N-30D 1 a2111649zn-30d.txt N-30D H&Q LIFE SCIENCES INVESTORS [GRAPHIC] SEMIANNUAL REPORT MARCH 31, 2003 To our Shareholders: At quarter-end on March 31, 2003, the net asset value per share of your Fund was $14.08. Total return for this quarter at net asset value was (1.8%), a change that lagged the Amex Biotech and NASDAQ Industrials Indices but which was favorable to the Dow Jones Industrial Average and the Russell 2000 Index for the same time period. Total return at market price was 2.61% during the quarter and 13.96% for the semi-annual period. Net asset value performance compared to the major indices for the quarter and six-month period ended March 31, 2003 was as follows:
FISCAL YEAR TO DATE QUARTER ENDED 9/30/02 - 3/31/03 3/31/03 ------------------- ------------- Net Asset Value +1.9% -1.8% AMEX Biotech Index +4.2% -1.5% Dow Jones Industrial Average +5.3% -4.2% NASDAQ Industrials +9.3% -0.7% Russell 2000 +0.6% -4.8%
The question, of course, is what can we expect from here. While we obviously don't know for certain, we believe that the recently completed quarter may signify a turning point. In the last few years we have been through a great deal of market turmoil. We saw a tremendous run up in market value in 2000, only to see a very significant and prolonged subsequent decline. As a benchmark, it is quite amazing to note that the NASDAQ Composite Index, which reached the 5000 level in 2000, was at 1341 at the close of the most recent quarter. This decline was punctuated along the way by a series of very tough blows to our collective psyche, including the September 11 attacks and last year's corporate governance crisis. During 2002 we detected a great deal of apprehension and even fear of the unknown in many investors. Entering the first quarter of 2003, geopolitical concerns were significant. As the quarter progressed, the focus of nearly the entire country rested on Iraq. A lot has changed in the last month or two. The scope and cost of loss in Iraq have been quantified. Importantly, the global and political worst-case scenarios have not come to pass. We are grateful and relieved about this, of course. And significantly, it looks to us that we have entered a more normal phase wherein performance of the economy and of individual companies could have a greater effect on the stock market and the share prices of individual companies. We think that there is an increasing likelihood that 1 companies that discover, develop and commercialize quality products will be rewarded with increased share price. Moreover, it appears to us that healthcare companies will be at the forefront of such a trend. We believe that all this bodes well for your Fund as we continue to identify innovative companies that may be able to cure recalcitrant diseases based on the application of novel scientific discoveries. Having said all this, we acknowledge that there are obviously other factors that could change this equation. As a general positive, we believe there is evidence that the economy is recovering, albeit slowly and with the creation of relatively few jobs. In recent months our view has been tempered by high corporate and household debt levels relative to income, concerns about employment, low savings rates, and by our sense of general public unease about the loss of paper wealth that has occurred in the last couple of years. However, more recently we have sensed a shift in the general mood of the public. It seems to us that after spending a month or more focused on the events in Iraq, the public is now looking forward rather than back. Importantly, a number of first quarter reports have met or exceeded expectations, including reports in the healthcare sector. This makes us more optimistic about the potential for progress in the next few quarters. We hope to see some modest improvement in the economy and particularly in the healthcare sector over the coming months. We are not sure how sustainable the current trends are - so we are not overly bullish - but we are certainly optimistic that 2003 will turn out to be a better year than the last two have proven to be. In this past quarter, we did not add any new private companies to the portfolio. We continue to evaluate a number of private investment opportunities, and have made new public purchases for the Fund. The Fund did, however, make follow-on investments in the following non-public companies in the portfolio: ACADIA Pharmaceuticals, CardioNet and Concentric Medical. As always, we encourage the Fund's shareholders to contact us with any questions or concerns they may have relating to the Fund, and hope to see you at the Annual Meeting of Shareholders on June 18th here in Boston. /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 [CHART] PORTFOLIO AS OF MARCH 31, 2003
TOTAL VENTURE DIFFERENCE AGRICULTURE/ENVIRO 2% 2% 0% BIOTECHNOLOGY 49% 12% 36% CROs 1% 0% 1% DIAGNOSTICS 6% 4% 2% HC INFO SERVICES 4% 2% 2% MEDICAL SPECIALTY 15% 6% 9% MEDICAL SUPPLIES 2% 1% 0% PHARMACEUTICALS 5% 2% 3% LIQUID ASSETS 16% 0% 16%
RESTRICTED 3 H&Q LIFE SCIENCES INVESTORS LARGEST HOLDINGS AS OF MARCH 31, 2003
% OF NET ASSETS --------------- Martek Biosciences 6.17% Celgene 4.66% Gilead Sciences 4.02% MedImmune 3.21% CV Therapeutics 2.69% Telik 2.54% Cubist Pharmaceuticals 2.50% CardioNet (Restricted) 2.35% IDEXX Laboratories 2.19% Exelixis 2.08%
H&Q LIFE SCIENCES INVESTORS SIGNIFICANT PORTFOLIO TRANSACTIONS QUARTER ENDED MARCH 31, 2003
UNITS HELD UNITS HELD 12/31/02 3/31/03 ---------- ---------- PURCHASES ACADIA Pharmaceuticals (Restricted) Series F 0 185,185 CardioNet (Restricted) 971,429 1,051,429 Charles River Labs 0 56,900 Concentric Medical (Restricted) 2,941,176 3,235,293 Eclipsys 0 94,800 IMPAX Laboratories 154,500 324,100 Kosan Biosciences 176,200 296,600 Lexicon Genetics 138,600 227,800 Millennium Pharmaceuticals 0 279,000 SALES Cytyc 109,956 0 Digene 9,000 0 Endologix 132,000 0 Envirogen 20,833 0 Gilead Sciences 300,000 150,000
4 H&Q LIFE SCIENCES INVESTORS SCHEDULE OF INVESTMENTS March 31, 2003 (UNAUDITED)
SHARES VALUE ------------ ------------- CONVERTIBLE SECURITIES - 30.0% OF NET ASSETS CONVERTIBLE PREFERRED (RESTRICTED) - 28.0% AGRICULTURAL/ENVIRONMENTAL TECHNOLOGIES - 1.7% 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* 17,778 BIOTECHNOLOGY - 11.4% 296,667 ACADIA Pharmaceuticals Series E* 801,001 185,185 ACADIA Pharmaceuticals Series F* 500,000 634,921 Agensys Series C* 2,000,001 1,587,302 Agilix Series B* 2,000,001 566,958 Avalon Pharmaceuticals Series B* 2,000,001 808,473 IDUN Pharmaceuticals Series A-1* 2,000,001 1,212,121 Raven biotechnologies Series B* 1,006,060 1,872,772 Raven biotechnologies Series C* 1,554,401 30,920 Therion Biologics Series A* 58,130 160,000 Therion Biologics Series B*# 300,800 271,808 Therion Biologics Series C*# 510,999 28,991 Therion Biologics Sinking Fund* 54,503 1,150,000 Triad Therapeutics Series A* 1,150,000 350,000 Triad Therapeutics Series B* 350,000 800,000 Triad Therapeutics Series C* 800,000 615,385 Zyomyx Series B* 1,230,770 400,000 Zyomyx Series C* 800,000 400,000 Zyomyx Series E* 800,000 DIAGNOSTICS - 3.5% 1,051,429 CardioNet Series C* 3,680,002 322,168 CytoLogix Series A*^ 265,917 151,420 CytoLogix Series B*#^ 124,982 130,000 Masimo Series D* 1,430,000 HEALTHCARE INFORMATION SERVICES - 1.8% 3,589,744 PHT Series D*^ 2,800,000 MEDICAL SPECIALTY - 6.3% 500,000 AbTox Series F* 5,000 3,235,293 Concentric Medical Series B* 2,199,999 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* 1,317,389 546,875 VNUS Medical Technologies Series E* 2,800,000
The accompanying notes are an integral part of these financial statements. 5
SHARES VALUE ------------ ------------- CONVERTIBLE PREFERRED - CONTINUED MEDICAL SUPPLIES - 1.5% 281,250 LocalMed Series D* $ 2,813 421,052 Novacept Series G*# 1,452,629 231,884 Novacept Series H* 800,000 PHARMACEUTICALS/DRUG DELIVERY - 1.8% 93,248 Galileo Laboratories Series F* 326,368 141,177 Theravance Series C* 1,270,593 133,334 Theravance Series D-1* 1,200,006 ------------- $ 43,869,385 ------------- PRINCIPAL AMOUNT ------------ CONVERTIBLE BONDS AND NOTES - 2.0% BIOTECHNOLOGY - 1.8% $ 4,200,000 CuraGen 6% Cvt. Deb. due 2007~ $ 2,856,000 DIAGNOSTICS - 0.1% 112,224 CytoLogix (Restricted) 6.75% Cvt. Note, due 2003*^ 112,224 HEALTHCARE INFORMATION SERVICES - 0.0% 1,053,262 FitForAll.com (Restricted) 10% Prom. Note*#+ 105 MEDICAL SPECIALTY - 0.1% 120,000 AbTox (Restricted) 12% Prom. Note*+ 120,000 ------------- $ 3,088,329 ------------- TOTAL CONVERTIBLE SECURITIES (Cost $61,620,907) $ 46,957,714 ------------- SHARES ------------ COMMON STOCKS - 53.6% AGRICULTURAL/ENVIRONMENTAL TECHNOLOGIES - 0.1% 57,032 Catalytica Energy Systems* $ 145,432 ------------- 145,432 ------------- BIOTECHNOLOGY - 35.3% BIOPHARMACEUTICALS - 25.3% 206,800 Adolor* 2,049,388 282,620 BioTransplant* 42,393 3,297 BioTransplant (Restricted) Warrants (expire 8/12/04)* 0 13,500 BioTransplant (Restricted) Warrants (expire 10/31/04)* 0 925 BioTransplant (Restricted) Warrants (expire 8/15/05)* 61 279,600 Celgene* 7,291,968 275,126 Corixa* 1,881,862 22,109 Corixa Warrants (expire 8/14/07)* 10,988
The accompanying notes are an integral part of these financial statements. 6
SHARES VALUE ------------ ------------- BIOTECHNOLOGY - CONTINUED 407,449 Cubist Pharmaceuticals* $ 3,263,666 133,333 Cubist Pharmaceuticals (Restricted) Warrants (expire 9/23/03)* 652,798 233,484 CV Therapeutics* 4,209,717 53,000 Genzyme* 1,931,850 150,000 Gilead Sciences* 6,298,500 296,600 Kosan Biosciences* 1,322,836 153,000 MedImmune* 5,022,990 146,982 Therion Biologics (Restricted)* 276,326 117,638 Transkaryotic Therapies* 696,417 135,135 Tularik* 682,432 76,000 Vertex Pharmaceuticals* 845,120 278,776 Vicuron Pharmaceuticals* 3,019,144 12,464 Vicuron Pharmaceuticals (Restricted) Warrants (expire 8/3/05)* 60,924 GENOMICS/DRUG DISCOVERY - 10.0% 198,000 Abgenix* 1,722,600 622,000 deCODE Genetics* 1,150,700 306,463 Dyax* 533,246 489,400 Exelixis* 3,259,404 227,800 Lexicon Genetics* 908,922 113,428 Lynx Therapeutics* 203,036 257,600 Lynx Therapeutics Warrants (expire 4/29/07)* 0 279,000 Millennium Pharmaceuticals* 2,192,940 116,307 Molecular Devices* 1,407,315 411,400 Rigel Pharmaceuticals* 304,436 296,428 Telik* 3,983,992 ------------- 55,225,971 ------------- CONTRACT RESEARCH ORGANIZATIONS - 1.4% 56,900 Charles River Labs* 1,452,088 61,500 Quintiles Transnational* 747,840 ------------- 2,199,928 ------------- DIAGNOSTICS - 2.6% 356,249 Biofield* 96,187 400,000 Biofield (Restricted)* 86,400 98,000 IDEXX Laboratories* 3,427,060 130,000 Masimo Labs (Restricted)* 1,300 457,081 Sontra Medical (Restricted)* 530,214 ------------- 4,141,161 -------------
The accompanying notes are an integral part of these financial statements. 7
SHARES VALUE ------------ ------------- HEALTHCARE INFORMATION SERVICES - 2.2% 94,800 Eclipsys* $ 755,651 303,000 WebMD* 2,733,060 204,139 Syntiro Healthcare Services (Restricted)* 2,041 101,283 Syntiro Healthcare Services (Restricted) Warrants (expire 10/15/04)* 0 ------------- 3,490,752 ------------- MEDICAL SPECIALTY - 8.8% 67,898 Biopure Class A* 226,779 5,555 Biopure (Restricted) Warrants (expire 8/4/03)* 0 666,666 Endocardial Solutions* 1,846,665 338,815 Martek Biosciences* 9,663,004 680,000 Orthovita* 2,040,000 ------------- 13,776,448 ------------- MEDICAL SUPPLIES - 0.5% 430,000 EP MedSystems* 713,800 ------------- 713,800 ------------- PHARMACEUTICALS/DRUG DELIVERY - 2.7% 125,000 Aradigm* 156,250 324,100 IMPAX Laboratories* 1,455,209 217,800 IVAX* 2,668,050 ------------- 4,279,509 ------------- TOTAL COMMON STOCKS (Cost $70,217,803) $ 83,973,001 ------------- PRINCIPAL AMOUNT ------------ TEMPORARY CASH INVESTMENTS - 12.0% $ 6,300,000 General Electric Capital Corp., 1.24%, due 4/16/03 $ 6,296,745 12,500,000 U.S. Treasury Bill, 1.10%, due 4/10/03 12,496,563 ------------- TOTAL TEMPORARY CASH INVESTMENTS (Cost $18,793,308) $ 18,793,308 ------------- TOTAL INVESTMENTS (Cost $150,632,018) $ 149,724,023 =============
---------- * Non income-producing security. # With warrants attached. ^ Affiliated issuers in which the Fund holds 5% or more of the voting securities (Total Value of $3,303,123). ~ 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, 2003 (UNAUDITED) ASSETS: Investments, at value (identified cost $150,632,018; see Schedule of Investments) $ 149,724,023 Cash 514,544 Interest receivable 47,634 Receivable for investments sold 6,605,025 Prepaid expenses 34,025 --------------- Total assets $ 156,925,251 --------------- LIABILITIES: Accrued advisory fee $ 172,515 Accrued other 135,180 --------------- Total liabilities $ 307,695 --------------- NET ASSETS $ 156,617,556 =============== SOURCES OF NET ASSETS: Shares of beneficial interest, par value $.01 per share, unlimited number of shares authorized, amount paid in on 11,123,431 shares issued and outstanding $ 154,340,660 Accumulated net investment loss (1,021,406) Accumulated net realized gain on investments 4,206,297 Net unrealized loss on investments (907,995) --------------- Total net assets (equivalent to $14.08 per share based on 11,123,431 shares outstanding) $ 156,617,556 ===============
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, 2003 (UNAUDITED) INVESTMENT INCOME: Dividend income (net of foreign tax of $260) $ 1,107 Interest income 323,957 --------------- Total investment income $ 325,064 EXPENSES: Advisory fees $ 1,061,847 Shareholder reporting 39,362 Trustees' fees and expenses 71,554 Legal fees 21,403 Transfer agent fees 25,127 Stock exchange listing fee 27,785 Accounting and auditing fees 37,286 Custodian fees 41,960 Other 20,146 --------------- Total expenses 1,346,470 --------------- Net investment loss $ (1,021,406) --------------- NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS: Net realized gain on investments $ 6,735,748 Decrease in net unrealized gain on investments (3,148,923) --------------- Net gain on investments $ 3,586,825 --------------- Net increase in net assets resulting from operations $ 2,565,419 ===============
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, 2003 SEPTEMBER 30, (UNAUDITED) 2002 --------------- --------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS: Net investment loss $ (1,021,406) $ (2,516,582) Net realized gain on investments 6,735,748 21,763,821 Decrease in net unrealized gain on investments (3,148,923) (69,655,392) --------------- --------------- Net increase (decrease) in net assets resulting from operations $ 2,565,419 $ (50,408,153) --------------- --------------- DISTRIBUTIONS TO SHAREHOLDERS FROM: Net realized capital gains $ (12,541,277) $ (27,512,988) --------------- --------------- CAPITAL SHARE TRANSACTIONS: Value of shares issued in reinvestment of distributions (713,809 and 1,090,624 shares, respectively) $ 9,007,964 $ 20,343,991 --------------- --------------- Total decrease in net assets $ (967,894) $ (57,577,150) NET ASSETS: Beginning of period 157,585,450 215,162,600 --------------- --------------- End of period $ 156,617,556 $ 157,585,450 =============== ===============
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, 2003 (UNAUDITED) CASH FLOWS USED FOR OPERATING ACTIVITIES: Interest income received $ 284,113 Dividends received 1,107 Operating expenses paid (1,402,536) --------------- Net cash used for operating activities $ (1,117,316) --------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of portfolio securities $ (15,912,405) Net maturities of temporary cash investments 11,788,889 Sales and maturities of portfolio securities 9,173,384 --------------- Net cash provided from investing activities $ 5,049,868 --------------- CASH FLOWS USED FOR FINANCING ACTIVITIES: Cash distributions paid, net $ (3,533,313) --------------- Net cash used for financing activities $ (3,533,313) --------------- NET INCREASE IN CASH $ 399,239 CASH AT BEGINNING OF PERIOD 115,305 --------------- CASH AT END OF PERIOD $ 514,544 =============== 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 $ 2,565,419 Accretion of discount (33,510) Net realized gain on investments (6,735,748) Net decrease in net unrealized gain on investments 3,148,923 Increase in interest receivable (6,334) Increase in prepaid expenses (15,059) Decrease in accrued expenses (41,007) --------------- Net cash used for operating activities $ (1,117,316) ===============
Noncash financing activities not included herein consist of stock distributions of $9,007,964. 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 FOR THE YEARS ENDED SEPTEMBER 30, MARCH 31, 2003 --------------------------------------------------------------------------------- (UNAUDITED) 2002(1) 2001 2000 1999 1998 ------------- ------------- ------------- ------------- ------------- ------------- Net asset value per share: Beginning of period $ 15.140 $ 23.090 $ 39.365 $ 17.804 $ 13.713 $ 18.825 ------------- ------------- ------------- ------------- ------------- ------------- Net investment loss $ (0.095)(2) $ (0.255)(2) $ (0.221)(2) $ (0.300) $ (0.205) $ (0.239) Net realized and unrealized gain (loss) on investments 0.225 (4.835) (12.134) 24.756 4.576 (4.133) ------------- ------------- ------------- ------------- ------------- ------------- Total increase (decrease) from investment operations $ 0.130 $ (5.090) $ (12.355) $ 24.456 $ 4.371 $ (4.372) ------------- ------------- ------------- ------------- ------------- ------------- Capital gains distributions to shareholders $ (1.190) $ (2.860) $ (3.920) $ (2.895) $ (0.280) $ (0.740) ------------- ------------- ------------- ------------- ------------- ------------- Net asset value per share: End of period $ 14.080 $ 15.140 $ 23.090 $ 39.365 $ 17.804 $ 13.713 ============= ============= ============= ============= ============= ============= Per share market value: End of period $ 12.260 $ 11.790 $ 18.450 $ 31.313 $ 14.125 $ 10.875 Total investment return at market value 13.96% (25.82%) (29.07%) 155.36% 32.90% (23.89%) RATIOS AND SUPPLEMENTAL DATA: Net assets at end of period $ 156,617,556 $ 157,585,450 $ 215,162,600 $ 318,271,356 $ 131,562,804 $ 100,030,321 Ratio of operating expenses to average net assets 1.72%* 1.71% 1.58% 1.51% 1.60% 1.62% Ratio of net investment loss to average net assets (1.31%)* (1.25%) (0.83%) (1.06%) (1.30%) (1.50%) Portfolio turnover rate 1.06% 17.36% 16.49% 12.70% 23.49% 18.21% Number of shares outstanding at end of period 11,123,431 10,409,622 9,318,998 8,085,152 7,389,487 7,294,722
(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 year ended September 30, 2002 was a decrease in net investment loss per share of $.006, an increase in net realized and unrealized loss on investments per share of $.006, and a decrease in the ratio of net investment loss to average net assets from (1.28%) to (1.25%). Per share data and ratios for the periods prior to October 1, 2001 have not been restated to reflect this change in presentation. (2) 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, 2003 (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 healthcare 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, adjusted for amortization of premiums and accretion of discounts. Dividend income is recorded on the ex-dividend date. 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. 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. 14 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, 2003. (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, 2003 totaled $15,912,405 and $14,825,345, respectively. At March 31, 2003, the total cost of securities for Federal income tax purposes was $150,632,018. The net unrealized loss on securities held by the Fund was $907,995, including gross unrealized gain of $39,384,606 and gross unrealized loss of $40,292,601. (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 LLC (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. 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 29% of the Fund's net assets at March 31, 2003. 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. During the six-month period ended March 31, 2003, the Fund sold restricted securities for cash and a proportionate interest in a 5% interest-bearing promissory note due October 31, 2004. The Fund's interest in the note has a par value of $80,800 whose estimated value of $40,000 at March 31, 2003 has also been determined by the Trustees and which is included in the Receivable for Investments Sold in the Statement of Assets and Liabilities. 15 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, 2003, 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 $ 1,142,496 $ 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. 5/2/00-3/24/03 2,000,208 2.700 801,001 Series F Cvt. Pfd. 3/19/03 500,000 2.700 500,000 Agensys Series C Cvt. Pfd.* 2/14/02 2,003,383 3.150 2,000,001 Agilix Series B Cvt. Pfd. 11/8/01 2,009,507 1.260 2,000,001 Avalon Pharmaceuticals Series B Cvt. Pfd. 10/22/01 2,005,767 3.528 2,000,001 Biofield Common 12/15/00 201,989 0.216 86,400 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 0.000 0 Common Warrants (expire 10/31/04) 10/31/94 0 0.000 0 Common Warrants (expire 8/15/05) 8/18/95 0 0.066 61 CardioNet Series C Cvt. Pfd. 5/3/01-3/25/03 3,697,953 3.500 3,680,002 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 1,046,778 6.000 1,045,200 Concentric Medical Series B Cvt. Pfd.* 5/7/02-1/24/03 2,218,703 0.680 2,199,999 Cubist Pharmaceuticals Common Warrants (expire 9/23/03) 9/23/98 235 4.896 652,798 CytoLogix^ Series A Cvt. Pfd. 1/13/98-7/21/99 1,552,564 0.825 265,917 Series B Cvt. Pfd.* 1/11/01 766,886 0.825 124,982 Cvt. Note 5/29/02 112,224 1.000 112,224 EPR Series A Cvt. Pfd. 3/9/94 800,331 0.100 17,778 FitForAll.com 10% Promissory Note* 2/22/00-9/18/00 1,073,999 0.000 105 Galileo Laboratories Series F Cvt. Pfd. 8/18/00 2,001,546 3.500 326,368 IDUN Pharmaceuticals Series A-1 Cvt. Pfd. 11/26/02 2,001,311 2.474 2,000,001 LocalMed Series D Cvt. Pfd. 2/9/96 1,126,970 0.010 2,813 Masimo Series D Cvt. Pfd. 8/14/96 910,027 11.000 1,430,000
16
ACQUISITION CARRYING VALUE SECURITY DATE COST PER UNIT VALUE ---------------------------------------- ---------------- --------------- --------------- --------------- Masimo Labs Common 8/14/96 $ 0 $ 0.010 $ 1,300 Novacept Series G Cvt. Pfd.* 3/27/01 2,001,065 3.450 1,452,629 Series H Cvt. Pfd. 4/25/02 800,000 3.450 800,000 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 2,800,000 Raven biotechnologies Series B Cvt. Pfd. 12/12/00 2,001,150 0.830 1,006,060 Series C Cvt. Pfd. 11/26/02 1,554,400 0.830 1,554,401 Senomyx Series E Cvt. Pfd. 2/19/02 2,002,601 2.900 2,000,000 Songbird Hearing Series D Cvt. Pfd. 12/14/00 2,003,239 0.010 4,264 Sontra Medical Common 6/24/02 1,119,976 1.160 530,214 Syntiro Heathcare Services Common 2/5/97 800,325 0.010 2,041 Warrants (expire 10/15/04) 10/15/98 0 0.000 0 Theravance 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 Therion Biologics Common 6/30/93-10/16/96 251,642 1.880 276,326 Series A Cvt. Pfd. 8/20/96-10/16/96 289,847 1.880 58,130 Series B Cvt. Pfd.* 2/24/99-6/22/99 600,609 1.880 300,800 Series C Cvt. Pfd.* 9/26/01 1,019,284 1.880 510,999 Sinking Fund Cvt. Pfd 10/17/94-4/3/96 582,505 1.880 54,503 TherOx Series H Cvt. Pfd. 9/11/00 2,001,249 3.030 1,317,389 Triad Therapeutics Series A Cvt. Pfd. 6/8/99 1,151,067 1.000 1,150,000 Series B Cvt. Pfd. 12/20/00 702,090 1.000 350,000 Series C Cvt. Pfd. 11/25/02 800,000 1.000 800,000 Vicuron Pharmaceuticals Warrants (expire 8/3/05) 6/28/99 905 4.888 60,924 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 2.000 1,230,770 Series C Cvt. Pfd. 3/2/00 800,000 2.000 800,000 Series E Cvt. Pfd. 7/22/02 800,000 2.000 800,000 --------------- --------------- $ 60,054,296 $ 45,711,778 =============== ===============
* With warrants attached ^ Affiliated issuers. 17 H&Q LIFE SCIENCES INVESTORS New York Stock Exchange Symbol: HQL 30 Rowes Wharf, 4th Floor Boston, Massachusetts 02110-3328 (617) 772-8500 www.hqcm.com 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 LLC CUSTODIAN AND TRANSFER AGENT State Street Bank and Trust Company INDEPENDENT ACCOUNTANTS PricewaterhouseCoopers LLP LEGAL COUNSEL Dechert LLP ---------- Shareholders with questions regarding share transfers may call 1-800-426-5523 Interim daily net asset value may be obtained from our website (www.hqcm.com) or 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 ---------- Out of concern for the environment and in an effort to reduce Fund expenses, this report is printed on recycled paper. HQHLS-SAR-03