS has a strong client base, including half of the DAX 30, nearly a third of the STOXX 50 and 20 per cent of the FTSE 100 companies. These include, among others, Allianz, Beazley, BP, Centrica, Daimler, Deutsche Post, Generali, JP Morgan, Meteor, Reuters and Volkswagen as well as companies from our six key focus industries.

For more information, see sqs.com

Chief Executive's Statement

Introduction

2012 has been a year of significant progress toward achieving our stated strategic goals. Key amongst these was to build revenues, particularly in the higher margin areas of Managed Services and Specialist Consultancy Services. SQS has had considerable success increasing revenue by 11.1% to €210.1 million (FY 2011: €189.1 million) with growth across all key geographies in which we operate.

Growth in our Managed Services business was especially strong, accounting for €72.2 million or 34% of total revenues in 2012 against €42.2 million or 22% of total revenues in 2011. Managed Services also saw significant margin improvement, delivering 9% EBIT margin during the period. This is primarily a result of the continuing maturation of contracts and increased automation.

We also delivered strong growth in our Specialist Consultancy Services business, which now accounts for €36.4 million or 17% of total revenues against 15% of total revenues in H1 2012 (this segment was not measured separately in 2011). Our long term goal for this business is for it to represent 25% of total revenues. A key objective for 2013 in helping us to achieve this is to roll out our Specialist Consulting offering on PLM (software Product Life Cycle Management in manufacturing) and SAP across all of our key geographies. Specialist Consultancy delivered an EBIT margin of 10% during the period. 

As a consequence of the above, and also in line with our stated strategy, we have been successfully reducing the proportion of total revenues derived from Regular Testing Services during the period, in many cases through transitioning Regular Testing clients to Managed Services contracts. We have also successfully begun the task of improving the margin mix from this side of the business, either through more efficient allocation of resources or through discontinuing the least profitable contracts. Furthermore, we have introduced a minimum value for new Regular Testing engagements. Although we are making good progress there is still much to do in this respect. Regular Testing Services EBIT margin during the period was 2% but we believe we can achieve 5% in the long term.

During the period, adjusted* PBT increased by 26.6% to €9.2 million (FY 2011: €7.3 million). Adjusted** EPS increased by 33% to €0.24 (FY 2011: €0.18), partly due to lower tax of 27%.

* Adjusted to add back IFRS effect of €1.3 million of amortisation of intangible assets of acquired companies in 2012

** Includes adjustments above and local GAAP tax rate which is €0.6 million higher than under IFRS because of €0.5 million deferred taxes, other tax assets under IFRS and minority interests

Conversion of operating profit to cash was 133% with operating cash flow improving to €14.1 million (FY 2011: €10.2 million). This improvement, particularly in the second half of 2012, was primarily due to the completion of our investment programme during the first half of the year and an increased focus on improving cash collection, with debtor days reducing from 64 (31 Dec 2011) to 58 days. We expect investments to remain at similar levels for the remainder of the first half of 2013 but will look to make further investments into growing our offshore test centre infrastructure mainly in the second half of 2013.

As a result of the improved cash flow we were able to significantly reduce our net debt during the period by 36% to €7.9 million at the period end (FY 2011: €12.3 million).

We have made significant progress during 2012 and our order intake of €101 million (FY 2011: €67 million) and order backlog (revenues still to be delivered) of €98 million gives us improved visibility going forward. We will continue to work hard on furthering our progress toward achieving our strategic goals during 2013. 

New Business

While winning a considerable number of new clients in our six key verticals during the period under review, we have been far more focused on increasing the value attained from existing clients. Transitioning existing Regular Testing clients over to Managed Services contracts has a positive effect upon the gross margins achievable from these clients over the long term. These higher margins have been demonstrated for the first time in FY 2012 as a larger proportion of Managed Services contracts have reached maturity. In addition, we have worked hard on implementing value based pricing which has also aided margins from the Managed Services and Specialist Consultancy business.

