H&Q LIFE SCIENCES INVESTORS
---------------------------
[Telescope Graphic]
[Medical Graphic]
[Medical Vials Graphic]
Annual Report
1 9 9 8
<PAGE>
[Alan G. Carr Graphic]
To our Shareholders:
At fiscal year-end on September 30, 1998, the net asset value of your Fund
was $13.71 per share. Performance data for the fiscal year, the first nine
months of the calendar year and the quarter ended September 30 compared to the
Dow Jones Industrial Average and the NASDAQ Index of stocks traded in the
over-the-counter market is as follows:
<TABLE>
<CAPTION>
CY To-Date Quarter Ended
Fiscal Year (9 months) 9/30/98
----------- ---------- -------
<S> <C> <C> <C>
Net Asset Value -23.3% -11.3% -15.9%
Dow Jones Industrial Average -1.3% -0.8% -12.4%
NASDAQ Industrials -25.0% -15.5% -22.7%
</TABLE>
To say that the quarter and the fiscal year just ended were
extraordinarily difficult and disappointing would be an understatement of the
obvious. The performance of small stocks and particularly of life sciences
stocks has been disappointing for an extended period of time. Perhaps about the
best that can be said is that the Fund did no worse than small companies in
general as measured by the NASDAQ Index.
Our view of the worldwide economic situation suggests that there are
significant earnings risks for large industrial companies. Many years of
significantly above-average capital investment has enhanced productivity, and
an overall strong economy has resulted in five years of expanding profit
margins as measured by the earnings of the Standard & Poors 500 Index of
industrial companies. Particularly in the face of declining imports from
Pacific Rim countries, Brazil and Russia, the risk is that the world has
overcapacity in virtually every industrial and commodity sector. Additionally,
those countries that are struggling need to export in order to obtain higher
currencies and rebuild their economies. The ability to raise prices in most
sectors is nonexistent (with the possible exception of pharmaceuticals and
medical products), resulting in virtually nonexistent inflation and an
increasing possibility of absolute price deflation. Estimates for the near- and
intermediate-term future earnings of the companies that make up the Standard &
Poors 500 Index are beginning to come down sharply.
Regardless, as investors sought perceived quality and liquidity, large
capitalization stocks have been bid up to premiums in valuation not seen for
over 25 years. In contrast, small companies, in the aggregate whose earnings
growth has generally been more rapid, have been
1
<PAGE>
ignored and, by most traditional measures, seem as undervalued both relatively
and absolutely as they were in 1974.
If, as we believe, valuations of the stocks of large capitalization
companies need to adjust to something more "normal", it is of course possible
that the capitalizations of small emerging companies would be further
negatively impacted. However, we also believe that the environment is most
similar to that of the second half of the 1970s where the stocks of small
emerging companies were the market leaders for several years on an absolute and
relative basis. Additionally, in the past these stocks have responded very
positively in most periods following the initiation of Federal Reserve Board
action to reduce interest rates, a trend which we believe is likely to
continue. We believe that life sciences companies are largely insulated from
the financial problems of the rest of the world, and while consumers, whose
installment debt is at a near record level, may have to curtail purchasing,
they will do so less in healthcare products and services.
In the meantime, the pace of scientific discovery and development in
biologics, pharmaceuticals, instruments and devices continues at an
extraordinary rate. We agree with an increasing number of other observers that,
in the early decades of the next century, advances in these technologies will
impact our lives and our economy equally as forcefully as electronics and
communications have done in the last two decades. While we are cautiously
optimistic over the near-term, our enthusiasm for the sectors in which your
Fund is invested has never been higher for the longer term.
[/s/ Alan G. Carr]
Alan G. Carr
President
Capital Gains Declaration
We hereby designate that the entire amount of the stock distribution
declared on November 16, 1998 with respect to our fiscal year ended September
30, 1998, constituted a capital gain dividend for Federal income tax purposes,
amounting to $0.28 per share.
2
<PAGE>
ANNUAL MEETING REPORT
As now required by Rule 30d-1 under the Investment Company Act of 1940, as
amended, below is a summary of the results of the Annual Meeting of
Shareholders for H&Q Life Sciences Investors. The Annual Meeting was held on
May 21, 1998, at 9:00 a.m. There were present in person or by proxy
5,853,944.7056 shares of beneficial interest, or 80.25% of the 7,294,722 shares
eligible to vote on the record date.
The first item of business was the election of Trustees of the Fund to
serve until the year 2001 Annual Meeting of Shareholders. The nominees elected
to serve until the year 2001 Annual Meeting were Lawrence S. Lewin and Uwe E.
Reinhardt, Ph.D. A total of 5,778,813.5215 shares voted for the election of Mr.
Lewin and 75,131.0841 shares abstained; 5,779,991.6215 shares voted for the
election of Dr. Reinhardt and 73,953.0841 shares abstained. The Trustees
serving until the 1999 Annual Meeting are Patrick J. Allen, Robert P. Mack,
M.D. and Eric Oddleifson.
The next item of business was the ratification of the selection of Arthur
Andersen LLP as independent public accountants of the Fund for the fiscal year
ending September 30, 1998. The selection of Arthur Andersen LLP was ratified by
a vote of 5,797,490.3858 shares for selection.
H&Q LIFE SCIENCES INVESTORS
---------------------------
PORTFOLIO
As of September 30, 1998
[Horizontal Bar Graphic]
[PLOTPOINTS BEGIN]
<TABLE>
<S> <C> <C>
VC Dif Total
0.27% 7.52% 7.79
10.73 20.61 31.34
0 5.36 5.36
2.70 5.46 8.16
1.00 5.00 6.00
2.22 4.76 6.98
6.88 8.91 15.79
0 12.15 12.15
0 6.43 6.43
</TABLE>
[PLOTPOINTS END]
3
<PAGE>
H&Q LIFE SCIENCES INVESTORS
---------------------------
LARGEST HOLDINGS
As of September 30, 1998
<TABLE>
<CAPTION>
% of Net Assets
---------------
<S> <C>
Sepracor 7.56%
Catalytica 7.30%
Quintiles Transnational 5.36%
Transkaryotic Therapies 3.72%
Gilead Sciences 3.24%
Martek Biosciences 2.79%
CareMonitor (Restricted) 2.58%
Biomatrix 2.53%
IDEXX Laboratories 2.34%
Omnicare 2.11%
</TABLE>
H&Q LIFE SCIENCES INVESTORS
---------------------------
SIGNIFICANT PORTFOLIO TRANSACTIONS
Quarter Ended September 30, 1998
<TABLE>
<CAPTION>
Units Held Units Held
PURCHASES 6/30/98 9/30/98
- ------------------------------------- ------------ -----------
<S> <C> <C>
Centocor 0 25,000
Coulter Pharmaceutical 0 80,000
Cubist Pharmaceuticals 390,683 404,783
Cubist Pharmaceuticals (Restricted) 0 266,666
Dyax (Restricted) Class A Series 5 0 66,055
Emisphere Technologies 0 59,500
INCYTE Pharmaceuticals 0 37,000
Sontra Medical (Restricted) 0 1,149,425
SALES
- -------------------------------------
Cell Therapeutics 28,572 0
Dura Pharmaceuticals 36,024 0
Elan Pharmaceuticals 50,000 0
Guidant 17,184 0
Human Genome Sciences 62,000 0
ImmuLogic Pharmaceutical 210,000 0
Omnicare 64,106 59,837
Voxel 113,000 0
</TABLE>
4
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Trustees
of H&Q Life Sciences Investors:
We have audited the accompanying balance sheet of H&Q Life Sciences
Investors (a Massachusetts business trust), including the Schedule of
Investments as of September 30, 1998, and the related statements of operations
and cash flows for the year then ended, and the statements of changes in net
assets and financial highlights for the years presented. These financial
statements and financial highlights are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these financial
statements and financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
September 30, 1998, by correspondence with the custodian. An audit also
includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe our audits provide a reasonable basis for our opinion.
As discussed in Note 5, the financial statements include investment
securities valued at $23,817,525 (23.8% of net assets) whose values have been
determined by the Board of Trustees in the absence of readily ascertainable
market values. However, because of the inherent uncertainty of valuation, the
Board of Trustees' determination of values may differ significantly from the
values that would have been used had a ready market existed for the securities
and the differences could be material.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
H&Q Life Sciences Investors as of September 30, 1998, the results of its
operations and cash flows for the year then ended, and the changes in its net
assets and financial highlights for the years presented, in conformity with
generally accepted accounting principles.
Boston, Massachusetts Arthur Andersen LLP
November 9, 1998
5
<PAGE>
H&Q LIFE SCIENCES INVESTORS
---------------------------
SCHEDULE OF INVESTMENTS
SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
CONVERTIBLE SECURITIES - 17.5% OF NET ASSETS
SHARES VALUE
- ----------------- Convertible Preferred - 17.4% ----------------
<S> <C> <C>
Agricultural/Environmental Technologies - 0.3%
177,778 EPR (Restricted) Series A* $266,667
Biotechnology - 5.9%
900,000 Exelixis Pharmaceuticals (Restricted) Series B* 1,800,000
100,000 Exelixis Pharmaceuticals (Restricted) Series C* 200,000
22,500 Telik (Restricted) Series G* 1,125,000
2,400 Telik (Restricted) Series I* 120,000
30,920 Therion Biologics (Restricted) Series A* 123,680
28,991 Therion Biologics (Restricted) Sinking Fund* 870
135,135 Tularik (Restricted) Series C* 1,351,350
240,000 Versicor (Restricted) Series C* 1,200,000
Diagnostics - 2.7%
148,423 CytoLogix (Restricted) Series A* 713,306
130,000 Masimo (Restricted) Series D* 1,170,000
1,149,425 Sontra Medical (Restricted) Series A* 800,000
Managed Care - 1.0%
225,989 KVM Technologies (Restricted) Series B (w/wts.)* 1,000,001
Medical Supplies - 2.2%
75,000 InterVentional Technologies (Restricted) Series F* 750,000
35,000 InterVentional Technologies (Restricted) Series G* 350,000
281,250 LocalMed (Restricted) Series D* 1,125,000
Medical Specialty - 5.3%
500,000 AbTox (Restricted) Series F* 5,000
1,088,710 CareMonitor (Restricted) Series A* 1,981,452
329,670 CareMonitor (Restricted) Series B* 599,999
104,152 Dyax (Restricted) Class A Series 1* 567,628
45,000 Dyax (Restricted) Class A Series 3* 245,250
129,080 Dyax (Restricted) Class A Series 4* 703,486
66,055 Dyax (Restricted) Class A Series 5* 360,000
170,213 Vectis (Restricted) Series B* 800,001
-----------
$17,358,690
-----------
PRINCIPAL
AMOUNT Convertible Bonds and Notes - 0.1% VALUE
---------- -----------
Medical Specialty - 0.1%
$ 120,000 AbTox (Restricted) 12% Promissory Note
due 1998 $120,000
-----------
$120,000
-----------
TOTAL CONVERTIBLE SECURITIES
(Cost $16,343,435) $17,478,690
-----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
H&Q LIFE SCIENCES INVESTORS
---------------------------
SCHEDULE OF INVESTMENTS
SEPTEMBER 30, 1998
(continued)
<TABLE>
<CAPTION>
SHARES VALUE
- ----------- COMMON STOCKS - 76.1% -------------
Agricultural/Environmental Technologies - 7.5%
<S> <C> <C>
516,666 Catalytica* $7,297,907
200,000 Consep* 162,500
75,000 Envirogen* 32,813
50,000 Envirogen Units* 34,375
----------
$7,527,595
----------
Biotechnology - 25.4%
Biopharmaceuticals - 22.1%
282,621 BioTransplant* $424,100
925 BioTransplant (Restricted) Warrants* 814
25,000 Centocor* 990,625
107,300 Cor Therapeutics* 831,575
80,000 Coulter Pharmaceutical* 1,990,000
404,783 Cubist Pharmaceuticals* 986,659
266,666 Cubist Pharmaceuticals (Restricted) Common* 551,999
133,333 Cubist Pharmaceuticals (Restricted) Warrants* 21,333
163,500 CV Therapeutics* 940,125
24,375 CV Therapeutics (Restricted)* 98,231
150,000 Gilead Sciences* 3,243,750
20,000 MedImmune* 1,295,000
80,000 Neurogen* 1,320,000
30,000 Neuralab (Restricted) Units* 1,200,000
80,000 Oxford GlycoSciences (Restricted)* 148,000
126,315 Pharming Group (Restricted)* 1,592,832
230,000 Ribi ImmunoChem Research* 704,375
60,624 SEQUUS Pharmaceuticals* 583,506
62,500 Synaptic Pharmaceutical* 921,875
146,982 Therion Biologics (Restricted)* 587,928
151,703 Transkaryotic Therapies* 3,640,872
8,035 Transkaryotic Therapies (Restricted) Warrants* 78,181
</TABLE>
The accompanying notes are an integral part of these financial statements.
7
<PAGE>
H&Q LIFE SCIENCES INVESTORS
---------------------------
SCHEDULE OF INVESTMENTS
SEPTEMBER 30, 1998
(continued)
<TABLE>
<CAPTION>
SHARES VALUE
- ----------- Biotechnology - continued --------------
<S> <C> <C>
Genomics/Drug Discovery - 3.3%
140,000 Gene Logic* 551,250
37,000 INCYTE Pharmaceuticals* 786,250
80,000 LJL BioSystems* 200,000
307,693 LJL BioSystems (Restricted)* 538,463
150,000 Lynx Therapeutics* 1,200,000
---------
$25,427,743
-----------
Contract Research Organizations - 5.4%
122,500 Quintiles Transnational* $5,359,375
-----------
$5,359,375
-----------
Diagnostics - 5.5%
373,252 Biofield* $699,848
12,500 Biofield (Restricted)* 19,875
332,417 Calypte Biomedical* 560,954
123,576 Cytyc* 1,251,207
98,000 IDEXX Laboratories* 2,339,750
130,000 Masimo Labs (Restricted)* 1,300
123,077 NeoPath* 607,693
-----------
$5,480,627
-----------
Managed Care - 5.0%
40,200 HBO $1,160,775
59,837 Omnicare* 2,109,254
104,000 Orthodontic Centers of America* 1,735,500
-----------
$5,005,529
-----------
Medical Supplies - 4.8%
430,000 EP Med Systems* $1,316,875
130,750 Exogen* 392,250
68,728 KeraVision* 292,094
231,043 Landec* 909,732
10,000 Novoste* 128,750
104,000 Perclose* 1,716,000
-----------
$4,755,701
-----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
8
<PAGE>
H&Q LIFE SCIENCES INVESTORS
---------------------------
SCHEDULE OF INVESTMENTS
SEPTEMBER 30, 1998
(continued)
<TABLE>
<CAPTION>
SHARES VALUE
- ----------- Medical Specialty - 10.4% -------------
<S> <C> <C>
992,900 Bioject Medical Technologies* $1,551,406
65,000 Biomatrix* 2,535,000
118,591 Focal* 1,215,558
200,000 Interpore Cross* 812,500
338,815 Martek Biosciences* 2,795,221
535,500 Bioject Medical Technologies (Restricted)
Warrants* 299,880
540,540 Reprogenesis (Restricted)* 1,199,999
-----------
$10,409,564
-----------
Pharmaceuticals/Drug Delivery - 12.1%
43,000 Biovail* $1,158,763
59,500 Emisphere Technologies* 468,563
261,000 Fuisz Technologies* 2,088,000
115,000 Sepracor* 7,561,250
251,666 Vivus* 872,966
-----------
$12,149,542
-----------
TOTAL COMMON STOCKS
(Cost $64,923,660) $76,115,676
-----------
TOTAL INVESTMENTS IN SECURITIES
(Cost $81,267,095) $93,594,366
===========
PRINCIPAL
AMOUNT VALUE
- -------------- TEMPORARY CASH INVESTMENTS - 7.7% -----------
$ 3,600,000 Ford Motor Credit Corp., 5.25%,
due 10/16/98 $3,591,600
4,100,000 General Electric Capital Corp., 5.51%,
due 10/7/98 4,087,449
----------
TOTAL TEMPORARY CASH INVESTMENTS $7,679,049
==========
</TABLE>
- ------------------
* Non income-producing security (see Notes 1 and 5).
The accompanying notes are an integral part of these financial statements.
9
<PAGE>
H&Q LIFE SCIENCES INVESTORS
---------------------------
BALANCE SHEET
SEPTEMBER 30, 1998
<TABLE>
<S> <C>
ASSETS:
Investments in securities, at value (identified
cost $81,267,095; see Schedule of
Investments) (Notes 1, 3 and 5) $93,594,366
Temporary cash investments, at amortized cost
which approximates value (see Schedule of
Investments) (Note 1) 7,679,049
------------
Total investments $101,273,415
Dividends and interest receivable 11,311
Receivable for investments sold 120,000
Prepaid expenses 8,533
------------
Total assets $101,413,259
------------
LIABILITIES:
Accrued advisory fee $106,703
Accrued other 80,937
Bank payable 1,195,298
------------
Total liabilities $1,382,938
------------
NET ASSETS:
Shares of beneficial interest, par value $.01 per
share, unlimited number of shares
authorized, amount paid in on 7,294,722
shares issued and outstanding (Note 1) $85,715,744
Accumulated net realized gain on investments 1,987,306
Net unrealized gain on investments (Note 3) 12,327,271
------------
Total net assets (equivalent to $13.71 per
share based on 7,294,722 shares
outstanding) $100,030,321
============
</TABLE>
The accompanying notes are an integral part of these financial statements.
10
<PAGE>
H&Q LIFE SCIENCES INVESTORS
---------------------------
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED SEPTEMBER 30, 1998
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (Note 1):
Dividends $4,764
Interest 131,694
----------
Total investment income $136,458
EXPENSES:
Advisory fees (Note 4) $1,553,695
Shareholder reporting 70,803
Custodian fees 64,493
Accounting and auditing fees 48,308
Trustees' fees and expenses 45,056
Legal fees 24,889
N.Y.S.E. fees 20,548
Transfer agent fees 17,915
Insurance expense 17,148
Other 20,527
----------
Total expenses 1,883,382
------------
Net investment (loss) ($1,746,924)
-------------
NET REALIZED AND UNREALIZED GAIN
ON INVESTMENTS:
Net realized gain on investments (Note 1) $3,011,272
Net (decrease) in unrealized gain on
investments (31,646,651)
-------------
Net (loss) on investments ($28,635,379)
-------------
Net (decrease) in net assets resulting
from operations ($30,382,303)
=============
</TABLE>
The accompanying notes are an integral part of these financial statements.
11
<PAGE>
H&Q LIFE SCIENCES INVESTORS
---------------------------
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED SEPTEMBER 30, 1998
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Interest received $120,489
Dividends received 2,763
Operating expenses paid (1,869,318)
------------
Net cash used for operating activities ($1,746,066)
------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales and maturities of portfolio securities $117,454,807
Purchases of portfolio securities (115,406,455)
------------
Net cash provided by investing activities $2,048,352
------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash distributions paid, net ($1,575,109)
-------------
Net cash used for financing activities ($1,575,109)
-------------
NET (DECREASE) IN CASH ($1,272,823)
CASH AT BEGINNING OF YEAR 77,525
-------------
CASH AT END OF YEAR ($1,195,298)
=============
RECONCILIATION OF NET (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS TO NET CASH
(USED FOR) OPERATING ACTIVITIES:
Net (decrease) in net assets resulting from operations ($30,382,303)
Net realized (gain) on investments (3,011,272)
Net decrease in unrealized gain on investments 31,646,651
Net (increase) in interest and dividends receivable (10,781)
Net decrease in prepaids and other receivables 13,746
Net (decrease) in accrued advisory fees and accrued
expenses (2,107)
-------------
Net cash used for operating activities ($1,746,066)
=============
</TABLE>
The accompanying notes are an integral part of these financial statements.
12
<PAGE>
H&Q LIFE SCIENCES INVESTORS
---------------------------
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the years ended
September 30, September 30,
1998 1997
----------------- ----------------
<S> <C> <C>
NET INCREASE (DECREASE) IN NET
ASSETS FROM OPERATIONS:
Net investment (loss) $1,746,924) ($1,534,917)
Net realized gain on investments 3,011,272 5,271,705
Net increase (decrease) in
unrealized gain on investments (31,646,651) 11,448,022
------------- ------------
Net increase (decrease) in net
assets resulting from
operations ($30,382,303) $15,184,810
------------- ------------
DISTRIBUTIONS TO SHAREHOLDERS
FROM:
Net realized long-term capital
gains ($5,188,917) ($10,949,328)
------------- ------------
CAPITAL SHARE TRANSACTIONS:
Value of shares issued in
reinvestment of distributions $3,613,808 $4,605,458
------------- ------------
Total increase (decrease) in
net assets ($31,957,412) $8,840,940
NET ASSETS:
Beginning of year 131,987,733 123,146,793
------------- ------------
End of year $100,030,321 $131,987,733
============= ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
13
<PAGE>
H&Q LIFE SCIENCES INVESTORS
------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
(Selected data for each share of beneficial interest outstanding throughout the
period indicated)
<TABLE>
<CAPTION>
For the years ended September 30,
--------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Net asset value per share:
Beginning of period $18.825 $18.445 $15.179 $11.007 $13.090
------- ------- ------- ------- -------
Net investment (loss) ($0.239) ($0.072) ($0.220) ($0.184) ($0.144)
Net realized and
unrealized gain
(loss) on
investments (4.133) 2.092 3.486 4.356 (1.304)
------- ------- ------- ------- -------
Total increase
(decrease) from
investment
operations ($4.372) $2.020 $3.266 $4.172 ($1.448)
------- ------- ------- ------- -------
Dilutive effect of sale
of common stock
and related
expenses from
rights offering -- -- -- -- ( 0.635)
------- ------- ------- ------- -------
Long-term capital
gains distribution to
shareholders ($0.740) ($1.640) -- -- --
------- ------- ------- ------- -------
Net asset value per share:
End of period $13.713 $18.825 $18.445 $15.179 $11.007
======= ======= ======= ======= ==========
Per share market value:
End of period $10.875 $15.125 $15.000 $12.875 $10.125
Total investment return (23.89%) 12.86% 16.50% 27.16% (21.36%)
Net assets:
End of period $100,030,321 $131,987,733 $123,146,793 $101,338,556 $73,484,287
RATIOS AND SUPPLEMENTAL DATA:
Ratio of operating
expenses to
average net assets 1.62% 1.67% 1.61% 1.83% 1.87%
Ratio of net
investment (loss) to
average net assets (1.50%) (1.38%) (1.25%) (1.57%) (1.23%)
Portfolio turnover rate 18.21% 18.94% 19.51% 29.48% 10.59%
Average commission
rate paid per listed
share purchased $0.05 $0.06 $0.07 $0.06 $0.07
Number of shares
outstanding at end
of period 7,294,722 7,011,362 6,676,420 6,676,420 6,676,420
</TABLE>
The accompanying notes are an integral part of these financial statements.
14
<PAGE>
H&Q LIFE SCIENCES INVESTORS
---------------------------
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(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 investment company industry.
Investment Securities
Transactions related to the investments of the Fund are recorded on the
date the securities are purchased or sold. 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 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 5, investments for which market quotations are not
readily available are valued at fair value as determined in good faith by
the Board of Trustees of the Fund. Temporary cash investments with a
maturity of 60 days or less are valued at amortized cost.
Gains and losses from sales of investments are recorded using the
"identified cost" method for both financial reporting and Federal income
tax purposes. Investment income and expenses are recorded on the accrual
basis.
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 tax
provision is required.
Distributions
The Fund records all distributions to shareholders from net investment
income and realized gains on the ex-dividend date. Such distributions are
determined in conformity with income tax regulations. The Fund has
adjusted for the effect of certain permanent book/tax differences by
reclassifying such differences against capital, in the amount of
$1,495,995 for the year ended September 30, 1998. This adjustment has no
effect on the Fund's net assets, net investment loss or net realized gain
and is designed to present the Fund's capital accounts on a tax basis.
Dividends
The current dividend policy is to declare dividends in stock. Stock
distributions will automatically be paid in newly issued shares of the
Fund unless otherwise instructed
15
<PAGE>
H&Q LIFE SCIENCES INVESTORS
---------------------------
NOTES TO FINANCIAL STATEMENTS
(continued)
by the shareholder. The shares will be valued at the lower of net asset
value or market price on the payable date. If a distribution were to be
declared in cash, it would then be subject to the Dividend Reinvestment
Plan. Under the Dividend Reinvestment Plan, distributions will
automatically be paid in additional shares of the Fund, unless State
Street Bank is otherwise instructed. Shareholders may request to be paid
in cash instead of shares by responding to the bank, brokerage or nominee
who holds the shares if the shares are in "street name" or by filling out
a form received from State Street Bank if the shares are in registered
form. A description of the automatic Dividend Reinvestment Plan may be
obtained by calling State Street Bank. It is expected that dividends, if
any, will be declared after fiscal year-end and will be payable for that
year before the end of January.
(2) Purchases and Sales of Investment Securities
The aggregate cost of purchases and proceeds from sales of investment
securities (other than temporary cash investments) for the period from
October 1, 1997 through September 30, 1998 totaled $20,690,877 and
$27,440,351, respectively.
(3) Tax Basis of Securities
At September 30, 1998, the total cost of securities for Federal income
tax purposes was $81,267,095. The aggregate gross unrealized gain on
securities in which there was an excess of market value over cost was
$34,317,304. The aggregate gross unrealized loss on securities in which
there was an excess of cost over market value was $21,990,033. The net
unrealized gain on securities held by the Fund was $12,327,271.
(4) Advisory Agreement
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) 1% of the average
net assets for the month of all other assets. The aggregate fee may not
exceed a rate when annualized of 1.375%. The Adviser is a wholly owned
subsidiary of Hambrecht & Quist Group. Certain officers and trustees of
the Fund are also officers of the Adviser.
(5) 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 23.8% of the Fund's net assets at
September 30, 1998.
The value of the venture capital and other restricted securities is
determined in good faith by the Board of 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. 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 September 30, 1998, as determined by the Board of Trustees
of the Fund.
16
<PAGE>
H&Q LIFE SCIENCES INVESTORS
---------------------------
NOTES TO FINANCIAL STATEMENTS
(continued)
<TABLE>
<CAPTION>
Carrying
Acquisition Value
Security Date Cost per Unit Value
- -------------------------------- ------------- ------------- ---------- ----------
<S> <C> <C> <C> <C>
AbTox
Series F Cvt. Pfd. 3/7/97 $1,100,500 $0.010 $5,000
12% Promissory Note due 1998 2/26/98 40,000
3/11/98 40,000
3/26/98 40,000
----------
120,000 1.000 120,000
Biofield***
Common 3/3/95 0
6/29/95 0
----------
0 1.590 19,875
Bioject Medical Technologies#
Common Warrants 12/9/96 0 0.560 299,880
BioTransplant###
Common Warrants 8/18/95 0 0.880 814
CareMonitor
Series A Cvt. Pfd. 1/26/96 1,352,603 1.820 1,981,452
Series B Cvt. Pfd. 8/21/97 599,999 1.820 599,999
Cubist Pharmaceuticals***
Common 9/23/98 599,999 2.070 551,999
Warrants 9/23/98 0 0.160 21,333
CV Therapeutics**
Common 11/12/96 60,938 4.030 98,231
CytoLogix
Series A Cvt. Pfd. 1/13/98 713,306 4.806 713,306
Dyax
Class A Series 1 Cvt. Pfd. 6/1/92 250,035
9/11/92 83,293
12/31/92 79,932
----------
413,260 5.450 567,628
Class A Series 3 Cvt. Pfd. 10/26/95 90,280 5.450 245,250
Class A Series 4 Cvt. Pfd. 10/30/96 404,279 5.450 703,486
Class A Series 5 Cvt. Pfd. 9/10/98 360,000 5.450 360,000
EPR
Series A Cvt. Pfd. 3/9/94 800,331 1.500 266,667
Exelixis Pharmaceuticals
Series B Cvt. Pfd. 3/28/96 901,325 2.000 1,800,000
Series C Cvt. Pfd. 3/31/97 200,720 2.000 200,000
InterVentional Technologies
Series F Cvt. Pfd. 8/21/92 600,185 10.000 750,000
Series G Cvt. Pfd. 3/8/95 350,431 10.000 350,000
KVM Technologies
Series B Cvt. Pfd. (w/wts.) 2/19/98 1,000,001 4.425 1,000,001
LJL BioSystems**
Common 6/17/97 800,001 1.750 538,463
LocalMed
Series D Cvt. Pfd. 2/9/96 1,126,745 4.000 1,125,000
Masimo
Series D Cvt. Pfd. 8/14/96 908,700 9.000 1,170,000
</TABLE>
17
<PAGE>
H&Q LIFE SCIENCES INVESTORS
---------------------------
NOTES TO FINANCIAL STATEMENTS
(continued)
<TABLE>
<CAPTION>
Carrying
Acquisition Value
Security Date Cost per Unit Value
- ----------------------------------- ------------- -------------- ---------- ---------
<S> <C> <C> <C> <C>
Masimo Labs
Common 8/14/96 1,300 0.010 1,300
Neuralab
Units 1/14/98 1,200,000 40.000 1,200,000
Oxford GlycoSciences***
Ordinary Shares 5/26/93 386,915 1.850 148,000
Pharming Group***
Common 8/28/95 864,932
4/25/96 38,730
10/15/97 302,777
---------
1,206,439 12.610 1,592,832
Reprogenesis
Common (w/wts.) 4/25/97 1,199,999 2.220 1,199,999
Sontra Medical
Series A Cvt. Pfd. 9/9/98 800,000 0.696 800,000
Telik
Series G Cvt. Pfd. 11/7/95 1,125,548 50.000 1,125,000
Series I Cvt. Pfd. 11/12/97 120,000 50.000 120,000
Therion Biologics
Common 6/30/93 251,307
8/20/96 669
10/16/96 2,227
---------
254,203 4.000 587,928
Sinking Fund Cvt. Pfd. (w/wts.) 10/17/94 200,630
4/19/95 78,179
7/12/95 78,000
10/17/95 78,000
1/25/96 73,176
4/3/96 73,800
---------
581,785 0.030 870
Series A Cvt. Pfd. 8/20/96 66,231
10/16/96 220,456
---------
286,687 4.000 123,680
Transkaryotic Therapies###
Common Warrants 11/5/93 200 9.730 78,181
Tularik
Series C Cvt. Pfd. 4/16/93 500,060 10.000 1,351,350
Vectis
Series B Cvt. Pfd. 2/5/97 800,091 4.700 800,001
Versicor
Series C Cvt. Pfd. 12/2/97 1,200,000 5.000 1,200,000
---------
$22,166,830 $23,817,525
=========== ===========
** Represents 70% of equivalent current market value of the issuer's registered securities.
*** Represents 85% of equivalent current market value of the issuer's registered securities.
# Represents 100% of equivalent current market value of the issuer's registered securities.
### Represents 60% of equivalent current market value of the issuer's registered securities.
</TABLE>
18
<PAGE>
H&Q Life Sciences Investors
50 Rowes Wharf, 4th Floor
Boston, Massachusetts 02110-3328
(617) 310-0567
Officers
Alan G. Carr, President
Kimberley L. Carroll, Treasurer
Kerri A. Bisner, Secretary
Sheldon A. Jones, Assistant Secretary
Trustees
Patrick J. Allen
Alan G. Carr
Lawrence S. Lewin
Robert P. Mack, M.D.
Eric Oddleifson
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
Independent Public Accountant
Arthur Andersen LLP
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.hamquist.com/capital/hqcm
---------
Out of concern for the environment and in an effort to reduce
Fund expenses, this report is printed on recycled paper.
HQHLS-AR-98
