N-30D 1 a2081250zn-30d.txt N-30D H&Q LIFE SCIENCES INVESTORS [GRAPHIC] SEMIANNUAL REPORT MARCH 31, 2002 To our Shareholders: At quarter-end on March 31, 2002 the net asset value of your Fund was $21.38 per share. Performance data for the six months and the quarter ended March 31 compared to the indices is as follows:
FISCAL YEAR TO DATE QUARTER ENDED 9/30/01 - 3/31/02 3/31/02 ------------------- ------------- Net Asset Value +1.7% -14.4% Dow Jones Industrial Average +17.6% +3.8% NASDAQ Industrials +30.1% +2.1% Russell 2000 +25.1% +3.1%
The Fund's second fiscal quarter ended March 31, 2002 was particularly disappointing following the Fund's strong performance during the prior quarter. During the quarter, the biotechnology sector retrenched due to both sector-specific and general factors. However, we continue to be confident in the future of healthcare in general and in emerging biotech and medtech growth companies in particular. We believe that the companies in this sector will continue to lead the advancement of knowledge and remain confident this progress will improve the human condition by providing products and services that will enhance the quality and duration of life. We have no doubt that Americans will appreciate the values of these products and will pay a premium price for them. As such we continue to believe that the investment opportunities in the future will be abundant. We also believe that as the economy generally improves over time, the healthcare sector will play a significant role in any advancement. While the stock prices of public biotechnology companies have declined during the most recent quarter, we were not aggressive buyers. Rather, we selectively reduced positions and allowed liquidity, as a percent of total assets, to rise to its highest level in recent years. We believe the Fund is well positioned to take advantage of the current situation. Valuations are becoming particularly attractive for both publicly traded and private companies. We expect that in the weeks and months ahead we will have opportunities to invest much of this liquidity at very attractive levels. Many public companies have equity market values with historically low premiums to their liquid assets creating unusual values for their technology and product opportunities. In our venture capital activity, we are now frequently seeing attractive valuations and some transactions are being done at a very significant discount to previous investment rounds completed 1-2 years ago. We believe that this also bodes well for the future. 1 Having made these assertions, it is also true that there are a number of factors that may have a mitigating impact on the Fund's performance. Certainly, the heightened scrutiny of accounting practices at a number of individual companies, as well as other corporate governance issues, is sobering to the general market. Furthermore, there are a number of issues specific to the pharmaceutical industry that are unsettling to investors. The Food and Drug Administration is still without a Commissioner, and seems to have recently become even more risk averse than usual. With several product approvals delayed, investors have concerns that product approval cycles are once again lengthening. This comes at a time when patent expirations are increasing with the threat of generic competition. These issues come amidst discussion of the control of drug pricing by government and increasing uncertainty about the ability of healthcare companies to sustain the ever-increasing cost of drug development. While these concerns are most apparent to major pharmaceutical companies, and less so for the emerging companies, sentiment does affect valuations. Some of these issues are likely to persist at least through the elections in November but we continue to believe that new products that cure or mediate the course of disease will continue to be rewarded. Two new venture investments were made in the quarter. SENOMYX discovers and develops novel flavor and fragrance molecules by combining its understanding of the biology of taste with receptor biology, combinatorial chemistry, high throughput screening and bioinformatics. AGENSYS develops fully human monoclonal antibodies to treat solid tumor cancers based on the Company's own proprietary drug targets. A follow-on investment was made in Sontra Medical in connection with its merger with ChoiceTel, a publicly traded company. This was a difficult quarter, but we believe strongly in the future growth of life sciences and in the entrepreneurial approach of the companies in which we invest. We continue to believe that attractive investment opportunities in the future will be abundant. /s/ Alan G. Carr /s/ Daniel R. Omstead Alan G. Carr Daniel R. Omstead President Emeritus President 2 H&Q LIFE SCIENCES INVESTORS PRIVACY NOTICE If you are a registered shareholder of the Fund, the Fund and Hambrecht & Quist Capital Management, the Funds' investment adviser, may receive nonpublic personal information about you from the information collected by the transfer agent from your transactions in Fund shares. Any nonpublic personal information is not disclosed to third parties, except as permitted or required by law. In connection with servicing your account and effecting transactions, the information received may be shared with the investment adviser and non-affiliates, including transfer agents, custodians or other service companies. Access to your nonpublic personal information is restricted to employees who need to know that information to provide products or services to you. To maintain the security of your nonpublic personal information, physical, electronic, and procedural safeguards are in place that comply with federal standards. The policies and practices described above apply to both current and former shareholders. If your Fund shares are held in "street name" at a bank or brokerage, we do not have access to your personal information and you should refer to your bank's or broker's privacy policies for a statement of the treatment of your personal information. H&Q LIFE SCIENCES INVESTORS PORTFOLIO As of March 31, 2002 [CHART]
TOTAL VENTURE DIFFERENCE ----- ------- ---------- AGRI/ENVIRONMENTAL 1.5% 1.4% 0.1% BIOTECHNOLOGY 46.0% 10.2% 35.8% CROs 0.5% 0.0% 0.5% DIAGNOSTICS 5.7% 2.8% 2.8% HEALTHCARE INFO SERVICES 3.5% 2.6% 1.0% MEDICAL SPECIALTY 13.2% 4.0% 9.2% MEDICAL SUPPLIES 1.4% 0.9% 0.5% PHARMACEUTICALS 6.1% 2.1% 4.0% LIQUID ASSETS 22.1% 0.0% 22.1% RESTRICTED
3 H&Q LIFE SCIENCES INVESTORS LARGEST HOLDINGS AS OF MARCH 31, 2002
% OF NET ASSETS --------------- Gilead Sciences 5.05% Martek Biosciences 4.98% Cubist Pharmaceuticals 4.38% CV Therapeutics 3.95% Celgene 3.23% Endocardial Solutions 2.53% Biovail 2.46% Versicor 2.42% Transkaryotic Therapies 2.37% MedImmune 2.21%
H&Q LIFE SCIENCES INVESTORS SIGNIFICANT PORTFOLIO TRANSACTIONS QUARTER ENDED MARCH 31, 2002
UNITS HELD UNITS HELD PURCHASES 12/31/01 3/31/02 --------- -------- ------- Agensys (Restricted) 0 634,921 Exelixis 126,000 212,000 Rigel Pharmaceuticals 0 339,000 Senomyx (Restricted) 0 689,679 Sontra (Restricted) Series B 357,640 622,558 WebMD 189,000 269,000 SALES ----- Affymetrix 40,000 0 Biovail 225,424 105,424 Curis 135,373 59,000 Gilead Sciences 300,000 300,000 Scios 73,000 0 Sepracor 140,000 0 Versicor 418,776 278,776
4 H&Q LIFE SCIENCES INVESTORS SCHEDULE OF INVESTMENTS March 31, 2002 (UNAUDITED)
CONVERTIBLE SECURITIES - 23.8% OF NET ASSETS SHARES CONVERTIBLE PREFERRED (RESTRICTED) - 21.9% VALUE ------------ ---------- AGRICULTURAL/ENVIRONMENTAL TECHNOLOGIES - 1.4% 250,000 Ceres Series C* $1,500,000 18,296 Ceres Series C-1*# 109,776 174,200 Ceres Series D*# 1,045,200 177,778 EPR Series A* 266,667 BIOTECHNOLOGY - 9.0% 266,667 ACADIA Pharmaceuticals Series E* 2,000,003 634,921 Agensys Series C* 2,000,001 1,587,302 Agilix Series B* 2,000,001 566,958 Avalon Pharmaceuticals Series B* 2,000,001 1,212,121 Raven biotechnologies Series B*^ 2,000,000 30,920 Therion Biologics Series A* 115,950 160,000 Therion Biologics Series B*# 600,000 271,808 Therion Biologics Series C*# 1,019,280 28,991 Therion Biologics Sinking Fund* 108,716 1,150,000 Triad Therapeutics Series A* 2,300,000 550,000 Triad Therapeutics Series B* 1,100,000 615,385 Zyomyx Series B* 2,461,540 400,000 Zyomyx Series C* 1,600,000 DIAGNOSTICS - 2.8% 914,286 CardioNet Series C*^ 3,200,001 322,168 CytoLogix Series A*^ 265,917 151,420 CytoLogix Series B*#^ 124,982 130,000 Masimo Series D* 1,430,000 1,149,425 Sontra Medical Series A*^ 578,506 622,558 Sontra Medical Series B*^ 313,333 HEALTHCARE INFORMATION SERVICES - 1.8% 225,989 KVM Technologies Series B*#^ 1,000,001 3,589,744 PHT Series D*^ 2,800,003 MEDICAL SPECIALTY - 3.9% 500,000 AbTox Series F* 5,000 1,088,436 OmniSonics Medical Technologies Series B*^ 1,600,001 689,679 Senomyx Series E* 2,000,000 426,439 Songbird Hearing Series D* 4,264 434,782 TherOx Series H* 1,999,997 546,875 VNUS Medical Technologies Series E* 2,800,000 MEDICAL SUPPLIES - 0.9% 281,250 LocalMed Series D* 2,813 421,052 Novacept Series G*# 1,999,997
The accompanying notes are an integral part of these financial statements. 5
SHARES CONVERTIBLE PREFERRED - CONTINUED VALUE ------------ ----------- PHARMACEUTICALS/DRUG DELIVERY - 2.1% 141,177 Advanced Medicine Series C* $1,270,593 133,334 Advanced Medicine Series D-1* 1,200,006 932,488 Galileo Laboratories Series F* 1,999,999 ----------- $46,822,548 ----------- PRINCIPAL AMOUNT CONVERTIBLE BONDS AND NOTES - 1.9% ------------ BIOTECHNOLOGY - 1.4% $4,200,000 CuraGen 6% Cvt. Deb. due 2007 ii $3,118,500 HEALTHCARE INFORMATION SERVICES - 0.4% 1,053,262 FitForAll.com (Restricted) 10% Prom. Note*#+ 105 900,000 KVM Technologies (Restricted) Adj. Cvt. Demand Note*#^ 900,000 MEDICAL SPECIALTY - 0.1% 120,000 AbTox (Restricted) 12% Prom. Note*+ 120,000 ----------- $4,138,605 ----------- TOTAL CONVERTIBLE SECURITIES (Cost $55,626,504) $50,961,153 ----------- SHARES COMMON STOCKS - 54.01% ------------ AGRICULTURAL/ENVIRONMENTAL TECHNOLOGY - 0.1% 57,032 Catalytica Energy Systems* $192,198 20,833 Envirogen* 30,625 38,000 Verdant Brands* 228 ----------- 223,051 ----------- BIOTECHNOLOGY - 35.5% BIOPHARMACEUTICALS - 29.2% 282,620 BioTransplant* 1,483,755 3,297 BioTransplant (Restricted) Wts. (expire 8/12/04)* 2,473 13,500 BioTransplant (Restricted) Wts. (expire 10/31/04)* 10,125 925 BioTransplant (Restricted) Wts. (expire 8/15/05)* 2,892 279,600 Celgene* 6,920,100 36,000 Cephalon* 2,268,000 145,071 Corixa* 895,088 407,449 Cubist Pharmaceuticals* 7,529,658 133,333 Cubist Pharmaceuticals (Restricted) Wts. (expire 9/23/03)* 1,839,395 233,484 CV Therapeutics* 8,452,121 106,000 Genzyme* 4,629,020 300,000 Gilead Sciences* 10,797,000 120,000 MedImmune* 4,719,600
The accompanying notes are an integral part of these financial statements. 6
SHARES BIOTECHNOLOGY - CONTINUED VALUE ------------ ---------- 146,982 Therion Biologics (Restricted)* $551,183 117,638 Transkaryotic Therapies* 5,064,316 135,135 Tularik* 2,221,619 278,776 Versicor* 5,040,270 12,464 Versicor (Restricted) Wts. (expire 8/3/05)* 133,215 GENOMICS/DRUG DISCOVERY - 6.3% 100,000 Abgenix* 1,889,000 247,463 Dyax* 910,664 212,000 Exelixis* 2,923,480 52,000 Lexicon Genetics* 491,400 150,000 Lynx Therapeutics* 327,000 116,307 Molecular Devices* 2,113,299 339,000 Rigel Pharmaceuticals* 1,203,450 296,428 Telik* 3,592,708 ---------- 76,010,831 ---------- CONTRACT RESEARCH ORGANIZATIONS - 0.5% 61,500 Quintiles Transnational* 1,091,625 ---------- 1,091,625 ---------- DIAGNOSTICS - 2.9% 356,249 Biofield* $162,093 400,000 Biofield (Restricted)* 145,600 109,956 Cytyc* 2,960,016 9,000 Digene* 321,750 98,000 IDEXX Laboratories* 2,630,320 130,000 Masimo Labs (Restricted)* 1,300 600,000 Sontra Medical (Restricted)*^ 6,000 ---------- 6,227,079 ---------- HEALTHCARE INFORMATION SERVICES - 1.4% 3,339,409 Codman Group (Restricted)* 8,349 204,139 Physician WebLink (Restricted)* 800,317 101,283 Physician WebLink (Restricted) Wts. (expire 10/15/04)* 10,128 269,000 WebMD* 2,065,920 ---------- 2,884,714 ---------- MEDICAL SPECIALTY - 9.2% 254,546 ATS Medical* 509,092 107,100 Bioject Medical Technologies* 412,335
The accompanying notes are an integral part of these financial statements. 7
SHARES MEDICAL SPECIALTY - CONTINUED VALUE ------------ ------------ 67,898 Biopure* $719,719 5,555 Biopure (Restricted) Wts. (expire 8/4/03)* 0 59,000 Curis* 125,670 666,666 Endocardial Solutions* 5,406,662 338,815 Martek Biosciences* 10,665,558 680,000 Orthovita*^ 1,666,000 132,000 Radiance Medical Systems* 165,000 ------------ 19,670,036 ------------ MEDICAL SUPPLIES - 0.5% 430,000 EP MedSystems* 1,087,900 ------------ 1,087,900 ------------ PHARMACEUTICALS/DRUG DELIVERY - 4.0% 125,000 Aradigm* 587,500 105,424 Biovail* 5,269,093 59,500 Emisphere Technologies* 1,012,095 30,000 Teva Pharmaceutical Industries ADR 1,640,100 ------------ 8,508,788 ------------ TOTAL COMMON STOCKS (Cost $59,042,491) $115,704,024 ------------ PRINCIPAL AMOUNT TEMPORARY CASH INVESTMENTS - 21.8% ------------ $ 6,700,000 American Express Credit, 1.45%, due 4/2/02 $6,699,730 11,000,000 American Express Credit, 1.80%, due 4/29/02 10,984,600 10,000,000 General Electric Capital Corp., 1.82%, due 5/8/02 9,981,294 5,000,000 U.S. Treasury Bill, 1.69%, due 4/11/02 4,997,653 4,000,000 U.S. Treasury Bill, 1.73%, due 4/25/02 3,995,387 10,000,000 U.S. Treasury Bill, 1.71%, due 5/2/02 9,985,275 ------------ TOTAL TEMPORARY CASH INVESTMENTS $46,643,939 ------------ (Cost $46,643,939) TOTAL INVESTMENTS IN SECURITIES (Cost $161,312,934) $213,309,116 ============
---------- * Non income-producing security. # With warrants attached. ^ Affiliated issuers in which the Fund holds 5% or more of the voting securities (Total Market Value of $14,454,744). ii Security exempt from registration under Rule 144A of the Securities Act of 1933. These securities may be resold in transactions exempt from registration, normally to qualified institutional buyers. + Issuer filed for bankruptcy. The accompanying notes are an integral part of these financial statements. 8 H&Q LIFE SCIENCES INVESTORS STATEMENT OF ASSETS AND LIABILITIES March 31, 2002 (UNAUDITED) ASSETS: Investments, at value (identified cost $161,312,934; see Schedule of Investments) $213,309,116 Cash 294,184 Interest receivable 41,300 Receivable for investments sold 1,236,941 Prepaid expenses 34,025 ------------ Total assets $214,915,566 ------------ LIABILITIES: Payable for investments purchased $577,992 Accrued advisory fee 244,961 Accrued other 98,068 ------------ Total liabilities $921,021 ------------ NET ASSETS $213,994,545 ============ SOURCES OF NET ASSETS: Shares of beneficial interest, par value $.01 per share, unlimited number of shares authorized, amount paid in on 10,009,516 shares issued and outstanding $142,121,188 Accumulated net investment loss (1,267,521) Accumulated net realized gain on investments 21,144,696 Net unrealized gain on investments 51,996,182 ------------ Total net assets (equivalent to $21.38 per share based on 10,009,516 shares outstanding) $213,994,545 ============
The accompanying notes are an integral part of these financial statements. 9 H&Q LIFE SCIENCES INVESTORS STATEMENT OF OPERATIONS For the Six Months Ended March 31, 2002 (UNAUDITED) INVESTMENT INCOME: Dividend income (net of foreign tax of $744) $3,909 Interest income 464,197 ---------- Total investment income $468,106 EXPENSES: Advisory fees $1,492,227 Trustees' fees and expenses 82,012 Legal fees 76,409 Shareholder reporting 44,058 Accounting and auditing fees 41,232 Custodian fees 35,025 Transfer agent fees 23,681 Stock exchange listing fee 14,708 Other 17,075 ---------- Total expenses 1,826,427 ----------- Net investment loss ($1,358,321) ----------- NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Net realized gain on investments $25,121,578 Decrease in net unrealized gain on investments (19,900,138) ----------- Net gain on investments $5,221,440 ----------- Net increase in net assets resulting from operations $3,863,119 ===========
The accompanying notes are an integral part of these financial statements. 10 H&Q LIFE SCIENCES INVESTORS STATEMENTS OF CHANGES IN NET ASSETS
FOR THE SIX FOR THE MONTHS ENDED YEAR ENDED MARCH 31, 2002 SEPTEMBER 30, (UNAUDITED) 2001 -------------- ------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS: Net investment loss ($1,358,321) ($1,942,140) Net realized gain on investments 25,121,578 43,069,447 Increase (decrease) in net unrealized gain on investments (19,900,138) (136,156,505) ------------ ------------ Net increase (decrease) in net assets resulting from operations $3,863,119 ($95,029,198) ------------ ------------ DISTRIBUTIONS TO SHAREHOLDERS FROM: Net realized capital gains ($19,737,875) ($33,130,936) ------------ ------------ CAPITAL SHARE TRANSACTIONS: Value of shares issued in reinvestment of distributions (690,518 and 1,233,846 shares, respectively) $14,706,701 $25,051,378 ------------ ------------ Total increase (decrease) in net assets ($1,168,055) ($103,108,756) NET ASSETS: Beginning of year 215,162,600 318,271,356 ------------ ------------ End of year $213,994,545 $215,162,600 ============ ============
The accompanying notes are an integral part of these financial statements. 11 H&Q LIFE SCIENCES INVESTORS STATEMENT OF CASH FLOWS For the Six Months Ended March 31, 2002 (UNAUDITED) CASH FLOWS USED FOR OPERATING ACTIVITIES: Interest income received $430,687 Dividends received 3,909 Operating expenses paid (1,907,491) ------------ Net cash used for operating activities ($1,472,895) ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of portfolio securities ($12,753,419) Net purchases of temporary cash investments (15,752,968) Sales and maturities of portfolio securities 34,952,535 ------------ Net cash provided from investing activities $6,446,148 ------------ CASH FLOWS USED FOR FINANCING ACTIVITIES: Cash distributions paid, net ($5,031,174) ------------ Net cash used for financing activities ($5,031,174) ------------ NET DECREASE IN CASH ($57,921) CASH AT BEGINNING OF YEAR 352,105 ------------ CASH AT END OF YEAR $294,184 ============ RECONCILIATION OF NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS TO NET CASH USED FOR OPERATING ACTIVITIES: Net increase in net assets resulting from operations $3,863,119 Accretion of discount (33,510) Net realized gain on investments (25,121,578) Decrease in net unrealized gain on investments 19,900,138 Net decrease in accrued expenses (64,140) Net increase in prepaid expenses (16,924) ------------ Net cash used for operating activities ($1,472,895) ============
Noncash financing activities not included herein consist of stock distributions of $14,706,701. The accompanying notes are an integral part of these financial statements. 12 H&Q LIFE SCIENCES INVESTORS FINANCIAL HIGHLIGHTS (SELECTED DATA FOR EACH SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT THE PERIOD INDICATED)
FOR THE SIX MONTHS ENDED MARCH 31, 2002 FOR THE YEARS ENDED SEPTEMBER 30, ---------------------------------------------------------- UNAUDITED)(1) 2001 2000 1999 1998 1997 ------------- ---- ---- ---- ---- ---- Net asset value per share: Beginning of period $23.090 $39.365 $17.804 $13.713 $18.825 $18.445 ------------ ------------ ------------ ------------ ------------ ------------ Net investment income (loss) ($0.141)* ($0.221)* ($0.300) ($0.205) ($0.239) ($0.072) Net realized and unrealized gain (loss) on investments 0.521 (12.134) 24.756 4.576 (4.133) 2.092 ------------ ------------ ------------ ------------ ------------ ------------ Total increase (decrease) from investment operations $0.380 ($12.355) $24.456 $4.371 ($4.372) $2.020 ------------ ------------ ------------ ------------ ------------ ------------ Capital gains distributions to shareholders ($2.090) ($3.920) ($2.895) ($0.280) ($0.740) ($1.640) ------------ ------------ ------------ ------------ ------------ ------------ Net asset value per share: End of period $21.380 $23.090 $39.365 $17.804 $13.713 $18.825 ============ ============ ============ ============ ============ ============ Per share market value: End of period $19.560 $18.450 $31.313 $14.125 $10.875 $15.125 Total investment return at market value 16.61% (29.07%) 155.36% 32.90% (23.89%) 12.86% RATIOS AND SUPPLEMENTAL DATA: Net assets at end of period $213,994,545 $215,162,600 $318,271,356 $131,562,804 $100,030,321 $131,987,733 Ratio of operating expenses to average net assets** 1.60% 1.58% 1.51% 1.60% 1.62% 1.67% Ratio of net investment loss to average net assets** (1.19%) (0.83%) (1.06%) (1.30%) (1.50%) (1.38%) Portfolio turnover rate 6.63% 16.49% 12.70% 23.49% 18.21% 18.94% Number of shares outstanding at end of period 10,009,516 9,318,998 8,085,152 7,389,487 7,294,722 7,011,362
(1) The Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies and began accreting discounts and amortizing premiums on all debt securities. The effect of this change for the six months ended March 31, 2002 was a decrease in net investment loss per share of $.003, a decrease in net realized and unrealized gain (loss) per share of $.003, and a decrease in the ratio of net investment loss to average net assets from (1.22%) to (1.19%). Per share data and ratios for the periods prior to October 1, 2001 have not been restated to reflect this change in presentation. * Net investment loss per share has been computed using average shares outstanding. ** Annualized. The accompanying notes are an integral part of these financial statements. 13 H&Q LIFE SCIENCES INVESTORS NOTES TO FINANCIAL STATEMENTS March 31, 2002 (UNAUDITED) (1) ORGANIZATION H&Q Life Sciences Investors (the Fund) is a Massachusetts business trust registered under the Investment Company Act of 1940 as a diversified closed-end management investment company. The Fund's investment objective is long-term capital appreciation through investment in securities of companies in the life sciences industries. The Fund invests primarily in securities of public and private companies that are believed to have significant potential for above-average growth. The Fund was organized on February 20, 1992 and commenced operations on May 8, 1992. The preparation of these financial statements requires the use of certain estimates by management in determining the entity's assets, liabilities, revenues and expenses. Actual results could differ from these estimates. The following is a summary of significant accounting policies consistently followed by the Fund, which are in conformity with those generally accepted in the United States of America. INVESTMENT SECURITIES Investments traded on national securities exchanges or in the over-the-counter market that are National Market System securities are valued at the last sale price or, lacking any sales, at the mean between the last bid and asked prices. Other over-the-counter securities are valued at the most recent bid prices as obtained from one or more dealers that make markets in the securities. As indicated in Note 4, investments for which market quotations are not readily available are valued at fair value as determined in good faith by the Trustees of the Fund. Temporary cash investments with maturity of 60 days or less are valued at amortized cost. Investment transactions are recorded on a trade date basis. Gains and losses from sales of investments are recorded using the "identified cost" method. Interest income is recorded on the accrual basis. Dividend income is recorded on the ex-dividend date. The Fund adopted the provisions of the AICPA Audit and Accounting Guide for Investment Companies, as revised, effective October 1, 2001 and began accreting discounts and amortizing premiums on all debt securities. Prior to this date, the Fund did not accrete discounts or amortize premiums on long-term debt securities. The cumulative effect of this accounting change had no impact on the total net assets of the Fund, but resulted in an increase in cost of securities and a corresponding decrease in net unrealized appreciation of $90,800 based on securities held at September 30, 2001. The effect of this change for the six months ended March 31, 2002 was to decrease net investment loss by $33,510 with a corresponding decrease in the change in net unrealized appreciation of $33,510. FEDERAL INCOME TAXES It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute to its shareholders substantially all of its taxable income and its net realized capital gains, if any. Therefore, no Federal income or excise tax provision is required. DISTRIBUTIONS The Fund records all distributions to shareholders from net investment income, if any, and realized gains on the ex-dividend date. Such distributions are determined in conformity with income tax regulations. Due to permanent book/tax differences in accounting for certain transactions, certain distributions may be treated as distributions from capital as opposed to distributions of net investment income or realized capital gains. 14 DISTRIBUTION POLICY The current distribution policy is to declare distributions in stock. Stock distributions will automatically be paid in newly issued shares of the Fund unless otherwise instructed by the shareholder. Pursuant to an SEC exemptive order, the Fund has implemented a fixed distribution policy that permits the Fund to make quarterly distributions at a rate of 2% of the Fund's net assets to shareholders of record. The Fund intends to use net realized capital gains when making quarterly distributions. This could result in a return of capital to shareholders if the amount of the distribution exceeds the Fund's net investment income and realized capital gains. It is anticipated that net realized capital gains in excess of the total distributed under this policy would be included in the December distribution. STATEMENT OF CASH FLOWS The cash amount shown in the Statement of Cash Flows is the amount included in the Fund's Statement of Assets and Liabilities and represents cash on hand at its custodian and does not include temporary cash investments at March 31, 2002. (2) SECURITIES TRANSACTIONS The aggregate cost of purchases and proceeds from sales of investment securities (other than temporary cash investments) for the six months ended March 31, 2002 totaled $12,985,392 and $34,704,547, respectively. At March 31, 2002, the total cost of securities for Federal income tax purposes was $161,312,934. The net unrealized gain on securities held by the Fund was $51,996,182, including gross unrealized gain of $79,994,628 and gross unrealized loss of $27,998,446. (3) INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES The Fund has entered into an Investment Advisory Agreement (the Advisory Agreement) with Hambrecht & Quist Capital Management Incorporated (the Adviser). Pursuant to the terms of the Advisory Agreement, the Fund pays the Adviser a monthly fee at the rate when annualized of (i) 2.5% of the average net assets for the month of its venture capital and other restricted securities up to 25% of net assets and (ii) for the month, for all other assets, 1.0% of the average net assets up to $250 million, 0.9% of the average net assets for the next $250 million, 0.8% of the average net assets for the next $500 million and 0.7% of the average net assets thereafter. The aggregate fee may not exceed a rate when annualized of 1.375%. Certain officers and Trustees of the Fund are also officers of the Adviser. The Adviser is an indirect wholly owned subsidiary of J.P. Morgan Chase & Co. On March 22, 2002, the Trustees of the Fund approved a new investment advisory agreement with Hambrecht & Quist Capital Management LLC, subject to certain conditions, including approval by the Fund's shareholders. The terms of the new agreement are substantially identical to those in the current Advisory Agreement. Trustees who are not affiliates of the Adviser receive an annual fee of $15,000 plus $1,500 for each meeting attended. (4) VENTURE CAPITAL AND OTHER RESTRICTED SECURITIES The Fund may invest in venture capital and other restricted securities if these securities would currently comprise 40% or less of net assets. The value of these securities represents 24% of the Fund's net assets at March 31, 2002. 15 The value of the venture capital and other restricted securities is determined in good faith by the Trustees. However, because of the inherent uncertainty of valuations, these estimated values may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material. In fiscal 2001, the Fund sold a restricted security subject to future contingent payments whose estimated value of $932,746 has also been determined by the Trustees and which is included in Receivable for Investments Sold in the Statement of Assets and Liabilities. The following table details the acquisition date, cost, carrying value per unit, and value of the Fund's venture capital and other restricted securities at March 31, 2002, as determined by the Trustees of the Fund.
ACQUISITION CARRYING VALUE SECURITY DATE COST PER UNIT VALUE ------------------------------------ ----------- ---------- -------------- --------- AbTox Series F Cvt. Pfd. 3/7/97 $1,110,615 $0.010 $5,000 12% Promissory Note 2/26/98-3/26/98 120,000 1.000 120,000 ACADIA Pharmaceuticals Series E Cvt. Pfd. 5/2/00 1,999,995 7.500 2,000,003 Advanced Medicine Series C Cvt. Pfd. 2/5/99 1,200,124 9.000 1,270,593 Series D-1 Cvt. Pfd. 8/28/00 1,200,606 9.000 1,200,006 Agensys Series C Cvt. Pfd. 2/14/02 2,000,001 3.150 2,000,001 Agilix Series B Cvt. Pfd. 11/18/01 2,000,001 1.260 2,000,001 Avalon Pharmaceuticals Series B Cvt. Pfd. 10/22/01 2,000,001 3.528 2,000,001 Biofield Common 12/15/00 200,000 0.364 145,600 Biopure Common Warrants (expire 8/4/03) 5/13/99 0 0.000 0 BioTransplant Common Warrants (expire 8/12/04) 8/12/94 0 0.750 2,473 Common Warrants (expire 10/31/04) 10/31/94 0 0.750 10,125 Common Warrants (expire 8/15/05) 8/18/95 0 3.126 2,892 CardioNet^ Series C Cvt. Pfd. 5/3/01 3,215,516 3.500 3,200,001 Ceres Series C Cvt. Pfd. 12/23/98 1,000,875 6.000 1,500,000 Series C-1 Cvt. Pfd.* 1/4/01 74,325 6.000 109,776 Series D Cvt. Pfd.* 3/14/01 1,045,200 6.000 1,045,200 Codman Group Common 1/26/96-8/24/97 1,952,757 0.003 8,349 Cubist Pharmaceuticals Common Warrants (expire 9/23/03) 9/23/98 235 13.796 1,839,395 CytoLogix^ Series A Cvt. Pfd. 1/13/98-7/21/99 1,550,040 0.825 265,917 Series B Cvt. Pfd.* 1/11/01 764,670 0.825 124,982 EPR Series A Cvt. Pfd. 3/9/94 800,331 1.500 266,667 FitForAll.com 10% Promissory Note* 2/22/00-9/18/00 1,073,999 0.000 105
16
ACQUISITION CARRYING VALUE SECURITY DATE COST PER UNIT VALUE ------------------------------------ ----------- ---------- -------------- --------- Galileo Laboratories Series F Cvt. Pfd. 8/18/00 $2,001,176 $2.145 $1,999,999 KVM Technologies^ Series B Cvt. Pfd.* 2/19/98 1,001,321 4.425 1,000,001 Adj. Cvt. Demand Note* 6/21/99-7/31/01 900,625 1.000 900,000 LocalMed Series D Cvt. Pfd. 2/9/96 1,126,970 0.010 2,813 Masimo Series D Cvt. Pfd. 8/14/96 910,000 11.000 1,430,000 Masimo Labs Common 8/14/96 0 0.010 1,300 Novacept Series G Cvt. Pfd.* 3/27/01 1,999,997 4.750 1,999,997 OmniSonics Medical Technologies^ Series B Cvt. Pfd. 5/24/01 1,602,982 1.470 1,600,001 PHT^ Series D Cvt. Pfd. 7/23/01 2,800,003 0.780 2,800,003 Physician WebLink Common 2/5/97 800,325 3.920 800,317 Warrants (expire 10/15/04) 10/15/98 0 0.100 10,128 Raven biotechnologies^ Series B Cvt. Pfd. 12/12/00 2,000,000 1.650 2,000,000 Senomyx Series E Cvt. Pfd. 2/19/02 2,000,000 2.900 2,000,000 Songbird Hearing Series D Cvt. Pfd. 12/14/00 1,999,999 0.010 4,264 Sontra Medical^ Common 3/26/01 0 0.010 6,000 Series A Cvt. Pfd. 9/9/98 800,420 0.503 578,506 Series B Cvt. Pfd. 3/26/01-2/28/02 307,333 0.503 313,333 Therion Biologics Common 6/30/93-10/16/96 251,642 3.750 551,183 Series A Cvt. Pfd. 8/20/96-10/16/96 289,847 3.750 115,950 Series B Cvt. Pfd.* 2/24/99-6/22/99 600,609 3.750 600,000 Series C Cvt. Pfd.* 9/26/01 1,019,280 3.750 1,019,280 Sinking Fund Cvt. Pfd 10/17/94-4/3/96 582,505 3.750 108,716 TherOx Series H Cvt. Pfd. 9/11/00 2,001,248 4.600 1,999,997 Triad Therapeutics Series A Cvt. Pfd. 6/8/99 1,150,860 2.000 2,300,000 Series B Cvt. Pfd. 12/20/00 1,100,000 2.000 1,100,000 Versicor Warrants (expire 8/3/05) 6/28/99 905 10.688 133,215 VNUS Medical Technologies Series E Cvt. Pfd. 8/20/01 2,800,000 5.120 2,800,000 Zyomyx Series B Cvt. Pfd. 2/19/99 800,550 4.000 2,461,540 Series C Cvt. Pfd. 3/2/00 800,000 4.000 1,600,000 ----------- ----------- $54,957,888 $51,353,630 =========== ===========
* With warrants attached. ^ Affiliated issuers. 17 H&Q LIFE SCIENCES INVESTORS 30 Rowes Wharf, 4th Floor Boston, Massachusetts 02110-3328 (617) 310-0567 OFFICERS Daniel R. Omstead, ENGSCD, President Alan G. Carr, President Emeritus Kimberley L. Carroll, Treasurer Jennifer L. Morris, Secretary TRUSTEES Alan G. Carr Lawrence S. Lewin Robert P. Mack, M.D. Eric Oddleifson Oleg M. Pohotsky Uwe E. Reinhardt, Ph.D. Henri A. Termeer INVESTMENT ADVISER Hambrecht & Quist Capital Management Incorporated CUSTODIAN AND TRANSFER AGENT State Street Bank and Trust Company LEGAL COUNSEL Dechert Price & Rhoads Shareholders with questions regarding share transfers may call 1-800-426-5523 Interim daily net asset value may be obtained by calling 1-800-451-2597 For copies of the Fund's DIVIDEND REINVESTMENT PLAN, please contact the Plan Agent, State Street Bank & Trust Co. P.O. Box 8200, Boston, MA 02266-8200 Telephone: 1-800-426-5523 H&Q LIFE SCIENCES INVESTORS New York Stock Exchange Symbol: HQL www.hqcm.com Out of concern for the environment and in an effort to reduce Fund expenses, this report is printed on recycled paper. HQHLS-SAR-02