Further to this, we have begun deploying a programme to increase the value we derive from our Regular Testing business. Although our strategy is not to grow this business as a proportion of total revenues, Regular Testing often provides us with an entry point into clients that may in time progress to Managed Services contracts and will therefore remain an important part of our business. As part of this strategy, we are being careful to limit new Regular Testing clients to only those that are likely to progress on to Managed Services contracts or generate gross margins above 30% in one of the six key verticals. In addition, we have implemented an expected minimum size on the value of new Regular Testing client engagements of €1.5 million.

Further to the above, and across all three of our service offerings, we are focusing on six key strategic sectors in which we have the greatest domain knowledge, namely manufacturing, financial services, energy, insurance, retail and telecommunications. About 90% of our business is now being conducted in these verticals and we have seen especially strong growth in the manufacturing sector during the year, not least as a result of the traction we are building through our partnership with Siemens. This focus on our key skills is further helping us to move away from commoditised business toward larger and higher margin contracts.

During the year, and also in line with our strategy, we signed our largest ever contract, worth €25 million over three years, and our largest ever contract extension, worth €24 million over the next two years.

Market & Industry Overview

A Nelson Hall study from 2012 estimates the total size of the global testing services market to be US$ 33,400 million of which US$ 8,600 million is specialist testing services contracted stand alone. Of this US$ 8,600 million North America accounts for the largest geographical segment representing 48% of the market with Europe at 40% and the Rest of the World at 12%.

Although Nelson Hall was forecasting growth to remain relatively flat in 2012, with North America growing by 4% and other geographies marginally contracting, growth is forecast to accelerate rapidly in 2013 and beyond. Nelson Hall anticipates the North American testing market will grow 12% in 2013 and 13% in 2014, Europe will grow 9% in 2013 and 10% in 2014 and the Rest of the World is expected to grow by 7% and 9% in 2013 and 2014 respectively. SQS believes that the 2013 market growth rates may be reduced when market research firms have factored in the reduced GDP growth rates for 2013.

The Nelson Hall study further breaks down the market by the motivations behind clients choosing to purchase specialist testing services. Chief amongst these, at 58% of the market, is to achieve efficiency gains, as provided by our Managed Services offering. Transformation requirements, as provided by our Specialist Consultancy Services offering, are the second most common reason behind purchases making up 17% of the market. This report gives reassurance therefore that SQS is correctly positioning its business in order to meet the greatest market need.

Further supporting SQS's strategic positioning is the report's examination of the growth rates in purchasing specialist testing services amongst the various industry sectors. Highest growth is seen among financial services, manufacturing and energy & utilities sectors, three of SQS's six target industry verticals.

Healthy growth for the overall testing market is further supported by a study published by Infiniti in October 2012 which forecasts a compound annual growth rate of 5.2% until 2015.

SQS remains by far the largest pure play testing specialist with revenues more than five times those of the nearest competitor. The Company also ranks tenth globally when compared with systems integrators in terms of revenues derived from testing services and as such is increasingly able to compete with and win larger contracts against these competitors.

SQS will continue to evaluate suitable acquisition opportunities both in Europe and overseas, mainly in the areas of Specialist Consultancy Services and in relation to the expansion of our Indian offshore test centre.

Strategy

The overall strategy of the Group remains on track to build SQS into the world's leading specialist in software quality services targeting revenue of €500m by 2017, from both existing and new markets.

Our three primary service offerings are Managed Services (MS) to meet the demand of clients seeking efficiency, Specialist Consultancy Services (SCS) to meet the demand of clients seeking transformation and quality and Regular Testing Services (RTS) to meet the demand of more price conscious clients, who tend to be served on a more local basis.

Our aim is to continue to increase the proportion of revenues derived from higher margin segments such as MS and SCS, thereby reducing the proportion of revenues derived from RTS. Our long term goal is to achieve a segment mix for MS, SCS and RTS (incl. contractors) of approximately 40%, 25% and 35% respectively, and we are making significant progress toward this. For FY 2012 MS, SCS and RTS (incl. contractors) represented 34%, 17% and 44% respectively, against respective contributions to H1 2012 revenues of 33%, 15% and 48%. It is anticipated that RTS will no longer be our largest segment by end of 2014.

