Final Results

Embargoed until 7am

9 March 2011

SQS Software Quality Systems AG

("SQS" or the "Company")

Results for the full year ended 31 December 2010

SQS Software Quality Systems AG (AIM: SQS.L), the world's largest pure play supplier of independent software testing and quality management services, today announces its results for the year ended 31 December 2010 (the "period").

Financial Highlights:

·; Turnover increased by 21.2% to €162.9 million (FY 2009: €134.3 million), while testing services market in Europe was forecast to grow by 6.5% in 2010 (Source: PAC November 2010)

·; Adjusted Gross Profit* up by 22.5% to €52.1 million (FY 2009: €42.5 million) on a Gross Profit Margin* of 32.0% (FY 2009: 31.7%)

·; Adjusted PBT** increased by 22.1% to €8.6 million (FY 2009: €7.0 million) despite the significant investment in headcount and Managed Services growth during the period

·; Adjusted EPS*** increased by 19.3% to €0.25 per share (FY 2009: €0.21 per share)

·; Net debt as at 31 December 2010 was €4.5 million (31 December 2009: net cash of €1.6 million) (30 June 2010: net debt of €6.2 million) reflecting increased receivables is tying up further working capital

·; Debtor days at period end steady at 55 (at 31 December 2009: 55)

* adjusted to add back €0.4 million accruals for partial retirement due to a change in IFRS accounting rules.

** adjusted to add back IFRS effects of €0.2 million pro forma interest on deferred payment milestones for acquisitions, €1.7 million of amortisation on intangible assets of acquired companies and €0.4 million accruals for partial retirement.

*** includes effects under **) and at local GAAP tax rate which is €0.3 million higher than under IFRS because of €0.3 million deferred taxes under IFRS.

Operational Highlights:

·; A period of strong second half growth in revenues and profits, and of continued substantial investment in staff and infrastructure

·; Hired and fully trained 359 new billable consultants to meet increasing demand for services

·; Normal utilisation with average billed days per consultant of 187 (FY 2009: 178 billed days)

·; Significant growth in Managed Services, now accounting for 11% of total revenues (FY 2009: 3%) with order intake of over €50 million in the period 

·; Improving revenue visibility (average Managed Services contract length of 3 years)

·; Continued expansion of offshore resources to meet high demand for blended professional services - offshore staff equal to 30.6% of billable workforce at 31 December 2010 (31 December 2009: 26.5%)

·; 137 new clients signed up during the period (FY 2009: 160) including numerous blue-chip clients and underpinning our strategy to focus towards larger contract sizes

Rudolf van Megen, Chief Executive Officer of SQS commented, "We are delighted with the significant growth experienced during the year, and particularly in the second half, in both revenues and profitability. The investments made in the first half of the year into infrastructure and sales staff and the continuing investment into offshore consultancy staff have been successful. To satisfy market demand we will see further strong staff recruitment in 2011. Our growing offshore and nearshore resources are helping us to become increasingly competitive and ultimately to improve overall margins.

"In addition, our Managed Services business, with which we have gone through a steep learning curve, has continued to grow strongly and contracted over €50 million of revenue during the period, although there are still areas where the performance of the division can be improved. As well as improving revenue visibility, Managed Services is also helping to increase brand awareness of SQS, leading to ever larger contract wins. We are now in an established growth pattern and, while our strategic focus for the coming year will be to continue to improve and innovate our services portfolio, further expansion of Managed Services, hiring onshore and offshore resources and improving the gross profit. Therefore, we are confident of a similar performance in 2011."

Enquiries:

About SQS

SQS is the world's largest pure play supplier of independent software testing and quality management services. SQS consultants design and oversee quality management processes during the software and IT systems life cycle and test the resulting products for errors and omissions.

Headquartered in Cologne, Germany, SQS has approximately 1,900 employees across Europe, Asia, North America and Africa. The Group has a presence in Germany (Cologne, Munich, Frankfurt, Stuttgart, Goerlitz and Hamburg), the UK (London, Woking, Birmingham, Manchester, Belfast), Ireland, the Netherlands, Switzerland, Austria, Sweden, Norway, Finland, India, Egypt, the United States and South Africa. SQS also has a minor stake in an operation in Portugal and a partnership operation in Spain.

With more than 5,000 completed projects, SQS has a strong customer base including 20% of the FTSE-100 companies, more than half of the DAX 30 and a third of the STOXX-50. It supports clients in a wide range of industries, including major corporations such as Allianz, Beazley, BP, Centrica, Daimler, Deutsche Post, Generali, JP Morgan, Meteor, Reuters, SEB, Siemens and Volkswagen.

Chief Executive's Statement

Introduction

We were quick to respond to improving market conditions at the beginning of 2010, accelerating our investment in infrastructure and sales staff during the first half of the year, and continually building up consultancy staff throughout 2010. We are therefore delighted that the benefits of these investments, which impacted profitability in the first half of the year, have already made a significant contribution to revenues and profits in the second half of the year. These investments will help us to benefit from the market conditions for further growth in 2011.

We enjoyed strong revenue growth across all of our core geographies during 2010 and the Company now appears to be in a well established growth phase. Revenues grew by 21.2% to €162.9 million (FY 2009: €134.3 million) during the period, significantly outperforming the predicted 6.5% growth for the testing services market in Europe as a whole (Source: PAC November 2010), demonstrating that SQS continues to build market share and extend its market leading position in independent software testing.

Profits also grew at a similar rate with adjusted PBT increasing by 22.1% to €8.6 million (FY 2009: €7.0 million). €6.2 million of this came through in the second half year with an adjusted PBT margin of 7.0% (adj. PBT H1 2010: €2.4 million with a margin of 3.2%), as positive effects of the first half investment were realised.

Considerable investment went into improving business practises and expanding staff numbers at our offshore centres during the year, improving the efficiency and flexibility of our service delivery. For example, recent political events in Egypt resulted in minimal disruption as the provision of services was transferred to alternative offshore and nearshore test centres. Staff numbers in offshore (India, Egypt, South Africa) and nearshore (Goerlitz & Belfast) test centres grew by 56% such that they accounted for 39% of the total billable workforce as at 31 December 2010: (31 December 2009: 31.5%). Given the continuing buoyant market conditions and the competitive pricing advantages afforded us by our offshore and nearshore facilities, this is a trend we would expect to see continuing into 2011.

In line with our stated strategy, we have also made further progress in growing our Managed Services business such that this now accounts for 11% of total revenues. In addition, Managed Services has secured order intake of over €50 million during the period. This pipeline gives us confidence that Managed Services can achieve our stated target of doubling the total revenue within the next 3 to 4 years, mainly with additional business from Managed Services then expected to account for up to 40 to to 50% of revenues. Ultimately this will lead to further improvements in revenue visibility and higher profit margins.

New Business

During the first half of the period we invested considerable resources into expanding our sales force, setting up dedicated sales teams in each of the geographies in which we are present. This, combined with the robust market conditions, has proved highly successful, with 137 new clients (FY 2009: 160) signed during the period. The now expanded sales force has been opening up new clients but is also working on the existing ones to expand business within those (e.g. opening new doors at other business units).

Despite the strong growth in our Managed Services offering the majority of new wins were for traditional consultancy services to assure or de-risk business and IT projects. We believe that these wins indicate a growing trend towards assigning testing projects to a specialist, independent testing provider. Our ongoing focus on the sale and provision of blended onshore/offshore Managed Services offerings has also proved highly successful during the period with 22 contracts or significant contract extensions signed (FY 2009: 15). Managed Services business is contracted in advance for longer periods than the rolling three to six month contracts typical of our traditional project business. As a result we are signing significantly larger contracts than for consultancy services previously, which leads to better visibility on revenues going forward. Order intake for Managed Services contracts during 2010 was at over €50 million and conversion of this pipeline began in HY2 2010 and is expected to take place over the next three years. Operationally, Managed Services have been through a steep learning curve and there are still areas where our operational performance will be improved going forward. We therefore will continue to invest into developing and training the managed services delivery methodology.

In addition, our Managed Services offerings are contributing towards improving our profile generally within the market. During recent months we have experienced growing recognition as a premium provider of testing services with the experience and capabilities to deliver services quickly, efficiently and in a scalable manner. This has meant that our traditional consultancy business is also now competing for, and winning, projects of increasing scale against the large European/US-system integrators as well as Indian system integrators providing testing services.

Notable examples of Managed Services client wins secured during the period include:

·; Our largest ever single-client contract win, a Managed Services contract with an existing client worth at least €15 million over a three and a half year period

·; A three year Managed Services contract with Specsavers involving a 50-strong SQS testing team based mainly in India

·; A blended onshore/offshore Managed Services contract with a European telecommunications provider worth €6.5 million over three years

In addition, a number of the initial Managed Services contracts were extended into longer duration contracts during the year, an encouraging reflection of the customer satisfaction we have provided to date.

Examples of traditional consultancy client wins secured during the period include:

·; An engagement with one of the world's leading insurance brokers to undertake a quality assurance review of their full IT programme delivery to ensure rigour and to provide a testing roadmap into the medium term.

·; An ERP Migration project with a major UK environmental recycling and services organisation. This end-to-end testing project is due to run until end 2011.

In addition, a large number of consultancy commitments were extended during the period:

·; A major utility organisation continues to extend SQS's onshore and offshore services across a range of technical and functional testing disciplines.

·; A major UK oil company extended its SQS on-shore based commitment for an additional team of consultants to support the User Acceptance Testing of their critical Oil trading platform

·; One of the largest Nordic banks recently extended their project based testing commitment with SQS.

·; A leading listed South African financial institution has recently extended its commitment to SQS to provide a significant team of on-site testing consultants to support the continuing implementation of business critical applications which in turn provide 24/7 data to multiple corporates and partners.

Services and product lines

SQS has three services and product lines (Professional Services, Software Testing Products and Training & Conferences) each of which are reported as separate revenue and profit segments. Professional Services is further split up into the regional reporting segments Central Europe Middle East (CEME) and West Organisation North South (WONS).

Professional Services for Business and IT

We offer three distinct forms of professional services for business and IT, each catering to a specific stage of the software lifecycle:

·; Management Consulting Services are provided early in the lifecycle of a project at the business requirements phase. We therefore help to initiate the resulting IT project and this can lead to a closer relationship with the decision makers and ultimately further work in the later stages of the project. This service line accounted for 9% of total revenues in the period (FY 2009: 10%) and grew by 5% during the course of the year.

·; Testing Consultancy Services are provided at the software implementation or development phase of the software lifecycle. Typically run as an IT project with services provided onsite, we provide professional testing services and quality management consulting to help clients increase efficiencies and to de-risk their IT projects. This service line accounted for 75% of total revenues in the period (FY 2009: 82%) but grew in absolute terms by 11.5% during the year.

·; Managed Testing Services are typically provided for software that is in productive use, i.e. in the 'maintenance phase'. We provide Managed Testing Services under long term engagements to provide regression testing for updates, patches and new releases. Such services often involve blended offshore/onshore delivery and accounted for 11% of total revenues in the period (FY 2009: 3%) and grew by 336% during the course of the year.

Software Testing Products

Our unique suite of software testing products has been developed from our experience of almost 30 years' working on software testing projects, culminating in a product set that is able to provide consistent and measurable support for testing services, several components of which can be integrated into other market leading tools. Our products are fully integrated into our services and offerings and are used by staff in onshore projects and our offshore centres, ensuring seamless interaction between the two.

The SQS Software Testing Products are used in our consultancy projects and Managed Services as a part of our asset based consultancy services but they are also sold separately to clients. Despite securing orders in the second half of the year we experienced some slippage in revenues such that Tools and Maintenance (incl. other third party tools) accounted for 2.7% of total revenues in the period (FY 2009: 2.3%). However, these orders are expected to complete post the year end during 2011.

IT Training and Conferences

During the year a total of seven iqnite® conferences were held in various cities across the globe and we are confident this service line will grow in the coming year. Our training division recorded a small amount of growth during the period and we are seeing increasing demand as companies begin to reallocate training budgets post recession; however a risk may be that the demand for testing is so big that employees at clients do not get time to be trained. Revenue from training and conferences represented 2.4% of total revenues in the period (FY 2009: 2.6%).

Acquisitions update

On July 4, 2010 the two year earn out period with Verisoft (now SQS India) came to an end. Final earn-out accounts were agreed during the second half of 2010 and Verisoft achieved the majority of its targets. With the earn-out finalised, SQS has now acquired 75% of the issued Verisoft shares. There is an option for SQS to acquire the remaining 25% of Verisoft which is exercisable either by SQS or the vendors until April 2016.

The earn-out period for Validate (now SQS Nordics) is now in its third year and will continue until June 2011.

Markets

A market study by PAC, published in November 2010, forecast an expected growth rate for the software testing services market in Europe of 6.5% per annum between 2010 and 2014. SQS significantly outperformed this prediction during the year with revenue growth of 21.2%, demonstrating that we are winning market share and extending our leading position as world leader in independent pure play testing services. The corresponding growth rates are 20% per annum for India and 13% per annum for South Africa.

The study further revealed for Germany that the industries with the highest growth rates are insurances and utilities at 8.5% per annum, while manufacturing is the largest industry segment with 22% of the total testing market. In the UK the strongest growing industries are utilities, insurance and banking with 8.5% per annum each, while the public sector is the largest overall industry covering 33% of the local market.

The same PAC stud highlighted that the size of the market for testing tools in Europe is estimated at €390 million and is growing at an annual rate of 5%, while the size of the testing tool market e.g. in India is estimated to be €70 million and expected to grow at 22% per annum.

During the year we experienced solid growth across all of the geographies in which we are present.

US sales still account for only approx. 1% of revenue but are growing. During the period, sales were achieved in the US via India but we now have staff on the ground in the US looking to sell our offerings. We have taken a strategic decision to grow the US business in enterprise IT projects besides the games testing part based on the delivery capabilities in India. This is to be a gradual, careful expansion of the sales footprint and SQS is confident it will contribute more going forward (possibly c. 2% in the current year). US customers are used to sourcing testing work from India so we do not need to evangelise the market additionally. This is a low-risk approach.

We are currently witnessing positive signs of growth across a wide-range of sectors in which we are present including energy & utilities, retail, logistics, telecoms, insurance and the rejuvenated financial sector.

Business strategy

Our core strategy for 2011 will be to achieve improvements to gross and net profit margins in both consultancy projects and Managed Services by focussing on utilisation and expansion of the appropriate resources and through the increasing provision of our asset based services. As part of this process we will be devoting much of our attention to servicing our existing contracts such that they can be fine tuned to provide clients with the optimal mix of onshore and offshore resources, resulting in the best service ratio for our clients and in improved margins for SQS long term. While we expect project margins to improve as a greater proportion of the workload for maturing projects is moved offshore, this process requires careful management to ensure a smooth transition and to maintain our high standards of service delivery and customer satisfaction.

Increasing the proportion of revenues contributed by our Managed Services business also remains a central part of our ongoing strategy. Managed Services contracts accounted for 11% of total revenues in 2010 (FY 2009: 3%) and we have an order book of over €40 million of business contracted for the coming three years.

Such contracts, which tend to be over a longer term than traditional project work, often command a fixed fee for a defined set of deliverables rather than the day-rate basis of our traditional offerings. They therefore allow us to gain greater visibility on revenues and further benefit SQS by allowing greater flexibility and control over project staffing. Profit contribution is also expected to increase at an accelerating rate as the majority of costs associated with a Managed Services project are borne at the beginning of the contract and reduce as elements of the workload are progressively moved to nearshore/offshore test centres. In addition, the large contract signings we have made with Managed Services customers are giving us greater credibility within our traditional markets, such that we are now winning larger contracts for project based work with new and existing clients.

We anticipate that investment into non-billable staff (i.e. administration, sales etc.) will be significantly lower than in billable at this stage.

Dividend

Our stated policy is to pay out approximately 30% of the adjusted profit after tax as a dividend.

SQS will therefore pay a dividend for the full year of €0.08 (2010: €0.07) per share.

Subject to shareholder meeting on 24 May 2011, the dividend will be paid on 26 May 2011 to all shareholders on the register at 20 May 2011.

Employees

Significant investment was made during the period to expand the headcount in order to meet the growing demands for our services and to help capitalise on the many opportunities made available by the ongoing robust market conditions.

The high levels of domain and methodology experience and expertise among our onshore and offshore consultants enabled us to hire and train a greater number of junior consultants during the year. This, along with the hiring of a greater proportion of offshore staff, has enabled us to reduce our average cost per employee, such that we are better able to address the competitive market environment in which we operate. In addition, investment made during the year into improving our unique asset based methodology, SQS PractiQ®, has enabled us to train new employees more quickly and efficiently.

The average number of permanent consultants (without administrative, R&D and sales staff) employed during the period was 1,366 (FY 2009: 1,148), a rise of 19%. At 31 December 2010 the permanent consultant headcount stood at 1,527, up 31% over the year (31 December 2009: 1,168) and 22% over the average headcount of the six months period (H1 2010: 1,249). The increase in the number of consultants can be broken down into a net increase of 202 (year end to year end) onshore consultants and 157 (year end to year end) offshore consultants. At this current time all new staff members appointed during 2010 have been fully trained and are already fee generating.

Our permanent offshore consultant headcount grew 50.1% during the year to 467 at 31 December 2010 (31 December 2009: 310). Offshore consultants now represent 30.6% of total headcount against 26.5% at the start of the period and 30.8% at 30 June 2010.

In addition, 10.9% of our revenue during the period was achieved via contractors (FY 2009: 9.1%).

On behalf of the Board, I would like to take this opportunity to express our gratitude to all of our staff that contributed to SQS during the period.

Board

On 2 March 2011, SQS has announced the appointment of Mr Diederik Vos as Chief Operating Officer with immediate effect. Mr Vos was previously European partner for Telecoms & High Tech at Pcubed, Head of Professional Services EMEA at Avaya and has held a number of roles at INS/Lucent Technologies and AT&T amongst others. Mr Vos has considerable experience in building up and running large service organisations, including offshore centres, and will play a lead role in SQS's strategy to expand its Managed Services division division as well to improve its operational performance.

Outlook

We are delighted with the significant growth experienced during the year, and particularly in the second half, in both revenues and profitability. The investments made in the first half of the year into infrastructure and sales staff and the continuing investment into offshore consultancy staff have been successful. To satisfy market demand we will see further strong staff recruitment in 2011. Our growing offshore and nearshore resources are helping us to become increasingly competitive and ultimately to improve overall margins.

In addition, our Managed Services business, with which we have gone through a steep learning curve, has continued to grow strongly and contracted over €50 million of revenue during the period, although there are still areas where the performance of the division can be improved.As well as improving revenue visibility, Managed Services is also helping to increase brand awareness of SQS, leading to ever larger contract wins. We are now in an established growth pattern and, while our strategic focus for the coming year will be to continue to improve and innovate our services portfolio, further expansion of Managed Services, hiring onshore and offshore resources and improving the gross profit. Therefore we are confident of a similar performance in 2011.

Rudolf van Megen

Chief Executive Officer

9 March 2011

Financial Review

Summary

Group turnover during the period was up by 21.2% to €162.9 million (FY 2009: €134.3 million).

Due to a change in the internal organisation of SQS, which became effective as of 1 January 2010, we no longer manage the Company by individual countries. Instead we have formed larger regional entities, which can be roughly delineated by the language predominantly spoken by the resident consultants.

Furthermore, by creating dedicated Managed Services units in each of the two services business units, the new organisation supports the implementation of more blended onshore/offshore delivery.

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

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

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

·; Other, which includes Software Testing Products, Training & Conferences and central group activities such as research and innovation.

Breakdown by Business Unit

Central Europe Middle East (CEME)

Revenue in CEME, our largest market, amounted to €96.4 million (2009: €84.7 million) in the period, an increase of 13.8%. The improvement in revenue was entirely organic and came from new Managed Services contracts and additional demand for traditional IT project services.

West Organisation North South (WONS)

Our business in predominantly English speaking geographies saw a strong recovery during the period with a 40.8% rise in revenues to €60.4 million (2009: €42.9 million). This occurred primarily as the result of a strong surge in demand for our services from the UK, Nordics and India and was especially encouraging given that our UK business had been hardest hit by recession during 2009. The majority of the growth came from the financial services, utilities & energy and retail sectors.

 Other Business

·; This segment experienced a decline in revenues in the period of 9.0% to €6.1 million (2009: €6.7 million). The markets for training, conferences and SQS software testing products remained weak during the period, suffering from the 2009 recession as a late-cycle business. Because SQS software testing products are an integral part of our asset based services methodology and additionally embedded in many managed services contracts their profit contribution is not fully visible in this segment but partly in the CEME and WONS results; especially as we can use our full tool set also in our test centres and have a competitive advantage over other Manages Service providers.

Foreign Exchange 

Foreign exchange had a positive impact on the reported performance for the period because the Euro weakened overall against all other currencies relevant to the SQS business. In total, 50% of the Group's revenue is generated in currencies other than the Euro (2009: 42%). Specifically, 26% (FY 2009: 22%) of Group revenue is generated in Sterling by our UK operation and 14% (FY 2009: 14%) of Group revenue is generated in Swiss Francs by our Swiss operation, the balance of 10% is generated in other currencies. On a constant currency basis, our reported revenues would have been €158.5 million (€162.9 million at reported exchange rate) and we would therefore have recorded adjusted profit before tax €0.4 million lower than the reported one of €8.6 million.

Margins and Profitability

Adjusted gross profit* was up 22.5% to €52.1m (FY 2009 €42.5m) with the adjusted gross margin* increasing to 32.0% (FY 2009: 31.7%). As a result of full utilisation of staff hired at the beginning of the year, the adjusted gross margin* improved from 30.5% in H1 2010 (29.4% in H1 2009) to 33.2% in the second half (33.9% in H2 2009).

Adjusted profit before tax** was up by 22.1% to €8.6 million (FY 2009 €7.0 million) with the profit margin moving to 5.3% (FY 2009: 5.2%).

The lower margins in the first half were temporary and were due to the build-up in consultants' headcount, test center infrastructure, and project and commercial management resources, all consequences of our strategic mid-term target to grow Managed Services business to up to 50% of our total business. During the second half we were able to make full use of those consultants hired and trained in H1 2010, as evidenced by the improved gross margin in H2 2010. We nevertheless continued to hire additional consultants in H2 in order to satisfy strong market demand. As many newly won Managed Services projects commenced in the second half this period was again impacted by project start up costs despite the overall improvement of gross margins. Typically, the costs in Managed Services projects are front-end loaded in the first year and projects tend to show much improved gross margins from year two onwards when the majority of the work can be executed by offshore resources.

Adjusted earnings per share*** was up by 19.3% to €0.25 (2009 €0.21).

* adjusted to add back €0.4 million accruals for partial retirement due to a change in IFRS accounting rules

** adjusted to add back IFRS effects of €0.2 million pro forma interest on deferred payment milestones for acquisitions, €1.7 million of amortisation on intangible assets of acquired companies and €0.4 million accruals for partial retirement.

*** includes effects under ** above and at local GAAP tax rate which is €0.3 million higher than under IFRS because of €0.3 million deferred taxes under IFRS.

Costs

Adjusted ****General & Administrative expenses totalled €27.2 million (2009: €21.5 million), representing 16.7% of Group revenues (2009: 16.0%). The absolute cost increase resulted from additional administrative needs in the Managed Services business as well as higher headcount in line with the general growth of the Company during the year.

****adjusted to add back IFRS effects on amortisation of intangible assets of acquired companies of €1.6 million an €0.1 million for revaluation of pension plans and stock options.

Sales & Marketing expenses totalled €13.0 million (2009: €11.1 million) representing 8.0% of Group revenues (2009: 8.2%). Cost increases resulted from adding sales capacity, mainly to support managed testing services, and from additional marketing campaigns undertaken in an effort to improve lead generation.

Research & Development expenses totalled €2.8 million (2009: €2.4 million) representing 1.7% of Group revenues (2009: 1.8%). R&D costs resulted from investments in our software testing tools with capitalised R&D of €3.1 million (2009: €3.3 million) and amortisation of €2.8 million (2009: €2.4 million). This resulted in a net positive effect of €0.3 million (2009: €0.9 million). Additionally €1.4 million regarding the development of a new Managed Services methodology have been capitalised.

Cash Flow and Balance Sheet

Cash flow from operating activities was €6.0 million (2009: €9.1 million) which represents an adjusted EBIT conversion of 66%. This was lower than the full conversion rates of adjusted EBIT into operating cash flow seen in previous years and this predominantly resulted from a build-up of working capital. This was due to the strong revenue growth seen in H2 2010 (+20.5% H2 2010 compared with H1 2010) and the strong increase of revenues from Managed Services contracts, which tie up more working capital in the first year of their existence due to investments in processes and infrastructure. Debtor days remained steady at 55 (2009: 55) as rapid invoicing and collection were maintained at the high level achieved in previous years at the year end.

Cash flow from financing activities was €3.2 million (2009: €0.7 million) and includes the payout of a dividend of €(1.9) million in May 2010 (2009: €(2.9) million). Cash outflow from investments was €(8.0) million (2009: €(8.2) million), including €(4.5) million (2009: €(3.3) million) for capitalised R&D on products and Managed Services methodology, €(0.9) million (2009: €(2.6) million) for investments in IT infrastructure and SAP as the SQS ERP system and €0 million (2009: €(1.9) million) as cash payments for earn out payments on acquisitions (2009: last earn out payment for Triton shares). Cash at the year-end was €4.3 million (2009: €5.4 million).

No shares were issued during the year. As a post balance sheet event 0.6 million shares were issued to satisfy deferred consideration obligations with regards to previous acquisitions in January 2011 (Validate and Verisoft). A further issue of 28,265 shares under a share purchase programme for SQS employees was also carried out in January 2011.

Taxation 

The reported tax charge of €1.5 million (2009: €1.3 million) includes current tax expenses of €1.8 million and no non-recurring tax credits as in 2009 (2009: tax credit of €0.6 million in the UK) and deferred taxes of €(0.3) million (2009: €0.2 million). The 2010 tax charge was considerably lower than anticipated due to a favourable tax structure over the legal entities with higher profits in those entities under a lower tax regime and lower profits in those entities under a higher tax regime. We incurred especially low tax rates on our profits in India and Egypt due to a special tax regime for most of our business in India which is done in an Special Economic Zone (SEZ) and the fact that we could offset tax losses in Egypt which we were not allowed to capitalise as deferred tax assets in prior years.

We anticipate a tax rate of 29% for 2011.

International Financial Reporting Standards (IFRS)

The Consolidated Financial Statements of SQS and its subsidiary companies ("SQS Group" or "SQS Konzern") are prepared in conformity with all IFRS Standards (International Financial Reporting Standards) and Interpretations of the IASB (International Accounting Standards Board) approved by the EU Commission and translated into the German language which are to be applied for those financial statements whose reporting period starts on or after 1 January 2010. The new and revised Standards and Interpretations of the IASB were not applied in the business year 2010 prior to the implementation date stipulated.

The SQS Group Consolidated Financial Statements for the twelve month period ended 31 December 2010 is presented in Euros.

A copy of the SQS Group Consolidated Financial Statements together with a notice of Annual General Meeting to be held at SQS headquarters in Cologne on 24 May 2011will be posted to shareholders shortly and electronic copies of these documents will also be available from the Company's website at www.sqs.com.

Rene Gawron

Chief Financial Officer

9 March 2011

1. Description of business activities

SQS, based in Cologne, Germany, is one of the largest independent European pure play providers of software testing and quality management services by turnover. SQS is independent from software vendors and other IT service suppliers. It can therefore provide unbiased opinions to customers on the software products and projects it is engaged to assess and improve. SQS offers services designed to support the quality of software and IT systems from initial project definition through the development stage and up to final implementation and, thereafter, in relation to ongoing maintenance. For more than twenty nine 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 24 offices in 13 countries worldwide with 1,875 employees at the end of 2010 (previous year 1,470 employees).

2. Summary of Significant Accounting Policies

Basis of preparation

The Consolidated Financial Statements of SQS and its subsidiary companies ("SQS Group" or "SQS Konzern") are prepared in conformity with all IFRS Standards (International Financial Reporting Standards) and Interpretations of the IASB (International Accounting Standards Board) approved by the EU Commission and translated into the German language which are to be applied for those financial statements whose reporting period starts on or after 1 January 2010. The new and revised Standards and Interpretations of the IASB were not applied in the business year 2010 prior to the implementation date stipulated.

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

Statement of compliance

The Financial Information of SQS and its subsidiaries ( 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 accounting policy and adjustment of figures from the previous year

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 2010. The changes do not have any effect on the accounting treatment of assets and liabilities or their valuation.

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 effect on the financial statements.

The adoption of follow new and amended IFRS and IFRIC interpretations was mandatory for accounting periods beginning on or after 1 January 2010 and relevant for the financial statements or performance of the SQS Group:

IFRS 2 Group Cash-settled Share-based Payment Arrangements (Amendment)

IFRS 3 Business Combination (revised)

IAS 27 Consolidated and Separate Financial Statements (Amendment)

IFRS 2 Group cash-settled share-based payment arrangement - For group reporting and consolidated financial statements, the amendment clarifies that if an entity receives goods or services that are cash settled by shareholders not without the group, they are outside the scope of IFRS 2. In the financial year 2010 the adoption of this amendment did not have any impact on the financial position or the performance of the SQS Group.

IFRS 3 Business combinations - Comprehensive revision on applying the acquisition method (effective from 1 July 2009). The revised standard continues to apply the acquisition method to business combinations, with some significant changes. For example, all payments to purchase a business are to be recorded at fair value at the acquisition date, with contingent payments classified as debt subsequently re-measured through the income statement. There is a choice on an acquisition-by-acquisition basis to measure the non-controlling interest in the acquiree either at fair value or at the non-controlling interest's proportionate share of the acquiree's net assets. All acquisition-related costs should be expensed. SQS have been applying IFRS 3 (Revised) prospectively to all business combinations since 1st July 2009. In the financial year 2010 SQS did not have any business combination.

IAS 27 Consolidated and Separate Financial Statements - The revised standard requires the effects of all transactions with non controlling interests to be recorded in equity if there is no change in control. The standard also specifies the accounting when control is lost. Any remaining interest in the entity is re-measured to fair value, and a gain or loss is recognised in profit or loss. The impact of this amendment is shown in the statement of changes in equity.

The following new an amended IFRS and IFRIC are mandatory for accounting periods beginning on or after 1 January 2010 but are not relevant to the group's operations:

IFRS 1 First-Time Adoption of International Financial Reporting Standards - Additional Exemptions for First-time Adopters

IAS 39 Financial Instruments: Recognition and Measurement - Eligible Hedged Items (Amendment)

IFRIC 17 Distributions of Non-cash Assets to Owners

IFRS 1 Additional exemption for First-time adopters - The amendment will provide relief to entities that are first-time adopters with oil and gas assets or leases by reducing the cost of transition to IFRS (effective on or after 1 January 2010).

IAS 39 Eligible Hedged Items - This amendment clarifies two hedge accounting issues: The Inflation in a financial hedged item and a one-sided risk in a hedged item.

IFRIC 17 Distributions of Non-Cash Assets to Owners (effective from 1 July 2009). The Interpretation clarifies that a dividend payable should be recognised when the dividend is appropriately authorised and is no longer at the discretion of the entity. Further it clarifies that an entity should measure the dividend payable at the fair value of the net assets to be distributed and an entity should recognise the difference between the dividend paid and the carrying amount of the net assets distributed in profit or loss.

The adoption of the interpretations and amendments to existing standards which were part of the IASB annual Improvement Project published in April 2009 did not have any material effect on results of operations, financial position or cash flows of SQS.

The following standards and amendments to existing standards have been published and are mandatory for the group's accounting periods beginning on or after 1 January 2011 or later periods, but the group has not early adopted them:

IFRS 1 First-Time Adoption of International Financial Reporting Standards - Limited Exemption from Comparative IFRS 7 Disclosures for First-time Adopters

IFRS 9 Financial Instruments: Classification and Measurement

IAS 24 Related Party Disclosures (Revised)

IAS 32 Financial Instruments: Presentation - Classification of Rights Issues (Amendment)

IFRIC 14 Prepayments of a Minimum Funding Requirement (Amendment)

IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments

IFRS 1 Limited Exemption from Comparative IFRS 7 Disclosures for First-time Adopters - The amendment gives first-time adopters the same transition provisions that Amendments to IFRS 7 provides to current IFRS preparers. These provisions give relief from providing comparative information in the disclosures required by the amendments in the first year of application. The amendment is effective on 1 July 2010, with earlier application permitted.

IFRS 9 Financial Instruments: Classification and Measurement - The standard as issued reflects the first phase of the IASB's work on the replacement of IAS 39. IFRS 9 introduces new requirements for classifying and measuring financial assets and is likely to impact the SQS Group's accounting for its financial assets. This standard is effective for periods beginning on or after 1st January 2013. However, the standard has not yet been endorsed by the EU.

IAS 24 Related Party Disclosures - The revised standard clarifies and simplifies the definition of a related party and removes the requirement for government-related entities to disclose details of all transactions with the government and other government-related entities. The standard is mandatory for annual periods beginning on or after 1st January 2011. SQS will need to consider the revised definition of related parties to ensure all the relevant information is still being capture.

IAS 32 Financial Instruments: Presentation - Classification of Rights Issues - The amendment addresses the accounting for right issues that are denominated in a currency of the issuer. Rights issued in foreign currencies that were previously accounted for as derivatives will now be classified as equity instruments. The amendment applies to annual periods beginning on or after 1st February 2010.

IFRIC 14 Prepayments of a Minimum Funding Requirement (Amendment) - IFRIC 14 provides guidance on assessing the recoverable amount of a net pension asset. The amendment permits an entity to treat the prepayment of a minimum funding requirement as an asset. The amendment is effective for annual periods beginning 1st January 2011.

IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments - The interpretation clarifies the accounting by an entity when the terms of a financial liability are renegotiated and result in the entity issuing equity instruments to a creditor of the entity to extinguish all or part of the financial liability (debt for equity swap).

Any gain or loss is recognised immediately in profit or loss, which is measured as the difference between the carrying amount of the financial liability and the fair value of the equity instruments issued. IFRIC 19 is effective for annual periods beginning on or after 1st July 2010.

Further, according to the assessment of SQS, the application of these standards and interpretations will not have an significant impact on results of operations, financial position or cash flows of SQS.

The interpretations and amendments to existing standards which are part of the IASB annual Improvement Project issued in 2010 have no material effect on results of operations, financial position or cash flows of SQS.

Basis of consolidation

The Financial Information comprises 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.

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

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.

As at 31 December 2010, the Company held interests in the share capital of more than 20 % of the following undertakings (all of those subsidiaries have been consolidated):

In the first half of 2010 SQS AG paid in line with the SQS Indias' acquisition contract a further amount of €203k (INR13,005,000) as part of the purchase price obligation. Furthermore, according to the agreement SQS purchased the further 15 % of the shares in SQS India with the effective date on 27 December 2010.

SQS AG holds 15% of the shares of SQS Portugal Lda with a book value of €0 (previous year €0).

Foreign currency translation

The Euro (€) is the functional and reporting currency of the 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 foreign currencies are translated at the functional currency spot rate of exchange ruling at the balance sheet date. All differences are taken to the consolidated income statement. Non-monetary items that are measured at historical costs in a foreign currency are translated using the exchange rate as at the date of initial transaction. 

The following subsidiaries have own functional currency:

At the reporting date, the assets and liabilities of these subsidiaries are translated into Euros at the exchange rate valid at the balance sheet date. The items of the income statement are translated at the weighted average exchange rate for the year. 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 are reclassified from equity to profit or loss as a reclassification adjustment when the gain or loss on disposal is recognised.

3. Segmental reporting

In January 2010 the SQS Group has changed its organisational structure. There are two major business units acting as provider for consultancy services in their regions. Both regional business units report their financial information to the management of SQS AG as chief decision maker. The third reporting unit includes the Training & Conferences business as well as the Software Testing Products. Both, Training & Conferences (T&C) as well as Software Testing Products (STP) are operating segments according to IFRS 8 as they are reported separately to the management of SQS AG. However, neither T&C nor STP fullfill the criteria of IFRS 8.13. Therefore the financial information according to T&C and STP has been aggregated according to IFRS 8.12 under the reporting segment "Other".

Based on this organisational structure the SQS Group has established the three following reportable operating segments:

·; CEME (Central Europe Middle East),

·; WONS (West Organisation North & South),

·; Other (includes STP (Software Testing Products) and T&C (Training & Conferences)).

The segments "WONS" and "CEME" administrate the existing places of business as follows:

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

·; CEME: SQS Germany, SQS Switzerland, SQS Austria, SQS Nederland, SQS Group Management Consulting, SQS Egypt.

The segment "Other" includes two important roles, namely selling and leasing of Software Testing Products and providing of Trainings as well as hosting of Conferences.

These profits centres run all revenue and profit generating units as market facing profit centres.

The profit centre is reportable to the Group Management Board (GMB) in Germany. Each segment has a regional board. The board includes three roles CEO (Chief Executive Officer), CMO (Chief Market Officer), and COO (Chief Operations Officer).

The Group Management Board monitors the operating results of the operating segments separately for the purpose of making decisions about resource allocation and performance assessment. Segment performance is evaluated based on operating profit or loss.

Transactions between the segments or legal entities are made on an arms length basis. Centrally incurred external costs relating to subsidiaries are recharged to the subsidiaries affected. Cost allocations between the segments or legal entities are not charged.

The non-profit Centres include important functions such as Portfolio Management, Marketing Communication, Finance & Administration, IT, Human Resources, Managed Services Support and Sales Support.

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

The assets and liabilities relating to the operating segments are not reported because they are not reported to the Group Management Board. Furthermore, Group financing (including finance costs and finance income) and income taxes are managed on a group basis and are not allocated to operating segments.

In fiscal year 2009 the Company had four reportable segments namely Germany, UK based business (including Ireland, South Africa and India as those countries are organised as a unit "UKISA"), Switzerland, and other countries. The segment "Other countries" included Austria, Nordic, Egypt, and the Netherlands.

Previous year information has been reclassified to correspond to the new reporting format.

The following tables present revenue and profit information regarding the SQS Group's operating segments for the years ended 31 December 2010 and 2009.

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 2010 amounted to €13,894k (2009: €9,640k). Cost of material relates mainly to the procurement of outside services such as contract software testing 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 the change in pension accruals and expenses for defined contribution plans such as direct insurance and provident fund costs.

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

Government grants

Government grants in the amount of €199k (2009: €578k) have been granted for personnel expenses for the additional employees in Görlitz and in UK (2009: Görlitz) and have been recognised as income. Of these an amount of €176k (2009: €374k) had not yet been paid to SQS at balance sheet date. There are no unfulfilled conditions or contingencies attached to these grants.

Amortisation and Depreciation

Amortisation and depreciation charged in the year ended 31 December 2010 amounted to €7,548k (2009: €6,534k). Of this, €2,833k (2009: €2,387k) was attributable to the amortisation of development costs.

Rentals and leasing

Operating lease costs in connection with office space and equipment in 2010 amounted to €6,261k (2009: €5,189k).

The lease contracts will expire between 2011 and 2014. Some of them can be prolonged or renewed, some allow price alignments.

5. Net finance costs

The net finance costs are comprised as follows:

Finance income results from fixed deposit investments and investments in securities maturing in the short term which yield interest income, or securities negotiable at short notice.

Interest expense relates to interest on bank liabilities. Further, an amount of €141k (2009: €387k) results from discounting the liability from:

- the purchase of SQS Group Management Consulting GmbH €0k (2009: €179k)

- the purchase of SQS Software Quality Systems Nordic AB €115k (2009: €103k) and

- the purchase of SQS India €26k (2009: €105k) calculated using the effective interest method.

Finance income and costs are stated after foreign exchange rate gains and losses.

6. Taxes on earnings

Deferred income tax is provided, using the liability method, on all temporary differences at the balance sheet date between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. The calculation is based on the tax rates anticipated in the respective countries as at the realisation date. These are essentially based on the statutory provisions applicable or passed by the government at the date of the Financial Statements.

As a basic principle, SQS Software Quality Systems AG in Germany is liable to corporate income tax, the solidarity surcharge and trade tax. The results of the Company are subject to corporate income tax. The German corporate income tax amounts to 15 % (2009: 15%). A 5.5% solidarity surcharge is imposed on corporate income tax. The trade income tax amounts to 15.75% of the taxable income. Consequently the total income tax rate amounts to approximately 30 %.

Consolidated income tax expense is as follows:

A reconciliation of income tax applicable to the accounting profit before income tax at the statutory income tax rate to the income tax expense in the income statement is as follows:

Deferred taxes with an amount of €0k (2009: €79k) were charged directly to equity.

In accordance with § 37 KStG (German corporation tax law) SQS has capitalised the corporation tax credit on 31 December 2010 at a present value of €1,134k (2009: €1,264k). The present value has been discounted using an interest rate of 5,5%. The tax credit will be paid off by eight further instalments until 2017.

For the assessment of deferred tax assets and liabilities, SQS Software Quality Systems AG applies a tax rate based on the current tax law in Germany of 30% (2009: 30%) which takes into account corporation tax, the solidarity surcharge and trade tax. For deferred tax assets and liabilities of the overseas subsidiaries, the local tax rates are taken as the basis.

Deferred income tax relates to the following:

Deferred tax assets are recognised when it is considered probable that economic benefit will flow to the entity. Based on the earnings situation of the past and on the business expectations for the foreseeable future, value adjustments are determined if applicable.

Where a company has suffered losses, deferred tax credits thereon are capitalised if the ability in the future to set off the losses with future income is permissible under the respective national provisions. According to the planning of SQS BV and SQS Nordic, a return to taxable profits is regarded as very probable.

SQS Egypt disposes of accumulated tax losses carried forward of €526k. In respect of these losses no deferred tax asset have been capitalised.

7. Earnings per share

The earnings per share presented in accordance with IAS 33 are shown in the following table:

Undiluted earnings per share are calculated by dividing the profit for the year attributable to equity shareholders by the weighted average number of shares in issue during 2010: 27,263,419 (2009: 26,242,287).

Diluted earnings per share are determined by dividing the profit for the year attributable to equity shareholders by the weighted average number of shares in issue plus any share equivalents which would lead to a dilution.

The adjusted earnings per share 2010 and 2009 were calculated based on the profit after tax:

- less the corporate income tax asset of €67k (2009: €72k),

- plus the interest cost of the purchase obligations of €141k (2009: €386k),

- plus amortisation cost of the acquired customer relationships as part of the business combinations of €1,557k (2009: €1,557k),

- plus expenses in terms of the employee participation program: the difference between the market share price and the selling price of shares €78k (2009: €23k),

- plus differences of evaluation of pensions according to IFRS and HGB (German GAAP) of €66k (2009: €106k).

- plus pension interest expenses of €49k (2009: €46k),

- plus expenses and claims vested as part of partial retirement of €356k (2009: €0k).

Further the difference between taxes on income payable under local GAAP and IFRS of €(270)k (2009: €(230k)) has been adjusted. This results in an adjusted profit after taxes of €6,721k (2009: €5,527k). This divided by shares 27,263,419 (2009: 26,242,287) shows adjusted earnings per share of €0.25 (2009: €0.21).

Management considers that the stock options given to employees may have a dilutive effect. On a weighted average basis shares resulting from stock option programmes amounted to 728,122 (2009: 776,492) shares. This effect leads to an immaterial difference between undiluted earnings and diluted earnings per share. The number of potential shares is calculated on a pro rata basis.

Instruments that could potentially dilute basic earnings per share in the future are authorised capital and conditional capital (see note 9).

8. Intangible assets

The composition of this item is as follows:

Development costs of software were capitalised in the business year in the amount of €3,127k (in the previous year €3,320k) and amortised over a period of 36 months. The other development costs were capitalised, but not yet amortised in the business year. These development costs relate to the consulting product 'Software Tests as Managed Services'. The estimated usefull life of this product covers a period of five years. Amortisation is expected to start in the second half of 2011.

The amortisation of software and remaining intangible assets is spread over the functional costs in accordance with an allocation key.

In order to test the recoverability of goodwill SQS conducted impairment tests, comparing the value in use of each cash generating unit with their carrying amounts. Impairment tests were carried out for the SQS UK based business (SQS UKISA), for SQS Nederland B. V., for the SQS Group Management Consulting GmbH (formerly Triton), for the SQS Software Quality Systems Nordic AB (formerly Validate), as well as SQS India (formerly VeriSoft InfoSystems and VeriSoft InfoServices).

Those entities are considered to be the cash generating units which are relevant for impairment testing as they represent the lowest level at which management of the SQS Group monitors the underlying value of each goodwill acquired within each transaction.

All impairment tests are based on the value in use of each cash generating unit. In order to determine the values in use management has set up budgets and forecasts for each cash generating unit. The key assumptions on which management has based its cash flow projections are the future development (growth) of revenues, the development of the gross margin based on the expected capacity of the SQS-consultants and the development of general and administrative costs as well as sales and marketing costs in relation to revenues.

In its budgets and forecasts management projected detailed cash flows over a period of five years. For the periods thereafter constant cash flows were assumed in accordance with the discounted cash flow method.

The determination of the cash flows is based on the state of knowledge as of November 2010. Beside experiences from the past, management considered the recent global economical development, the actual orders on hand, the actual number of SQS-consultants as well as the strategy of SQS for the coming five years.

The budgets of the European cash generating units except SQS Nordic show an increase in revenues for 2011 between 10 % and 31.2 % compared to the year 2010. For the years 2012 to 2015 the growth per year is reduced to 10 % for each of those cash generating units. Management expects that all subsidiaries are going to grow higher than the market. Regarding SQS India management assumes a growth of 69.1 % for 2011 and a further growth between 12 % and 20 %for each of the years 2012 until 2015.

Further management expects that the gross margin ratio will slightly be increased and that the expense ratio of general and administrative costs as well as sales and marketing costs will be decreased for most of the subsidiaries of SQS.

In accordance with IAS 36, the impairment tests were based on the following assumptions:

·; 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 carrying amount of the cash generating unit and from the value in use,

·; 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 the calculations when estimating the future cash flows and the book value,

·; For the transition from the value of the entire business to the value in use of the equity holders, the entire liabilities at market value (= book value) were eliminated,

·; The growth rate in perpetuity of 1.0, and 1.5% for India, respectively ,

·; The goodwill was allocated entirely to the carrying amount of the cash generating unit in accordance with IAS 36.80 and IAS 36.81,

·; The discount rates applied to the cash flow projections were pre-tax interest rates in a range between 8.5 % and 10.7 %.

Neither in 2010 nor in 2009 impairment losses or reversals of impairment losses have been recognised.

9. Equity

SQS is listed on the AIM market in London and on the Open Market in Frankfurt (Main).

Subscribed Capital

The subscribed capital amounts to €27,263,419 (in the previous year €27,263,419 ). This is divided into (in the previous year 27,263,419) individual registered shares with an arithmetical share in the share capital of €1 each. Each share entitles the holder to one right to vote. No preference shares have been issued. The capital is fully paid up.

The movements in the issued share capital are as follows:

On 26 November 2010 the management board resolved to use Authorised Capital I and increased the share capital from €27,263,419 by €367,053 to €27,630,472 by using 367,053 new registered non-par value shares against contribution in kind. The supervisory board has consented to this resolution. This resolution became effective with the entry in the commercial register on 7 January 2011.

On 29 November 2010 and 16 December 2010 the management board resolved to use the Authorised Capital II and increased the share capital from €27,630,472 by €28,265 to €27,658,737 by using 28,265 new registered non-par value shares against cash for employee participation. The supervisory board has consented to this resolution. This resolution became effective with the entry in the commercial register on 24 January 2011.

On 17 December 2010 the management board resolved to use Authorised Capital I and increased the share capital from €27,658,737 by €234,552 to €27,893,289 by using 234,552 new registered non-par value shares against contribution in kind. The supervisory board has consented to this resolution. This resolution became effective with the entry in the commercial register on 24 January 2011.

As the capital increases legally became effective in January 2011 as at 31. December 2010 the issues of shares are shown as additional paid in capital in share premium.

SQS had no shares in its ownership as at 31 December 2010.

Conditional capital

The General Meeting of 2 June 2006 resolved a conditional capital by an amount of up to €1,500,000 by issuance of up to 1,500,000 new individual registered shares (Conditional Capital II). This resolution became effective with the entry of 30 June 2006. The Conditional Capital II serves to grant up to 1,500,000 share options as incentive compensation for SQS employees and executives. The increase of the Conditional Capital will be made in the case of exercising of the stock options from holders.

Authorised capital

The General Meeting of 20 May 2009 resolved a cancellation of the Authorised Capital I, the Authorised Capital II, the Authorised Capital III and the Authorised Capital IV and a creation of a new Authorised Capital I and Authorised Capital II by issuing of up to 10,400,000 and up to 2,600,000 new registered non-par value shares, respectively, against contributions in cash or in kind until 30 April 2014.

On 5 November 2009 the Authorised Capital I was partially used by using of 1,021,299 new registered non-par value shares against contribution in kind for the acquisition of Triton Unternehmensberatung GmbH (3rd tranche).

Further the management board resolved on 11 November 2009 to use the Authorised Capital II by issuing 57,045 new registered non-par value shares against cash for employee participation.

Thereafter, the authorised capital developed as follows:

On 26 November 2010 and 17 December 2010 the Authorised Capital I was partially used by issuing of 601,605 new registered non-par value shares against contribution in kind for the acquisition of Validate Group and Verisoft Group (2nd tranche). The entry into the commercial register took place on 24 January 2011. After its partial utilisation the remaining Authorised Capital I now totals 8.777.096.

Further the management board resolved on 29 November 2010 and 16 December 2010 to use the Authorised Capital II by issuing 28,265 new registered non-par value shares against cash for employee participation. After utilisation of the Authorised Capital II this amounts to 2,514,690.

Share premium

Additional paid-in capital includes any premiums received on the issuing of the share capital. Any transaction costs associated with the issuing of shares are deducted or set off from additional paid-in capital, net of any related income tax benefits. Equity-settled share-based employee remuneration is also credited to additional paid-in capital until related stock options are exercised.

Statutory reserves

The statutory reserves in SQS AG were created in accordance with Section 150 of the Stock Corporation Act (Germany). Statutory reserves must not be used for dividends.

Other reserves

Other reserves comprise differences from the translation of foreign operations with an amount of €(4.088)k (2009: €(6,226)k).

Further, other reserves comprise IPO costs from former years that are accounted for net of taxes in the amount of €1,134k (2009: €1,134k).

Retained earnings

Retained earnings represent the accumulated retained profits less payments of dividend and losses of SQS Group.

The General Meeting of 26 May 2010 resolved to pay €0.07 dividends per share for the business year 2009 in the total amount of €1,908,439.33.

Non Controlling Interests

Up to 1 January 2010 the excess and any further losses applicable to minorities have been allocated against the majority interest. In the case that the subsidiary reported profits, such profits were allocated to the majority interest until the minority's share of losses previously absorbed by the majority had been recovered.

Since 1 January 2010 the pro rata profit or loss and each component of other comprehensive income are attributed to the minority interests even if those results have a deficit balance. According to IAS 27 the profit or loss attribution for previous periods has not been restated.

10. Notes to the Statement of Cash Flows

The cash flow statement shows how the funds of the Group have changed in the course of the business year through outflows and inflows of funds. The payments are arranged according to investment, financing and business activities.

The sources of funds on which the cash flow statement is based consist of cash and cash equivalents (cash on hand and bank balances).

Cologne, 9 March 2010

SQS Software Quality Systems AG

SQS Software Quality Systems AG

Stollwerckstrasse 11

D-51149 Cologne