Octopus AIM VCT 2 plc : Annual Financial Report

Octopus AIM VCT 2 plc

Final Results

7 March 2018

Octopus AIM VCT 2 plc, managed by Octopus Investments Limited, today announces the final results for the year ended 30 November 2017.

These results were approved by the Board of Directors on 7 March 2018.

You may view the Annual Report in full at www.octopusinvestments.com in due course. All other statutory information will also be found there.

Financial Summary

* The proposed final dividend will, if approved by shareholders, be paid on 18 May 2018 to shareholders on the register on 20 April 2018.
**Total return is calculated as (movement in NAV + dividends paid in the period) divided by the NAV at the beginning of the period.

Chairman's Statement

Introduction
I would particularly like to welcome new shareholders who have joined the share register and I do hope that I will see some of you at the AGM on 3rd May 2018. The year under review has once again seen the stock market rise, demonstrating considerable resilience despite a series of challenges, particularly in the second half when an unexpected General Election resulted in further political uncertainty at a time when Brexit has dominated politics with little room for any other business. Despite almost daily negative press, the economy continued to grow in 2017, helped by an international economic recovery which acted as a counter to some of the headwinds caused by a squeeze on the domestic consumer. Against this background smaller companies outperformed the wider market and it was encouraging to report another year of positive returns for the Company, as a result of the progress made by many of the portfolio companies in the year.

Performance
The Net Asset Value on 30 November 2017 was 87.1p per share, which is a significant increase on the NAV of 80.6p reported at 30 November 2016. Adding back the 4.1p of dividends paid in the year, to adjust the year end NAV to 91.2, gives a total return of 13.2%. In the same twelve months, the FTSE All Share Index rose by 13.4%, the FTSE SmallCap (excluding investment companies) Index by 19.4% and the FTSE AIM All Share Index by 27.1%, all on a total return basis.

Once again progress in the underlying companies was the single biggest driver of performance, with some of the investments made in the past five years now making a significant impact on the portfolio as they achieved sales and profits growth. Some of the more mature holdings also did well, demonstrating their ability to continue to grow. Performance is covered in more detail in the Manager's report.

In the year under review AIM has raised £5.9 billion of new capital, an increase on the £5.0 billion raised in the previous year, demonstrating its ability to provide additional growth capital for its members. Against this background the Investment Manager has invested £4.2 million into qualifying companies, up from £2.3 million in the previous year.

New VCT Regulations
The latest November budget came at the end of the Patient Capital Review that was designed to see where funding gaps for small growing companies exist and address them. It has resulted in some further tweaks to VCT legislation, mostly around the speed at which new money raised needs to be invested in qualifying companies as well as raising the overall percentage to be held in qualifying companies from 70% to 80%. This is covered in detail in the Investment Manager's section of the report. At this stage there has been little impact on the portfolio itself and no need to change investment policies. That is a situation that may change in the future, but any change is much more likely to be evolutionary rather than immediately dramatic, although there are signs of a developing trend towards investing in smaller and earlier stage companies which fit the HMRC regulations. These may take a few years to contribute meaningfully to performance, not least because the companies will invariably require additional capital.

Dividends
The Board has a policy of providing shareholders with a yield of 5%, subject to a minimum payment of 3.6p per year. In September an interim dividend of 2.1p was paid to all shareholders. The Board is recommending a final dividend in respect of the year to 30 November 2017 of 2.1p per share, making 4.2p in total paid in respect of the year, in line with the yield objective. Subject to the approval of shareholders at the AGM the dividend will be paid on 18 May 2018 to shareholders on the register on 20 April 2018.

Dividend Reinvestment Scheme
In common with a number of other VCTs in the industry, the Company has established a Dividend Reinvestment Scheme (DRIS) following approval at the AGM in 2014. Some shareholders have already taken advantage of this opportunity. For investors who do not need income, but value the additional tax relief on their reinvested dividends, this is an attractive scheme and I hope that more shareholders will find it useful. In the course of the year 553,855 new shares have been issued under this scheme, returning £0.5 million to the Company. The final dividend referred to above will be eligible for the DRIS.

Share Buybacks
During the year to 30 November 2017 the Company continued to buy back shares in the market from selling shareholders and purchased 1,831,169 ordinary shares for a total consideration of £1,527,000. We have maintained a discount of approximately 4.5% (equating to a 5.0% discount to the selling shareholder after costs), which the Board monitors and intends to retain as a policy which fairly balances the interests of both remaining and selling shareholders. Buybacks remain an essential practice for VCTs, as providing a means of selling is an important part of the initial investment decision and has enabled the Company to grow. As such I hope you will all support the appropriate resolution at the AGM.

Share Issues
A Top-Up offer to raise £4.3 million was announced on 6 February 2017 and closed fully subscribed on 18 April 2017 having raised £4.3 million net of costs.

An offer to raise up to £12 million with an overallotment facility of up to a further £4 million alongside the Octopus AIM VCT plc was launched 16 June 2017. The offer closed to new applications on 14 November 2017 fully subscribed, having raised £16 million net of costs.

Risks and Uncertainties
In accordance with the Listing Rules and the Companies Act 2006 under which the Company operates, the Board has to comment on potential risks and uncertainties, which could have a material impact on the Company's performance. A risk arises from the requirement to maintain compliance with HMRC regulations requiring 70% of the Company's assets to be invested in qualifying holdings, rising to 80% from 6 April 2019. Other risks include economic conditions, which impact particularly on smaller companies in which the Company invests, and this could have an adverse impact on share prices. Further details of the risks and uncertainties faced by the Company and the processes in place to mitigate them are set out in the Business Review of the Annual Report and Accounts.

VCT Status
PricewaterhouseCoopers LLP provides the Board and Investment Manager with advice concerning continuing compliance with HMRC regulations for VCTs. The Board has been advised that the Company is in compliance with the conditions laid down by HMRC for maintaining approval as a VCT. A key requirement is to maintain at least 70% qualifying investment level which, at 30 November 2017, was at 89% for the Company.

Annual General Meeting
The Annual General Meeting will be held on 3 May 2018. I very much hope that you will be able to come. After the formal business, our Investment Managers will make a presentation and there will, of course, be a chance for you to ask questions. At the Annual General Meeting, a resolution will be proposed to extend the life of the Company until 2023 in order to preserve the VCT status of the Company for the benefit of both existing shareholders and new investors participating in the current share offer.

Outlook
The uncertainty that has dominated market sentiment for some time continues with the key unknown about the nature of our eventual relationship with the EU and the consequent impact on our economy yet to be resolved. A rise in the rate of inflation has exacerbated the longer term squeeze on consumers and this dampened the rate of economic growth towards the end of 2017. However, international growth has been picking up and so talk of a UK recession has receded with even the most bearish pundits settling for slow growth of around 1.5%.

The portfolio now contains 72 holdings across a range of sectors and many of them have already demonstrated their management's ability to grow their businesses successfully in difficult economic conditions. The balance of the portfolio towards profitable companies remains, and the cash available for new investments will allow us to take advantage of any future weakness in valuations should it occur.  

Keith Mullins
Chairman
7 March 2018

Investment Manager's Review

Introduction
Despite being a year filled with newspaper headlines predicting economic gloom and emphasising an unstable political situation caused by a minority government post the June General Election, equity markets performed very well in the year to November 2017. Although there were bouts of volatility, notably in the second half, all indices rose, with smaller companies outperforming their larger peers. The pound has remained relatively weak, but the initial impact of its fall on overseas earners in the FTSE100 immediately post the referendum has washed through and smaller companies have generally seen their businesses grow faster and been rewarded with higher share prices in the year under review. There have been some notable contributors to the portfolio, both positive and negative, but we are pleased to report a rise in the NAV and the maintenance of the 5% yield objective.