We will also look to achieve further margin expansion through the continued refinement of value-based pricing, aligning the balance of onsite and test centre delivery overheads, and ensuring we derive appropriately superior revenues for our higher value services.

In addition, we aim to improve the margins achievable from RTS through maintaining a minimum value of €1.5 million for new contracts and through specifically targeting contracts that are likely to provide greater future value. We will also look to improve the overall margins of our existing RTS business through cost-effective re-allocation of staff and through discontinuing contracts that cannot be made sufficiently profitable and are not expected to lead to greater future value.

We will also continue to target new business within the six key industry verticals previously mentioned, in which SQS has strong domain, application and technology expertise and in which we are currently seeing strong demand.

Further to this, we will look to extend our presence in the US market, mainly in the fields of product testing for the Manufacturing and Specialty Services industries.

In the US market it is possible for us to achieve superior margins in software product testing as work can be almost entirely automated, is repeatable over multiple releases and can be performed from our off-shore test centres. Although only 0.6% of our revenues are currently derived from the provision of these services we currently achieve our highest EBIT margins, in excess of 20%, on these revenues and this is a segment with considerable scope for growth.

We also plan to begin phase two of the expansion of our Indian test centre facilities during 2013. This will enable us to facilitate the offshore servicing of our rapidly growing Managed Services business. We anticipate that this will result in a cash outflow of €3 million over the second half of 2013 and first half of 2014.

Dividend

In line with our stated policy of paying out 30% of adjusted profit after tax as a dividend SQS will pay a dividend for the full year of €0.07 per share (2011: €0.05). Subject to shareholder approval the dividend will be paid following the AGM on 29 May 2013. In accordance with German law, SQS pays one dividend in each financial year.

Board

On 1 January 2013, Ralph Gillessen was appointed as Chief Marketing Officer responsible for all regional market units, sales and marketing. Ralph's appointment was made internally having worked in various senior sales and consultancy positions within SQS over the past 11 years, including running SQS's largest profit centre, Central Europe Middle East, for the past two years.

On 14 January 2013, Riccardo Brizzi joined SQS as Chief Operating Officer in charge of overall operations. Riccardo is an internationally experienced manager specialised in IT and Managed Services. He joined from SAP where he had spent the previous six years in a variety of senior management positions, most recently as head of strategic client delivery. Prior to this he has worked for Cap Gemini and Vodafone.

Both the above appointments were made as essential steps toward achieving our long-term strategy of growing SQS into a €500 million revenue company.

Employees

The period end number of permanent consultants increased 11% to 1,855 (31 Dec 2011: 1,675) and an optional c. 240 contractors were retained during the period.

Test centre headcount (offshore and nearshore) was flat at 41% of total headcount at period end (42% at 31 December 2011). Offshore headcount did not increase as a proportion of total headcount because of the requirement from new large Managed Services contracts to have a higher on-site presence during their initial phases as well as from an increased level of automation.

We have begun Phase II of the expansion of our Indian test centre facilities in which we plan to employ a further 350 consultants to satisfy growing market demand. It is our objective that offshore and nearshore test centre headcount will account for 48% of total headcount by the start of 2014.

Outlook

During the period we made considerable progress regarding our stated strategic move away from the provision of short-term contracts for regular testing services while simultaneously delivering above-market growth in revenues and profits mainly through Managed Services. Together these developments have enabled us to increase our overall margins while providing greater revenue visibility. In addition, we completed the first phase of our investment programme in the test centre in India and greatly improved cash collection during the year, enabling us to substantially reduce our net debt position.

Going forward we will continue to extend our US presence and invest in the build out of our test centre infrastructure in India in order to satisfy the growing demand generated from Managed Services.

We continue to work toward these goals and, although we maintain caution regarding the wider economic outlook, indications for the first quarter of 2013 give us confidence that we will be able to report further progress going forward.

Diederik VosExecutive Officer6 March 2013

Financial Review

Summary

Group turnover during the period was up by 11.1% to €210.1 million (FY 2011: €189.1 million).

The business units, which also represent the accounting segments according to IFRS 8, are:

Central Europe Middle East (CEME), which includes the services businesses in the markets of Germany, Switzerland, Austria, Netherlands, France, Luxemburg and Egypt. Furthermore, this segment manages all billable staff that are employed by the aforementioned countries including the German / French language offshore centre in Egypt.

