Final Results

5 March 2014

SQS Software Quality Systems AG

("SQS" or the "Company")

Results for the year ended 31 Dec 2013

SQS Software Quality Systems AG (AIM: SQS.L), the world's largest supplier of independent software testing and quality management services, today announces its results for the twelve months ended 31 December 2013 (the "period").

Financial Highlights:

· Turnover increased by 7.5% to €225.8m (FY 2012: €210.1m)

· Gross margin up to 32.0% (FY 2012: 31.2%)

· Adjusted* PBT increased by 34.5% to €12.4m (FY 2012: €9.2m)

· Adjusted** EPS increased by 25.0% to €0.30 (FY 2012: €0.24)

· Operating cash flow improved to €22.8m (FY 2012: €14.1m)

· Net debt*** as of 31 December reduced to €2.9m (FY 2012: €7.9m)

· Proposed dividend of €0.09 per share (FY 2012: €0.07 per share)

* adjusted to add back IFRS effects of €0.8m including amortisation of intangible assets of acquired companies, actuarial adjustments for pensions, net of tax effects from share capital increase and extraordinary items of €2.6m for goodwill write off SQS Nordic, €0.4m due diligence costs for Thinksoft and provisions for interest from a tax audit.** includes adjustments under * and a local tax expense which is €0.4m higher than under IFRS due to deferred taxes.

*** Includes €5m cash outflow relating to acquisition of Thinksoft

Operational Highlights:

· Acquisition of majority stake of Thinksoft Global Services ("Thinksoft") for up to €17.5m

· Successful placing of new Ordinary Shares to raise £11.4m (before expenses) to fund, in part, the acquisition of Thinksoft

· Revenues from Managed Services contracts increased 24.1% to €91.1m (FY 2012: €73.4m), now the largest business segment accounting for 41% of total revenue (FY 2012: 35%)

· Gross margin improved by 0.8 percentage points to 32.0% (FY 2012: 31.2%) due to an increased test centre share of delivery and good staff utilization rates

· Improving visibility with order intake from Managed Services of €112.5m (FY 2012: €101m)

· Average revenue per client increased by 23% compared with FY 2012 as a result of continuing strategic focus on larger client engagements

· 47% of total billable headcount in offshore/nearshore test centres (FY 2012: 41%)

· Strong growth in US business, now accounting for 3% of revenues (FY 2012: 0.2%)

Diederik Vos, Chief Executive Officer of SQS, commented, "2013 has been a year of significant progress toward our strategic goals of increasing SQS's offshore capabilities and focussing our efforts on servicing larger contracts. These developments are improving our profitability and, combined with our good revenue growth in the period, have resulted in a substantial increase in earnings.

"This progress is anticipated to be further accelerated by the acquisition of Thinksoft, of which the first stage completed at the end of last year, which increases our offshore headcount, deepens our expertise in the financial services sector and expands our international reach. Thinksoft is already delivering a number of new opportunities and will make a full contribution to the Company's performance in 2014.

"This, together with solid trading during the first quarter of 2014, gives us confidence in delivering continued growth in the coming year." 

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, offshore automation processes and deep domain knowledge in various industries. Headquartered in Cologne, Germany, the company now employs approximately 3,800 staff (incl. Thinksoft). SQS (incl. Thinksoft) has offices in Germany, the UK, Australia, Egypt, Finland, France, India, Ireland, Malaysia, the Netherlands, Norway, Austria, Singapore, Sweden, Switzerland, South Africa, UAE and the US. In addition, SQS maintains a minority stake in a company in Portugal. In 2013, SQS generated revenues of 225.8 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, Commerzbank, Daimler, Deutsche Post, Generali, JP Morgan, Meteor, Reuters, UBS and Volkswagen as well as other companies from the six key industries of SQS.

For more information, see www.sqs.com.

Chief Executive's Statement

Introduction

We made excellent progress during 2013 with regard to all of our stated strategic goals. In terms of our target of approaching €500m in revenues by 2017, we recorded organic growth of 7.5% to €225.8m (FY 2012: €210.1m) and this will be enhanced by the acquisition of Thinksoft, which will make a full contribution to group revenues in 2014 and beyond.

