7th Mar 2006 07:02
SQS Software Quality Systems AG07 March 2006 Embargoed until 0700 Tuesday, 7 March 2006 SQS Software Quality Systems AG Maiden Preliminary Results For the full year ended 31st December 2005 SQS Software Quality Systems AG (AIM:SQS.L) the leading independent pan-Europeanprovider of quality management and testing services for software development,today announces its maiden preliminary results for the full year ended 31stDecember 2005. Financial Highlights: • Turnover up by 12.5% to €54.7m (2004: €48.7m) • Profit before tax up 38.5% to €3.7m (2004: €2.7m) • EBITDA up 18% to €6.8m (2004: €5.8m) • Adjusted earnings per share up 66% to €0.22 (2004: €0.13) • Improved gross margin • Continued strong underlying cash flow; borrowings decreased by 57% to €6.7m (2004: €15.8m) Operational Highlights: • Successful AIM flotation raising €16m on September 20, 2005, followed by a secondary listing on the new German Entry Standard on December 2, 2005 • Grew recurring revenues - secured significant contract renewals with existing client base • Improved sales capabilities - to further grow the business and establish the framework for long term outsourcing contracts • Invested in growth markets - increased activity in embedded systems by successfully securing a sizeable contract with a leading aircraft manufacturer; finished a major Mercury tool integration project at a telecom carrier by providing high tech software engineering services Commenting on the results, Rudolf van Megen, CEO, said: "During the year, SQS strengthened its position as the leading independentpan-European provider of quality management and testing services for softwaredevelopment and once again grew at almost three times the rate of the EuropeanIT service market.""In 2006, we will concentrate on both acquisitive and organic growth, focusingon expanding markets such as outsourcing and embedded systems. Trading has beenencouraging in the first two months of 2006, and as expected, growth is wellahead of the comparable period last year. The pipeline remains strong." For further information please contact: SQS Software Quality Systems AG www.sqs.deRudolf van Megen (CEO)/Rene Gawron (CFO) +49 (2203) 91 54 0 Evolution Securities Limited 020 7071 4300Jeremy Ellis/Mike Read Smithfield 020 7360 4900Sara Musgrave Print resolution images are available for the media to view and download from www.vismedia.co.uk Notes to Editors SQS is the leading independent pan-European provider of quality management andtesting services for software development. SQS consultants design and overseequality management processes during software and systems development, and testthe resulting products for errors and omissions. Headquartered in Cologne, Germany, SQS now has operations across Europe withoffices in seven countries and has over 470 employees. SQS has a strong presencein Germany (Cologne, Munich, Frankfurt, Stuttgart and Hamburg) with subsidiariesin the UK, Netherlands, Switzerland and Austria. SQS also has a minor stake inan operation in Portugal and a partnership operation in Spain. With over 3,000 completed projects under its belt, SQS has a strong customerbase including half of the DAX 30 companies and 30% of the STOXX-50. Theyinclude names like Dresdner Bank, Lloyds TSB, Deutsche Telekom, Vodafone,Daimler Chrysler, and Airbus spread across the full range of industries. SQS is the first German company to have a primary listing on AIM, completing itsIPO on 20 September 2005 raising £10.8m before expenses at an issue price of190p. SQS is included in the Software and Computer Services sector (9530) withinthe Computer Services subsector (9533) and has a RIC code of SQS.L. SQScompleted a secondary listing on the Deutsche Boerse in Frankfurt on 2ndDecember 2005. For further information, please visit www.sqs-uk.com. Chief Executive's Statement Introduction I am pleased to present SQS's maiden preliminary results following its admissionto AIM in September 2005. SQS had an excellent year, recording a materialincrease in both profit and revenues. This improvement resulted from anexcellent underlying performance in our core businesses. During the year we alsoinvested in three growth markets by developing our long term software testingoutsourcing business, increasing our presence in the software testing ofembedded systems, and building technical test frameworks that support automationof software testing. Business remained strong within our existing client baseand we also secured a number of additional new projects which provide theplatform for further growth in the current year. Results Turnover from continuing operations rose 12.5% to €54.7m (2004: €48.7m).Underlying profit before tax increased 38.5% to €3.7m (2004: €2.7m) benefittingfrom improved margins. EBITDA rose by 18% to €6.8m (2004: €5.8m). Margins improved despite continuing price pressure as a result of improvingutilisation of billable consultants throughout the Group. Turnover growth was highest in Other European Countries (Switzerland, Austriaand the Netherlands), especially Switzerland, where turnover grew by 67%, and inthe United Kingdom where turnover grew by 18.2%. Adjusted earnings per share (adjusted to add back deferred taxes and IFRS taxdifferences) of €0.22 rose by 66 % (2004: €0.13). The balance sheet has been considerably strengthened during the year reflectingthe benefit of the €14.1m net proceeds from our admission to AIM and thepositive net income in 2005. We reduced our borrowings by €9.0m to €6.7m (2004:€15.8m). Cash balances and marketable securities at the year end stood at €6.5m(2004: cash €1.5m). Dividend As SQS was quoted for only three months of the year the Board is not proposing adividend in respect of 2005. Moreover, the Directors consider that at this timeit is more appropriate to reinvest funds in the development of the Company'sgrowing businesses. However, the Board intends to pursue a