West Organisation North South (WONS), which includes the services businesses in the markets of the United Kingdom, Ireland, Sweden, Norway, Finland, USA, South Africa and India. Furthermore, this segment manages all billable staff that are employed by the aforementioned countries including the English-language offshore centres in India and South Africa.

The segment "Other" includes training & conferences. In 2011 the business regarding the sale of software testing tools developed by SQS had also been allocated to this segment. However, internally developed software testing products became an important part of the Managed Services business and have therefore been integrated into the segments CEME and WONS. The figures for 2011 have not been amended.

Breakdown by Business Unit

Central Europe Middle East (CEME)

Revenue in CEME, our largest market, amounted to €129.1 million (2011: €114.2 million) in the period, an increase of 13.1%. The improvement in revenue was entirely organic and came from new Managed Services contracts, additional demand for specialist consultancy services and the revenues from the sale of software testing tools which were shown under "Other" in 2011.

West Organisation North South (WONS)

Our business in predominantly English speaking geographies saw healthy growth during the period with a 12.5% rise in revenues to €77.0 million (2011: €68.4 million). This occurred primarily as the result of a strong surge in demand for our services from the UK, Ireland and India. The majority of the growth came from the retail, utilities & energy and financial services sectors.

Other Business

Due to the change within the segments regarding the sale of internally developed software testing tools, this segment experienced a decrease in revenues in the period of 37.6% to €4.0 million (2010: €6.5 million). The markets for training and conferences continued to be difficult due to the overall economic climate, resulting in lower revenues in the UK, but some improvement in the German market. SQS software testing products are an integral part of our asset based services methodology and additionally embedded in many managed services contracts, their profit contribution is not fully visible in this segment but in 2012 is fully included in the CEME and WONS result.

Foreign Exchange

Foreign exchange had an overall positive impact on the reported revenue and profit for the period as the Euro weakened against Sterling, Swiss Franc and Swedish Krona, which are the most important currencies to the SQS business, while it strengthened against the Indian Rupee. In total, 47% of the Group's revenue is generated in currencies other than the Euro (2011: 45%). Specifically, 24% (FY 2011: 23%) of Group revenue is generated in Sterling by our UK operation and 14% (FY 2011: 12%) of Group revenue is generated in Swiss Francs by our Swiss operation, the balance of 9% is generated in other currencies. On a constant currency basis, our reported revenues would have been €205.1 million (€210.1 million at reported exchange rate) and we would have recorded adjusted profit before tax €0.1 million lower than the reported €9.2 million.

Margins and Profitability

Gross profit was up 13.8% to €65.6 million (FY 2011: €57.7 million) with the gross margin at 31.2% (FY 2011: 30.5%). The increase was mainly influenced by above average gross margins from a growing share of managed services (2012: 32.7% gross margin), specialist consultancy (2012: 34.9% gross margin) and product testing (2012: 47.2% gross margin), while the share of revenues from regular testing services came down.

Gross margins from our traditional field, Regular Testing Services, were at 28.4% and gross margins from contractors were at 20.5%. We continue to work on improving margins in regular testing services through the re-allocation of staff and reduction in the amount of travel and will ultimately discontinue engagements if there is no other option.

The resulting adjusted profit before tax (adjusted to add back IFRS effect of €1.3 million of amortisation of intangible assets of acquired companies) was up by 26.6% to €9.2 million (FY 2011 €7.3 million) with the profit margin moving to 4.4% (FY 2011: 3.8%).

Adjusted earnings per share (includes adjustments above and local GAAP tax rate which is €0.6 million higher than under IFRS because of €0.5 million deferred taxes, other tax assets under IFRS and minority interests) were up by 33.3% to €0.24 (2011: €0.18).

Costs

Adjusted General & Administrative expenses (adjusted to add back IFRS effects on amortisation of intangible assets of acquired companies of €1.3 million) totalled €35.6 million (2011: €31.2 million), representing 16.9% of Group revenues (2011: 16.5%). The absolute cost increase resulted chiefly from hiring and staff training costs (€1.3 million), further build out of the local US business (€0.9 million) and redundancy costs (€0.6 million).