In the year to 30 November 2017 AIM has continued to raise new capital for companies, both already quoted and new flotations, and the Company has deployed existing cash steadily throughout the year as well as raising new cash for future investments. The latest prospectus offer closed in November 2017 having raised the full £16 million net which, added to the cash already raised, made a total of £20.3 million net for the year. The investment rate picked up in 2017 and although the new year fundraising season has yet to get into full swing we are already seeing some companies with ambitions to float later in 2018, as well as some earlier stage companies looking to raise money now with the intention of floating at some time in the future, many of which will be VCT qualifying.

The Alternative Investment Market
AIM performed exceptionally well in 2017, producing a total return of 27.1%, well ahead of the 13.4% achieved by the FTSE All share Index. This reflected a general enthusiasm for smaller company shares as well as some particularly strong performances from some of the larger constituents of the AIM index such as Fevertree, Hutchison China Medtech, ASOS and Boohoo. Without its top five contributors AIM's performance would have been 9.5 percentage points lower over the year and more in line with the FTSE Smallcap Index (ex investment companies) which achieved a total return of 19.4%. Share trading volumes were once again higher, helped by smaller companies continuing to be seen as an attractive asset class. In addition, September once again saw a reasonable results season confirming that for many smaller companies the economy remained supportive despite the volatility seen in the aftermath of the surprise General Election result in June. Although the total number of AIM companies has shrunk further, to 950 at 30 November 2017, compared to 993 a year earlier, we believe that the quality has continued to rise and see nothing fundamentally wrong with AIM just because it has fewer companies on the market. The number of new issues once again rose, and included a mixture of early stage companies accessing state aided finance and some already well established companies. AIM is still best described as a collection of smaller growth companies.

Companies have continued to raise new capital throughout the year. In the twelve months to 30 November 2017 AIM raised a further £4.4 billion of new capital for existing companies as well as a total of £1.5 billion for new companies floating on the market. Although the level of fundraising for new companies was similar to last year, the funds raised for existing companies grew significantly, demonstrating that AIM's ability to provide finance for good growth companies as well as attracting new entrants. VCTs play a significant part in that funding process and we identify below the companies we have invested in during the second half of the year.

Performance
Adding back dividends paid in the year, the Net Asset Value increased in the year giving a total return of 13.2%. This compares with a total return for the FTSE All Share Index of 13.4%, the FTSE SmallCap (excluding investment companies) of 19.4% and the FTSE AIM All Share Index of 27.1%. The NAV didn't manage to keep pace with the AIM Index in a year when some particularly large constituents in the index dominated and drove its very good performance. It was also a year of two halves and the fund gave up some of its gains in the second half in less certain market conditions when some shares that had performed well in the first half paused for breath. Individual months in the year under review saw share prices suffering significant bouts of volatility and once again the market generally remained wary of smaller companies that have yet to make a profit (of which there are several in the VCT), although more established companies exceeding expectations once again performed well. Cash rose as a result of the successful fundraising and a proportion of this was invested in Octopus Portfolio Manager and the Micro-Cap fund ahead of being deployed in qualifying investments in order to reduce any drag on performance.

The market continued to reward companies that met or exceeded expectations with higher share prices and this resulted in some very good contributions to performance from many of the more established and profitable companies in the portfolio, as well as from some of the more recent investments whose businesses made significant progress in the year. Among the larger holdings GB Group, RWS, Breedon, Quixant, Learning Technologies and Craneware were significant contributors to performance for the year as a whole. The particular factors that drove the individual share prices were as ever stock specific, with Quixant and Craneware demonstrating strong organic growth leading to forecast upgrades, and GB Group, RWS and Learning Technologies supplementing organic growth with earnings enhancing acquisitions. For example, as a result of the latest acquisition of Moravia, RWS has moved into a new market providing localisation and translation services to some of the largest software companies in the world. As well as adding a new leg to the business, there should be plenty of opportunities to cross-sell its core patent translation to these clients in the future, further underpinning the on-going opportunity to grow organically. Learning Technologies, Breedon and GB Group also benefitted from acquisitions that they had already made, and recognition of the opportunities that these opened up for future growth. Thus, although these shares have all performed very well we continue to hold them for the longer-term growth opportunities that we still feel they have. Among some of the more recent investments, Yu Group, the alternative energy supplier to small and medium sized corporates, Loop-up, the software company providing sophisticated yet simple to use conference call services and Gear4music, the on-line musical instrument and accessory supplier, all demonstrated that they could continue the strong growth in profits they had enjoyed post-flotation, and their shares performed exceptionally well in the period.

Individual companies suffered from specific headwinds which resulted in poor share price performance. We wrote about Tasty in the interim report and unfortunately the second half of the year was just as challenging in terms of cost pressures and a consumer squeezed by the effects of inflation. Recovery in the shares still seems some way off. The other underperformer in that sector was DP Poland which operates the Dominos Pizza franchise in Poland. Although not yet profitable, it has demonstrated that it can roll out both owned and sub-franchised stores and that the model produces profitable stores. We believe that the share price will recover once it achieves critical mass, but the shares have been affected in the short term by worries over competition. The other company to suffer from internal problems was TLA. Its shares were suspended in June following the discovery of accounting irregularities. It finally produced its results for 2016 in November, and its shares were re-listed at a far lower level than the suspension price. A new finance director has been appointed in early 2018 and the latest report from the company indicates that it is trading profitably despite all the problems. The shares have started to recover but will probably need further reassurance in the shape of clean figures showing the expected recovery in profitability before that process is complete. Elsewhere, early stage companies yet to reach profitability were responsible for most of the drag on performance, some of which had setbacks or found themselves in need of cash to achieve the next milestone. Futura Medical, Microsaic, Oxford Pharmascience, Midatech Pharma and Sphere Medical all came into that category. Sphere Medical found that it was unable to raise sufficient funds on AIM and so announced the decision to de-list. The proposed structure would have been non-qualifying and so we had no choice but to sell the shares at a loss.

There are a number of more recent constituents of the portfolio that have yet to make an impression in public markets and whose shares have been dull awaiting evidence of progress in their businesses. These include some very recent holdings such as appScatter, Beeks Financial, Maxcyte and Escape Hunt as well as some investments from the previous year such as Osirium and Free Agent. Investing for a VCT involves backing companies when they are small and still at an early stage of development and share price progress depends on them being noticed by a wider circle of investors as they produce results and develop their businesses over time. Although the earlier stage companies in the portfolio represent a relatively small proportion by value we expect them to contribute to future performance when they start to demonstrate growth in their businesses. In the year under review there were some examples of companies that demonstrated that they had started to achieve that in the period and whose shares outperformed including Cambridge Cognition, Ergomed, Nasstar, Wandisco and Mycelx. The latter was helped by a recovery in the oil price and increased demand for its technology to clean hydrocarbons out of water.

The non-qualifying element of the equity portfolio also did well in the year as our earlier strategy of investing in larger more liquid, profitable companies to counterbalance new earlier stage qualifying holdings continued to pay off. Further investments were made into Octopus Portfolio Manager and the FP Octopus Micro Cap Growth funds to manage liquidity while cash is awaiting investment.

Portfolio Activity
Having made four new qualifying investments in Escape Hunt, Faron Pharmaceuticals, Maxcyte Group and Velocity Composites at a total cost of £1.8 million in the first half of the year, we added three further new qualifying holdings at a cost of £1.8 million in the second half, as well as two further qualifying investments of £0.3 million into DP Poland and £0.3 million into Faron Pharmaceuticals, both of which were follow-on investments in existing holdings. This made a total investment of £4.2 million in qualifying investments for the year which was considerably higher than last year's £1.96 million reflecting a more buoyant AIM market. Two of the three new qualifying investments were new issues. appScatter manages all apps for a commercial customer, registering and tracking each app and ensuring their compatibility with appstores worldwide as well as making sure that they fit with corporate requirements and any local industry regulations. It is an early stage company and its platform launched officially in November. FairFX is an international online payments provider that was already quoted on AIM. It raised VCT qualifying money to expand its existing platform alongside a non-qualifying fundraising to acquire CardOne, a profitable company with a banking licence. FairFX is expected to report a profit for 2017. The third investment was in another new issue, Beeks Financial Cloud Group. It provides direct connection to exchange servers for foreign exchange and derivatives traders. It is expanding its operation into new markets and is expected to return to profitability in 2018. The two follow-on investments were in DP Poland to accelerate the roll-out of restaurants in order to achieve critical mass and Faron Pharmaceuticals to invest in the development of its next products which will follow on from Traumakine, its drug currently undergoing phase III trials.

The Investment Manager continued to use non-qualifying investments to manage liquidity while awaiting new qualifying investment opportunities. We have held onto existing AIM holdings where we see the opportunity for further development but have invested any new funds raised into a mixture of the Octopus managed portfolios with a small proportion going into the FP Octopus UK Micro Cap Growth fund. This strategy is designed to obtain a better return on funds awaiting investment than the very low rates available on cash.

There were no major sales in the year although we took the opportunity to take some profits in Quixant, Wandisco, and Restore, and sold the entire holding in Ideagen after the shares had a very good run. The disposal of Gordon Dadds resulted from an existing investment in Work Group which had ceased to be qualifying when it turned itself into a cash shell and de-listed. We sold the shares at a loss after they re-listed once the deal was done and Gordon Dadds reversed into it. The other significant loss came from the disposal of Sphere which was due to de-list and turn itself into a non-qualifying holding. In all disposals raised £3.2 million in cash.

New VCT Regulations
The budget in November 2017 contained some further adjustments to the VCT regulations in the light of the Patient Capital Review, a year-long consultation which was published at around the same time. We do not believe that there needs to be any material change to our investment approach although the new requirements are that any funds raised after 6th April 2018 should be 30% invested in qualifying holdings within 12 months, and for financial years ending after 6 April 2019 the portfolio will also have to maintain a minimum of 80% invested at cost in qualifying holdings. We are determined to maintain a threshold of quality and to invest where we see the potential for returns from growth. However, the emphasis of the new regulations is definitely to encourage investment into earlier stage companies and to that extent, it seems likely over a number of years, that the portfolio will see a rise in the number of smaller companies receiving our initial investment. We would expect to invest further in those companies as they demonstrate their ability to grow.

At present there has been little change to the profile of the portfolio, as we continue to hold the larger market capitalisation companies, in which we invested several years ago as qualifying companies, or which we bought in the market prior to the rule changes where we see the potential for them to continue to grow.

In order to qualify companies must:

• have fewer than 250 full time equivalent employees; and
• have less than £15 million of gross assets at the time of investment and no more than
• £16 million immediately post investment; and
• be less than seven years old from the date of its first commercial sale (or 10 years if a knowledge intensive company) if raising State Aided (i.e. VCT) funds for the first time; and
• have raised no more than £5 million of State Aided funds in the previous 12 months and less than the lifetime limit of £12 million (or from 6th April 2018 £10 million in 12 months £20 million lifetime limit if a knowledge intensive company); and
• produce a business plan to show that the funds are being raised for growth and development.

The latest changes are to encourage VCTs to keep their investment rate up after raising money - hence the 70% limit rises to 80% from 30 November 2019 for the Company. However, allowing knowledge intensive companies to raise up to £10 million of the £20 million lifetime limit in a twelve month period rather than the existing £5 million will improve flexibility as will the proposed change to the amount of time allowed for re-investment of cash from sales of qualifying holdings from six to twelve months.

Outlook
All of the uncertainties around Brexit, political stability and the resilience of our economic growth that we have talked about previously are still unresolved and will remain so in the foreseeable future, and this has already lead to increased market volatility. However, global growth has been rising and this has boosted our economy, which still shows no signs of falling into recession as predicted by some forecasters in the immediate aftermath of the Brexit vote. The most likely outcome would seem to be a continuation of the slow growth rate that we have been experiencing and in these conditions it should be possible for small companies and their share prices to make progress, as long as there is not an event that causes a wider collapse in capital markets.
The portfolio now contains 72 holdings with investments across a range of sectors including several such as Craneware, Gooch and Housego, Gear4music, Clinigen, Cello, DP Poland and GB Group that have significant international exposure, providing some balance. Domestic companies such as Breedon, Vertu and Staffline have already demonstrated their management's ability to grow their businesses successfully in difficult economic conditions and there are a number of newer holdings that we expect to demonstrate progress over the coming year. The balance of the portfolio towards profitable companies remains. The VCT currently has funds available for new investments which should allow us to take advantage of any dip in valuations should sentiment weaken in the future and we remain selective when viewing new investment opportunities.

The AIM Team
Octopus Investments Limited
7 March 2018

Directors' Responsibility Statement

The Directors are responsible for preparing the Annual Report and the financial statements in accordance with applicable law and regulations.

Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have elected to prepare the financial statements in accordance with the Financial Reporting Standard applicable in the United Kingdom and Republic of Ireland ("FRS 102"). Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period.

In preparing these financial statements the Directors are required to:

• select suitable accounting policies and then apply them consistently;
• make judgments and accounting estimates that are reasonable and prudent;
• state whether applicable UK accounting standards have been followed, subject to any material departures disclosed and explained in the financial statements; and
• prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Company will continue in business;
• prepare a strategic report, a Directors' report and Directors' remuneration report which comply with the requirements of the Companies Act 2006.

The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company's transactions, to disclose with reasonable accuracy at any time the financial position of the Company and to enable them to ensure that the financial statements comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

The Directors are responsible for ensuring that the Annual Report and Accounts, taken as a whole, are fair, balanced, and understandable and provides the information necessary for shareholders to assess the Company's performance, business model and strategy.

The Directors are responsible for ensuring the Annual Report and the financial statements are made available on a website. Financial statements are published on the Company's website in accordance with legislation in the United Kingdom governing the preparation and dissemination of financial statements, which may vary from legislation in other jurisdictions. The maintenance and integrity of the Company's website is the responsibility of the Directors. The Directors' responsibility also extends to the ongoing integrity of the financial statements contained therein.

Directors' responsibilities pursuant to DTR4

The Directors confirm to the best of their knowledge:

• the financial statements, prepared in accordance with the Financial Reporting Standard applicable in the United Kingdom and Republic of Ireland ("FRS 102"), give a true and fair view of the assets, liabilities, financial position and profit and loss of the Company; and
• the Annual Report includes a fair review of the development and performance of the business and the financial position of the Company, together with a description or the principal risks and uncertainties that it faces.

On Behalf of the Board

Keith Mullins
Chairman
7 March 2018

Income Statement

There is no other comprehensive income for the period.

• the 'Total' column of this statement represents the statutory income statement of the Company; the supplementary revenue return and capital return columns have been prepared in accordance with the AIC Statement of Recommended Practice
• all revenue and capital items in the above statement derive from continuing operations
• the Company has only one class of business and derives its income from investments made in shares and securities and from bank and money market funds, as well as OEIC funds.

Balance Sheet

The statements were approved by the Directors and authorised for issue on 7 March 2018 and are signed on their behalf by:

Keith Mullins
Chairman
Company No: 05528235

Statement of changes in Equity

Cash Flow Statement