We made substantial progress during the year toward our stated strategy of growing the proportion of revenues from Managed Services, which increased by 24.1% and now account for 41% of total revenues (FY 2012: 35%). Managed Services is now our largest and most profitable business segment and our continuing strategy to grow the proportion of billable staff in our nearshore and offshore operations increased the share of test centre staff significantly to stand at 47% at the year end (FY 2012: 41% at year end) of total billable headcount.

Our high margin Specialist Consultancy Services increased revenues during the period by 0.7% to €36.7m (2012: €36.4m), reversing the decline in revenues in this area witnessed during the first half of 2013.

We also made excellent progress in our plans to focus on larger, high-value contracts, such that average revenues per client increased by 23% to € 523k during 2013. This significantly increased the gross margins we achieved for our Regular Testing Services (RTS) business to 30.2% (2012: 28.4%) with unchanged overheads of 26.4% of RTS revenue (2012: 26.4%).

All of the above developments contributed to improving our overall gross margin from 31.2% to 32.0% which, combined with improving revenues, resulted in increased profitability. Adjusted* PBT increased by 34.5% to €12.4m (FY 2012: €9.2m), including a €0.6m reduction in finance costs (adjusted) when compared to 2012 helped by a movement in foreign exchange rates.

Operating cash flow improved to €22.8m (FY 2012: €14.1m) with our EBITDA to operating cash flow conversion rate increasing to 119% (2012: 84%) as a result of improved order and invoicing workflow control. We continued to use our cash to significantly reduce our net debt position, which as at 31 December 2013 stood at €2.9m (31 December 2012 €7.9m). If we had not acquired Thinksoft during the period we would have ended 2013 with a net cash position of €2.1m.

We have also continued our rapid penetration of the extensive and fast growing US market during the year and it is expected that this will be further enhanced by our acquisition of Thinksoft, announced in November 2013. Thinksoft greatly deepens our expertise and presence in the Banking, Financial Services and Insurance (BFSI) sectors, all part of the six key verticals on which we are strategically focussed.

We have therefore delivered against all of our strategic objectives during the year and our increasing scale, both as the result of organic growth and our acquisition of Thinksoft, better positions us to capitalise on the on-going growth within the markets in which we operate, enabling us to bid on ever larger contracts. We will therefore continue to deploy our existing strategic initiatives going forward and will assess further potential acquisition opportunities that can complement our organic growth and accelerate progress toward our goals.

New Business

In order to improve profitability, particularly in our traditional Regular Testing Services business segment, we have continued to focus on larger, higher-value contracts and to terminate lower margin contracts where profitability could not be sufficiently improved. We achieved considerable success with this strategy during the year, reducing the total client numbers to 424 from 486 while revenues increased by 7.5%. Together these developments resulted in our average annual revenue per client being 23% higher at 31 December 2013 than at 31 December 2012.

Forward visibility improved by 11% during the year with order intake for Managed Services deals of €112.5m during the year (FY 2012: €101m). The order intake comprises a mix of both new contracts and contract extensions. In addition to this we have signed a number of new contracts in Specialist Consulting and Regular Testing Services with high potential to develop into future Managed Services engagements.

Market Overview

The software testing landscape continued to outperform the overall IT services market during the year. The 2013 Nelson Hall market report, showing an expected growth rate of 7% in testing services for Europe for 2014, has yet to be updated but we are not aware of any market reports that contradict this analysis. This growth rate was broken down by Nelson Hall to show forecast growth of 9.5% per annum until 2018 in 'Specialist Testing Services' (testing services provided by organisations such as SQS in standalone contracts) against a fall of 3% per annum until 2018 for 'Traditional Testing Services' (services bundled within a development contract). This was ascribed to Specialist Testing Services being perceived by clients as providing faster execution at reduced cost, and confirms that SQS is firmly positioned in the fastest growing segment of the market.

The 2013 Nelson Hall report further supported SQS' strategic focus by highlighting that expected growth was most pronounced in a number of our key sectors. These included retail&logistics (driven by m-commerce and e-commerce), energy&utilities (driven by deregulation) and banking (driven by regulatory compliance). This also supports the rationale behind our acquisition of Thinksoft which greatly complements our capabilities within the banking sector and presence within this market.