Sales & Marketing expenses totalled €15.9 million (2011: €14.3 million) representing 7.6% of revenues (2011: 7.6%). Absolute cost increases resulted from adding sales capacity, mainly to support Managed Services, Specialist Consultancy and the local US business.

Research & Development expenses totaled €3.5 million (2011: €3.5 million) representing 1.7% of Group revenues (2011: 1.9%). R&D costs resulted from investments in our software testing tools with capitalised R&D of €2.5 million (2011: €2.5 million) and amortisation of €2.7 million (2011: €3.0 million), resulting in a net negative effect of €(0.3)million (2011: net negative effect of €(0.5) million).

Additionally €0.6 million (2011: €1.3 million) regarding the development of PractiQ methodology have been capitalised and €0.6 million (2011: €0.2 million) were amortised, resulting in a net effect of €0.0 million (2011: net positive effect of €1.0 million). As all major SQS services have now been productised and most SQS consultants are certified for these products we expect that investment in PractiQ methodology will continue to be on the current low level going forward.

Cash Flow and Balance Sheet

Cash flow from operating activities was €14.1 million (2011: €10.2 million) which represents an adjusted EBIT conversion of 133% (2011: 118%). This was much better than the conversion rates of adjusted EBIT into operating cash flow seen in previous years and this predominantly resulted from a reduction of working capital and debtor days mostly in managed services contracts in the second half of 2012. Debtor days ended lower than the previous year at 58 (2011: 64) and were significantly reduced from 74 at the end of the first half.

Cash outflow from financing activities was €(3.5) million (2011: inflow of €7.3 million) and includes the payout of a dividend of €(1.4) million in May 2012 (2011: €(2.2) million) and a net pay back of borrowings and leasing contracts of €(2.1) million.

Cash outflow from investments nearly halved to €(4.4) million (2011: €(8.9) million), including €(3.1) million (2011: €(3.8) million) for capitalised R&D on products and Managed Services/PractiQ methodology; €(1.3) million (2011: €(2.1) million) for investments in IT infrastructure and software; and €(0) million (2011: (€2.8) million) for investments in the test centre building in Pune, India. There were no cash payments for earn out payments on acquisitions in the last two years. Cash at the year-end was €11.9 million (2011: €9.3 million).

No shares were issued in 2012.

Taxation

The reported tax charge of €1.9 million (2011: €1.4 million) includes current tax expenses of €2.4 million and deferred taxes of €(0.5) million (2011: €(0.9) million). Deferred taxes mostly occurred due to losses in legal entities and resulting tax assets earned by these. The 2012 current tax charge on the adjusted PBT was slightly lower than expected at 27% due to above average profitability in those legal entities located in lower than average tax systems.

We anticipate a tax rate of 29% for 2013.

International Financial Reporting Standards (IFRS)

The Consolidated Financial Statements of SQS and its subsidiary companies ("SQS Group" or "SQS Konzern") are prepared in conformity with all IFRS Standards (International Financial Reporting Standards) and Interpretations of the IASB (International Accounting Standards Board) approved by the EU Commission and translated into the German language which are to be applied for those financial statements whose reporting period starts on or after 1 January 2012.

The SQS Group Consolidated Financial Statements for the twelve month period ended 31 December 2012 are presented in Euros.

A copy of the SQS Group Consolidated Financial Statements together with a notice of Annual General Meeting to be held at SQS headquarters in Cologne on 29 May 2013 will be posted to shareholders by mid April 2013 and electronic copies of these documents will also be available from the Company's website at www.sqs.com.

Rene GawronChief Financial Officer

6 March 2013

Notes to the Consolidated Financial Statements

at 31 December 2012

1. Description of business activities

SQS, based in Cologne, Germany, is one of the largest independent European pure play providers of software testing and quality management services by turnover. SQS is independent from software vendors and other IT service suppliers. It can therefore provide unbiased opinions to customers on the software products and projects it is engaged to assess and improve. SQS offers services designed to support the quality of software and IT systems from initial project definition through the development stage and up to final implementation and, thereafter, in ongoing maintenance.