progressive dividend policy in future andtherefore intends to pay a final dividend for the year ending 31st December2006. The Board There has been one change to our supervisory board in preparation for ouradmission to AIM last year. There were no changes to our management board.We are pleased to welcome Jeremy Hamer who joined our supervisory board onAugust 25, 2005. Mr Hamer is also a director of a number of other quoted andunquoted companies including Inter Link Foods plc and Avingtrans plc, and he isnon-executive chairman of Glisten plc. With over ten years experience as a boardmember of various UK quoted companies, his appointment is a significant step forSQS as a public company. Mr Hamer has replaced Hartmut Voss who had served onour supervisory board since 2000. We thank him for his valuable contribution andcommitment. Strategy Our strategy is to strengthen our market position as the leading independentpan-European provider of quality management and testing services for softwaredevelopment. We aim to grow our business with long term outsourcing contractsand investment in expanding markets such as embedded systems in the aircraftmanufacturing and automotive industries. We intend to strengthen our position ina number of key European markets and will actively look for acquisitions tosupport and accelerate this strategy. EmployeesOn behalf of the board, I would like to thank all our employees for theircontribution, hard work, and excellent support during the last year. I amconfident that we have the team in place to capitalise on the opportunitiesavailable and to enable us to deliver long term shareholder value. Outlook During the year, SQS strengthened its position as the leading independentpan-European provider of quality management and testing services for softwaredevelopment and once again grew at almost three times the rate of the EuropeanIT service market.In 2006, we will concentrate on both acquisitive and organic growth, focusing onexpanding markets such as outsourcing and embedded systems. Trading has beenencouraging in the first two months of 2006, and as expected, growth is wellahead of the comparable period last year. The pipeline remains strong. Rudolf van MegenChief Executive Officer7th March 2006 Review of Business During 2005, we continued to strengthen our business by improving utilisationrates and overheads, and increasing the number of clients to over 300. Weachieved this by increasing the number of projects staffed with internationalteams and by hiring 37 additional employees, mainly consultants, with strongsoftware engineering backgrounds as well as senior project management skills. Asa service company helping its clients to improve the quality of their softwareand IT systems, our commitment to quality is paramount. Strategic Update Market driversSoftware quality management and testing constitutes a segment of the IT servicesmarket and therefore growth in the IT services market closely correlates withgrowth in software quality management and testing. Research conducted by theEuropean Information Technology Observatory ("EITO") showed the European growthrate for IT services to be approximately 4.7% in 2005. In 2005, SQS achievedgrowth at almost three times that rate.Market drivers include the increasing complexity of software and IT systems,higher regulatory demands imposed on IT systems by requirements such as theSarbanes Oxley Act, and the high number of IT projects that either fail or areout of budget and/or time.In addition, continuing return on investment (ROI) pressures, coupled withincreasing "industrialisation" of the software engineering process has led to anincreased demand for outsourced software testing as well as better qualitymanagement of embedded systems. Strategic GoalsThe SQS Group strategy builds on five strategic goals which all contribute tomarket leadership as a service company and resulting shareholder value. Theyare: • to extend leadership in independent quality management and testing by delivering added value to our customers in order to achieve their goals • to grow the business significantly above the market growth rate for IT services • to remain the financially strongest independent quality service company in Europe • to extend and retain a strong base of highly motivated, skilled, and best performing employees • to spot and anticipate trends in IT quality management and testing and use them for the benefit of our clients. Services and product lines • IT professional services: within its broad range of software testing and quality management services, SQS has enhanced its offerings in the fields of code quality management, assessments of software development and IT organisations, quality management in standard software package projects, and outsourcing. • Tools, licences, and maintenance: SQS's specialist range of software testing tools which work in conjunction with the tools available from competitors has been enhanced by Version 8.0 of our SQS-Test Professional product. The first press release for this product was presented to the market in December 2005. • IT training and IT events: The training business was extended. ISTQB and ISEB courses were updated for the new versions of the syllabus. The successful SQC conferences (Software and Systems Quality Conferences), heldin Germany and the UK are two of the largest quality management and softwaretesting events in Europe. We plan to expand these into one further country in2006. SQS has been investigating partnership opportunities for theseconferences, and is pleased to have formed a media alliance with one of Europe'smost influential publishers, IDG Communications (e.g. "Computerwoche" inGermany). The partnership with IDG is expected to increase the number ofdelegates, exhibitors, and sponsors attending our conferences in 2006. Geographic review GermanyRevenue in Germany, our traditional home market, was €34.2m (2004: €34.1m)contributing 63% to the Group's total revenue compared with 70% in the prioryear. This reflects the increase in services rendered for Group companies inother territories as well as the fact that our growth in Germany was limited bythe number of available skilled consultants. Services sold within the Group(mainly to Switzerland and the UK) increased by 59% to €3.9m (2004: €2.4m). Weintensified our hiring activities and skills training in the second half of 2005in order to be able to grow the local business in Germany significantly in 2006.During the year, we secured key contract renewals with our largest client (apublic service organisation in Germany) and other major customers, all of whichprovide a solid base for the current year. We have also increased the businessbase in embedded systems by securing extended contracts with our largestaircraft manufacturing client. We have successfully finished the first majorMercury tool integration project at a telecom carrier by providing high techsoftware engineering services. Mercury is the worldwide leading company in thefield of software testing tools. We have hired a number of high calibre salesmanagers, some with extensive experience in outsourcing projects and globalaccount development, who will enable SQS to grow its business with internationalclients. United KingdomIn the United Kingdom, which is our second largest regional segment and thelargest European market for IT services in general, we generated revenues of€9.2m (2004: €7.8m), 17% of the Group's total. This represented an 18% increaseyear on year. While business with existing and new clients increased,professional training revenue grew by 17% and SQS conference revenue grew by23%. We also achieved above average market growth in our services with logocertification for telecommunication applications. To improve earnings we haveinitiated measures for improving profits in the UK operation such as improvingutilisation of billable staff and reducing overheads. The UK market continues to be very fragmented as a handful of similar and largersized pure play testing services companies serve this market. We continue tofocus on further consolidation. Other European Countries (Switzerland, Austria, and the Netherlands)Switzerland, Austria and the Netherlands contributed aggregate revenue of €11.3m(2004: €6.8m), or 21% of the Group's total turnover. This strong year on yearincrease of 67% predominantly came from our Swiss operation due to successfulwins of recurring project business with major Swiss clients in financialservices and telecommunications. During the year we doubled the number of localSwiss consultants to 16, and as we continue to add local staff we expect this toreduce the demand on our German operation, which limited our sales growth inGermany in 2005. Summary We aim to grow organically by adding more consultants and offering a greaterrange of services to our existing client base. In particular, we will look toincrease our market presence in test outsourcing, software testing of embeddedsystems as well as building technical test frameworks that support testautomation. The existing client relationships, of which we have over 300, arethe backbone to our future growth. Where appropriate, we will also seek to consolidate other specialists in ourfield and pursue infill acquisitions to further establish or strengthen ourmarket position in selected European countries. Finance Director's Review Results Total revenue for the year grew by 12.5% to €54.7m (2004: €48.7m). ITProfessional Services was the major contributor with revenues of €50.7m (2004:€44.9m) a 13% increase year on year. Revenue from tool licenses and maintenancewas €2.1m (2004: €2.2m), with IT training and IT events contributing €1.9m(2004: €1.6m). Earnings before interest, tax, depreciation, and amortisation (EBITDA) was up18% year on year to €6.8m (2004: €5.8m). Profit before tax was €3.7m (2004:€2.7m), up 38.5%. The improved result was based on improved gross margins andrelatively reduced administrative expenses and research & development overheads,while sales & marketing expenses increased in order to foster future revenuegrowth. Adjusted* earnings per share improved to €0.22 (2004: €0.13). *based on net income increased by €1.1m deferred taxes and IFRS tax differenceson capitalised R&D and IPO costs but including actual profit taxes of €0.2mpayable under local GAAP Costs Administrative costs of €8.5m (2004: €7.9m) were 15.5% of sales (2004:16.3%),increased in absolute terms because of the improvement of local infrastructurein Switzerland and hiring costs. Sales & marketing costs of €3.5m increasedrelative to sales (to 6.4% from 5.8%), as we continued to invest in additionalsales resources to support current and future organic growth of the business.Research and development costs of €2.7m were marginally reduced relative tosales (to 4.9% from 5.0%), reflecting a peak in efforts for Version 8.0 of theSQS-TEST Professional tool and course development for our training products. Taxation The Group tax charge of €1.3m has two components; one is tax on profits payableunder local GAAP of €0.2m, and the other is the deferred tax and tax differencesthat we are required to show under IFRS of €1.1m. Due to tax breaks and a taxeffective expensing of the IPO costs under German local GAAP, SQS will pay no ornegligible tax on profits in Germany, Austria and the Netherlands. The remaining€0.2m tax on profits arose in the UK and Switzerland. Deferred tax and IFRS taxdifferences were €1.1m on capitalised R&D and IPO costs. Cash Flow and Financing The group generated operating cash inflow of €2.8m (2004: €4.4m). Althoughoperating profits have risen, operating cash flow was impacted by an €0.9mincrease in receivables and tax payments of €0.6m (2004: •-0.2m). Cash flow fromfinancing activities was €5.1m (2004: •-1.9m) and includes a positive cash flowfrom the net proceeds of the IPO of €14.1m and the pay back of loans andconvertible bonds of •-9.0m (2004: •-1.6m). Cash flow from investments was•-8.5m (2004: •-1.7m), including •-2.7m for capitalised R&D for products andinvestments in intangible assets (2004: •-1.4m), and an additional •-5.6m inmarketable securities. In total, cash and marketable securities were €6.5m(2004: €1.5m) at the year end. Foreign Exchange Approximately 70% of the Group's turnover is generated in Euros. With theexception of SQS UK Group Ltd and Software Quality Systems (Schweiz) AG, allsubsidiaries of SQS are located in the currency area of the Euro. For theconversion of the local currency into Euros, the official fixed exchange ratewas chosen. For the conversion of the balance sheet items from foreign currencyinto Euros, the official mean rate as at 31st December 2005 was used. The Group's exposure to foreign exchange risks is negligible as more than 90% ofthe business is billed and served locally. Amortisation Amortisation of goodwill is no longer carried out due to the changed IFRSaccounting rules. On account of the high amortisation of these goodwill valuesin previous years, their book values today lie considerably below the originalacquisition costs. No reductions in value were necessary by reason of theimpairment tests carried out in accordance with IAS 36. International Financial Reporting Standards (IFRS) The Consolidated Financial Statements of SQS and its subsidiary companies ("SQSGroup") are prepared in accordance with all IFRS Standards, as has been the casesince 2001. In addition, they conform with the Interpretations of the IASB(International Accounting Standards Board) applied to those financial statementswhich have reporting periods starting on or after 1st January 2005. The SQS Group Consolidated Financial Statements for the business year 2005 wereprepared in accordance with uniform accounting and valuation principles inEuros. First-time application of new standards; change in the accounting policy andadjustment of figures from the previous year SQS has applied standards of the Improvements Project of the IASB and otherchanged standards which are binding for the business year commencing 1 January2005. The changes have led to some additional details but they did not have anyeffect on the approach and valuation. Since 1 January 2004, SQS applies IFRS 3 and IAS 36 and 38 in the version of2004. As a result, the scheduled amortisation of goodwill is no longer carriedout. SQS performs annual intrinsic value tests for each cash generating unit. Further, in 2004 SQS altered the presentation of minority interests inaccordance with IAS 1 in the version of 2003. This item is now shown underequity. The accounting and valuation methods correspond to the methods appliedin the previous year. SQS does not apply any further changed or newly passed standards prior to thebinding date stipulated. Nor, according to the assessment of SQS, would theapplication of these standards have any effects on the financial statements. Rene GawronChief Financial Officer7th March 2006 Consolidated Profit and Loss Accountfor the business year ended 31st December 2005 (IFRS) •''000 (Notes) 2005 2004 Revenue 54,737 48,668 Cost of sales 35,563 31,942 ------- -------Gross profit 19,174 16,726 General and administrative expenses 8,473 7,942Sales and marketing expenses 3,525 2,829Research and development expenses 2,690 2,426 ------- -------Profit before tax and financing result (EBIT) 4,486 3,529 Net interest -773 -848 ------- -------Profit before taxes (PBT) 3,713 2,681 Income tax (5) 1,319 767Value added tax (5) 0 220 ------- -------Profit for the year 2,394 1,694 Attributable to:Equity shareholders 2,394 1,737Minority interests 0 -43 ------- -------Consolidated profit for the year 2,394 1,694 ======= ======= Earnings per share, undiluted (•) (7) 0.21 0.17 ======= ======= Earnings per share, diluted (•) (7) 0.20 0.17 ======= ======= Consolidated Balance Sheet as at 31st December 2005 (IFRS) •''000 (Notes) 2005 2004 Current assetsCash and cash equivalents 839 1,478Marketable securities 5,626 0Trade receivables 11,433 8,804Other receivables 518 438Work in progress 135 251Income tax receivables 306 218 -------- -------- 18,857 11,189 Non-current assetsIntangible assets (8) 2,395 1,649Goodwill (8) 11,589 11,589Tangible assets 756 905Deferred taxes (5) 2,007 2,006 -------- -------- 16,747 16,149 -------- --------Total Assets 35,604 27,338 ======== ======== Current liabilitiesBank loans and overdrafts 3,776 3,159Convertible bonds 0 1,130Liabilities under leasing contracts 0 11Trade creditors 1,844 2,261Other accruals 75 67Tax accruals 239 525Tax liabilities 1,957 1,787Other Current liabilities 5,232 4,943 -------- -------- 13,123 13,883 Non-Current liabilitiesBank loans 2,971 11,478Liabilities under leasing contracts 0 0Other accruals 151 145Pension accruals 305 323Deferred taxes (5) 859 574 -------- -------- 4,286 12,520 -------- --------Total Liabilities 17,409 26,403 ======== ======== Shareholders' equity (17)Share capital 15,763 4,202Share premium 10,935 1,669Statutory reserves 53 53Foreign currency exchange adjustments 200 143Retained earnings -8,756 -5,132 -------- --------Equity attributable to equity shareholders 18,195 935 Minority interests 0 0 -------- --------Total Equity 18,195 935 -------- -------- -------- --------Equity and Liabilities 35,604 27,338 ======== ======== Consolidated Cash Flow Statement as at 31st December 2005 (IFRS) •''000 (Notes) 2005 2004 Net cash flow from operating activitiesProfit before taxes 3,713 2681Add back forDepreciation and amortisation 2,361 2288Profit/(loss) on the sale of fixed assets -33 -14Other non-cash (expenses)/income not affectingpayments -145 -45Net interest income 766 824 ------ ------Operating profit before changes in thenet current assets 6,662 5,734Decrease/(increase) in trade receivables andreceivables from partly completed contracts not yetbilled -2,629 -1737Increase/(decrease) in work in progress, otherassetsand pre-paid expenses and deferred charges 38 338Decrease/(increase) in trade creditors -417 -205Increase/(decrease) in remaining accruals 14 198Increase/(decrease) in pension accruals -18 59Increase/(decrease) in other liabilities anddeferred income 456 656 ------ ------Cash flow from operating activities 4,106 5,043Cash effect of foreign exchange rate movements 7 24Interest payments -833 -820Tax payments -509 164 ------ ------Net cash flow from current business activities 2,771 4,411 Cash flow from investment activitiesPurchase of intangible assets -2,740 -1437Purchase of tangible assets -221 -230Proceeds from the sale of tangible assets 35 24Purchase of marketable securities available for sale -5,632 0Foreign currency result -7 -24Interest received 67 31Changes in financial resources due to loss of controlof subsidiary undertakings 0 -80 ------ ------Net cash flow from investment activities -8,498 -1,716 Cash flow from financing activitiesDividends paid 0 0Proceeds from the issue of share capital (17) 15,909 0Repurchase of shares 0 -96Costs for IPO -1,790 0Dividends paid to minority interest 0 0Proceeds from borrowings 0 0Repayment of convertible bonds -1,130 0Repayment of finance loans -7,890 -1634Redemption / termination of leasing contracts -11 -89 ------- ------Net cash flow from financing activities 5,088 -1,819 Change in the level of funds affecting payments -639 876Cash and cash equivalentsat the beginning of the year 1,478 602 ------- ------Cash and cash equivalentsat the end of the year 839 1,478 ======= ====== Notes to the Financial Informationat 31 December 2005 1. Summary of Significant Accounting Policies Basis of preparation The Consolidated Financial Statements of SQS and its subsidiary companies ("SQSGroup" or "SQS Konzern") are prepared in conformity with all IFRS Standards(International Financial Reporting Standards, formerly IAS = InternationalAccounting Standards) and Interpretations of the IASB (International AccountingStandards Board) adopted by the EU Commission which are to be applied for thosefinancial statements whose reporting period starts on or after 1 January 2005.The new and revised Standards and interpretations of the IASB were not appliedin the business year 2005 prior to the binding date stipulated. The Financial Information has been prepared on the historical cost basis. TheFinancial Information is presented in Euros and amounts are rounded to thenearest thousand (€000) except when otherwise indicated. Statement of compliance The Financial Information of SQS and its subsidiaries (together the 'SQS Group')has been prepared in accordance with IFRS as adopted for use in the EU. First-time application of new standards; Change in the accounting policy andadjustment to figures from the previous year SQS has applied standards of the Improvements Project of the IASB and otherchanged standards which are binding for the business year commencing 1 January2005. The changes had led to some additional details but did not have any effecton the approach and valuation. Since 1 January 2004, SQS has applied IFRS 3 and IAS 36 and 38. As a result, thescheduled amortisation of the goodwill is no longer carried out. SQS performsannual intrinsic value tests for each cash generating unit. Further, in 2004, SQS altered the presentation of minority interests inaccordance with IAS 1 in the version of 2003. This item is now shown underequity. The accounting and valuation methods correspond to the methods appliedin the previous year. SQS does not apply any further changed or newly passed standards prior to thebinding date stipulated. Nor, according to the assessment of SQS, would theapplication of these standards have any effects on the financial statements. Basis of consolidation The Financial Information comprises the financial statements of SQS SoftwareQuality Systems AG and its subsidiaries as at 31 December each year. Subsidiarycompany financial statements are prepared on a consistent basis to those ofother SQS Group companies. All companies in the SQS Group have the sameaccounting reference date of 31 December. All inter-company balances and transactions, including unrealised profitsarising from intra-group transactions, have been eliminated in full. Subsidiaries are consolidated from the date on which control is transferred tothe SQS Group and cease to be consolidated from the date on which control istransferred out of the SQS Group. Goodwill Goodwill arising on acquisition is initially measured at cost, being the excessof the cost of the business combination over the acquirer's interest in the fairvalue of the identifiable assets, liabilities and contingent liabilities. Anyminority interest in the acquiree is stated at the minority's proportion of thenet fair values of those items. Following initial recognition, goodwill ismeasured at cost less any accumulated impairment losses. Goodwill is reviewedfor impairment, annually or more frequently if events or changes incircumstances indicate that the carrying value may be impaired. At the acquisition date goodwill is allocated to each of the cash-generatingunits expected to benefit from the combination's synergies. Impairment isdetermined by assessing the recoverable amount of the cash-generating unit, towhich the goodwill relates. Where the recoverable amount of the cash-generatingunit is less than the carrying amount, an impairment loss is recognised. Wheregoodwill forms part of a cash-generating unit and part of the operations withinthat cash generating unit are disposed of, the goodwill associated with thedisposed operation is included in the carrying amount of the operation whendetermining the gain or loss on disposal of the operation. Goodwill disposedof in this circumstance is measured on the basis of the relative values of theoperation disposed of and the portion of the cash-generating unit retained. 5. Taxes on earnings Deferred income tax is provided, using the liability method, on all temporarydifferences at the balance sheet date between the tax bases of assets andliabilities and their carrying amounts for financial reporting purposes. Thecalculation is based on the tax rates anticipated in the respective countries asat the realisation date. These are essentially based on the statutory provisionsapplicable or passed by the government at the date of the Financial Statements. As a basic principle, SQS Software Quality Solutions AG and its Germansubsidiaries are liable to corporate income tax, the solidarity surcharge andtrade tax. The results of the Company are subject to corporate income tax at25%. A 5.5 % solidarity surcharge is imposed on corporate income tax. The tradeincome tax amounts to 19% of the taxable income and is deductible for thepurpose of determining the taxable income. The tax credit granted to persons liable to tax in Germany follows the so-calledhalf-income system, i.e. only 50 % of the income from the company is liable totax in the hands of the shareholder. Consolidated income tax expense / (income) are as follows: 31 December 31 December 2005 2004 €000 €000 Current tax expense/ (income) 238 372Tax on IPO costs 716 -Adjustments in respect of current income tax ofprevious periods 115 (48)Reversal of the value adjustment on deferred taxclaims - (160)Deferred tax 250 603Taxes on income 1,319 767 A reconciliation of income tax applicable to the accounting profit before incometax at the statutory income tax rate to the income tax expense in the FinancialInformation is as follows: 31 31 December December 2005 2004 €000 €000Profit/ (loss) before tax multiplied by thestandard rate ofGerman income tax of 40% 1,477 1,072Adjustments in respect of current income taxof 115 (48)previous yearsDifferential tax rates in respect of overseassubsidiaries (209) (77)Expenditure not allowable for income tax 16 14purposesAdjustments in respect of deferred taxes - (160)Other (80) (34) At effective income tax rate of 35 % (2004: 29 1,319 767%) In the SQS Group, there are tax credit balances of approx. • 2,000,000 (2004 •2,000,000) which are partly available to the shareholders in the framework ofdistributions. For the assessment of the deferred tax claims and debts, SQS Software QualitySolutions AG and its German subsidiaries apply a tax rate based on the currenttax law in Germany of 40% (2004: 40 %) which takes into account corporation tax,the solidarity surcharge and trade tax.For the deferred tax claims of the overseas subsidiaries, the local tax ratesare taken as the basis. Deferred income tax relates to the following: 31 December 31 December 2005 2004 €000 €000 Losses carried forward 1,857 1,861Pension accruals 74 75Other accruals 76 70 Deferred tax assets 2,007 2,006 Capitalised development costs (780) (557)Trade receivables (18) (17)Other (61) Deferred tax liabilities (859) (574) Net deferred tax assets 1,148 1,432 Deferred tax assets are recognised when it is considered probable that economicbenefit will flow to the entity. Based on the earnings situation of the past andon the business expectations for the foreseeable future, value allowances areformed if this criterion is not fulfilled. Where a company has suffered losses, deferred tax claims thereon are capitalisedif the ability in the future to set off the losses with later income ispermissible under the respective national provisions. According to the planningof the company, a return to the tax profit zone in the short term is regarded asvery probable. Under other taxes, a back-payment of V.A.T. is shown following the results of anexternal audit. The payment continues to be the subject of dispute and will beclarified before the tax court. 7. Earnings per share The earnings/ (loss) per share presented in accordance with IAS 33 are shown inthe following table: 31 December 31 December 2005 2004 €000 €000 Profit/ (loss) for the year attributable to equityshareholders 2,394 1,737 Weighted average number of shares in issue,undiluted 11,671,119 10,085,497Weighted average number of shares in issue, diluted 11,714,477 10,272,169 Undiluted earnings per share (•) 0.21 0.17Diluted earnings per share (•) 0.20 0.17Adjusted earnings per share (•) 0.22 0.13 Undiluted earnings per share are calculated by dividing the profit for the yearattributable to equity shareholders by the weighted average number of shares inissue during 2005: 11,671,119 (2004: 10,085,497) after adjusting for the impactof changes in the issued share capital in each year and of a 1.4:1 bonus shareissue on 16 August 2005. Diluted earnings per share are determined by dividing the profit for the yearattributable to equity shareholders by the weighted average number of shares inissue plus the share equivalents which would lead to a dilution. The directorsconsider that there are no share equivalents which would have a dilutive effect.The former convertible bonds have no diluting effect under IAS 33 since themarket value of the rights were below the price of the conversion right oroption price. The new convertible bonds lead to a theoretically differencebetween undiluted earnings and diluted earnings per share but the effect is veryminimal and does not change the amount of earnings per share. The adjusted earnings per share were calculated by adding back IFRS differenceson IPO costs of • 716,000 (2004: • nil) and deferred taxes of • 365,000 (2004: •395,000). This results in taxes on income payable under local GAAP of • 238,000(2004: • 592,000) and profit after adjusted taxes of • 3,475t (2004: • 2,089t),divided by 15,763,080 shares issued as at 31 December 2005 results in adjustedearnings per share of • 0.22 (2004: • 0.13). 8. Intangible assets The development of the intangible assets of the SQS Group is presented as anAnnex to the Consolidated Notes (Consolidated Fixed Asset Analysis).The item is comprised as follows: Book values Remaining 31.12. 31.12. useful life 2005 2004 Years T• T• SQS Group (UK) Ltd. and affiliated subsidiarycompanies, Great Britain Part I 4,696 4,696 Part II 6,105 6,105SQS BV, Netherlands 555 555Other 233 233Goodwill 11,589 11,589Development costs 0 0 472 Capitalisation 2003 1 472 943 Capitalisation 2004 2 1,609 0Capitalisation 2005 2,081 1,415Software 1 to 3 256 234Remaining intangible assets 59 0Intangible assets 2,396 1,649 No impairment losses in accordance with IAS 36 on account of falling anticipatedpayments were necessary in the business year 2005. Development costs werecapitalised in the business year in the amount of • 2,415t (in the previous year• 1,415t) and amortised over a period of 36 months, since the conditions underIAS 38 were fulfilled. The scheduled amortisation of goodwill was, in compliance with IFRS 3, no longercarried out. Under the performance of an impairment test in accordance IAS 36 inthe version of 2005, no reduction in the value of the goodwill was established. The impairment test was carried out in accordance with IAS 36.80 for SQS Group(UK) Ltd, as well as the Dutch subsidiary at the business level of thesubsidiary. This is the lowest level at which the management of the SQS Groupcontinuously monitors the intrinsic value of the goodwill acquired with thiscompany. Thus, the cash generating unit is equal to the subsidiary company. In order to test the intrinsic value of the goodwill, the attainable amount (usevalue) of the cash generating unit is, under IAS 36, compared with the bookvalue of this cash generating unit. The use value is determined as the futureearnings value. In order to determine the use value, the discounted cash flowmethod (DCF method) was applied. For this purpose, the current plans of the companies, which take intoconsideration the status of the accounts up until the end of October of thebusiness year, were taken as the basis. For the year 2006, detailed planning isavailable in this regard; for the following years up until 2010, assumptionswere made for the individual result and asset or debt items. For the periodthereafter, a constant cash flow was assumed in accordance with the DCF method. With regard to the development of earnings, it is assumed for both subsidiariesthat also in the future an above-average growth in sales against the market willbe achieved. In both geographical partial markets, the recovery is clear. In theUK, a growth of 24 % against prior year was achieved in the business year 2005as 22 % in 2004. A corresponding further increase in personnel is planned. It isfurther assumed that the gross margin can be increased. It is assumed in thisrespect that as from the year 2007 the price level will approach the level of2004. In the following years, further increases are expected; however, the levelof 2001 will not be exceeded in this respect. In addition, it is assumed thatthere will be an increase in the utilisation of the full work capacity of theemployees. The marketing costs and also the general and administrative costs areplanned to rise absolutely, falling relative to sales. The administration is,with the capacities existing today, sufficient to cope with further growth. In the planning period, on the basis of these expectations and planningassumptions, annual cash flows will be achieved which ensure a reasonable rateof return on the funds invested.In accordance with IAS 36, the following special features were taken intoaccount: • Expenses and income, assets and debts in connection with taxes on earnings, such as active and passive deferred taxes, tax reimbursement claims, tax liabilities and tax accruals, were eliminated both from the book value and from the use value, • the cash flows, either in or out, from financing activities have not been taken into account, • For reasons of practicability, in compliance with IAS 36.79, the trade receivables and trade creditors and also other liabilities were included in our calculations when estimating the future cash flows and the book value, • For the transition from the value of the entire business to the use value of the equity holders, the entire liabilities at the market value (= book value) were eliminated. • The goodwill was allocated entirely to the book value of the cash generating unit in accordance with IAS 36.80 and IAS 36.81, • The determination of the discount rate was made in accordance with IAS 36.55-57; as the capital cost rate for the equity, a risk-adjusted interest rate of 18.5 % p.a was assumed, which was calculated from a risk-free interest rate, an average risk surcharge and also a factor to take into consideration branch and other risks. For the interest on capital from outside sources, the actual interest rate of the companies of 5.7 % for capital from outside sources was taken, with a slightly increasing tendency in the future. Neither interest rate is corrected by taxes. The discounting was then made with the average interest rate weighted according to the ratio of shareholders' equity / capital from outside sources. For the remaining goodwill values, the cash generating unit is the operatingunit which today derives the benefit from the investment. This is, in the onecase, the region North, in the other case the region West of SQS AG. In bothcases, the book values still present of the cash generating units or thegoodwill are so small in relation to the anticipated returns that a detailedinvestigation was waived.The amortisation of development costs is contained in the costs for research anddevelopment. The amortisation of software and remaining intangible assets aswell as the impairment losses under IAS 36 are spread over the functional costsin accordance with an allocation key.No write-ups on account of the lapse of the grounds which led to valueadjustments in previous years needed to be carried out in 2005, as was alreadythe case in the business year 2004. 17. Share capital On 20 September 2005 SQS AG was floated on the AIM market of the London StockExchange. On that date, 5,673,000 new shares were issued at a price of 190 penceper share. This corresponded to about • 2.82 per share on the basis of theexchange rate at that time. In total, approx. • 16 million were raised. On 2 December 2005, SQS additionally listed in the Entry-Standard in Frankfurt(Main). Subscribed Capital The subscribed capital amounts to • 15,763,080 (2004: • 4,204,126). It isdivided into 15,763,080 (2004: 4,204,126) fully paid shares of • 1 each. The subscribed capital developed as follows: Individual shares Nominal value Number • Status at 1 January and 31 December 2004 4,204,126 4,204,126 Increase in capital in return forcontributions 74 74Increase in capital as result ofcapitalisation of reserves 5,885,880 5,885,880Increase in capital as a result of issueof shares for cash on flotation 5,673,000 5,673,000Status at 31 December 2005 15,763,080 15,763,080 Own Shares The Management Board was authorised to acquire up to a total of 10 % of thenominal capital of the Company for purposes other than trading in securities.The quotation price has been fixed with regard to the upper and lower limit andany offer has to be issued to all shareholders. The authorisation expired on 31July 2005. The Management Board is authorised, with the consent of the Supervisory Board,to offer the shares to employees or former employees of the SQS Group or toshareholders. The price at which these shares are offered must not be below thepurchase price. The Management Board is further authorised, with the consent of the SupervisoryBoard, to redeem the shares so purchased. In 2004, the Management Board exercised this right to purchase 2,448 shares,which were acquired for an aggregate consideration of • 95,000. In 2005, afurther 200 shares were acquired for a consideration of • 7,000. Through the increase in capital from company funds, the number of own sharesrose to 6,356, which were subsequently sold at the issue price within theframework of the stock exchange floatation to two members of the supervisoryboard at a total price of • 18,000. Accordingly, SQS had no shares in itsownership as at 31 December 2005. Conditional capital The General Meeting of 12 April 2002 resolved the conditional increase in theshare capital by an amount of up to • 31,112. The resolution became effectivewith the entry of 6 June 2002. Following the increase in capital, theconditional capital amounted to 43,556.80 • as at 16 August 2005 and to74,668.80 • as at 20 September 2005. By resolution of the General Meeting of 14September 2005 and the subsequent entry in the Commercial Register of23 September 2005, the existing conditional capital was revoked and increasedagain by 52,800 •. The conditional capital serves as security for the convertible bonds (see above"Convertible bonds" and point 13 of the Notes). Authorised capital By resolution of the General Meeting of 12 July 2005, the capital (• 243t)previously authorised was revoked. The executive board is empowered, by resolution of the General Meeting of 12July 2005, to increase the nominal capital by • 3,500t up until 12 July 2010with the approval of the supervisory board, either through one single or severalissues of new individual registered shares, in return for cash or contributionsin kind (Authorised capital 1). The power to increase the nominal capital isrestricted to the purpose of acquisition of businesses or the acquisition ofholdings in businesses. In addition, the executive board was empowered, likewise by resolution of 12July 2005, to increase the nominal capital by • 1,500t up until 12 July 2010with the approval of the supervisory board, either through one single or severalissues of new individual registered shares in return for cash or contributionsin kind (Authorised capital 2). Thereafter, the authorised capital developed as follows: T•Status at 1 January 2004 243Status at 31 December 2004 243Revocation of the authorised capital (243)Increase in the authorised capital 1 3,500Increase in the authorised capital 2 1,500Status at 31 December 2005 5,000 Convertible bonds with conversion rights The executive board was, in the Extraordinary General Meeting of 12 April 2002,authorised to issue a total of 31,112 interest-bearing convertible bonds by 30April 2002, in either a single or several transactions, in a nominal value of •36.32 each with a term of no longer than two years. The executive board exercised this right and issued a convertible bond in atotal value of • 1,130t. Through the redemption of the convertible bond which is the subject of thisagreement in the amount of 50 % of the total amount as at 3 January 2005 and theremaining 50 % as at 26 September 2005, these conversion rights have beenextinguished in full. SQS has, on the basis of the resolution of the General Meeting of 14 September2005, undertaken to grant the vendor of the shares in SQS Group (UK) Ltdconvertible bonds in a total nominal amount of • 53t, divided into 52,800convertible bonds of a nominal value of • 1.00 each, if the party entitled paysinto SQS the nominal amount of • 1.00 per share. The exercise of the right ofconversion is limited in time up until 31 July 2008. Up until completion of thepreparation of these Financial Statements, the party entitled had not exercisedthis right. 20. Notes to the Statement of Cash flows The cash flow statement shows how the funds of the Group have changed in thecourse of the business year through outflows and inflows of funds. The paymentsare arranged according to investment, financing and business activities. The sources of funds on which the cash flow statement is based consist of cashand cash equivalents (cash on hand and bank balances) as well as tradablesecurities. 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SQS Software Quality Systems AG