The results of the report also supported our Managed Services strategy in revealing that 57% of decisions to purchase software testing services are made by efficiency seeking clients and that there was an increasing move toward larger multi-year contracts. Managed Services contracts are designed to deliver efficiency and are typically significantly larger in size than Regular Testing Services contracts.

In terms of the geographical markets in which we operate, our core markets within Central Europe continued to perform very strongly, particularly Germany, Austria and the Netherlands. In Western Europe, Ireland was very strong, although the UK market remains relatively weak. In the Nordics business continued to fall, but at a lower rate than previously as a result of the restructuring measures we put in place to improve utilisation and reduce overheads. During the period we wrote off €2.6m of goodwill in relation to our business in this region.

The US is our fastest growing geography, with the market continuing to show healthy demand for our offerings. Our average run rate of almost $1m revenue per calendar month during Q4 of 2013 is up 185% from an average of $0.35m per calendar month during Q1 and Q2 last year. We will continue to focus on increasing our penetration of this market, building organically on our successes in the manufacturing sector, aided by our partnership with Siemens. The acquisition of Thinksoft has also provided us with a number of leads in the financial sector within the US.

Acquisitions

In November of 2013 we announced the acquisition of a majority stake of up to 52.9% of the issued share capital of Thinksoft for up to €17.5m. The integration of Thinksoft into SQS is progressing well and Thinksoft will be consolidated into the accounts of the Company from 1 January 2014 onwards such that it will make a full contribution to our 2014 results (less minorities profit share at earnings per share level). Thinksoft achieved revenues of €23.4m in FY 2013, with PBT of €5.4m. The tender offer process is expected to complete in mid-March this year, at which point the Company will acquire the remaining tender offer shares and the top up shares from the founders if any are required in order to achieve the targeted 52.9% interest in Thinksoft share capital.

This acquisition was very much in line with our strategy of increasing offshore resources to service our growing Managed Services business. However, the principle rationale behind the acquisition was not improving margin through cost savings but increasing our sales resource, expanding our geographic presence and improving our domain capabilities in the fast-growing Banking, Financial Services and Insurance ("BFSI") sectors.

Thinksoft is one of the largest independent software testing companies focused solely on the BFSI sector, with 84% of its 782 employees based in three test centres in India and the remaining 16% in customer facing sales offices in London, New York, Dubai, Bangalore and Singapore. Therefore, the acquisition effectively doubled our offshore delivery capability from India while adding significant sales capability and banking experience and expertise.

In addition, Thinksoft added new customer relationships in geographies in which we are already present, including the UK, India, Austria and the USA and has also expanded our reach into new geographies including Singapore, Belgium, Australia and the Gulf Region. As a result of the acquisition we are currently witnessing a number of new opportunities in the Financial Services sector, particularly in the US and APAC. We therefore hope to be able to announce new contract wins by Thinksoft in the coming months but, as with all substantial contracts, the bidding processes can be relatively protracted.

SQS will continue to look at selective acquisitions to complement our strategy, with a focus on adding regional markets in Europe and the US.

Strategy

We made strong progress during 2013 with regard to all of our stated strategic goals.

We remain focussed on building revenues toward our target of €500m by 2017 and recorded organic growth of 7.5% to €225.8m (FY 2012: €210.1m) and this will be considerably enhanced by the acquisition of Thinksoft, which will make a full contribution to revenues in 2014 and beyond.

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.

We made substantial progress during the year toward our stated strategy of increasing the proportion of revenues from Managed Services. Revenues from Managed Services increased by 24.1% during the year and now account for 41% of total revenues (FY 2012: 35%). Managed Services has now become our largest business segment, having surpassed over a year in advance our initial target of accounting for 40% of total revenues and we have since revised this target to 50% by 2016.

We also achieved a further increase in gross margins for our Specialist Testing business segment which were 36.0% in FY 2013 (FY 2012: 34.9%). Revenues for Specialist Testing grew by 0.8% to €36.7m during the period (2012: €36.4m). Although a relatively low growth rate this reversed the trend seen at H1 2013, where revenues had been below the previous period as a result of specialist staff being temporarily engaged in the initial stages of large Managed Services projects. Specialist Testing accounts for 16% of total revenues and our mid-term goal is for this business segment to account for 20% of revenues.

We also made excellent progress in our plans to focus on larger, high-value contracts, such that average revenues per client increased by 23% during 2013. Regular Testing Services accounted for 34% of total revenues in 2013, a significant reduction from 38% in 2012. This reduction was in line with our mid-term strategy of Regular Testing Services accounting for 25% of total revenues.

We also made progress with our continuing strategy of delivering margin expansion through better balancing onsite and test centre delivery on projects.

In addition, we maintain our focus on targeting new business within the six key industry verticals in which SQS has strongest domain, application and technology expertise. As a result of this we have seen significant growth in the manufacturing sector and our acquisition of Thinksoft is expected to greatly enhance our presence and pipeline of opportunities in the fast growing BFSI sector.

The substantial and fast-growing US market continues to be of strategic focus and was again our fastest growing geography in 2013. The acquisition of Thinksoft is providing further opportunities in the US and is expected to accelerate our current growth in the region.

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 €0.09 per share (2012: €0.07). Subject to shareholder approval the dividend will be paid following the AGM, on 30 May 2014. In accordance with German law, SQS pays one dividend in each financial year.

Board

Heinz Bons, Principal Consultant at SQS, David Bellin, Chairman of EMC Ltd (Bicester, UK) and Anne Baumeister as an additional employee representative to comply with the requirements under German law, were elected as additional members of the supervisory board.

In January 2013 Ralph Gillessen was promoted internally to Chief Marketing Officer and Riccardo Brizzi as Chief Operating Officer both joined the SQS group main board .

Employees

As mentioned in our full year 2012 results announcement, to satisfy increasing demand for our Managed Services offerings we began Phase II of the expansion of our Indian test centre facilities with the objective of increasing offshore/nearshore headcount to 48% of total headcount by the start of 2014. We made strong progress toward this target during the year such that billable offshore and nearshore staff accounted for 47% of our total headcount at 31 December 2013, up from 41% at 31 December 2012. From January 2014 onwards including the billable Thinksoft headcount this number is at 60% of total billable staff.

Total headcount at the period end had increased 22.7% during the period to 2,789 (31 Dec 2012: 2,272) with an additional c. 210 contractors retained during the period.

Fully loaded costs per fee earning consultant (including all overheads, but without contractor costs) were €90,000 for the year (2012: €96,800), down 7.1%. This decrease came from a stronger staff mix towards test-centres and cost reductions from weakening currencies in India and Egypt against the Euro, Sterling and US Dollar. Despite this significant increase in permanent staff we continued our careful focus on utilisation and as a result of this we are pleased to announce that utilisation had further improved and was slightly ahead of our operational targets at 193 billable days per project ready consultant on an annualised basis (FY 2012: 192 days).

Outlook

2013 has been a year of significant progress toward our strategic goals of increasing SQS's offshore capabilities and focussing our efforts on servicing larger contracts. These developments are improving our profitability and, combined with our revenue growth in the period, have resulted in a substantial increase in earnings.

This progress is anticipated to be further accelerated by the acquisition of Thinksoft, of which the first stage completed at the end of last year, which increases our offshore headcount, deepens our expertise in the financial services sector and expands our international reach. Thinksoft is already delivering a number of new opportunities and will make a full contribution to the Company's performance in 2014.

This, together with solid trading during the first quarter of 2014, gives us confidence in delivering continued growth in the coming year.

Diederik VosChief Executive Officer5 March 2014

Financial Review

Summary

SQS Group turnover grew by 7.5% to €225.8m (FY 2012: €210.1m) during the period.

As part of our mid-term strategy, a new organizational structure has been put in place at the beginning of 2013. Instead of two large regions the focus is now on the types of business.

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

· Managed Services (MS) to meet the demand of clients seeking efficiency in long-term engagements (between twelve months up to five years) of which a growing share (in many cases) is delivered from nearshore and offshore test centres. This also includes long term engagements for testing standard software package products;

· Specialist Consultancy Services (SCS) to meet the demand of clients seeking transformation and quality in specialized projects with skills like SAP, PLM (Product Lifecycle Management), Process Consulting and Improvement, and Load and Performance Testing as long as these resources are not active in MS projects; and

· Regular Testing Services (RTS) to meet the demand of more price conscious clients in IT projects who tend to be served with a smaller number of consultants on a more local basis and typically contracted for a short term (e.g. three months).

Alongside these major segments we are active via contractors (as far as these have not been included in MS), and in training & conferences and software product testing tools summarized as "Other".

Due to a change in valuation of Swiss pension assets required under IAS 19 by changes in regulations in Switzerland during 2013, there has been a minor adjustment of the 2012 P&L (€-60k), balance sheet and cash flow statement, which are therefore labelled as "adjusted" in the attached tables. The effect of this has been minor, with no visible effect on earnings per share for 2012.

Breakdown by business unit

Managed Services (MS)

Revenue in MS, our largest segment, amounted to €91.1m in the period (2012: €73.4m), an increase of 24.1%. The improvement in revenue was entirely organic and predominantly came from the extension of existing long term managed services contracts.

Specialist Consultancy Services (SCS)

This segment only saw a small increase during the period of 0.7% to €36.7m (2012: €36.4m). The low growth rate has been the result of demand for these ERP, PLM and process specialists in MS engagements (thus their revenue and margin contribution is counted under MS above), which we expect to be of a temporary nature.

Regular Testing Services (RTS)

Revenues from this segment decreased in line with our strategic goals during the period with a reduction of -2.8% to €77.0m (2012: €79.3m). As a result this segment represented 34% of total revenues during the period (2012: 38%).

Other

Revenue in the 'Other' segment amounted to €21.0m in the period (2012: €21.0m), no change against last year. Direct revenues from tools and trainings were lower. This is a result of our sales focus on the growth segments MS and SCS above mainly delivered by SQS consultants. Also in many client engagement SQS own tools are increasingly delivered as part of the service revenue ("Software as a Service") and would thus be reported under e.g. MS above.

Margins and Profitability

Gross profit improved by 10.2% to €72.3m (2012: €65.6m), with the gross margin at 32.0% (2012: 31.2%). The increase in the gross margin was mainly influenced by an improved gross margin from Managed Services contracts with 34.2% (2012: 33.5%) due to a growing proportion of contracts now entering a more mature life cycle phase. Gross margin from SCS was 36.0% (2012: 34.9%) and RTS improved to 30.2% (2012: 28.4%) as a result of our focus on more profitable client engagements.

Adjusted* profit before tax for the period was €12.4m (2012: €9.2m), an increase of 34.5%, with the adjusted * profit margin rising to 5.5% (2012: 4.4%). The profit before taxes benefitted from the improved gross margin and substantially lower finance costs of €0.9m (2012: €1.4m) mostly due to a positive impact from exchange rate gains of +€0.2m (2012: -€0.25m from exchange rate losses).

Adjusted** earnings per share increased to €0.30 (2012: €0.24) and were calculated on the undiluted and weighted average number of shares of 28,201,084 (2012: 27,893,289) which had increased after the placing of c. 2.6m new shares in November 2013.

* adjusted to add back IFRS effects of €0.8m including amortisation of intangible assets of acquired companies, actuarial adjustments for pensions, net of tax effects from share capital increase and extraordinary items of €2.6m for goodwill write off SQS Nordic, €0.4m due diligence costs for Thinksoft and provisions for interest from a tax audit.

** includes adjustments under * and a local tax expense which is €0.4m higher than under IFRS due to deferred taxes.

Costs

General & Administrative expenses (before adjustments of €0.8m and €2.6m under * above) for the period were €38.5m (2012: €35.6m). While slightly ahead as a percentage of revenue to 17.1%, the absolute growth was mainly due to increased hiring, staff training costs and investment in the US business.

Sales & Marketing costs for the period were €17.3m (2012: €15.9m) representing 7.7% of sales (2012: 7.6%).

Research & Development expense during the period reduced to €3.2m (2012: €3.5m) representing 1.4% (2012: 1.7%) of revenues. Research and development investment was mainly focused on the development of software testing tools and our proprietary PractiQ methodology.

Cash Flow and Financing

Cash flow from operating activities increased by 62.2% to €22.8m (2012: €14.1m). This resulted from a further improvement of the EBITDA to operating cash flow conversion rate of 119% (2012: 84%) due to improved order and invoicing workflow, particularly with our largest clients, despite an increase in total debtor days to 64 (2012: 58).

Cash outflow for investments increased to €23.9m (2012 €4.4m outflow) mainly due to an investment of €17.8m for the majority of the shares of Thinksoft. Of that an amount of €8.2m was paid to acquire 26% of the currently issued share capital of Thinksoft in December 2013. The remaining €9.6m were paid to an escrow account in India to fund the future acquisition of a further 26% of the Thinksoft share capital in an open offer procedure, which is expected to close in March 2014. As a result no control of Thinksoft was obtained in 2013 but the company will be consolidated in the accounts of SQS group from 1 January 2014 onwards.

A further cash outflow of €1.3m occurred for the second phase of the building of our India based offshore test centre in Pune creating another c. 350 work spaces.

Cash inflow from financing activities was €9.6m (2012: €3.5m outflow) reflecting the further redemption of loans and lease contracts, an increased dividend payment and an inflow of €13.9m from the placing of 2.6m new shares.

Balance Sheet

We closed the period with €15.2m (2012: €11.9m) of cash on the balance sheet and borrowings of €18.1m (2012: €19.7m). The resulting net debt position at the period end was therefore €2.9m (2012: €7.9m). These movements are in line with our policy to reduce net debt by freeing up positive cash flow from operations. Without the investment into Thinksoft we would have ended with a net cash position of €2.1m.

The restructuring measures we have taken in the Nordic region have led us to review the carrying value of those assets resulting in a write off of €2.8m (incl. exchange rate differences) to now €3.0m.

The number of ordinary shares in issue has increased to 30,562,679 by 2,618,507 ordinary shares for a placing and additional 50,883 ordinary shares from the exercise of employee stock options

Taxation

The reported tax charge of €3.4m (2012: €1.9m) includes current tax expenses of €3.7m (2012: €2.4) and deferred taxes of €-0.4m (2012: deferred taxes of €-0.5m). The tax rate on local GAAP results was 30% (2012: 27%), slightly increased above the normalized tax rate of 29% from an accrual for tax payments resulting from a tax audit in Germany.

For the full year 2014, we expect an actual tax rate of 29%.

Foreign Exchange

Approximately 58% of the Group's turnover is generated in Euros. For the conversion of revenues and costs generated in local currencies into Euro, the relevant official average exchange rate for the twelve-months-period of 2013 was chosen. For the conversion of the balance sheet items from local currency into Euro, the official exchange rate as at 31 December 2013 was used.

Due to a general strengthening of the Euro, foreign exchange had a small €89,000 negative translational impact on earnings for the period. Had the Pound/Swiss Franc/Indian Rupee/Swedish Krona/US-Dollar to Euro exchange rates remained the same as in 2012, our non-Euro revenues for the period would have been €3.2m higher, resulting in an increase in PBT of €89,000.

International Financial Reporting Standards (IFRS)

The Consolidated Financial Statements of SQS and its subsidiary companies ("SQS Group") are prepared in conformity with all IFRS (International Financial Reporting Standards) and Interpretations of the IASB (International Accounting Standards Board) which are mandatory at 31 December 2013.

The SQS Group Consolidated Financial Statements for the twelve month period ended 31 December 2013 were prepared in accordance with uniform accounting and valuation principles in Euros.

Rene GawronChief Financial Officer5 March 2014

Notes to the Consolidated Financial Statements at 31 December 2013

1. Description of business activities

SQS, based in Cologne, Germany, is one of the largest independent pure play providers of software testing and quality management services by revenue. SQS is independent from software vendors and other IT service suppliers. It can therefore provide unbiased opinions to customers on 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 2,789 employees at the end of 2013 (previous year 2,272 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 2013.

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 2013.

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 1 January 2013:

IFRS 1 First-time Adoption of International Financial Reporting Standards - Government Loans - Amendments to IFRS 1

IFRS 1 First-time Adoption of International Financial Reporting Standards - Regulations for hyperinflation and the removal of fixed dates of application for first-time adopters

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

IFRS 13 Fair Value Measurement - Standardization of rules for measuring Fair Value

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

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

IAS 19 Employee benefits - Abolition of corridor method

IFRS 10, 12, IAS 27 Investment Entities - Exemption to the consolidation requirements for investment entities

Furthermore, in the 2009-2011 annual improvements cycle, the IASB issued improvements on existing standards.