For more than thirty years, SQS has been offering a comprehensive range of consulting services for enterprise and technical software systems to its clients who include "blue chip" companies in a variety of sectors, such as financial services, telecommunications, logistics and manufacturing. SQS currently has 2,272 employees at the end of 2012 (previous year 2,073 employees) across Europe, Asia, North America and Africa. SQS has a strong presence in Germany and the UK and offices in Austria, Egypt, Finland, France, India, Ireland, the Netherlands, Norway, South Africa, Sweden, Switzerland, and the United States. Furthermore, SQS has a minor stake in an operation in Portugal and a partnership operation in Spain.

SQS is listed on the London Stock Exchange (AIM) and is also traded on Deutsche Börse, Frankfurt.

2. Summary of significant accounting policies

Basis of preparation and statement of compliance

The Consolidated Financial Statements of SQS and its subsidiary companies ("SQS Group" or "SQS Konzern") are prepared in conformity with all IFRS Standards (International Financial Reporting Standards) and Interpretations of the IASB (International Accounting Standards Board) approved by the European Commission and translated into the German language which are to be applied for those financial statements whose reporting period starts on or after 1 January 2012.

The Financial Information has been prepared on an historical cost basis. The Financial Information is presented in Euro and amounts are rounded to the nearest thousand (€k) except when otherwise indicated.

First-time application of new standards and changes in accounting policies

SQS has applied the Standards and Interpretations of the IASB as applicable in the EU which are binding for financial years commencing on or after 1 January 2012. The changes regarding standards that have been issued or amended since 31 December 2011 do not have a material effect on the financial statements of SQS Group.

SQS does not apply any further changed or newly passed standards prior to the implementation date stipulated. Further, according to the assessment of SQS, the application of these standards would not have any material effect on the financial statements of SQS Group.

The adoption of the following amended IFRS and IFRIC interpretations was mandatory for accounting periods beginning on or after 1 January 2012:

IFRS 7 Financial Instruments: Disclosures - Transfers of Financial Assets

2. Summary of significant accounting policies (continued)

The following standards and amendments to existing standards have been published and are expected to be mandatory after endorsement by the European Commission for the group's accounting periods beginning after 1 January 2012 or later periods, but the group has not early adopted them:

IAS 1 Presentation of Items of Other Comprehensive Income (Amendment)

IAS 12 Income Taxes - Recovery of Underlying Assets (Amendment)

IAS 19 Employee Benefits (Amendment)

IAS 27 Separate Financial Statements (as revised in 2011)

IAS 28 Investments in Associates and Joint Ventures (as revised in 2011)

IAS 32 Offsetting Financial Assets and Financial Liabilities (Amendment)

IFRS 1 Severe Hyperinflation and Removal of Fixed Dates (Amendment)

IFRS 1 Government Loans (Amendment)

IFRS 7 Financial Instruments: Disclosures - Offsetting Financial Assets and Financial Liabilities (Amendment)

IFRS 9 Financial Instruments: Classification and Measurement

IFRS 10 Consolidated Financial Statements

IFRS 11 Joint Arrangements

IFRS 12 Disclosure of Interests in Other Entities

IFRS 10-12 Transitional Guidance (Amendment)

IFRS 10,12 and

IAS 27 Investment Entities (Amendment)

IFRS 13 Fair Value Measurement

IFRIC 20 Stripping Costs in the Production Phase of a Surface Mine

In addition, the IASB has published amendments to existing standards in May 2012 which are part of the Annual Improvements Project. The amendments are expected to be effective for periods beginning on or after 1 January 2013.

Of these, the following standards may have an impact on the financial statements of SQS Group:

IAS 1 Financial Statement Presentation - Presentation of Items of Other Comprehensive Income - The amendments may influence the presentation of items that are reclassified into profit or loss which have to be separated from items that will never be reclassified. These amendments are to be applied for periods beginning on or after 1 July 2012.

