Half Yearly Report

SQS Software Quality Systems AG

("SQS" or the "Company")

Results for the six months ended 30 June 2013

SQS Software Quality Systems AG (AIM: SQS.L), the world's largest supplier of independent software testing and quality management services, today announces its unaudited results for the six months ended 30 June 2013 (the "period").

Financial Highlights:

· Turnover increased by 4.9% to €107.8m (H1 2012: €102.8m)

· Gross profit increased by 5.5% to €33.2m (H1 2012: €31.5m)

· Adjusted* PBT increased by 36.2% to €4.5m (H1 2012: €3.3m)

· Adjusted** EPS increased by 33.3% to €0.12 (H1 2012: €0.09)

· Operating cash flow improved to €4.4m (H1 2012: €3.1m)

· Net debt as of 30 June reduced 28% to €10.3m (H1 2012: €14.3m)

* adjusted to add back €0.4m of amortisation of intangible assets of acquired companies.** includes adjustments under * and an add back of €0.1m for deferred tax income.

Operational Highlights:

· Revenues from Managed Services contracts of €42m (H1 2012: €34m), now accounting for 39% of total revenue (H1 2012: 33%)

· Managed Services contracts gross margin improved to 33.2% (H1 2012: 29.9%)

· Improving visibility with Managed Services order intake of €49.0m (H1 2012: €30.4m)

· Average revenue per client has increased by 15% compared with H1 2012 as a result of our continued focus on larger client engagements

· Adjusted* EBIT margin improved to 4.6% (H1 2012: 4.1%) including continued investment

· Offshore/nearshore test centre billable headcount increased to 44% of total billable headcount (H1 2012: 42%)

· US business now accounts for 2% of total revenues (FY 2012: 0.6%)

Diederik Vos, Chief Executive Officer of SQS, commented, "We are very pleased with our performance during the first 6 months of 2013 in which we have made progress on all metrics. Our focus on larger contracts led to a 15% year-on-year increase in average revenue per client during the period. We have made an excellent start to the second half and recently achieved our 2014 target of 40% of revenues coming from Managed Services. Per our five year plan we now aim to reach 50% of revenues from Managed Services by FY 2016.

"These developments, alongside our continued success in increasing our offshore to onshore staff ratio, have provided improved margins for the Company during the period, which, combined with continued revenue growth, has resulted in a significant increase in earnings.

"We expect to maintain this positive momentum toward meeting our strategic goals and, with improving visibility and strong current trading, are confident of continuing growth, both organic and acquisitive. We are therefore confident of meeting full year market expectations."

Enquiries:

About SQS Software Quality Systems

SQS is the world's leading specialist in software quality. This position stems from over 30 years of successful consultancy operations. SQS consultants provide solutions for all aspects of quality throughout the whole software product lifecycle driven by a standardised methodology, high offshore automation processes and deep domain knowledge in various industries. Headquartered in Cologne, Germany, the company employs approximately 2,600 staff. SQS has offices in Germany, the UK, Egypt, Finland, France, India, Ireland, the Netherlands, Norway, Austria, Sweden, Switzerland, South Africa and the US. In addition, SQS maintains a minority stake in a company in Portugal. In 2012, SQS generated revenues of 210.1 million Euros.

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

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

For more information, see sqs.com 

Chief Executive's Statement

Introduction

The six months under review has been a very successful period for the Company in terms of progression toward meeting the strategic goals put in place at the time that I became CEO last year. 

We increased the proportion of revenues from Managed Services to 39% (H1 2012: 33%) and since the period end have surpassed our FY 2014 target of 40%. The proportion of our billable staff delivering from our offshore and nearshore operations is also increasing in line with our targets such that it now stands at 44% (FY 2012: 42%). In addition, as part of our stated strategy to focus on larger higher-value contracts, we have increased our average revenue per contract by 15% on a year-on-year basis.

During the period we successfully increased revenues and profits and improved margins particularly in Germany, the Netherlands, Austria and Ireland while business was broadly flat due to a weaker market environment in the UK and fell in the Nordics. We have taken a number of restructuring measures in the Nordics to improve sales efficiency, staff utilization and reduce overheads. We expect the full benefit of these measures to only become visible in next years' results.

Revenues increased 4.9% to €107.8m (H1 2012: €102.8m) while gross profit increased by 5.5% to €33.2m (H1 2012: €31.5m). This is a slight improvement in gross margins from 30.7% to 30.8%, although gross margin on revenues derived from our own resources moved from 32% to 33% due to a higher share of test centre delivery.

Adjusted EBIT* increased 16.6% to €5.0m (H1 2012: €4.3m) including €0.5m additional costs relating to the start-up of a local US business and €0.6m additional recruitment and training costs. Adjusted* PBT increased by 36.2% to €4.5m (H1 2012: €3.3m), partly as a result of finance costs being €0.5m lower than in H1 2012.

Operating cash flow of €4.4m has continued to improve as a result of improved order and invoicing control (H1 2012: €3.1m). We have continued to use the cash we are generating to reduce our net debt position, which as of 30 June 2013 stood at €10.3m, 28% less than at 30 June 2012 (€14.3m).

In summary, the six months under review has seen a strong performance by the Company and we believe we are well positioned to capitalise on current market growth. This growth is being driven by a general improvement in economic conditions, coupled with an industry trend toward the provision of testing services by independent suppliers such as SQS and away from the more traditional provision by systems integrators (Nelson Hall 2013). We therefore remain confident of achieving our longer term target of becoming a €500m revenue Company in 2017.

* adjusted to add back €0.4m of amortisation of intangible assets of acquired companies.

New Business

As laid out in our stated strategy, we have sought to focus the business on larger, higher-value contracts setting a potential minimum engagement volume of €1.5m. We have also sought to improve the profitability of lower margin existing contracts and where this has not been possible have taken the decision to terminate those contracts. As a result of our success in implementing this strategy our total number of active clients fell during the period under review from 496 to 460 while revenues increased by 4.9%. Together these developments resulted in our average annualized revenue per client being 15% higher at 30 June 2013 than in 2012.

In terms of forward visibility our order intake for Managed Services improved substantially to stand at €49m at the end of the six month period (H1 2012: €30.4m)  This is chiefly as a result of contract extensions and add-ons from existing clients such as UBS, but we have also had a number of orders for significant new projects. These include, for example, contracts with three global car manufacturers as well as a new contract with a leading aircraft engine manufacturer. We are confident of further growth in the second half of the year as many clients choose to extend contracts before the year end in order to meet their annual budgets.

Further to this, our previously announced preferred partnership with industrial automation supplier Siemens to provide testing services to its industrial clients continues to provide us with entry into numerous initial contracts. This partnership has been particularly effective in securing us new business in the US, where we are focused on the high margin software product testing and certification market and where we are currently experiencing our fastest growth.

Market & Industry Overview

The software testing landscape has continued to outperform the overall IT services market during the period with an expected growth rate of 5% in Europe for 2013 and 7% for 2014, according to a 2013 report by market analysts Nelson Hall. Nelson Hall's report also expects the mix of services within software testing spending to increasingly turn towards 'Specialist Testing Services' (i.e. services provided by organisations such as SQS in standalone contracts and not as part of a software development contract) and larger multi-year contracts, both in line with our areas of focus.

The Nelson Hall report further stated that the total global market for testing services in 2012 was worth $34.5bn. Within this global services market, Specialist Testing Services was valued at an estimated $10.5bn and is forecast to increase by approximately 9.5% per year between 2012 and 2018 to reach $18.1bn by 2018. Conversely, the 'Traditional Testing Services' market (where testing services are bundled with systems integration etc.) is expected to decline by 3% per year between 2012 and 2018 from $24bn to $19.75bn.

As a result of these changes Nelson Hall expects the total testing services market to have grown from $34.5bn in 2012 to $37.8bn by 2018 and Specialist Testing Services to have grown from 30% to 48% of that total. Nelson Hall attributes the move from Traditional Testing Services to Specialist Testing Services to clients increasingly turning to standalone testing rather than embedded testing. This trend is expected to result from a variety of intents from clients, including faster execution and an overall reduction in costs.

The report highlights that software testing contracts are evolving into larger multi-year contracts and that growth is most pronounced in some of our key sectors, such as banking (driven by regulatory compliance), retail&logistics (driven by m-commerce and e-commerce applications) and energy&utilities (driven by deregulation). The results of the report also support our Managed Services strategy in revealing that 57% of software testing services purchase decisions are made by efficiency seeking clients, a demand typically fulfilled by Managed Services contracts.

Consolidation within the IT services industry and within the software testing industry remains a real opportunity and we are currently evaluating suitable acquisition candidates.

Strategy

We remain firmly focused on our Group strategy of building SQS, through both organic and acquisitive growth, into the world's leading specialist in software quality services with revenue approaching €500m in 2017.

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

As stated in our full year 2012 results announcement, we have set out to improve the margins achievable from our RTS business through only targeting new contracts that are likely to provide greater future value and maintaining a minimum potential value of €1.5m on any new contracts. In addition, we continued to look for ways to re-allocate staff in a more cost-effective manner on existing contracts and to discontinue those contracts that are not sufficiently profitable. 

We have been very proactive during the period in our implementation of these strategic targets for our RTS offering and this has resulted in some degree of success. Gross margins from RTS have improved to 29.7% (FY 2012: 28.4%). In addition, and in line with our stated strategy, revenue from RTS as a percentage of total revenue is down to 37% (FY 2012: 38%). The focus on higher value RTS contracts has also directly contributed to the aforementioned 15% year-on-year increase in average revenue per client. 

Our mid-term goals for segment mix for MS, SCS and RTS were previously stated at 40%, 25% and 35% respectively. In H1 2013, the mix was 39%, 16% and 37%, the remaining 8% with other revenues such as contractors. We are pleased to report that post-period-end we have reached our mid-term target of 40% for Managed Services and our aim is to continue to grow this part of the business as a proportion of total revenues to 50%. As such, we aim to have a segmental target split of 50% MS, 20% SCS, 25% RTS and 5% Other. We also succeeded in improving Managed Services gross margins during the period to 33.3% from 29.9% H1 2012.

SCS saw a slight decline in the period as a number of our specialist consultancy staff were moved onto working on the early stages of some major MS assignments. This decline is expected to be temporary. In addition, we have previously stated that we expect RTS to no longer be our largest segment by end of 2014 and we believe we are on target to achieve this goal.

Our strategy of delivering further margin expansion through the introduction of appropriate value-based pricing, balancing onsite and test centre delivery and the continued alignment of overheads, remains. In addition, we maintain our focus on targeting new business within the six key industry verticals in which SQS has strongest domain, application and technology expertise.

Furthermore, we have achieved rapid growth in our US business during the six month period with revenues from the region now accounting for 2% of total revenues (FY 2012: 0.6%). We will continue to focus on extending our services into the US software product testing market, where higher margins and a greater level of repeat business are achievable, and we expect the rapid growth achieved in H1 to continue into the second half of 2013. After continuing investments into our US business during H1 we expect the US operation to be EBIT positive on a monthly basis during H2 2013 for the first time.

We have also begun phase two of the expansion of our Indian test centre facilities, enabling us to facilitate the offshore servicing of our rapidly growing Managed Services business. As previously mentioned in our FY 2012 results announcement, we anticipate this will result in a further cash outflow of €2.5m over the second half of 2013 and first half of 2014.

Dividend

In accordance with German law, SQS can only pay one dividend in each financial year. We expect to declare a dividend with our final results for the year ending 31 December 2013, in line with our current policy of paying out a fixed proportion of full year earnings.

Board

Post the period end, Heinz Bons, Principal Consultant at SQS, and David Bellin, Chairman of EMC Ltd (Bicester, UK), were elected as additional members of the supervisory board.

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

Employees

As mentioned in our full year 2012 results announcement, to satisfy increasing demand for our Managed Services offerings we began Phase II of the expansion of our Indian test centre facilities with the objective of increasing offshore/nearshore headcount to 48% of total headcount by the start of 2014. We have made strong progress during the past six months in this respect such that the offshore staff accounted for 44% of our total headcount at June 30 2013, up from 41% at Dec 31 2012.

Total headcount at the period end had increased 10% during the six months to 2,509 (31 Dec 2012: 2,272) with an optional 204 contractors retained during the period. Hiring the right level and quantity of talent was more difficult in the German speaking countries and in some cases we could have delivered higher revenues if we had been able to fill all vacancies in time.

Fully loaded costs per fee earning consultant (incl. all overheads, but without contractor costs) were €46.7k for the six-month period (H1 2012. €49.2k), down 5.1%. This decrease came from a stronger staff mix towards test-centres and cost reductions from weakening currencies in India and Egypt against the Euro, Sterling and US Dollar. Despite this significant increase in permanent staff we continued our careful focus on utilisation and as a result of this we are pleased to announce that utilisation had further improved and was ahead of our operational targets at 191 billable days per consultant on an annualised basis (FY 2012: 190 days).

Outlook

We are very pleased with our performance during the first 6 months of 2013 in which we have made progress on all metrics. Our focus on larger contracts led to a 15% year-on-year increase in average revenue per client during the period. Post-period-end we have made an excellent start in the second half and also achieved our 2014 target of 40% of revenues coming from Managed Services. Per our five year plan we now aim to reach 50% of revenues from Managed Services by FY 2016.

These developments, alongside our continued success in increasing our offshore to onshore staff ratio, have provided improved margins for the Company during the period, which, combined with continued revenue growth, has resulted in a significant increase in earnings.

We expect to maintain this positive momentum toward meeting our strategic goals and, with improving visibility and strong current trading, are confident of continuing growth, both organic and acquisitive. We are therefore confident of meeting full year market expectations.

Diederik VosChief Operating Officer, Chief Executive Officer4 September 2013

Financial Review

Summary

SQS Group turnover grew by 4.9% to €107.8m (H1 2012: €102.8m) during the period.

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

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

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

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

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

Alongside these major segments there is business with contractors (as far as these have not been included in MS), training & conferences and software product testing tools summarized as "Other".

Breakdown by business unit

Managed Services (MS)

Revenue in MS, our largest segment, amounted to €42.1m in the period (H1 2012: €34.0m), an increase of 23.8%. The improvement in revenue was entirely organic and predominantly came from the extension of existing long term managed services contracts.

Specialist Consultancy Services (SCS)

Our business in this segment saw a small decline during the period of -4.8% to €17.0m (H1 2012: €17.8m). This occurred primarily as the result of demand for these ERP, PLM and process specialists in MS engagements (thus their revenue and margin contribution is counted under MS above), which we expect to be of a temporary nature.

Regular Testing Services (RTS)

This segment was flat in revenues in line with our strategic goals during the period with a slight increase of 0.3% to €39.7m (H1 2012: €39.6m). This represents a further reduction of this segment from 39% (H1 2012) to 37% of total revenues.

Other 

Revenue in the Other segment amounted to €9.0m in the period (H1 2012: €11.4m), a decrease of 20.7%. Revenues from third party tool re-selling nearly halved, however all other business lines summarized in "Other" decreased as well. This is a result of our sales focus on the growth segments MS and SCS above. 

Margins and Profitability

Gross profit improved by 5.5% to €33.2m (H1 2012: €31.5m), with the gross margin at 30.8% (H1 2012: 30.7%). The increase in the gross margin was mainly influenced by an improved gross margin from managed services contracts with a gross margin of 33.2% (H1 2012: 29.9%) due to a growing proportion of contracts now entering a more mature life cycle phase. Gross margins from SCS were 34.0% (H1 2012: 35.6%) and RTS 29.7% (H1 2012: 31.8%) reflecting continuing margin pressure in the RTS segment. However RTS gross margin in H1 2013 improved compared with FY 2012 (28.4%) representing some improvement as we further focused on more profitable client engagements. Gross margins from contractor business reduced by more than 5% as a result of employing some contractors on projects billed through our existing preferred supplier framework contracts at lower margins.

Adjusted* profit before tax for the period was €4.5m (H1 2012: €3.3m), an increase of 36.2%, with the adjusted profit margin rising to 4.2% (H1 2012: 3.2%). The profit before taxes benefitted from reduced overhead costs as a percentage of revenue and substantially lower finance costs mostly due to a positive impact from exchange rate gains of +€0.2m (H1 2012: -€0.3m for exchange rate losses) from intercompany transactions.

Adjusted** earnings per share increased to €0.12 (H1 2012: €0.09).

* adjusted to add back €0.4m of amortisation of intangible assets of acquired companies.** includes adjustments under * and an add back of €0.1m for deferred tax income.

Costs

General & Administrative expenses (before IFRS amortisation of intangible assets of acquired companies of €0.4m) for the period were €18.6m (H1 2012: €17.8m). While coming down 0.1% as a percentage of revenue to 17.2%, the absolute growth was mainly due to increased hiring and training costs (€0.6m) and investment in the US business (€0.5m).

Sales & Marketing costs for the period were €8.3m (H1 2012: €7.9m), continuing to represent 7.7% of sales (H1 2012: 7.7%).

Research & Development expense during the period reduced to €1.4m (H1 2012: €1.6m) representing 1.3% (H1 2012: 1.6%) of revenues. Research and development investment was mainly focused on the development of software testing tools and our proprietary PractiQ methodology.

Cash Flow and Financing

Cash flow from operating activities increased strongly to €4.4m (H1 2012: €3.1m). This was a further improvement of EBIT to operating cash flow conversion of 89% (H1 2012: 73%) due to improved order and invoicing workflow, particularly with our largest clients, despite a slight increase in total debtor days (incl. work in progress) to 76 (H1 2012: 73.5).

Cash outflow from investments increased to €2.5m (H1 2012 €1.9m outflow) mainly due to an investment in a second phase in our building for our India based offshore test centre creating another c. 350 work spaces.

Cash outflow from financing activities was €4.7m (H1 2012: €2.2m outflow) reflecting the further redemption of loans and an increased dividend payment.

Balance Sheet

We closed the period with €7.0m (30 June 2012: €6.7m) of cash on the balance sheet and borrowings of €17.3m (30 June 2012: €21.0m). The resulting net debt position at the period end was therefore €10.3m (30 June 2012: €14.3m). These movements are in line with our policy to reduce net debt by freeing up positive cash flow from operations and lower investment levels.

The restructuring measures we have taken in the Nordics have led us to review the carrying value of €5.7m of those assets. This review will be completed during H2 and take into account the trading in the Nordic region over this period.

Taxation

The tax charge of €1.3m (H1 2012: €0.5m) includes current tax expenses of €1.2m (H1 2012: €0.8m) and deferred tax expenses of €0.1m (H1 2012: tax income €0.3m). The tax rate on local GAAP results was 26% (H1 2012: 24%), which was a return to more normal tax rates after tax breaks in the past. For the full year, we expect an actual tax rate of 30%.

Foreign Exchange

Approximately 57% of the Group's turnover is now generated in Euros. For the conversion of revenues and costs generated in local currencies into Euros, the relevant official average exchange rate for the six-month-period of 2013 was chosen. For the conversion of the balance sheet items from local currency into Euros, the official exchange rate as at 30 June 2013 was used.

Due to a general strengthening of the Euro, foreign exchange had a small €97,000 negative translational impact on earnings for the period. Had the Pound/Swiss Franc/Indian Rupee/Swedish Krona/Euro exchange rates remained the same as in H1 2012, our non-Euro revenues for the period would have been €1.1m higher, resulting in an increase in PBT of €97,000.

International Financial Reporting Standards (IFRS)

The Interim Consolidated Financial Statements of SQS and its subsidiary companies ("SQS Group") are prepared in conformity with all IFRS (International Financial Reporting Standards, formerly International Accounting Standards) and Interpretations of the IASB (International Accounting Standards Board) which are mandatory at 30 June 2013, whereas the interim reports are published in an abbreviated form according to IAS 34. The Interim Consolidated Financial Statements have neither been audited nor reviewed.

The SQS Group Consolidated Financial Statements for the six month period ended 30 June 2013 were prepared in accordance with uniform accounting and valuation principles in Euros.

Rene GawronChief Financial Officer4 September 2013

Notes to the interim consolidated financial statements (unaudited)

at 30 June 2013

1. Summary of Significant Accounting Policies

Basis of preparation and statement of compliance

The Interim Consolidated Financial Statements of SQS and its subsidiaries ("SQS Group") are prepared in conformity with all IFRS Standards (International Financial Reporting Standards) and Interpretations of the IASB (International Accounting Standards Board) which are mandatory at 30 June 2013, whereas the interim reports are published in an abbreviated form according to IAS 34. The Interim Consolidated Financial Statements have neither been audited nor reviewed.

The accounting policies applied preparing the Interim Consolidated Financial Statements 2013 are consistent with those used for the Consolidated Financial Statements at 31 December 2012.

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

The interim consolidated financial statements do not include all information and disclosures required in the annual financial statements, and should be read in conjunction with the Group's annual financial statements as at 31 December 2012.

Basis of consolidation

As at 30 June 2013, the Company held interests in the share capital of more than 20% of the following undertakings (all of those subsidiaries have been consolidated):

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

Use of estimates

The preparation of the Interim Financial Statements in compliance with the International Financial Reporting Standards requires the disclosure of assumptions and estimates made by management, which have an effect on the amount and the presentation of revenues, expenses, assets and liabilities shown in the other comprehensive income or profit or loss, in the statement of financial position as well as any contingent items. There may be deviations from these estimates.

The main estimates and judgements of the management of SQS refer to:

· the useful life of intangible assets and property, plant and equipment,

· the criteria regarding the capitalisation of development costs,

· the recoverability of deferred taxes on tax losses carried forward,

· the discount rate, future salary increases, mortality rates and future pension increases regarding the valuation of defined benefit obligations.

There have been no changes in estimates compared to the year 2012.

2. Segmental reporting

According to the mid-term strategy a new organizational structure is in place since 1 January 2013. Instead of different regions the focus is now on the types of our business. Our three primary service offerings are:

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

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

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

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

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

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

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

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

The following tables present revenues and profit or loss for each of the SQS Group's reportable segments for the interim period ended 30 June 2013 and 30 June 2012 and for the year ended 31 December 2012, respectively.

3. Expenses

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

Cost of material

Cost of material included in the cost of sales in the interim period ended 30 June 2013 amounted to €10,921k (at mid-year 2012: €12,778k). Cost of material mainly relates to the procurement of external services such as contracted software engineers. In addition, certain project-related or internally used hardware and software is shown under cost of material.

Employee benefits expenses

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

Amortisation and depreciation

Amortisation and depreciation charged in the interim period ended 30 June 2013 amounted to €3,195k (at mid-year 2012: €3,533k). Of this, €1,527k (at mid-year 2012: €1,437k) was attributable to the amortisation of development costs.

4. Net finance costs

The net finance costs are comprised as follows:

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

Interest expense relates to interest on bank liabilities and finance lease liabilities.

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

5. Taxes on earnings

The line item includes current tax expenses in the amount of €1,178k (at mid-year 2012: €788k) and deferred tax expenses in the amount of €144k (at mid-year 2012 deferred tax income: €239k).

6. Earnings per share

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

Undiluted profit per share is calculated by dividing the profit for the six month period attributable to owners of the parent by the weighted average number of shares in issue during the six month period ended 30 June 2013: 27,893,289 (at mid-year 2012: 27,893,289).

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

The adjusted profit per share is calculated by adjusting the profit after tax for deferred taxes, the amortisation cost of the acquired customer relationships as part of the business combinations, the pension interest expenses and the change in the present value of the corporate income tax asset. This adjusted profit after tax divided by the weighted average number of shares in issue during the six month period ended 30 June 2013: 27,893,289 shares, (at mid-year 2012: 27,893,289 shares) shows adjusted earnings per share of €0.12 (at mid-year 2012: €0.09).

7. Intangible assets

The composition of this item is as follows:

Development costs of software were capitalised in the interim period ended 30 June 2013 in the amount of €1,140k (at mid-year 2012: €1,132k). They are going to be amortised over a period of 36 months. The other development costs mainly relate to the methodology 'PractiQ', used by SQS to provide Managed Services. In the interim period 2013 an amount of €250k (at mid-year 2012: €292k) has been capitalised. The estimated useful life of this intangible assets covers a period of five years.

The amortisation of development costs is included in the research and development expenses.

The amortisation of software and remaining intangible assets is allocated to the functional costs by an allocation key.

8. Property, plant and equipment

The development of property, plant and equipment of the SQS Group is presented as follows:

9. Bank loans and overdrafts

The finance liabilities are comprised as follows:

For SQS AG and some subsidiaries bank overdraft agreements are in place.

10. Other current and non-current liabilities

The item is comprised as follows:

The remaining other liabilities comprise trade accruals and other items due to the short term. Their carrying amounts are considered to be reasonable approximation of fair value.

SQS has a liability regarding a put option granted to the minority stakeholders of SQS India with an amount of €1,968k (at 31 December 2012: €1,988k) measured on the basis of the formula laid down in the put option contract. This liability is non-current.

11. Other provisions

Other provisions include warranty costs in the amount of €14k (at 31 December 2012: €14k). Thereof an amount of €5k (at 31 December 2012: €5k) is non-current.

12. Equity

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

The development of equity is presented in the Consolidated Statement of Changes in Equity.

Subscribed Capital

The subscribed capital amounts to €27,893,289 (at 31 December 2012: €27,893,289). This is divided into 27,893,289 (at 31 December 2012: 27,893,289) 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.

There are no changes in the subscribed capital compared to 31 December 2012.

SQS had no shares in its ownership as at 30 June 2013.

Conditional Capital

The General Meeting of 29 Mai 2013 approved the proposal of the Supervisory Board and Management Board regarding the reduction of the Conditional Capital 2 from €1,500,000 to €185,000. Furthermore, the Supervisory Board is authorised to issue option rights up to €1,300,000 (Conditional Capital 3) until 31 December 2013. In addition, the management board is, with the consent of the supervisory board, authorised to issue option rights up to €1,300,000 (Conditional Capital 4) until 31 December 2014.

The Conditional Capital 3 and the Conditional Capital 4 serve to grant share options to the management board members and employees respectively.

The changes in the Conditional Capital 2, 3 and 4 became effective with entry in the commercial register on 21 June 2013.

Authorised capital

The authorised capital amounts to €11,291,786 (at 31 December 2012: €11,291,786). There are no changes in the authorised capital compared to 31 December 2012.

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, IPO costs from former years and a cash flow hedge reserve regarding the fair values of interest and currency swaps.

Retained earnings

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

The General Meeting of 29 May 2013 resolved to pay €0.07 dividends per share for the business year 2012 in the total amount of €1,952,530.23, that have been paid to the shareholders of SQS AG in 2013.

13. Non-controlling Interests

The pro rata profit or loss and each component of other comprehensive income are attributed to the non-controlling interests.

14. Notes to the Statement of Cash flows

The consolidated Statement of Cash flows 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 investing, financing and operating activities.

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

15. Related party transactions

Under IAS 24, related persons and related companies are persons and companies who have the possibility of controlling another party or exercising significant influence over their finance or business policy. In the SQS Group, these are the management board members as well as the members of the supervisory board.

Further, the real estate investment fund "S.T.O.L. Immobilien Verwaltung GmbH & Co. KG", Cologne, "S.T.O.L. Verwaltungs GmbH", Cologne, and "Am Westhover Berg GbR mbH", Cologne who are tenants of the SQS office at Cologne are considered to be related parties as these entities are owned by former management and employees of SQS AG.

In detail, the following transactions have taken place with these individuals and companies:

Mr. Gawron and the member of the supervisory board received dividends as shareholders of SQS AG (see Note 12). At the date the dividends were paid, Mr. Gawron held 0.2% and the members of the supervisory board 0.1% of the shares in SQS AG.

SQS uses property owned by the closed real estate investment fund "S.T.O.L. Immobilien Verwaltung GmbH & Co. KG", Cologne, and the real estate investment fund "Am Westhover Berg GbR mbH", Cologne. The general partner of these, "S.T.O.L. Immobilien Verwaltungs GmbH", assumes the administration of the funds. The shares in all these companies are held by employees and former management board members of SQS AG. The contractual conditions of the lease of properties are comparable with normal market conditions. The total expenses incurred under these contracts amounted in the interim period to €449k (at mid-year 2012: €446k).

The total emoluments of the management board members amounted in the interim period ended 30 June 2013 to €790k (at mid-year 2012: €550k). The increase in the ongoing remuneration of the management board was caused by the higher number of management board members in 2013 (four members in the current half-year compared to three members in the previous half-year period).

Additionally, the former management board member Mr. van Megen received a termination payment of €365k (at mid-year 2012: the regular payments of €208k).

The emoluments of the supervisory board members amounted in total to €50k (at mid-year 2012: €50k), of which €50k have not yet been paid by the end of the interim period.

16. Post interim period events

The Extraordinary General Meeting of 27 August 2013 resolved to increase the number of members of the supervisory board from three to six members and a corresponding amendment to the company's Articles of Associations.

Based on the resolution by the Extraordinary General Meeting of 27 August 2013 the following members have been elected as additional members of supervisory board:

· Heinz Bons, Dipl.-Kfm., Principial Consultant at SQS Software Quality Systems AG, Frechen

· David Bellin, MBA, Chairman of EMC Ltd (Bicester, UK), Tring (UK).

In addition, a futher representative of the employees will be elected pursuant to the One Third-Participation Act (Drittbeteiligungsgesetz) as a further new member of supervisory board.

The changes will become effective upon registration in the commercial register.

Cologne, 03 September 2013

SQS Software Quality Systems AG

SQS Software Quality Systems AG

Stollwerckstrasse 11

D-51149 Cologne