SQS Software falls on profit downgrade

SQS Software issued a veiled profit warning when reporting its interims yesterday and promptly fell 15.7% to 480p.

It’s had a great run since December 2011 when its shares were only 146.50p and investors clearly decided to take profits. Given the balance of risks, that seems like a sensible move.

The cause of the fall was the revelation that: “We will further react, adapt and manage potential impacts on our clients from continued global economic uncertainties. For all these reasons we have to be more cautious and anticipate our profits for the full year to be slightly below the Board’s previous expectations.”

According to management, analysts had expected adjusted pre-tax profit for the full year to be in the region of €22.5 to €25m, but it has been downgraded to around €21m. It has been hit by lower gross margins in Regular Testing Services (RTS) business (34% of revenues), which have declined from 33.6% from the first half of 2014 to 26.4% in this half.

This news is hardly disastrous but, if you’re bearish on the prospects for both the US and German economies as I am, they could be in for tough times. Certainly, the balance of risk in the short term is to further downside.

For the six months to 30 June 2015, revenues increased by 16.1% to €150.3 with pre-tax profits of 5.2m against €3.3m for the same period a year earlier.

Although its two recent US acquisitions should drive up US business, paying for them has increased its net debt to €26.5m. Moreover, operating cash flow  was also negative to the tune of €5.2m, compared with an outflow of 2.6m at the same stage in 2014.

That said, the company explained: “we continue to expect receivable days to return to more normalised levels during the second half of the current year to

deliver strong cash generation resulting in a significantly strengthened balance sheet by the end of the current financial year.”

Management confirmed that, as payments are weighted to the second half, by year end it expects positive cashflow to the tune of €26m — as in 2014.

In a note issued yesterday, Canaccord Genuity reduced its price target from 730p to 650p and maintained its ‘Buy’ stance. Analyst Arun George commented: “We downgrade our full year 2015 adjusted pre-tax profit forecast by around 7% to €22.8m and full year adjusted pre-tax profit by around 6% to €27.7m. Given the uncertainty on the timing and path of margin recovery, we reduce our price target to 650p (previously 730p). This implies an estimated calendar year EV/EBITDA (enterprise value/earnings before interest, tax, depreciation and amortisation) of around 8 times.”