IFRS 9 Financial Instruments: Classification and Measurement - The standard as issued reflects the first phase of the IASB's work on the replacement of IAS 39. IFRS 9 introduces new requirements for classifying and measuring financial assets and is likely to impact the SQS Group's accounting for its financial assets. This standard

2. Summary of Significant Accounting Policies (continued)

is expected to be effective for periods beginning on or after 1 January 2015. However, the standard has not yet been endorsed by the EU.

IFRS 13 Fair Value Measurement - The standard establishes a single source of guidance under IFRS for all fair value measurements. IFRS 13 does not change when an entity is required to use fair value, but rather provides guidance on how to measure fair value under IFRS when fair value is required or permitted. This standard will be effective for annual periods beginning on or after 1 January 2013.

All other new and amended IFRSs and IFRICs will not have any material effect on the financial position or performance of SQS.

Basis of consolidation

The consolidated financial statements comprise the financial statements of SQS Software Quality Systems AG and its subsidiaries as at 31 December each year. Subsidiary company financial statements are prepared on a basis consistent with those of other SQS Group companies. All companies in the SQS Group have the same accounting reference date of 31 December.

Subsidiaries are consolidated from the date on which control is transferred to the SQS Group and cease to be consolidated from the date on which control is transferred out of the SQS Group. SQS obtains and exercises control through voting rights.

All inter-company balances and transactions, including unrealised profits arising from intra-group transactions, have been eliminated in full.

As at 31 December 2012, the Company held interests in the share capital of more than 20 % of the following undertakings (all of those subsidiaries have been consolidated):

2. Summary of Significant Accounting Policies (continued)

SQS AG holds 15% of the shares of SQS Portugal Lda with a book value of € nil (at 31 December 2011: € nil).

Foreign currency translation

The Euro (€) is the functional and reporting currency of the parent company and its Euroland subsidiaries. For these entities, transactions in foreign currencies are initially recorded in the functional currency at the exchange rates valid at the date of the transaction. Monetary assets and liabilities denominated in such foreign currencies are retranslated at the rates prevailing on the balance sheet date. All differences arising from translation of monetary items are recognised in profit or loss.

Translation differences on items whose fair value gain or loss is recognised in other comprehensive income or profit or loss are recognised in other comprehensive income or profit or loss, respectively.

The following subsidiaries have their own functional currency:

At the reporting date, the assets and liabilities (including any goodwill) of these subsidiaries are translated into Euros at the exchange rate valid at the reporting date. As the exchange rate did not fluctuate significantly in 2012, the items of the income statement were translated at the weighted average exchange rate for the year 2012. The exchange differences arising on translation are recognised in other comprehensive income and accumulated in a separate reserve in equity.

On disposal of a foreign entity, the cumulative amount of exchange differences relating to that particular foreign entity is reclassified from equity to profit or loss as a reclassification adjustment when the gain or loss on disposal is recognised.

3. Segmental reporting

Based on the internal organisational structure SQS Group is divided into two major business units. Both units are acting as provider for consultancy and testing services in their regions. Both regional business units are operating segments as well as reporting segments according to IFRS 8 as they report their financial information directly to the group management board of SQS AG as chief decision maker. A third reporting unit represents the Training & Conferences business which is reported separately to the management of SQS AG. 

3. Segmental reporting (continued)

In the financial statements the three segments are presented as:

·; CEME (Central Europe Middle East),

·; WONS (West Organisation North & South),

·; Other (Training & Conferences).

The segments "WONS" and "CEME" represent business regions they are present in as follows:

·; CEME: SQS Germany, SQS Switzerland, SQS Austria, SQS Netherland, SQS Group Management Consulting, SQS Egypt, SQS France and

·; WONS: UKISA (UK, Ireland and South Africa), SQS Nordic (Sweden, Norway and Finland), SQS India (India, USA).

In the years before the business regarding the selling and leasing of software testing products (STP) developed respective financial effects had been allocated to the reporting segment "Other". In January 2012 the internal organisation regarding STP had been changed. Internally developed software testing products have become an important part of the managed service business and therefore have been integrated into the operating segments CEME and WONS. The corresponding information regarding the business year 2011 has not been restated because the relevant information is not available and the cost to develop it would be excessive.

The group management board consisting of CEO (Chief Executive Officer), CFO (Chief Financial Officer) and COO (Chief Operating Officer) monitors the results of the operating segments separately in order to allocate resources and to assess the performance of each segment. Segment performance is evaluated based on operating profit or loss as well as cash flow.

Transactions between the segments are made on an arm's length basis. Centrally incurred external costs relating to subsidiaries are recharged to the subsidiaries affected. Cost allocations between the segments are not charged.

Non-profit centres represent important functions such as Portfolio Management, Marketing, Finance & Administration, IT, Human Resources, Managed Services Support and Sales Support.

The non-profit centres are allocated to the operating segments as far as they provide direct services to the segments. As far as they provide general services to the whole group their costs are not allocated and shown under 'Non-allocated costs'.

The assets and liabilities relating to the operating segments are not reported separately to the Group Management Board. Finance costs and income taxes are managed on a group basis. Due to this they are not allocated to operating segments.

The following tables present revenue and profit information regarding the SQS Group's reportable segments for the years ended 31 December 2012 and 2011.

3. Segmental reporting (continued)

3. Segmental reporting (continued)

Additional Information

The following tables present additional information about the revenues from external customers by individual services:

The following revenue information by geographical region is based on the location of the customer. The information disclosed for non-current assets relates to property, plant and equipment, and intangible assets including goodwill.

4. Expenses

The Consolidated Income Statement presents expenses according to function. Additional information concerning the origin of these expenses by type of cost is provided below:

Cost of material

The cost of material included in the cost of sales in the year ended 31 December 2012 amounted to €24,752k (2011: €18,197k). Cost of material mainly relates to the procurement of external services such as contracted software engineers. In addition, certain project-related or internally used hardware and software is shown under cost of material.

4. Expenses (continued)

Employee benefits expenses

The expenses for retirement benefits include current service costs regarding defined benefit plans and expenses for defined contribution plans.

The average numbers of employees in the operating segments of the SQS Group were as follows:

Government grants

Government grants in the amount of €296k (at 31 December 2011: €124k) have been granted for personnel expenses for the additional employees in economically weak regions and have been recognised as income. Of these an amount of €150k (at 31 December 2011: €53k) had not yet been paid to SQS at the reporting date. There are no unfulfilled conditions or contingencies attached to these government grants.

Amortisation and Depreciation

Amortisation and depreciation charged in the year ended 31 December 2012 amounted to €7,521k (2011: €7,399k). Of this, €3,528k (at 31 December 2011: €3,236) was attributable to the amortisation of development costs.

Rentals and leasing

Operating lease costs in connection with office space and equipment in 2012 amounted to €6,440k (2011: €6,290k).

The lease contracts will expire between 2013 and 2016. Some of them can be prolonged or renewed, some allow price alignments.

5. Net finance costs

The net finance costs are comprised as follows:

Finance income mainly results from fixed deposit investments which yield interest income.

Interest expense relates to interest on bank loans, finance lease liabilities and a bonded loan.

6. Taxes on earnings 

SQS Software Quality Systems AG in Germany is liable to corporate income tax, the solidarity surcharge and trade income tax. The German corporate income tax rate amounts to 15 % (2011: 15%). A 5.5% solidarity surcharge is imposed on the corporate income tax rate being effective with a rate of 0.825%. The trade income tax amounts to 16.6% of the taxable income. Consequently the total income tax rate in Germany amounts to approximately 32 %.

Consolidated income tax expense is as follows:

A reconciliation between actual tax expense and the product of group accounting profit multiplied by the tax rate of SQS AG is as follows:

6. Taxes on earnings (continued)

Deferred taxes with an amount of €405k (2011: €317k) were charged to other comprehensive income.

SQS has capitalised a corporate tax credit at a present value of €852k (at 31 December 2011: €997k). The present value has been discounted using an interest rate of 5.5%. The tax credit will be paid off by five further instalments until 2017. In the statement of financial position it is presented as non-current income tax receivable.

For the assessment of deferred tax assets and liabilities the local tax rates of the respective entities of SQS Group are applied.

Deferred income taxes relate to the following financial positions: