Annual Financial Report

Downing Strategic Micro-Cap Investment Trust Plc
LEI Code: 213800QMYPUW4POFFX69
4 May 2020
Annual Financial Report for the year ended 29 February 2020

The investment objective of the company is to generate capital growth for shareholders over the long term, from a focused portfolio of UK micro-cap companies (those whose market capitalisations are under £150 million at the time of investment) targeting a compound return of 15% per annum over the long term.

The Directors of Downing Strategic Micro-Cap Investment Trust PLC announce the company's results for the year ended 29 February 2020.

Key points

DSM’s strategy remains compelling, despite current economic turmoil
Pre-covid
- Invested in 12 positions, with the potential to invest in 18
- Necessary changes made in most positions, improving the appropriate management teams and putting financing in place to execute on catalysts which should generate returns over our planned investment horizon.
Mid-covid
- Most portfolio positions are well capitalised to survive covid, taking into account downside scenarios
- DSM is well positioned with more than 15% of NAV in cash, allowing flexibility to support existing positions if appropriate, and to take advantage of market weakness in potential new positions that have been in diligence for some time
- Little direct exposure to high street retail and leisure sectors
Post-covid
- All companies have an identifiable ‘niche’ and should continue to have ‘survivability’ for the products and services that they offer
- Most positions show balance sheet strength, and that, combined with strong management teams, should allow a return to some form of normality
Significant ‘double discount’ on the NAV of the Trust, as the manager believes the intrinsic value of the portfolio is significantly higher than current share prices reflect, combined with the ‘covid’ discount that the Trust currently trades on.

Judith MacKenzie the lead manager, said “2020/21 was going to be a defining period where we felt confident that we could demonstrate to investors that our strategic initiatives within our investments were beginning to drive returns through re-ratings, corporate activity and improved underlying performance. Performance was improving, in part, due to the changes brought about in governance, and improvements at structural and operational levels within most businesses. The social and economic disruption of Covid has deferred, but not fundamentally altered, that prospect for this portfolio. Given the strength of balance sheets in the majority of investees, and our belief in the ability of these businesses to weather the current issues, it is not difficult for us to look to a post-covid world where these companies will demonstrate earnings and values at a significant premium to the current share prices and DSM’s NAV. Our job now is to help these competent management teams navigate the current crisis, as they adapt their businesses for the future.”

Financial highlights

	29 February	28 February	Change
Assets	2020	2019	%
Net assets (£’000) (1)	39,096	41,475	(5.74)
Net asset value (‘NAV’) per Ordinary Share	71.30p	74.59p	(4.41)
Mid-market price per Ordinary Share	63.00p	73.00p	(13.70)
Discount	11.64%	2.13%

	Year ended	Year ended
	29 February	28 February
Revenue	2020	2019
Revenue return per Ordinary Share	1.91p	1.50p
Capital return per Ordinary Share	(4.01p)	(19.97p)
Total return per Ordinary Share	(2.10p)	(18.47p)

	%	%
Decrease in NAV since admission (2)	(28.70)	(25.41)
Decrease in share price since admission (2)	(37.00)	(27.00)

(1) The change in net assets reﬂects market movements during the year.
(2) 9 May 2017

Chairman’s Statement

It is not easy to report at the start of May 2020 with this virus demarcating former and future worlds. National responses necessarily challenge the basis of our collective economic life and change business conditions. The result looks to be the most sudden drop in output and incomes in modern history: the National Institute of Economic and Social Research has forecast a 25% drop in gross domestic product in the second quarter for the UK; the Ofﬁce of Budget Responsibility has forecast a fall of 35% assuming a further three month lockdown.

How sharp will recovery be? Whilst science is cautious to suggest steps to more economic activity without immunisation, society, and likely limits to ﬁscal and monetary action, put pressure on the need for renewed growth and sustainable lifestyles. Where will priorities lie? Will we emerge much as we were or will this be a time of some ‘creative destruction’? Will we see changes in social values, business models, the structure of employment? Fewer, leaner businesses; core unemployment? Will the return of the consumer transform demand? What will be the response to the cost of recovery – taxation, inﬂation, or continuing conﬁdence in tomorrow’s funding? This crisis could mark structural economic and social change, not just a passing event. Meanwhile, it is going to be some time before Covid-19 itself becomes ‘just a nuisance’.

Your board has two tasks. One is to report on the past: the 2019 portfolio, its performance and how the manager and board responded over that now relatively normal period; the other is to join with the manager and try to look at where your company and its portfolio stands today – and speak usefully about that to shareholders in practical terms. The manager has set the ground with, if I may say so, an excellent assessment of the investments – see the Investment Manager’s Report.

The past ﬁnancial year

The company started the year with net assets of 74.59p per share and a mid-market share price of 73p, a discount of 2.13%. By the half-year, after one serious disappointment (see later) net assets were at 72.47p. Up to mid-February, performance was reasonable. Downing Strategic Micro-Cap Investment Trust’s (‘DSM’s’) manager continued its active involvement in investee companies to good effect. Shares remained in the mid 70p range. We made some buybacks and the discount generally remained in single ﬁgures.

The manager dealt with indifferent management in a couple of investments and helped reshape poor boards in a couple more.

At least seven of DSM’s twelve investments continued to perform as expected; they were, and are, well run, their value unrecognised and the potential for shareholders sound. Three had, and have, new chairmen driving change, of which two had refreshed strategy with further equity. Two need further time, one of which gained a dominant shareholder providing a chairman whom we hope will continue to direct management. One of our most problematic investments had been nicely on the mend, generating sustainable positive cash ﬂow and with disposable businesses worth much more than their carrying value.

Were this report to have been written at the end of January, I would be saying that the portfolio was much as we, and the manager, needed it to be: good value companies with good prospects of realising that value.

Our one disaster had been Redhall: a high-integrity, specialist engineering company that had undergone a turnaround process but lacked board strength and managerial grip to cope with subsequent contract delays on public sector contracts. It went into administration with the various divisions acquired at advantageous prices from the administrators by competitors. Interestingly, given today’s climate, it was HMRC who pulled the plug.

Then the market crash started in early March and now, at the time of writing, your company’s NAV is 64.15p a decline of nearly 20% from mid-February. The discount, which at one point hurtled out to some 35%, is still at 21%. I know that is distressing for Shareholders. More so now that the shares are around 45p and some retail sales were made at 32p or less.

Looking forward

It may be brave or foolish, or both, to attempt to make predictions during this crisis; markets do seem to fail to grasp structural change and to have a bias toward treating corrections as temporary. Nevertheless, the fundamental strengths of most of DSM’s portfolio, even during extended lockdown and slow recovery, are well set out on in the Background to the Investments section. Some investments, AdEPT for example, which has seized the opportunity for managed communications, have already addressed changing needs. Volex has produced an excellent assessment of its strong position. Another, FireAngel, is moving into the remote management of risk, raising signiﬁcant cash from knowledgeable investors including a highly regarded technology investor. All are relevant to the future and most have available cash reserves. DSM meanwhile has 15.5% of its net assets in cash and 17.7% in high-yield loan notes serviced by a turnaround that is now reporting proﬁts.

DSM is positioned both to support existing holdings and take advantage of new opportunities in this disturbed market.

But we are still sailing towards an economic and social disaster – at least until some immunity and some vaccine emerges. A lot needs rethinking; see the ‘tailpiece’. Rethinking is also the challenge for our portfolio companies – and most are up to doing that.

Your board will continue to hold its open sessions, quite separate from board meetings, with the manager.

Share price and discount

With the support of knowledgeable investors and with relatively modest buybacks, your board was pleased to see the discount remaining mostly in single ﬁgures through to the end of February 2020 (2.13%). Then, as with the stock market in March, DSM’s NAV started to decline and an increasing share price discount followed.

There were no large sales, just a sad run of what must have been retail investors. Given one of the worst stock market corrections ever, there seemed no point in trying to intervene and change the tide with buybacks – even though the discount was ridiculously wide. Market and economic dislocation continue and the directors, using their permitted discretion, will not be exercising the redemption facility at present. We will continue to consult with the major shareholders and expect to return to considering buybacks and use of the redemption facility after economies and markets have stabilised when we will also return to our principle of trying to keep the discount within reasonable bounds. I am sorry for anyone who was a forced seller, but these are just not times to stand against the market.

Dividend

In addition to dividend income, the Company continues to beneﬁt from loan note interest. Investment company regulations require that no more than 15% of the Company’s annual income is retained. We are therefore proposing a dividend of 1.6p per share (2019: 1.25p), which is the minimum level to comply with the regulations. A resolution seeking shareholder approval for the payment of this dividend on 3 July 2020 to shareholders on the register at 29 May 2020 (ex-dividend date 28 May 2020) will be proposed at the annual general meeting (‘AGM’).

Managers

Every year we review DSM’s manager. Your board is more of a hands-on board than most. It has been a tough year and we think the manager has continued to grip this portfolio thoroughly and that grip is well expressed in its report. I would also encourage investors to read the quarterly investor letter, the last of which, published in February, just began to touch on Covid-19.

Board

At the interim I expressed our sadness, and for him our delight, that Andy Grifﬁths had been accepted as a mature ofﬁcer in the Royal Fleet Auxiliary. We set out to ﬁnd someone with a similar media and broad background and an enquiring mind. I was delighted to announce in November that Will Dawkins, Head of UK Board Practice at Spencer Stuart and one-time Foreign Editor of the Financial Times, had joined the board. He certainly has exactly that mind and has brought that perspective to a board of complementary individuals.

In response to these awful times, your board has decided to forego taking its fees for the current, Covid- ravaged, quarter and use those fees to make a modest national contribution of £28,750 to some of those in the front line of this pandemic. With the help of Will Dawkins, who chairs the Evelyn Trust, a Cambridge - based charity supporting medical research and health and wellbeing projects, we are developing a scheme with the Doctors’ Support Network, a charity that provides peer support to doctors and medical students in times of stress. We have asked that our contribution be taken as a gift towards the dedication of doctors and medical students who have stepped forward into front line work during this pandemic. I add my thanks to fellow board members Linda Bell, Robert Legget and Will Dawkins not only as directors in difﬁcult times but for this generous initiative.

AGM

We will work with our company secretary and media advisers to provide a ‘virtual’ AGM. We will need Shareholders to complete proxies for voting, as always. We are planning a webinar and slides with an opportunity for questions. The provisional date for the AGM is 24 June 2020. We will issue the notice for the AGM separately from this report once arrangements are ﬁnalised.

Tailpiece

At the beginning of the month Henry Kissinger, still going strong, wrote in the Wall Street Journal, “When the Covid-19 pandemic is over, many countries’ institutions will be perceived as having failed. Whether this judgment is objectively fair is irrelevant. The reality is the world will never be the same after the coronavirus… The historic challenge for leaders is to manage the crisis while building the future. Failure could set the world on ﬁre.”

Let’s hope for the best.

Hugh Aldous

Chairman
1 May 2020

Investment Manager’s Report

“The best way out is always through”
Robert Frost

There is a painful difference between the 29 February 2020, the year end of the Company, and when I am writing this, at the start of May 2020. It is a different world. So much has already been written about the invidious disease that I will not add to it. We cannot forecast yet how we will emerge from this. All I am certain of now is that every bit of evidence I see points to things getting worse before they get better. I ﬁnd it difﬁcult to look at a blue screen and a market that seems to be seeing the bright-side-of-life when the economic indicators tell me to expect the worst.

As fund managers, what do we do? We see the way through, plain and simple. We base our decisions on what we know, as opposed to the daily narrative. We keep close to our investments, which are a collective group of 12 management teams, employing c.14,500 people between them, all trying to ﬁnd their way through. Of these employees, c. 14% have been furloughed (as at 31 March 2020). Less than 1% have been made redundant, and all management teams have taken steps to ensure the survival of their businesses. Of the eight manufacturing companies, seven are operational in some way. Net debt in the portfolio is minimal, with 50% of investments holding net cash. All have now put out Covid - related trading statements, and all have levers to pull and are being prudent in their cash management. We have been reassured by the quick action that our companies have taken to reduce cash operating expenses and other discretionary cash outﬂows.

‘Survival’ was not part of our investment thesis when we invested in these businesses nearly three years ago. But now survival is the obstacle that needs to be the new opportunity. Both for existing investments and those that we may purchase along the way from here.

The beneﬁts of a strategic investment trust at this point in time are:

It is closed ended. We are not facing redemptions like open-ended funds can.
We think we have been through the ‘bulk’ of the turnaround pain in the portfolio. With nearly 20 changes to the boards of these 12 companies, we believe have the right teams, structures and KPIs in place.
We are typically very close to our companies as we are looking after 12 between three fund managers and one analyst.
The Trust has more than 15% cash, which affords us the ability to support current positions in a meaningful way, or to introduce new positions into the portfolio.

So, what are we doing?
As you would expect, we are in regular dialogue with our investments. We are now intimate with the view of their home ofﬁce/ kitchen/ family thanks to Teams and Zoom video calls. We are writing to the boards of our investments, where appropriate, and suggesting that if they are furloughing, then the board and senior management team should also be taking a cut in take-home pay over this period. So far over 50% of our investees have made the decision to cut salaries of the senior management team and/or board. We are urging management to act quickly and making sure that if funding does become an issue then they are on the front foot.

We own no ‘zombie’ companies – those which are continuing to operate with a fully furloughed workforce and zero revenue – most of these are in the direct retail or leisure sectors where we have steered clear. Our companies are relatively well capitalised and/or have balance sheet optionality which should provide some degree of additional liquidity if required as a last resort. In addition, many produce or provide some essential goods and/or services and some are seeing increased demand in parts of their business during this time of disruption.

It is worth looking at how we have classiﬁed our companies into buckets, to ensure our focus is where we need it most. Reassuringly, we state that circa 73% of the portfolio is not keeping us awake at night, and believe that only 2.4% might become cash consumptive if the lockdown is prolonged. It is also useful to think about how they will come out the other end.

We have categorised the companies as follows:

1) “Their survival does not keep us awake at night” – (accounting for 72.9% of the portfolio as at 23 April 2020), includes cash and accrued interest.

a. AdEPT Technology – generates over 70% of its revenues on a recurring basis in normal times and has exposure to essential sectors such as government and healthcare. The business does have high debt, but ample liquidity through a drawn revolver facility. AdEPT may be a beneﬁciary when we come through Covid as we expect that some aspects of remote working could stick. We think this could be driven by employees’ requests but also corporates requirement to reduce overheads and downsize ofﬁce space, facilitated by allowing more remote working and rotating staff into the ofﬁce.

b. FireAngel – recently raised over £6 million, before expenses, to help fund working capital and the ﬁnal stages of the turnaround plan. This provides balance sheet certainty, allowing the company to improve and grow margins. Downing is an 18% shareholder alongside BGF at 7%, who is also supportive. Our only thoughts here are to ensure the ﬁnal steps of the turnaround are executed and that Covid is not a distraction. FireAngel’s products are critical safety devices and the company is involved in several council roll outs of smoke and carbon dioxide detection products across public housing stock. We do not expect these activities to be impaired post-Covid.

c. Hargreaves Services – will undoubtedly see a slowdown in demand for its services during the lockdown. The business does have a material net bank debt position of £35 million, however that compared with net assets of £130 million, within which inventory is over £60 million. This inventory position has doubled from £35 million the previous year, unwinding this increase would generate enough cash to de- gear the business. While management has highlighted that they do not expect this to happen in the current ﬁnancial year, we think that it is an option for liquidity (albeit at a reduced price) if the situation worsened. The banking facility does need to be renewed in August 2020, but given the underlying assets, we do not think that this will be a problem. On the other side of Covid, we think that Hargreaves could prosper from an economy ﬂush with stimulus. This would create demand for the company’s services into infrastructure and its signiﬁcant land bank for building as often these sectors are a core focus to drive growth and employment.

d. Ramsdens – is the closest we have to a zombie company, with all its physical stores now closed as non- essential businesses. It does have a website which continues to trade although this is also operating at a much lower level. From a going concern perspective, we think that there is limited risk as the company has furloughed around 90% of its staff and will beneﬁt from other government support. Ramsdens has a net cash balance sheet with around £10 million of cash. It also had almost £12 million of precious metals inventory (as at the last interim) which can be readily liquidated. This was a key attraction at the outset of our investment and management has demonstrated a willingness to do so when metal prices are strong – gold is approaching highs not seen since the last recession. As we emerge from lockdown, Ramsdens is probably in a good position with its diversiﬁed business model. A meaningful cohort of the UK is likely to wish to travel abroad creating demand for Ramsden’s FX services. It is also likely that another cohort will require short-term liquidity through which the pawnbroking service will also beneﬁt.

e. Science in Sport – Predictably, SiS is being affected in traditional physical distribution channels. However, we note pockets of strength in online and the current crisis is an opportunity to drive more customers to .com with higher margins. There has been minimal disruption in terms of manufacturing, picking and packing, and supply chain. Innovation continues to drive around a quarter of sales growth and the business is launching speciﬁc indoor training products for Zwift and Peloton (cycle and spin platforms) which are no doubt strong during this global lockdown. Management have cut £4.7 million from this year’s marketing budget – around 50% of the total – and the early indications are that this has had an immaterial effect on engagement. We are hopeful that some of this cost discipline could remain in the post-Covid world and that SiS can be a leaner, more proﬁtable business earlier than we expected. The company recently raised around £4.5 million via a placing, which alongside cash balances of £4 million, secures the ability to trade through this crisis.

f. Synectics – is experiencing signiﬁcant disruption but it has a robust business model focused on mission critical products in security and surveillance. It is still operational, albeit at a reduced capacity. The balance sheet is also robust with net cash of around £4 million and access to facilities of another £5 million. The business is owned in part by its long-standing chairman who is aligned with shareholders and has historically run the business with a very prudent mindset. As we emerge from Covid and perhaps enter a more challenging economic environment, we expect that global governments’ requirement to drive growth and jobs could beneﬁt many of Synectics end markets.

g. Volex – has issued a remarkably strong trading update, revising guidance for 2021 down by only 10% and maintaining its dividend. This is in a market where almost every company is pulling guidance completely and suspending dividend payments. There are pockets of strength with various customers with increased demand from working at home, as well as signiﬁcantly higher orders with existing and even some new healthcare customers. Some of these end products are directly involved in treating Covid patients. The business has neither furloughed staff, nor closed facilities, it is largely business as usual albeit with some sites at marginally reduced capacity through labour constraints. However, we think that this manufacturing can and has been shifted elsewhere. The business ended the 2020 ﬁnancial year with over $30 million of net cash and access to available liquidity of over $60 million. We expect it to perform well this year.

2) “The ones that are not in the home-and-dry category but have excellent levers to pull” – accounting for 24.6% of the Net Asset Value

a. Duke Royalty – has modest gearing post the payment of its most recent dividend in March 2020, with estimated net debt of around £10 million. The royalty ﬁnance model should protect the business from more than a -6% fall in revenue in any one year. However, this assumes that the underlying royalty partners can remain trading. From this perspective, we note that the business is well diversiﬁed across geographies and industries with some more cyclical areas being offset by more defensive ones. In addition, we take comfort in knowing that management has applied the initial investment criteria strictly. This includes no/low debt, senior security, step-in rights, a sustainable competitive advantage, multi-cycle track record of management, and, importantly, a 2x EBITDA/ royalty payment coverage requirement.

b. Gama Aviation – predictably, Covid and the global lockdown is having a signiﬁcant effect on the business with US and Europe maintenance activity down by around 50% at the beginning of April. Europe charter was also signiﬁcantly affected (but we do not think that this is a material contributor to earnings in any case). Appropriate staff have been furloughed in the UK and the US. In our view, the signiﬁcant cash generating division of the group is unlikely to be materially affected. This ‘special missions’ division provides public sector contracts to the likes of the NHS and the MoD. These are multiyear in nature and some are paid in advance. Other sources of revenue include management fees which we expect would continue to be paid by owners and ultimately, Gama can (and has in the past) used aircraft as collateral against collecting these fees from owners or, where they are in default, original creditors. The software businesses have seen a limited effect and recently announced a new $2.5 million SaaS-type contract. We think that liquidity should be okay – the company has $30 million undrawn headroom on its facility with an additional $17 million of cash. This includes $13 million of cash received from the recent disposal of its US associate for $33 million. The balancing $20 million will be received over the next four years. We are hopeful that during this time of lower ﬂying activity, the business will be able to unwind a proportion of its debtor book without offsetting expenses and this could generate a sustainable improvement in cash ﬂow with the right working capital controls post-Covid.

c. Real Good Food – Its manufacturing facilities are fully operational, and still selling sugar paste, bars and other cake decorations into end markets. However, supermarkets are reducing stock keeping units (SKUs), and this may have an impact on this business. Brighter Foods has diversiﬁed its client base, however it is still dependent on Slimming World, who obviously is not holding group meetings. Although it has made inroads to selling bars online, it is inevitable that this will impact turnover. But people are still eating cakes and bars, so when recovery happens, then we do expect this business to beneﬁt as we think the structural shift towards food-to-go/ convenience will transcend Covid. In terms of liquidity, the company has numerous levers such as invoice discounting, asset ﬁnance and overdrafts as they have not made signiﬁcant use of these post restructuring. We have a board position and are fully engaged in ensuring that management is taking all appropriate actions to get through the crisis. The bulk of our holding is in secured loan notes with an attractive coupon. Post-Covid we expect that the equity value of Real Good Food could be multiples of its current share price, as we have set out in our investor letter many times before.

3) “The ones that might suffer in a prolonged downturn” – account for 2.4% of the portfolio. Unsurprisingly, these have direct balance sheet risk.

a. Braemar Shipping – has announced that its shipbroking arm is beneﬁtting from the volatility in tanker rates and activity in shipping ﬁnance. Trading is in line with the board’s expectations. The company has £18.8 million of net debt, excluding vendor loan notes of £6.7 million. However, that being said, the company has banking facilities of £40 million, made up of a revolving facility of £35 million and an accordion facility of £5 million. The group also has access to global cash management arrangements and feels conﬁdent these facilities provide sufﬁcient headroom in this Covid world. The new chairman is looking at strategic options for the other divisions and believes there is ﬂexibility in the cost base. Although there are sufﬁcient banking facilities, if broking goes into a downturn there would likely have to be structural changes in the business.

b. Pennant – is in a strong position as it is servicing large defence clients, who themselves are well funded. The downside is that the turnover and contracts can be very ‘lumpy’ making cash management a challenge at the best of times. Recent ﬁnal results highlighted the timetable for ongoing contract delivery, albeit hampered by the ability to get product out the door in the factory. The company has net debt of £2.2 million, however it is in ﬁnal stages of negotiation for a £4 million facility, which with agreed milestone payments from major customers, should be sufﬁcient for the company to trade through this period. We note that the company has proposed a resolution at its AGM to increase the ability to allot shares without a vote, to 20% of the equity. This allows ﬂexibility for a timely and cost efﬁcient fund-raise should it be required.

Portfolio activity

In the year we have been reducing our position in Braemar, having sold £654,154 out of the position realising a loss of £279,353. We have also sold £1,519,264 of Volex realising a gain of £653,455. There has been a redemption of £339,440 capital of the Real Good Food Loan Note and repayment of interest and redemption premium of £84,305 which is a gain of 24.8% on cost. We have also sold a small amount of Pennant.

These disposals were reﬂective of a concern on balance sheet risk in Braemar, a rebalancing of the portfolio after a very strong performance in the share price of Volex, a reﬁnancing at Real Good Food, and concerns on timing of contracts in Pennant.

Since the period end the position in Braemar has been further reduced, and proﬁts have continued to be taken in Volex, albeit it still remains our highest conviction position as the largest in the portfolio. We have also reduced the exposure to Gama Aviation and purchased stock in FireAngel through a placing.

As yet, we have not added any new positions although, at the time of writing, we have three prospective positions to add. We don’t want to time markets, but we would like to be in the position to buy when markets get more challenging. And they will. These are likely to be toe-hold positions that we will not discuss until we are conﬁdent that the position size is correct. Of course, should any of our existing companies require funding then we have cash to support these.

What to expect over the next 12 months?

Never has writing an outlook statement been more difﬁcult. We have no idea how this will pan out, but what I can say is that you have a fund management team that knows its investments, is proactive, and looking to the future as to how our businesses emerge from this challenge.

In our January 2019 investor letter, we quoted Jeff Bezos, who stated that he built Amazon’s strategy around what he knew would not change, rather than trying to craft a strategy around things in which change seemed inevitable. While we do expect signiﬁcant disruption from Covid, and there will undoubtedly be long-term effects and changes in people’s behaviour, we think that the portfolio is grounded in structural ‘themes’ which are unlikely to change materially.

We have management teams that are incentivised with skin in the game. We have businesses who operate in end markets that are required for the world to go around. We don’t have exposure to leisure or direct retail. Where we have balance sheet risk, we have sought to minimise it or ensure that survival is a priority. Other than that, we are dealing with what we can control, being cognisant of what we cannot, but not being obsessed by it. We will also be brave when markets become more challenging and take toe-hold positions in quality businesses that are priced wrongly or top up when businesses we know well are seeing their share prices affected.

Most importantly, we are concentrating on getting through.

Judith MacKenzie

Head of Downing Fund Managers
and partner of Downing LLP
1 May 2020

Investments as at 29 February 2020

	As at February 2020	As at February 2020	As at February 2019
	Market Value	% of Total	% of Total
	(£’000)	Assets	Assets
Volex	5,978	15.29	12.95
Real Good Food 10% Loan Note (29/06/2020) (1)	5,674	14.52	14.50
AdEPT Technology Group	3,496	8.94	8.76
Ramsdens Holdings	2,960	7.57	6.30
Synectics	2,786	7.13	8.57
Hargreaves Services	2,765	7.07	7.45
Duke Royalty	1,899	4.86	4.65
Real Good Food 12% ‘C’ Secured Guaranteed Loan Note (16/05/2021) (1)	1,232	3.15	2.88
Braemar Shipping Services (2)	1,100	2.82	4.55
Gama Aviation	1,096	2.80	3.68
Science in Sport	986	2.52	2.63
FireAngel Safety Technology	919	2.35	0.97
Pennant International Group	630	1.61	2.65
Real Good Food	223	0.57	0.77
Other	–	–	3.86
Total investments	31,744	81.20	85.17
Cash	6,051	15.47	13.27
Other net current assets	1,301	3.33	1.56
Total investments	39,096	100.00	100.00

(1) Unquoted
(2) Quoted on the Main Market

All investments are in Ordinary Shares and traded on AIM unless indicated. The total number of holdings as at 29 February 2020 was 12 (28 February 2019: 13).

As at 29 February 2020 loan notes represented 17.66% (2019: 19.07%) of the portfolio.

The table above includes net current assets of £7,352,000 that are also disclosed in the statement of ﬁnancial position.

Background to the investments

(unless otherwise stated all information provided as at 29 February 2020)

AdEPT Technology Group PLC (AdEPT) (8.94% of net assets)

Cost: £3.63m. Value as at 29 February 2020, £3.50m

Adept Technologies is an independent provider of uniﬁed communications and managed services for the communications and IT sector

Update to the investment case

Positive interim results, delivering a 26% increase in revenue
Managed services revenue up to 82% of total revenue
Interim dividend increased by 4%
New NED appointed to the board
Successful fund raise of £4.25m to support acquisitive growth strategy
Covid resulting in reduced levels of activity but bodes well longer term as rise of homeworking

Progress against investment case
AdEPT is a quality business with attractive recurring revenue. Our investment case was predicated on the ability of management to acquire businesses at a good price, and the migration to become a managed service business. Managed services now account for 82% of total revenue. The interim results to 30 September 2019 saw the board report a year of continued progress and delivery of its organic and acquisitive growth strategy. There was organic growth across the group, and this was achieved alongside a continuation in AdEPT’s acquisitive growth strategy. The latest results demonstrate strength of its capex-light highly cash generative business model which is focused on high levels of recurring revenue. The recent fund raise provides ﬂexibility for acquisitions going forward, however we are pleased that the company is keen to drive down the debt/EBITDA ratio which will prove its strong cash generative capabilities.

Braemar Shipping Services PLC (Braemar) (2.82% of net assets)

Cost: £2.07m. Value as 29 February 2020, £1.10m

Braemar Shipping operates four divisions servicing the worldwide shipping market; shipbroking, technical, logistics and ﬁnancial

Update to the investment case

Trading expected to be in line with expectations for FY to end 29 Feb 2019
Shipbroking division has performed strongly
Performance of Logistics and Engineering needs to improve
Covid resulting in reduced charter rates with likely impact on earnings in Shipbroking

Progress against investment case
Braemar issued a trading update for the year ended 29 February 2020, and reported that the Shipbroking division has performed well, largely driven by strong tanker markets in Q4 2019. The group expects the forward order book will be c. 15% higher than at the half year. New ofﬁces in Athens and Geneva are being planned, reﬂecting the positive long-term prospects for growth. Advisory fees from mandated business continued to grow in the Financial division, however there were fewer material transaction-based success fees than anticipated. The Logistics division traded in line with the previous year and a review of strategic options is underway. The Engineering division saw continuing losses and the board is currently reviewing possible options to improve performance. Despite the uncertain outlook due to the coronavirus, management are conﬁdent that the business is well positioned to beneﬁt from a return to normal trading conditions.

Duke Royalty PLC (Duke) (4.86% of net assets)

Cost: £2.06m. Value as at 29 February 2020, £1.90m

Duke Royalty is a diversiﬁed royalty investment company providing alternative capital solutions to a range of proﬁtable businesses

Update to the investment case

Positive interim results
Two follow-up investments totalling £1.65m
New revolving credit facility of £30m
Maintaining high and stable dividend
£17.5m raised via placing to build royalty portfolio and pay down inherited credit facility
Inevitably some impact on portfolio from Covid however well secured royalty payments in majority of portfolio

Progress against investment case
Our investment case was predicated on the identiﬁcation of suitable royalty partners and deployment of capital into those companies. In September, Duke announced that it had entered into a new £30 million revolving credit facility which replaces the previous £15 million facility. This will support the group’s growth strategy by providing access to additional capital, at reasonable cost, without relying solely on equity markets. A number of follow-on investments have been made into existing royalty partners, with Duke providing capital to undertake synergistic M&A transactions, a core part of the group’s investment mandate. The group’s activities have materially increased its revenue, proﬁtability and cashﬂow. The board reported that having entered the second half of the year with a strong pipeline of new royalty opportunities and greater ﬁnancial ﬂexibility, due to its new credit facility and recent successful equity raise, it is conﬁdent that it can continue the rapid growth achieved to date.

FireAngel Safety Technology Group PLC (FireAngel) (2.35% of net assets)

Cost: £3.82m. Value as at 29 February 2020, £0.92m

FireAngel is focused on providing smoke detectors, carbon monoxide detectors and other home safety products and solutions

Update to the investment case

European patent granted for FireAngel Predict
Board reorganisation
Exceptional charges incurred
Investment in connected technology beginning to bear fruit
Fundraise of c. £6m announced post period end. Securing long-term ﬁnancing and future
Short-term negative impact of Covid but still selling products

Progress against investment case
FireAngel announced its ﬁnal results for the year ended 31 December 2019 and reported that sales for the period were expected to be up 20% and the underlying operating loss is expected to be in line with market expectations. Exceptional charges have been incurred during the year, including increasing warranty provisions for increased product replacement costs, restructuring and fundraising costs, and a charge relating to stock provisions and the impairment of intangible development costs. This is a result of a complete review of product lines and future development plans in line with the group’s evolved strategy to become a more technology-led connected home solutions provider. The board believes that the company’s connected home safety system strategy is now proving to be correct and proposes to narrow its focus to developing and promoting those products and services which give the highest and quickest returns. This focus should make the company less complex, less cash consumptive, and support its gross margin improvement plans in both the short and medium term. The board stated that FireAngel’s results continue to be negatively impacted by legacy issues as a result of certain historically poor internal processes. However, the strategic decision to invest heavily in future technology is proving to be correct., with the investment made in connected technology now beginning to come through in successful real-world trials, the ﬁnancial beneﬁts of which are expected to be realised in the short, medium and long term.

Gama Aviation PLC (Gama) (2.80% of net assets)

Cost: £5.17m. Value as at 29 February 2020, £1.10m

Gamma Aviation specialises in air and ground aviation support activities

Update to the investment case

Operational platform strengthened
Progress on outstanding litigation
Plans to enter rotary special missions market
Sale of US Air associate
Subsidiary secures $2.5m contract
Short term disruption due to impact of Covid

Progress against investment case
The signiﬁcant transformation taking place within the business was evident in the series of announcements
that the company made during the period. In its latest results for the six months to 30 June 2019, Gama reported signiﬁcant progress which demonstrate the impact of the changes management has undertaken to strengthen the group’s operational platform.

In December, the group announced a litigation update on legal proceeding with a number of parties and welcomed the progress being made. In aggregate, the board continues to anticipate a net cash inﬂow as an overall result of all litigation matters subject to the successful collection of the Taleveras trade receivables. In a further development, the group completed the purchase three Airbus H145 helicopters. This marks another signiﬁcant milestone in its plans to enter the rotary special mission market where management is positive about the available opportunities. The group also announced the sale of its US Air associate, Gama Aviation LLC. We think that strategically divesting minority investments simpliﬁes the corporate and ﬁnancial structure, allowing further reinvestment in growing the group’s wholly owned subsidiaries. Finally, the group’s global services subsidiary, myairops, secured a $2.5million contract with one of the world’s largest business aviation operators. This is another example of Gama’s strategic organic investment into innovative services that simplify business aviation.

Hargreaves Services PLC (Hargreaves) (7.07% of net assets)

Cost: £3.65m. Value as at 29 February 2020, £2.77m

Hargreaves Services is a land a property company, and a specialist haulage business

Update to the investment case

£2.8 million disposal of tungsten mine and 10-year mining services contract
Acquisition by German associate
Positive interim results
Short-term impact from Covid particularly in property division

Progress against investment case
Hargreaves sold its subsidiary, Drakelands, for £2.8m in cash on 29 November 2019, while the group entered into a 10-year mining services contract with the new owner. This creates the opportunity for future tungsten production at the mine with associated local employment and provides Hargreaves shareholders with substantial medium-term earnings potential. The group also announced an acquisition by its German associate company,

Hargreaves Raw Material Services GmbH (‘HRMS’), which furthers its strategy of creating an integrated specialist manufacturing and minerals trading business in Germany’s industrial heartland. HRMS is now an integrated speciality manufacturing and trading entity with an annualised revenue in excess of €300 million. The group’s latest interim results for the six months ended 30 November 2019, were positive and demonstrate Hargreaves’ progress in delivering higher quality earnings from its distribution and services business. Early indications that the initiatives being driven by its German associate in developing and enhancing the underlying value of the investment are encouraging.

Pennant International Group PLC (Pennant) (1.61% of net assets)

Cost: £0.96m. Value as at 29 February 2020, £0.63m

Pennant delivers integrated support solutions for the defence industry.

Update to the investment case

Several new contract wins
Board reorganisation – new Operations Director
Acquisition of Australian software business ADG
Strong order book of £33 million and sizeable pipeline of single-source opportunities
Disruption to delivery of projects because of Covid

Progress against investment case

Pennant announced a number of new contracts wins
in the period. The ﬁrst, valued at circa £3.4 million is for the design and build of a helicopter maintenance training aid. Progress was also made on the Qatar programme, enabling the revenues and proﬁts to be recognised in the current year. A further two international contracts were won by the group – Pennant Australasia Pty Ltd was awarded a contract for the supply of training aids and associated services for aviation technician training for the Australian Defence Force. The group also received an order valued at circa £1.5 million for the provision of additional training aids to the Middle East. Finally, it has received a statement of intent for a potential major new contract anticipated to be worth up to £5 million. These wins demonstrate not only the increasing diversity of Pennant’s product and services portfolios but also the group’s continued ability to win business internationally.

The group completed the acquisition of Australian software business ADG in March 2020. There are clear synergies between the two businesses and numerous opportunities to provide an end-to-end solution to the users of Pennants products. With a contracted order book of £33 million scheduled for delivery over the next three years, together with a sizeable pipeline of single-source opportunities, the board remains conﬁdent of future prospects and of building and delivering long-term shareholder value.

Ramsdens Holdings PLC (Ramsdens) (7.57% of net assets)

Cost: £2.62m. Value as at 29 February 2020, £2.96m

Ramsdens is a diversiﬁed ﬁnancial services provider and retailer. Providing FX services, pawnbroking and the sale of jewellery.

Update to the investment case

Board expects FY PBT ahead of market expectations
Strong trading over Christmas period
Jewellery performed well instore and online
FX negatively impacted by Covid-19 and stores now closed temporarily. Strong balance sheet with net cash provides comfort to investors

Progress against investment case
In its last trading update issued in January 2020, Ramsdens announced that the group had delivered strong trading during the Christmas period, with each of its key business segments performing ahead of the prior year. As a result, the board now expects the group’s full year proﬁt before tax to be comfortably ahead of market expectations. Proﬁts derived from the purchase of precious metals segment have been higher than previously anticipated reﬂecting the high gold price. The jewellery retail segment continued to perform well, both in store and online. The Christmas period saw double digit revenue growth in this segment reﬂecting the value, breadth and appeal of Ramsdens’ jewellery proposition. The group’s share price dropped sharply in February. We believe that this drop was driven by fear over the potential impact of Covid-19 on Ramsdens FX business as people stop travelling overseas. We believe this a macro-driven event rather than a deterioration in fundamentals and think the shares offer good value at current levels.

As announced on 25 March 2020 Ramsden’s closed its stores in light of the government announcement regarding Covid. Whilst this will have a short-term impact on trading the group is well capitalised, with a £10 million net cash balance sheet and a £10 million undrawn credit facility. The business will also beneﬁt from a number of government initiatives. In combination, these factors leave the business well placed to navigate the coming months.

Real Good Food PLC (RGD) (including loan notes) (18.24% of net assets)

Cost: £8.76m. Value as at 29 February 2020, £7.13m

Real Good Food manufactures sugar paste, icings and snack bars

Update to the investment case

Board changes
Improved performance from focus on two core divisions
Trading remains in line with our expectations for the year in both divisions
Lower cost base in place and improving performance increasingly evident
Sites operating despite Covid

Progress against investment case
Real Good Food continues to progress against our revised investment thesis. The underlying businesses are performing satisfactorily, and the group has returned to a positive operating proﬁt position after 18 months of restructuring. Renshaw (Cake Decoration) is currently the more challenging situation as the market is becoming more competitive. However, Renshaw has a track record of innovation and we believe that it has signiﬁcant recovery potential from here. Brighter Foods (Food Ingredients) manufactures nutritional food bars and we believe that there is a structural undersupply of capacity in the UK and European market for this rapidly growing medium of consumption. Based on these numbers, we arrive at a group which we think can generate up to £9 million of EBITDA. We believe that a buyer could ﬁnd material cost savings from the removal of central costs if the business were separated or acquired into a larger business. Therefore, some additional value could be ascribed to this upon exit. RGD has stated that it seeks to return value to stakeholders and we believe that 2020 is likely to be the deﬁning year for the Trust’s investment in RGD.

Science in Sport PLC (SiS) (2.52% of net assets)

Cost: £1.50m. Value as at 29 February 2020, £0.99m

SiS manufactures and distributes sport nutrition products

Update to the investment case

Senior management appointments, CFO, NED, two directors
Results in line with market expectations
Integration of the PhD acquisition completed
Strong growth in e-commerce sales
Post period end fundraise securing future through Covid

Progress against investment case
Science in Sport announced its pre-close trading update for the ﬁnancial year ended 31 December 2019. The results for the year are in line with market expectations and show a strong performance in key growth metrics. 2019 was a landmark year for the group, representing the ﬁrst full year of ownership of the PhD brand following its acquisition in December 2018. Integration of the acquisition was completed successfully during the year, PhD protein production was brought in house, a new PhD e-commerce platform was launched, and synergies were delivered to plan. New product development was a key growth driver during the year for both the SiS and PhD brands; new products delivered 25% of total group sales growth with successful product launches including PhD’s Smart Bar Plant and SiS’ innovative football range. The outlook for 2020 continues to be strong and beneﬁts from key appointments to the executive management team. The strengthened management team, along with important operational progress, has positioned the group for the next stage of its growth.

Synectics PLC (Synectics) (7.13% of net assets)

Cost: £3.98m. Value as at 29 February 2020, £2.78m

Synectics designs, integrates, controls and manages surveillance technology and network security systems

Update to the investment case

Investments continue to deliver good progress in international systems business
Systems division performance offset by continued weakness in other divisions
Order deferrals and customer-led delays delaying progress
Covid is disrupting business short term however the business has net cash on the balance sheet and is conﬁdent of weathering the current environment

Progress against investment case
Synectics announced its audited ﬁnal results for the year ended 30 November 2019 and reported that difﬁcult market conditions for its UK integration business meant that results overall were in line with revised market
expectations. The group’s core systems division, supplying Synectics’ high end proprietary surveillance systems globally, performed well, however, this positive momentum was offset by continued weakness in the group’s UK integration businesses. Based on the pipeline of expected new orders, and customer schedules initially indicated, the group had anticipated a signiﬁcant improvement in revenue and proﬁts from its integration and managed service division in the second half of the year. However, the weak performance reported at the half year has continued. UK market conditions remain difﬁcult and, with apparent uncertainty among Synectics’ private and particularly public sector customers, the pattern of order deferrals and customer-led delays in the progress of existing contracts continues.

Volex PLC (Volex) (15.29% of net assets)

Cost: £3.92m. Value as at 29 February 2020, £5.98m

Volex manufacturers and distributes power cords and cable assemblies.

Update to the investment case

Acquisitions on track, margin expansion and cash generation ahead of plan
Acquisitions allow more complex integrated manufacturing
Further opportunities to improve efﬁciencies and reduce costs
Two new contracts in power cords
Temporary closure of Chinese plants due to Covid, now reopened

Progress against investment case
Volex issued a very strong set of interim results for the period to 29 September 2019. The group also announced that the group would recommence the payment of a dividend, starting with an interim dividend of one pence per share. This is the ﬁrst dividend it has paid since 2013 and it has been made possible due to the signiﬁcant re-positioning seen across the business. The group is now cash generative, creating healthy proﬁts across its two business divisions, and in acquisitive growth mode. Looking forward, Volex is taking the opportunity to selectively invest in increasing capacity in its key facilities and leveraging is global footprint. It continues to vertically integrate its power cord manufacturing capability and optimise its supply chain and production capacity to reﬂect economic trends. The group’s share price fell in February following the Covid-19 outbreak. However, it later announced that all of its four sites in China had resumed operations, albeit at a reduced capacity.

Statement of Directors’ responsibilities

The Directors are responsible for preparing the Annual Report and Financial Statements in accordance with applicable law and regulation.

Company law requires the Directors to prepare Financial Statements for each ﬁnancial year. Under that law the Directors have prepared the Company’s Financial Statements in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union. 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 for that period.

In preparing these Financial Statements the Directors are required to:

select suitable accounting policies and then apply them consistently;
make judgements and estimates that are reasonable and prudent;
state whether IFRS as adopted by the European Union have been followed, subject to any material departures disclosed and explained in the Financial Statements; and
prepare the Financial Statements on a going concern basis unless it is inappropriate to presume that the Company will continue in business.

The Directors are responsible for keeping adequate accounting records that are sufﬁcient to show and explain the Company’s transactions and 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 also responsible for preparing the Strategic Report, Directors’ Report, Directors’ Remuneration Report, the Corporate Governance Statement and the Report of the Audit Committee in accordance with the Companies Act 2006 and applicable regulations, including the requirements of the Listing Rules and the Disclosure and Transparency Rules.

The Directors consider that the Annual Report, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s position and performance, business model and strategy.

Each of the Directors conﬁrms that, to the best of his or her knowledge:

the Financial Statements, which have been prepared in accordance with IFRS as adopted by the European Union on a going concern basis, give a true and fair view of the assets, liabilities, ﬁnancial position and proﬁts of the Company; and
the Strategic Report includes a fair review of the development and performance of the business and the position of the Company, together with a description of the principal risks and uncertainties that it faces.

For and on behalf of the Board
Hugh Aldous
Chairman
1 May 2020

Statement of Comprehensive Income
for the year ended 29 February 2020

	Year ended 29 February 2020			Year ended 28 February 2019
	Revenue	Capital	Total	Revenue	Capital	Total
	£’000	£’000	£’000	£’000	£’000	£’000
Losses on investments at fair value through proﬁt or loss	–	(1,904)	(1,904)	–	(10,725)	(10,725)
Investment income	1,505	–	1,505	1,326	–	1,326
	1,505	(1,904)	(399)	1,326	(10,725)	(9,399)
Investment management fee	(76)	(303)	(379)	(95)	(380)	(475)
Other expenses	(378)	–	(378)	(395)	–	(395)
	(454)	(303)	(757)	(490)	(380)	(870)
Proﬁt/(loss) before taxation	1,051	(2,207)	(1,156)	836	(11,105)	(10,269)
Taxation	–	–	–	–	–	–
Proﬁt/(loss) for the year	1,051	(2,207)	(1,156)	836	(11,105)	(10,269)
	Revenue	Capital	Total	Revenue	Capital	Total
	p	p	p	p	p	p
Earnings/(loss) per Ordinary Share	1.91	(4.01)	(2.10)	1.50	(19.97)	(18.47)

The total column of this statement represents the Statement of Comprehensive Income of the Company prepared in accordance with International Financial Reporting Standards (‘IFRS’) as adopted by the European Union.

The supplementary revenue and capital return columns are prepared under guidance published by the Association of Investment Companies (‘AIC’).

The proﬁt/(loss) for the year disclosed above represents the Company’s total comprehensive income. The Company does not have any other comprehensive income.

All items in the above statement are those of a single entity and derive from continuing operations. No operations were acquired or discontinued during the period.

Statement of Changes in Equity
for the year ended 29 February 2020

	Share capital	Special reserve	Capital reserve	Revenue reserve	Total
	£’000	£’000	£’000	£’000	£’000
Year ended 29 February 2020
At 28 February 2019	56	54,506	(13,911)	824	41,475
Proﬁt/(loss) for the period	–	–	(2,207)	1,051	(1,156)
Buyback of Ordinary Shares into treasury	–	–	(496)	–	(496)
Cancellation of Ordinary Shares	–	(33)	–	–	(33)
Expenses for share buybacks	–	–	(3)	–	(3)
Dividends paid	–	–	–	(691)	(691)
At 29 February 2020	56	54,473	(16,617)	1,184	39,096

Year ended 28 February 2019
At 28 February 2018	56	54,506	(2,806)	(12)	51,744
Proﬁt/(loss) for the period	–	–	(11,105)	836	(10,269)
Dividends paid	–	–	–	–	–
At 28 February 2019	56	54,506	(13,911)	824	41,475

Statement of Financial Position
as at 29 February 2020

	29 February 2020	28 February 2019
	£’000	£’000
Non-current assets
Investments held at fair value through proﬁt or loss	31,744	35,326
	31,744	35,326
Current assets
Trade and other receivables	1,398	740
Cash and cash equivalents	6,051	5,504
	7,449	6,244
Total assets	39,193	41,570

Current liabilities
Trade and other payables	(97)	(95)
	(97)	(95)
Total assets less current liabilities	39,096	41,475
Net Assets	39,096	41,475

Represented by:
Share capital	56	56
Special reserve	54,473	54,506
Capital reserve	(16,617)	(13,911)
Revenue reserve	1,184	824
Equity shareholders’ funds	39,096	41,475
Net asset value per Ordinary Share	71.30p	74.59p

Statement of Cash Flow
for the year ended 29 February 2020

	Year ended 29 February 2020	Year ended 28 February 2019
	£’000	£’000
Operating activities
Loss before taxation	(1,156)	(10,269)
Losses on investments at fair value through proﬁt or loss	1,904	10,725
Increase in other receivables	(658)	(626)
Increase/(decrease) in other payables	2	(24)
Purchases of investments	(969)	(15,006)
Sales of investments	2,647	–
Net cash inﬂow/(outﬂow) from operating activities	1,770	(15,200)
Financing activities
Buyback of Ordinary shares into treasury	(496)	–
Cancellation of Ordinary Shares	(33)	–
Expenses of for share buybacks	(3)	–
Dividends paid	(691)	–
Net cash outﬂow from ﬁnancing activities	(1,223)	–
Change in cash and cash equivalents	547	(15,200)
Cash and cash equivalents at start of year	5,504	20,704
Cash and cash equivalents at end of year	6,051	5,504
Comprising of:
Cash and cash equivalents	6,051	5,504

Notes

1. General information

Downing Strategic Micro-Cap Investment Trust PLC (‘the Company’) was incorporated in England and Wales on 17 February 2017 with registered number 10626295, as a closed-end investment company limited by shares.

The Company commenced its operations on 9 May 2017. The Company intends to carry on business as an investment trust within the meaning of Chapter 4 of Part 24 of the Corporation Tax Act 2010.

2. Accounting policies

The principal accounting policies followed by the company are set out below:

Basis of accounting
The annual Financial Statements of the Company have been prepared in accordance with International Financial Reporting Standards (‘IFRS’) as adopted by the European Union. These comprise standards and interpretations approved by the International Accounting Standards Board (‘IASB’), together with interpretations of the International Accounting Standards’ and Standing Interpretations Committee (‘IASC’) that remain in effect, and to the extent that they have been adopted by the European Union.

These Financial Statements are presented in Sterling (£) rounded to the nearest thousand. Where presentational guidance set out in the statement of recommended practice ‘Financial Statements of Investment Trust Companies and Venture Capital Trusts’ (‘SORP’), issued by the Association of Investment Companies (‘AIC’) issued in October 2019 is consistent with the requirements of IFRS, the Directors have sought to prepare the Financial Statements on a consistent basis compliant with the recommendations of the SORP.

Going concern
The Financial Statements have been prepared on a going concern basis and on the basis that approval as an investment trust company will continue to be met.

The Directors have made an assessment of the Company’s ability to continue as a going concern and are satisﬁed that the Company has the resources to continue in business for the foreseeable future, being a period of 12 months from the date these Financial Statements were approved. Furthermore, the Directors are not aware of any material uncertainties that may cast signiﬁcant doubt upon the Company’s ability to continue as a going concern, having taken into account the liquidity of the Company’s investment portfolio and the Company’s ﬁnancial position in respect of its cash ﬂows and investment commitments. Therefore, the Financial Statements have been prepared on the going concern basis.

Presentation of statement of comprehensive income
In order to better reﬂect the activities of an investment trust and in accordance with guidance issued by the AIC, supplementary information which analyses the income statement between items of revenue and capital nature has been presented alongside the income statement. The revenue proﬁt for the year is the measure the Directors believe is appropriate in assessing the Company’s compliance with certain requirements set out in the Investment Trust (Approved Company) (Tax) Regulations 2011.

Accounting developments
The following amendments to standards effective this year, being relevant and applicable to the Company, have been adopted, although they have no impact on the Financial Statements:

IFRS 16 Leases – effective 1 January 2019

Critical accounting judgements and uses of estimation
The preparation of ﬁnancial statements in conformity with IFRS requires management to make judgements, estimates and assumptions that affect the application of policies and the amounts reported in the balance sheet and the income statement. The estimates and associated assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis of making judgements about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

The estimates and underlying assumptions are reviewed on an ongoing basis. There were no signiﬁcant accounting estimates or signiﬁcant judgements in the current period.

Investments held at fair value
All investments held by the Company (quoted equity investments and unquoted loan notes) are classiﬁed at ‘fair value through proﬁt or loss’ as the investments are managed and their performance evaluated on a fair value basis in accordance with the investment strategy and this is also the basis on which information about the investments is reported to the Board. Investments are initially recognised at cost, being the fair value of the consideration given. After initial recognition, investments are measured at fair value, with unrealised gains and losses on investments recognised in the statement of comprehensive income and allocated to capital. Realised gains and losses on investments sold are calculated as the difference between sales proceeds and cost.

For investments actively traded in organised ﬁnancial markets, fair value is generally determined by reference to quoted market bid prices at the close of business on the balance sheet date, without adjustment for transaction costs necessary to realise the asset.

When a purchase or sale is made under a contract, the terms of which require delivery within the time frame of the relevant market, the investments concerned are recognised or derecognised on the trade date.

Unquoted investments are valued by the Directors at the balance sheet date based on recognised valuation methodologies, in accordance with International Private Equity and Venture Capital Valuation (‘IPEVC’) Guidelines issued in December 2015 such as dealing prices or third-party valuations where available, net asset values and other information as appropriate.

All investments for which fair value is measured or disclosed in the Financial Statements will be categorised within the fair value hierarchy in the notes of the Financial Statements, described as follows, based on the lowest signiﬁcant applicable input:

Level 1 reﬂects ﬁnancial instruments quoted in an active market.
Level 2 reﬂects ﬁnancial instruments whose fair value is evidenced by comparison with other observable current market transactions in the same instrument or based on a valuation technique whose variables include only data from observable markets.
Level 3 reﬂects ﬁnancial instruments whose fair value is determined in whole or in part using a valuation technique based on assumptions that are not supported by prices from observable market transactions in the same instrument and not based on available observable market data. For investments that are recognised in the Financial Statements on a recurring basis, the Company determines whether transfers have occurred between levels in the hierarchy by re-assessing the categorisation (based on the lowest signiﬁcant applicable input) at the date of the event that caused the transfer.

Income

Dividends receivable on quoted equity shares are taken into account on the ex-dividend date. Where no ex- dividend date is quoted, they are brought into account when the Company’s right to receive payment is established.

Special dividends will be taken to revenue or capital account depending on their nature. In deciding whether a dividend should be regarded as a capital or revenue receipt, the Company will review all relevant information as to the reasons for the sources of the dividend on a case-by-case basis.

Interest income on loan notes is accrued on a daily basis. Provision is made against this income where recovery is doubtful or where it will not be received in the foreseeable future. Where the loan notes only require interest or a redemption premium to be paid on redemption, the interest and redemption premium is recognised as income or capital as appropriate once redemption is reasonably certain.

Dividend and interest receivable are initially recognised at fair value. They are subsequently measured at their amortised cost using the effective interest method less any provision for impairment. The Company recognises the losses allowance for expected credit losses (‘ECL’) as per IFRS 9. Losses allowance are deducted from the gross carrying amount of the Dividend and interest receivables carried at amortised cost. A provision for impairment is established when the carrying value of the receivable exceeds the present value of the future cash ﬂow discounted using the original effective interest rate. The carrying value of the receivable is reduced through the use of an allowance account and any impairment loss is recognised in the Statement of Comprehensive Income.

Expenses

All expenses are accounted for on an basis. All expenses are charged through the revenue account in the statement of comprehensive income except as follows:

expenses which are incidental to the acquisition and disposal of an investment which are charged to capital.

All other expenses are allocated to revenue with the exception of 80% of the Investment Manager’s fee which is allocated to capital. This is in line with the Board’s expected long-term split of returns from the investment portfolio in the form of income and capital gains respectively.

Taxation

The charge for taxation is based on revenue proﬁt for the year. Deferred taxation is recognised in respect of all timing differences that have originated but not reversed at the balance sheet date. Investment Trusts which have approval under Section 1158 of the Corporation Tax Act 2010 are not liable for taxation on capital gains. Any tax relief obtained in respect of investment management fees and other capital expenses charged or allocated to the capital column of the Statement of Comprehensive Income is reﬂected in the capital reserve and a corresponding amount is charged against the revenue column of the Statement of Comprehensive Income. The tax relief is the amount by which corporation tax payable is reduced as a result of these capital expenses.

Cash and cash equivalents

Cash and cash equivalents are deﬁned as cash in hand, demand deposits and short-term, highly liquid investments readily convertible to known amounts of cash and subject to insigniﬁcant risk of changes in value.

Share issue costs

Share issue costs relating to Ordinary Shares issued by the Company are charged to the share premium account.

Repurchase of Ordinary Shares for cancellation or to be held in Treasury

The cost of repurchasing shares including the related stamp duty and transaction costs is charged to capital reserves and dealt with in the Statement of Changes in Equity. Share repurchase transactions are accounted for on a trade date basis. Where shares are cancelled or held in Treasury and subsequently cancelled, the nominal value of those shares is transferred out of called up share capital and into special reserve. Should shares held in Treasury be reissued, the sales proceeds up to the purchase price of the shares will be transferred to capital reserves. The excess of the sales proceeds over the purchase price will be transferred to share premium.

Segmental reporting

The Directors are of the opinion that the Company is engaged in a single segment of business, being investment business. The Company only invests in companies quoted in the UK.

Capital reserve

Capital reserve includes:

gains and losses on the disposal of investments;
exchange difference of a capital nature;
expenses, together with the related taxation effect, allocated to this reserve in accordance with the above policies; and
increase and decrease in the valuation of investments held at period end.

This reserve is distributable.

Revenue reserve
This reserve includes proﬁt for the year recognised in the revenue column of the Statement of Comprehensive Income. This reserve is distributable.

Special reserve
The Company cancelled its share premium account following a court order issued on 12 July 2017. As a result, a distributable special reserve was created. This reserve is distributable.

Capital redemption reserve
This reserve represents the repurchase and subsequent cancellation of the Ordinary Shares of the Company. This reserve is not distributable.

Dividends payable to shareholders
Dividends to shareholders are recognised as a liability in the period in which they are paid. Dividends declared and approved by the Company after the balance sheet date have not been recognised as a liability of the Company at the balance sheet date.

3. Earnings/(loss) per Ordinary Share

	Year ended 29 February 2020		Year ended 28 February2019
	Net return	Per share	Net return	Per share
	£’000	Pence	£’000	Pence
Revenue return	1,051	1.91	836	1.50
Capital return	(2,207)	(4.01)	(11,105)	(19.97)
Total return	(1,156)	(2.10)	(10,269)	(18.47)

Weighted average number of Ordinary Shares excluding treasury shares		55,049,771		55,600,002

4. Net Asset Value per Ordinary Share

NAV per Ordinary Share is based on net assets at the period end and 54,830,002 (2019: 55,600,002) Ordinary Shares, being the number of Ordinary Shares in issue excluding treasury shares at the year end.

	Year ended 29 February 2020		Year ended 28 February 2019
	NAV per share	NAV Attributable	NAV per share	NAV Attributable
	£’000	Pence	£’000	Pence
Ordinary Shares: Basic and diluted	71.30	39,096	74.59	41,475

5. Principal risks

The Company is exposed to a variety of risks and uncertainties. The Directors have carried out a robust assessment of the Company’s emerging and principal risks and the disclosures in the annual report that describe the principal risks and the procedures in place to identify emerging risks and explain how they are being managed or mitigated.

The Company maintains a risk matrix which sets out the key risks facing the Company and how they can be mitigated. The principle risks remain unchanged since last year and are set out in the following table with an explanation of how they are mitigated.

Risk	Mitigation
Investment performance
The investment objective of the Company may not be achieved as returns are reliant primarily upon the performance of the portfolio.	The security of the Company’s assets, dealing procedures, accounting records and adherence to regulatory and legal requirements depend on the effective operation of the control systems of the service providers. The board monitors the implementation and results of the investment process with the Investment Manager. The Investment Manager attends all Board meetings and provides the Board with information including performance data, an explanation of stock selection decisions, portfolio exposure and the rationale for the portfolio composition.
The Company will invest primarily in the smallest UK quoted or traded companies, by market capitalisation. Smaller companies can be expected, in comparison to larger companies, to have less mature businesses, a more restricted depth of management and a higher risk proﬁle.	The Investment Manager has signiﬁcant experience in small cap investing and deploys an approach that is designed to maximise the potential for the investment objective to be achieved over the longer-term.
The coronavirus pandemic poses a signiﬁcant risk to the Company’s portfolio, the full extent of which cannot yet be reliably determined. Should efforts by the UK and governments worldwide to bring the outbreak under control not prove effective, the impact on the economy and the consequences for the portfolio companies may harm investment performance of the Company.	The Company has a small portfolio which allows the Investment Manager to work closely with each portfolio company and provide active support where it can.
Operational
The Company relies on external service providers. In the event that they are unable, or unwilling, to perform in accordance with its terms of appointment the Company may impact the Company’s performance. Disruption to the accounting, payment systems or custody records could prevent the accurate reporting and monitoring of the Company’s ﬁnancial position.	Due diligence is undertaken before contracts are executed with potential service providers.
The security of the Company’s assets, dealing procedures, accounting records and adherence to regulatory and legal requirements depend on the effective operation of the control systems of the service providers.	The Company’s assets are subject to a strict liability regime and in the event of a loss of ﬁnancial assets held in custody assets of an identical type or the corresponding amount must be returned unless the loss was beyond the reasonable control of the custodian. The Board monitors the performance of service providers together with the associated costs. The Board also reviews reports on the effective operation of the internal controls of service providers. The Board also considers the business continuity arrangements of the Company’s key service providers. The Board may terminate all key contracts on normal market terms.
Financial
The Company’s investment activities expose it to a variety of ﬁnancial risks that include interest rate, currency and liquidity risk.	Further details of these risks are disclosed in the Financial Statements together with a summary of the policies for managing these risks.
Legal and compliance
The Company has been accepted by HM Revenue & Customs as an investment trust, subject to continuing to meet the relevant conditions.	The Investment Manager monitors investment movements and the amount of proposed dividends, if any, to ensure that the relevant provisions of the Corporation Tax Act 2010 are not breached. A report is provided to the Board at each meeting.
The Company is subject to the Companies Act 2006, the Alternative Investment Fund Manager’s Directive, the UK Listing Rules and Disclosure & Transparency Rules and the Market Abuse Regulations.	The Company Secretary and the Company’s professional advisers provide reports to the Board in respect of compliance with all applicable rules and regulations and will ensure that the Board is made aware of any changes to these rules and regulations. Compliance with the accounting rules affecting investment trusts is also monitored

Coronavirus pandemic
A key feature of the Investment Manager’s approach is in seeking to have a strategic involvement with all investee companies. This has allowed the Manager to be closely involved with the developments in the investee companies in relation to the coronavirus pandemic and its consequences. The Board and Manager will continue to monitor such developments and the potential impact of the pandemic on the individual companies and the portfolio as a whole.

Brexit
The Board follows developments in the plans for the UK leaving the EU. The ultimate relationship between the UK and the EU remains unclear at this time and the potential impact on the portfolio uncertain but the Investment Manager considers the range of risk for each investment and the Board continues to monitor events.

6. Related parties and Investment Manager

Investment Manager
Downing LLP have been appointed as the Investment Manager to the Company. The relationship is governed by an agreement dated 23 March 2017.

The total investment management fee charged by Downing LLP for the period ended 29 February 2020 was £378,799 (2019: £475,195). The amount outstanding at 29 February 2020 was £28,786 (2019: £33,824).

During the year under review, Judith MacKenzie was a Non-Executive Director of Real Good Food plc in which the Company has an investment. An annual fee of £25,000 is paid to Downing LLP for Judith’s services as a director of Real Good Food plc.

Directors
Disclosure of the Directors’ interests in the Ordinary Shares of the Company and fees and expenses payable to the Directors are set out in the Directors’ Remuneration Report. At 29 February 2020, there were no outstanding Directors’ fees (2019: none).

7. Non-adjusting events after the reporting date

On 11 March 2020, the World Health Organization declared the outbreak of a strain of novel coronavirus disease, COVID-19, a global pandemic. The UK and other governments worldwide have taken steps designed to contain the outbreak, including advising self-isolation, travel restrictions, quarantines and cancellations of gatherings and events. The effect on the UK and global economies will be signiﬁcant. This has resulted in public equity markets seeing signiﬁcant falls in prices since the reporting date. At 30 April 2020, the Company's net asset value stood at 64.15 per share, a fall of 10.0% since 29 February 2020.

Announcement based on audited accounts

The financial information set out in this announcement does not constitute the Company's statutory financial statements in accordance with section 434 Companies Act 2006 for the year ended 29 February 2020, but has been extracted from the statutory financial statements for the year ended 29 February 2020 which were approved by the Board of Directors on 1 May 2020 and will be delivered to the Registrar of Companies. The Independent Auditor's Report on those financial statements was unqualified and did not contain any emphasis of matter nor statements under s 498(2) and (3) of the Companies Act 2006.

The statutory accounts for the year ended 28 February 2019 have been delivered to the Registrar of Companies and received an Independent Auditors report which was unqualified and did not contain any emphasis of matter nor statements under s 498(2) and (3) of the Companies Act 2006.

A copy of the full annual report and financial statements for the year ended 29 February 2020 will be printed and posted to shareholders shortly. Copies will also be available to the public at the registered office of the Company at St. Magnus House, London, EC3R 6HD and will be available for download from www.downingstrategic.co.uk

Enquiries:

Judith McKenzie	Downing Fund Managers	07771 980 687
Hugh Aldous	Chairman	07785 294 789
Robert Finlay	Shore Capital	07771 765 675

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