The impact of new standards and amendments that require restatements of previous financial statements of SQS Group are as follows:

IAS 1 Presentation of Items of Other Comprehensive Income - Amendments to IAS 1

The amendments to IAS 1 introduce a grouping of items presented in OCI. Items that will be reclassified ('recycled') to profit or loss in the future have to be presented separately from items that will never be reclassified. The amendment affects presentation only and has no impact on the Group's financial position or performance.

IAS 1 Clarification of the requirement for comparative information (Amendment)

This amendment clarifies the difference between voluntary additional comparative information and the minimum required comparative information. An entity must include comparative information in the related notes to the financial statements when it voluntarily provides comparative information beyond the minimum required comparative period. The amendment clarifies that the opening statement of financial position (as at 1 January 2012 in the case of the SQS Group), presented as a result of retrospective restatement or reclassification of items in financial statements does not have to be accompanied by comparative information in the related notes. As a result, the SQS Group has not included comparative information in respect of the opening statement of financial position as at 1 January 2012. The amendment affects presentation only and has no impact on the Group's financial position or performance.

IAS 19 Employee Benefits (Revised 2011)

The Group applied IAS 19 (Revised 2011) retrospectively in the current period in accordance with the transitional provisions set out in the revised standard. The opening statement of financial position of the earliest comparative period presented (1 January 2012) and the comparative figures have been accordingly restated.

As a result, the SQS Group has made certain changes in the measurement of the obligations for pensions, especially in view of the accounting for defined benefit plans.

The key change in the measurement of the pension obligation was in Switzerland and relates primarily to the inclusion of risk sharing elements in the valuation of the defined benefit liability. These were especially employee contributions. As a result, the adjusted value of the defined benefit obligation as at 1 January 2012 has declined.

The change in the measurement of the defined benefit obligations relates also to the treatment of other expected administrative costs. Furthermore, all past service costs are recognised at the earlier of when the amendment/curtailment occurs or when the related restructuring or termination costs are recognised (rather than spread such costs over the term of obligations).

The interest cost and expected return on plan assets used in the previous version of IAS 19 are replaced with a net-interest amount under IAS 19 (Revised 2011), which is calculated by applying the discount rate to the net defined benefit liability at the start of each annual reporting period. The expense arising from unwinding the interest on pension obligations is now offset against interest income from plan assets.

All re-measurements of the net defined benefit liability were recognised through other comprehensive income (OCI). In previous financial statements for the year ended 31 December 2012, the difference between the expected return of plan assets and interest income of plan assets were recognised in profit or loss.

The adjustments to the provision for pre-retirement part-time working arrangements result from a change in the measurement of top-up amounts, which are now required, in accordance with revised IAS 19, to be recognised as other long-term employee benefits.

Under the new rules, the expenses for top-up amounts are required to be recognised over the period of the working phase of such arrangements and then released over the period of the work-free-phase (rather than recognising the full amount as a provision at the start of the working phase).

The removal of the corridor approach and other amendments to IAS 19 did not have any impact on the financial statements of the SQS Group because this approach was not applied in the previous financial statements.

The new rules were required to be applied retrospectively.

For this reason, the statement of financial position at 1 January 2012 and at 31 December 2012 has been adjusted as follows:

The adjustments resulting from revised IAS 19 did not have any cash flow impact. For this reason, there are no changes in the cash flow for the Group for the year 2012. However, there are some shifts between individual reconciliation line items.

IAS 19 (Revised 2011) also requires more extensive disclosures.

The following standards and amendments to existing standards have been published and have been endorsed by the European Commission for the group's accounting periods beginning after 1 January 2013 or later periods, but the group has not early adopted them:

IFRS 9 Financial Instruments: Classification and Measurement - Regulations for the accounting of financial instruments measured at amortized cost or Fair Value

IFRS 10 Consolidated Financial Statements - Guidelines for limiting the scope of consolidation

IFRS 11 Joint Arrangements - Regulations for accounting treatment of jointly controlled entities

IFRS 12 Disclosure of Interests in Other Entities - Disclosure requirements for interests held in other entities

IFRS 10, 11 and 12 Transitional guidelines until these standards applied

IFRS 14 Regulatory Deferral Accounts (not yet endorsed)

IAS 19 Employee Benefits Recognition of contributions from employees or third parties to defined benefit plans 

IAS 27 Separate Financial Statements - Limiting IAS 27 to separate financial statements

IAS 28 Investments in Associates and Joint Ventures - Revision of accounting rules for associated companies and joint ventures

IAS 32 Financial Instruments: Presentation - Offsetting of financial assets and liabilities

IAS 36 Impairment of assets - Additional disclosures relating the different levels of Fair Value measurement as well as the valuation methods applied and key assumptions for level 2 and level 3 valuations

IAS 39 Financial Instruments: Recognition and Measurement - Novation of derivatives

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

IFRIC 21 Levies - Recognition of obligations to pay levies (not yet endorsed)

Furthermore, in the 2010-2013 annual improvements cycle, the IASB issued improvements on existing standards. Those amendments have not yet been endorsed by the EU.

None of those standards and amendments will most likely have any material impact on the annual consolidated financial statements of the SQS Group.

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 2013, the Company held interests in the share capital of more than 20% of the following undertakings (all of those subsidiaries have been consolidated):

On 1st October 2013 SQS AG has acquired non-controlling interests in SQS Nederland BV increasing its shares to 95.1% for an amount of € 100k.

SQS AG holds 15% of the shares of SQS Portugal Lda with a book value of € nil (at 31 December 2012: € nil).

On 8th November 2013 SQS AG signed a share purchase agreement in order to acquire up to 53.57 % shares of the Indian Company Thinksoft Global Service Limited ("Thinksoft"), Chennai. Thinksoft Global Services Ltd. is one of largest independent software testing companies focused on the Banking, Financial Services and Insurance sector ("BFSI") and is listed on the Bombay Stock Exchange (the "BSE") and National Stock Exchange (the "NSE") of India.

On 17 December 2013, SQS AG acquired a first portion of 26 % of the shares and voting rights in Thinksoft. The purchase price for this first portion was €8,179k. The second portion is likely to be acquired in March 2014. As SQS did not control and was not able to exercise significant influence on the entity on 31 December 2013, Thinksoft has not been consolidated yet. In the statement of financial position the acquired shares are shown under other financial investments.

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 rates did not fluctuate significantly in 2013, the items of the income statements of these entities were translated at the weighted average exchange rate for the year 2013. 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 when the gain or loss on disposal is recognised.

3. Segmental reporting

Based on the international organisational structure for SQS group a new organizational structure is in place since 1 January 2013. Instead of different regions the focus is now on the types of our business. Our three primary service offerings are

· Managed Services (MS) to meet the demand of clients seeking efficiency in long-term engagements (between six months up to five years) of which a growing share (in many cases) is delivered from nearshore and offshore test centres. This also includes long term engagements for testing standard software package products,

· Specialist Consultancy Services (SCS) to meet the demand of clients seeking transformation and quality in specialized projects with skills like SAP, PLM (Product Lifecycle Management), Process Consulting and Improvement, and Load and Performance Testing as long as these resources are not active in MS projects,

· Regular Testing Services (RTS) to meet the demand of more price conscious clients who tend to be served on a more local basis and are typically contracted for a short term (e.g. three months).

Beside these major sectors there is the business with contractors (as far as these have not been included in MS), training & conferences and software testing tools. Each of these minor operating segments represent less than 10 % of the Group's revenues and the Group's profit. Thus, all these other segments are presented as "Other".

The group management board consisting of CEO (Chief Executive Officer), CFO (Chief Financial Officer), COO (Chief Operating Officer) and CMO (Chief Market 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.

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

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

The figures regarding the year 2012 have been amended according to the new structure of the operating segments.

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. Therefore 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 2013 and 2012.

The following revenue information by geographical regions 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 2013 amounted to €22,147k (2012: €24,752k). 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.

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 €0k (2012: €296k) 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 2012: €150k) 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 €9,082k (2012: €7,521k). Of this, €3,505k (2011: €3,528k) was attributable to the amortisation of development costs.

Rentals and leasing

Operating lease costs in connection with office space and equipment in 2013 amounted to €6,668k (2012: €6,440k).

The lease contracts will expire between 2014 and 2017. Some of them can be prolonged or renewed, some allow price alignments.

5. Net finance costs

The net finance costs are comprised as follows: