SQS

I identified SQS as a stock to watch about a year ago. Today they came out with bumper interim results, a statement that they would comfortably beat full year market estimates, and an improved balance sheet too.

They're the leading specialist providing software testing. This market's growing ahead of software in general, with several drivers; M&A (where systems need to be integrated), new software spending, web functionality needing to be built into business systems, and compliance. 25% organic revenue growth isn't too dusty - five times the industry average. And with a 20% rise in the number of new clients being acquired, the company is establishing a great pipeline to keep growth motoring over the next 18 months.

Gross margin was up despite expansion - unusual in the computer services sector. They've had the benefit of a price rise (5% in the UK) but even so, they must be managing their new hires pretty tightly to get such a good result.

What I really like, though, is that the quality of deals is also improving, with more long term contracts. Not only that, but the company is being hired earlier in projects - testing all the way through, and becoming an integral part of the project, rather than just being brought in at the end. It's like the difference between internal audit and year end financial audit. (Although if external auditors think they're unpopular, they should just try doing an internal audit job - nobody loves internal auditors, not even their finance directors.)

SQS also shone light on the way offshoring is working for them. It's not an either/or decision for SQS's customers. They start off with the majority of the work being done on site; but as the relationship becomes deeper, and as the project matures, more work can be offshored - moving up to 50 percent within a year or two, and probably 70 percent of the work after three years. That's very different from the way most people think about offshoring - "sack all your staff and set the call centre up in Delhi instead." (Offshore firms like Wipro have some big PR they need to do in the UK.)

I have looked hard at the SQS account because something has got to be wrong, hasn't it? These results are too good to be true... except they are true. And I can't see anything wrong with them!