H&Q HEALTHCARE INVESTORS
[GRAPHIC]
ANNUAL REPORT
2002
To our Shareholders:
At fiscal year-end on September 30, 2002, the net asset value of your Fund was
$18.16 per share. Performance data for the fiscal year and the quarter ended
September 30, 2002, compared to the indices, are as follows:
QUARTER ENDED
FISCAL YEAR 9/30/02
----------- -------
Net Asset Value -23.5% -9.3%
AMEX Biotech Index -29.0% -8.3%
Dow Jones Industrial Average -14.2% -17.9%
NASDAQ Industrials -14.2% -21.8%
Russell 2000 -10.5% -21.7%
The final quarter of your Fund's fiscal year was one of the worst on record
for the general market averages. Your Fund's decline was significant, but
overall less severe on a relative basis.
We believe we are in a period of no widely held consensus. Some may believe
a return to recession is highly likely in an economy of excess capacity
worldwide, nervous and indebted consumers, a possible real estate bubble, war
risk, and potential deflation, an outlook not fully reflected in security
prices.
Others look at the correction in equity prices of the last few years,
including those of companies leading the world's strongest economy, no
meaningful inflation, and historically low interest rates and wonder why stocks
shouldn't be bought. They may believe the U.S. economy has always rebounded in
the past and will again.
We espouse neither of these extremes, but we do believe moderation of this
polarization of sentiment may be required to set the foundation of the next bull
market. We are encouraged, however, that within the context of the overall
market, a positive consensus does seem to be developing toward healthcare
companies. Through all the recent turmoil, these companies have, in our
judgment, continued to invent and develop new innovative products with exciting
potential to enhance diagnosis and therapy. The number and therapeutic potential
of products heading for FDA approval in the next year or so is inspiring. In our
view, many of the
1
sponsoring companies have reasonable business plans (unlike some of the
"dotcoms" of a few years ago). Further, we believe that there are no
telecom-like over capacity issues here. In our view, these new products,
intended to improve the human condition, will largely generate their own demand.
We believe that recognition of these developments is reflected in the better
relative performance of the sector in the third quarter of 2002 and is likely to
continue. We are cautiously adding to or initiating positions in the stocks of
the more attractive of these companies, which may, over time, reduce our cash
position.
Many large investment firms have announced significant layoffs and staff
reductions. In the first quarter, we made a significant addition of a very
experienced staff member as we continue to build for the future. As a private
company owned by its management, Hambrecht & Quist Capital Management LLC, your
Fund's adviser, has the ability to take a longer-term view and build its most
important asset, its people.
The corporate governance, accounting and security analysts controversies
have clearly had depressing affects on stock prices. We wonder if good analysis
might have uncovered a lot of these controversies earlier; perhaps not as to the
accounting issues, which, in our view are largely rooted in the tax code.
As portfolio managers, we have long believed that one of our foremost
duties was the analysis of analysts, including our own, and especially those who
work for sell-side brokers and investment bankers. Perhaps the recent long bull
market made investors feel "entitled" to stock profits, and able to blame others
for their losses. We do not believe we are "entitled" to anything more than the
opportunity to use our energy and talent to find investments likely to yield
long-term profit growth.
/s/ Alan G. Carr /s/ Daniel R. Omstead
Alan G. Carr Daniel R. Omstead
President Emeritus President
2
H&Q HEALTHCARE INVESTORS
LARGEST HOLDINGS
AS OF SEPTEMBER 30, 2002
% OF NET ASSETS
---------------
Gilead Sciences 5.91%
Transkaryotic Therapies 3.55%
Martek Biosciences 2.99%
Celgene 2.86%
CV Therapeutics 2.70%
Triad Therapeutics (Restricted) 2.13%
CardioNet (Restricted) 1.98%
IDEXX Laboratories 1.94%
Teva Pharmaceutical Industries 1.94%
Telik 1.89%
H&Q HEALTHCARE INVESTORS
SIGNIFICANT PORTFOLIO TRANSACTIONS
QUARTER ENDED SEPTEMBER 30, 2002
UNITS HELD UNITS HELD
PURCHASES 6/30/02 9/30/02
--------- ------- -------
Adolor 232,980 311,300
Corixa 246,389 441,471
Exelixis 467,100 732,600
IVAX 154,800 214,800
Lexicon Genetics 78,500 111,500
WebMD 403,500 454,500
Zyomyx (Restricted) Series E 0 600,000
SALES
-----
ATS Medical 381,818 0
Bioject Medical Technologies 130,900 0
Curis 92,500 0
3
PORTFOLIO
AS OF SEPTEMBER 30, 2002
[CHART]
TOTAL VENTURE DIFFERENCE
----- ------- ----------
AGRI/ENVIRONMENTAL 1.90% 1.80% 0.10%
BIOTECHNOLOGY 46.60% 11.40% 35.20%
CROs 0.40% 0.00% 0.40%
DIAGNOSTICS 7.50% 4.00% 3.50%
HEALTHCARE INFORMATION SERVICES 3.20% 2.30% 0.90%
MEDICAL SPECIALTY 12.20% 6.50% 5.70%
MEDICAL SUPPLIES 1.90% 1.40% 0.50%
PHARMACEUTICALS 6.00% 2.80% 3.20%
LIQUID ASSETS 20.30% 0.00% 20.30%
ANNUAL MEETING REPORT
The Annual Meeting was held on June 25, 2002 at 9:00 a.m. The shareholders
voted on the following items and the resulting votes are presented below.
(1) To elect two Trustees of the Fund to hold office for a term of three years
or until their respective successors shall have been duly elected and
qualified.
FOR WITHHELD BROKER NON-VOTES
--- -------- ----------------
Alan G. Carr 11,312,002 190,275 0
Henri A. Termeer 11,329,924 172,353 0
The nominees were elected to serve until the 2005 Annual Meeting of
Shareholders. The Trustees serving until the 2003 Annual Meeting are
Lawrence S. Lewin and Uwe E. Reinhardt, Ph.D. The Trustees serving until
the 2004 Annual Meeting are Robert P. Mack, M.D., Eric Oddleifson and Oleg
M. Pohotsky.
(2) To approve a new investment advisory agreement between the Fund and
Hambrecht & Quist Capital Management LLC.
Shareholders overwhelmingly approved the new investment advisory agreement.
FOR AGAINST ABSTAIN BROKER NON-VOTES
--- ------- ------- ----------------
11,241,442 127,177 133,658 0
(3) To ratify the selection of PricewaterhouseCoopers LLP as the Fund's
independent accountants for the fiscal year ended September 30, 2002.
Shareholders overwhelmingly ratified the selection of the Independent
Public Accountants.
FOR AGAINST ABSTAIN BROKER NON-VOTES
--- ------- ------- ----------------
11,414,037 32,153 56,087 0
4
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE TRUSTEES AND SHAREHOLDERS OF H&Q HEALTHCARE INVESTORS:
In our opinion, the accompanying statement of assets and liabilities, including
the schedule of investments, and the related statements of operations, of
changes in net assets and of cash flows and the financial highlights present
fairly, in all material respects, the financial position of H&Q Healthcare
Investors (the "Fund") at September 30, 2002, and the results of its operations,
the changes in its net assets, its cash flows and the financial highlights for
the two years then ended in conformity with accounting principles generally
accepted in the United States of America. These financial statements and
financial highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits, which included confirmation of securities at
September 30, 2002 by correspondence with the custodian, provide a reasonable
basis for our opinion.
The financial statements of the Fund as of September 30, 2000 and for the three
years then ended were audited by other independent accountants whose report
dated November 3, 2000 expressed an unqualified opinion on those statements.
PricewaterhouseCoopers LLP
Boston, Massachusetts
November 19, 2002
5
SCHEDULE OF INVESTMENTS
SEPTEMBER 30, 2002
CONVERTIBLE SECURITIES - 29.9% OF NET ASSETS
SHARES CONVERTIBLE PREFERRED (RESTRICTED) - 27.9% VALUE
------ -----
AGRICULTURAL/ENVIRONMENTAL TECHNOLOGIES - 1.8%
375,000 Ceres Series C* $2,250,000
27,443 Ceres Series C-1*# 164,658
277,967 Ceres Series D*# 1,667,801
222,222 EPR Series A* 333,333
BIOTECHNOLOGY - 10.8%
400,000 ACADIA Pharmaceuticals Series E* 2,000,000
952,381 Agensys Series C* 3,000,000
2,380,953 Agilix Series B* 3,000,001
850,436 Avalon Pharmaceuticals Series B* 2,999,998
1,818,182 Raven biotechnologies Series B*^ 3,000,000
47,407 Therion Biologics Series A* 177,776
240,000 Therion Biologics Series B*# 900,000
407,712 Therion Biologics Series C*# 1,528,920
36,092 Therion Biologics Sinking Fund* 135,344
1,750,000 Triad Therapeutics Series A* 3,500,000
825,000 Triad Therapeutics Series B* 1,650,000
923,077 Zyomyx Series B* 1,846,153
600,000 Zyomyx Series C* 1,200,000
600,000 Zyomyx Series E* 1,200,000
DIAGNOSTICS - 2.9%
1,371,429 CardioNet Series C*^ 4,800,002
484,829 CytoLogix Series A*^ 400,178
227,130 CytoLogix Series B*#^ 187,472
160,000 Masimo Series D* 1,760,000
HEALTHCARE INFORMATION SERVICES - 1.7%
338,983 KVM Technologies Series B*#^ 3,390
5,384,615 PHT Series D*^ 4,200,000
MEDICAL SPECIALTY - 6.5%
636,364 AbTox Series F*+ 6,364
4,411,764 Concentric Medical Series B* 3,000,000
1,632,653 Omnisonics Medical Technologies Series B*^ 2,400,000
1,034,519 Senomyx Series E* 3,000,002
639,659 Songbird Hearing Series D* 6,397
652,173 TherOx Series H* 2,999,996
820,313 VNUS Medical Technologies Series E*^ 4,200,003
MEDICAL SUPPLIES - 1.4%
343,750 LocalMed Series D* 3,438
631,580 Novacept Series G*# 2,178,951
347,826 Novacept Series H* 1,200,000
PHARMACEUTICALS/DRUG DELIVERY - 2.8%
1,398,732 Galileo Laboratories Series F* 2,999,986
The accompanying notes are an integral part of these financial statements.
6
SHARES CONVERTIBLE SECURITIES - CONTINUED VALUE
------ -----
211,765 Theravance Series C* $1,905,885
200,000 Theravance Series D-1* 1,800,000
-----------
$67,606,048
-----------
PRINCIPAL
AMOUNT CONVERTIBLE BONDS AND NOTES - 2.0% VALUE
------ -----
BIOTECHNOLOGY - 1.8%
$6,800,000 CuraGen 6% Cvt. Deb. due 2007ii $4,335,000
DIAGNOSTICS - 0.1%
212,636 CytoLogix (Restricted) 6.75% Cvt. Note, due 2003*^ 212,636
HEALTHCARE INFORMATION SERVICES - 0.0%
1,577,366 FitForAll.com (Restricted) 10% Prom. Note*#+ 158
1,425,982 KVM Technologies (Restricted)
Adj.Cvt. Demand Note*#^ 14,260
MEDICAL SPECIALTY - 0.1%
180,000 AbTox (Restricted) 12% Prom. Note*+ 180,000
-----------
$4,742,054
-----------
TOTAL CONVERTIBLE SECURITIES
(Cost $87,073,734) $72,348,102
-----------
SHARES COMMON STOCKS - 49.8%
------
AGRICULTURAL/ENVIRONMENTAL TECHNOLOGY - 0.1%
71,483 Catalytica Energy Systems* $248,046
-----------
248,046
-----------
BIOTECHNOLOGY - 34.0%
BIOPHARMACEUTICALS - 27.2%
311,300 Adolor* 4,364,426
429,898 BioTransplant* 748,023
2,760 BioTransplant (Restricted) Warrants (expire 8/12/04)* 0
6,300 BioTransplant (Restricted) Warrants (expire 10/31/04)* 0
1,150 BioTransplant (Restricted) Warrants (expire 8/15/05)* 1,173
410,400 Celgene* 6,911,136
54,000 Cephalon* 2,204,280
441,471 Corixa* 2,794,511
33,164 Corixa Warrants (expire 8/14/07)* 0
550,556 Cubist Pharmaceuticals* 2,813,341
200,001 Cubist Pharmaceuticals (Restricted) Warrants
(expire 9/23/03)* 486,202
312,823 CV Therapeutics* 6,541,129
163,000 Genzyme* 3,359,430
426,636 Gilead Sciences* 14,305,105
210,000 MedImmune* 4,393,200
The accompanying notes are an integral part of these financial statements.
7
SHARES BIOTECHNOLOGY - CONTINUED VALUE
------ -----
226,760 Therion Biologics (Restricted)* $850,350
264,912 Transkaryotic Therapies* 8,585,798
270,270 Tularik* 1,851,350
418,165 Versicor* 3,562,766
18,696 Versicor (Restricted) Warrants (expire 8/3/05)* 56,836
113,700 Vertex Pharmaceuticals* 2,102,313
GENOMICS/DRUG DISCOVERY - 6.8%
297,000 Abgenix* 1,927,530
447,000 deCODE Genetics* 983,400
387,802 Dyax* 752,336
732,600 Exelixis* 3,626,370
111,500 Lexicon Genetics* 447,115
1,191,000 Lynx Therapeutics* 809,880
386,400 Lynx Therapeutics Warrants (expire 4/29/07)* 0
174,461 Molecular Devices* 2,182,507
616,100 Rigel Pharmaceuticals* 985,760
370,237 Telik* 4,583,534
-----------
82,229,801
-----------
CONTRACT RESEARCH ORGANIZATIONS - 0.4%
91,400 Quintiles Transnational* 869,214
-----------
869,214
-----------
DIAGNOSTICS - 4.5%
522,617 Biofield* 209,047
600,000 Biofield (Restricted)* 192,000
324,330 Cytyc* 3,476,818
18,500 Digene* 146,150
152,000 IDEXX Laboratories* 4,704,096
160,000 Masimo Labs (Restricted)* 1,600
685,621 Sontra Medical (Restricted)*^ 2,139,138
-----------
10,868,849
-----------
HEALTHCARE INFORMATION SERVICES - 1.4%
306,208 Syntiro Healthcare Services (Restricted)* 1,200,473
188,096 Syntiro Healthcare Services (Restricted) Warrants*
(expire 10/15/04) 18,810
454,500 WebMD* 2,295,225
-----------
3,514,508
-----------
The accompanying notes are an integral part of these financial statements.
8
SHARES MEDICAL SPECIALTY - 5.7% VALUE
------ -----
101,848 Biopure Class A* $356,468
8,333 Biopure (Restricted) Warrants (expire 8/4/03)* 0
1,000,000 Endocardial Solutions* 3,230,000
198,000 Endologix* 198,000
441,409 Martek Biosciences* 7,230,279
1,020,000 Orthovita*^ 2,805,000
------------
13,819,747
------------
MEDICAL SUPPLIES - 0.5%
645,000 EP MedSystems* 1,290,000
------------
1,290,000
------------
PHARMACEUTICALS/DRUG DELIVERY - 3.2%
225,000 Aradigm* 472,500
214,800 IVAX* 2,635,596
70,000 Teva Pharmaceutical Industries ADR 4,690,000
------------
7,798,096
------------
TOTAL COMMON STOCKS
(Cost $95,051,000) $120,638,261
------------
PRINCIPAL
AMOUNT TEMPORARY CASH INVESTMENTS - 19.7%
------
$11,200,000 American Express Credit, 1.74%, due 10/18/02 $11,190,797
7,000,000 General Electric Capital Corp., 1.75%,
due 10/21/02 6,993,194
10,500,000 U.S. Treasury Bill, 1.60%, due 10/17/02 10,492,533
19,000,000 U.S. Treasury Bill, 1.64%, due 10/3/02 18,998,269
------------
TOTAL TEMPORARY CASH INVESTMENTS
(Cost $47,674,793) $47,674,793
------------
TOTAL INVESTMENTS
(Cost $229,799,527) $240,661,156
============
-------------------
* 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 $24,362,079).
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.
ADR - American Depository Receipt.
The accompanying notes are an integral part of these financial statements.
9
STATEMENT OF ASSETS AND LIABILITIES
SEPTEMBER 30, 2002
ASSETS:
Investments, at value (identified cost
$229,799,527; see Schedule of Investments) $240,661,156
Cash 42,819
Receivable for investments sold 1,673,623
Interest receivable 66,867
Prepaid expenses 29,415
------------
Total assets $242,473,880
------------
LIABILITIES:
Accrued advisory fee $299,376
Accrued trustees' fees 22,500
Accrued other 146,226
------------
Total liabilities $468,102
------------
NET ASSETS $242,005,778
============
SOURCES OF NET ASSETS:
Shares of beneficial interest, par value $.01 per
share, unlimited number of shares authorized,
amount paid in on 13,323,483 shares issued and
outstanding $215,202,502
Accumulated net realized gain on investments 15,941,647
Net unrealized gain on investments 10,861,629
------------
Total net assets (equivalent to $18.16 per
share based on 13,323,483 shares outstanding) $242,005,778
============
The accompanying notes are an integral part of these financial statements.
10
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED SEPTEMBER 30, 2002
INVESTMENT INCOME:
Dividend income (net of foreign tax
of $4,102) $19,194
Interest income 1,480,403
Other income 2,876
----------
Total investment income $1,502,473
EXPENSES:
Advisory fees $4,233,892
Legal fees 233,494
Trustees' fees and expenses 144,698
Shareholder reporting 126,461
Custodian fees 81,117
Accounting and auditing fees 73,348
Transfer agent fees 53,595
Other 149,092
----------
Total expenses 5,095,697
------------
Net investment loss ($3,593,224)
------------
NET REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS:
Net realized gain on investments $33,875,011
Decrease in net unrealized gain on investments (106,220,050)
------------
Net loss on investments ($72,345,039)
------------
Net decrease in net assets
resulting from operations ($75,938,263)
============
The accompanying notes are an integral part of these financial statements.
11
STATEMENTS OF CHANGES IN NET ASSETS
FOR THE YEAR ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001
------------- -------------
NET INCREASE (DECREASE) IN
NET ASSETS RESULTING FROM
OPERATIONS:
Net investment loss ($3,593,224) ($2,222,151)
Net realized gain on investments 33,875,011 63,501,379
Decrease in net unrealized
gain on investments (106,220,050) (201,564,026)
------------- -------------
Net decrease in net assets
resulting from operations ($75,938,263) ($140,284,798)
------------- -------------
DISTRIBUTIONS TO SHAREHOLDERS
FROM:
Net realized capital gains ($39,468,231) ($52,289,670)
------------- -------------
CAPITAL SHARE TRANSACTIONS:
Value of shares issued in
reinvestment of distributions
(1,281,419 and 1,519,574 shares,
respectively) $28,039,066 $36,365,104
------------- -------------
Net decrease in net assets ($87,367,428) ($156,209,364)
NET ASSETS:
Beginning of year 329,373,206 485,582,570
------------- -------------
End of year $242,005,778 $329,373,206
============= =============
The accompanying notes are an integral part of these financial statements.
12
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED SEPTEMBER 30, 2002
CASH FLOWS USED FOR OPERATING ACTIVITIES:
Interest and other income received $1,370,528
Dividends received 19,194
Operating expenses paid (5,158,838)
------------
Net cash used for operating activities ($3,769,116)
------------
CASH FLOWS PROVIDED FROM INVESTING ACTIVITIES
Purchases of portfolio securities ($45,375,053)
Net sales of temporary cash investments 1,812,048
Sales and maturities of portfolio securities 58,247,860
------------
Net cash provided from investing activities $14,684,855
------------
CASH FLOWS USED FOR FINANCING ACTIVITIES:
Cash distributions paid, net ($11,429,165)
------------
Net cash used for financing activities ($11,429,165)
------------
NET DECREASE IN CASH ($513,426)
CASH AT BEGINNING OF YEAR 556,245
------------
CASH AT END OF YEAR $42,819
============
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 ($75,938,263)
Accretion of discount (112,751)
Net realized gain on investments (33,875,011)
Decrease in net unrealized gain on investments 106,220,050
Decrease in accrued expenses (50,376)
Increase in prepaid expenses (12,765)
------------
Net cash used for operating activities ($3,769,116)
============
Noncash financing activities not included herein consist of
stock distributions of $28,039,066.
The accompanying notes are an integral part of these financial statements.
13
FINANCIAL HIGHLIGHTS
(SELECTED DATA FOR EACH SHARE OF BENEFICIAL INTEREST
OUTSTANDING THROUGHOUT THE PERIOD INDICATED)
FOR THE YEAR ENDED SEPTEMBER 30,
--------------------------------------------------------------------------------
2002 (1) 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
Net asset value per share:
Beginning of year $27.350 $46.147 $21.771 $16.711 $23.106
------------ ------------ ------------ ------------ ------------
Net investment loss ($0.283)(2) ($0.195)(2) ($0.290) ($0.176) ($0.217)
Net realized and unrealized
gain (loss) on investments (5.727) (13.822) 28.131 5.596 (5.108)
------------ ------------ ------------ ------------ ------------
Total increase (decrease)
from investment operations ($6.010) ($14.017) $27.841 $5.420 ($5.325)
------------ ------------ ------------ ------------ ------------
Capital gains distributions
to shareholders ($3.180) ($4.780) ($3.465) ($0.360) ($1.070)
------------ ------------ ------------ ------------ ------------
Net asset value per share:
End of year $18.160 $27.350 $46.147 $21.771 $16.711
============ ============ ============ ============ ============
Per share market value:
End of year $14.100 $21.740 $36.188 $16.313 $13.125
Total investment return
at market value (25.24%) (27.23%) 151.66% 27.39% (26.05%)
RATIOS AND SUPPLEMENTAL DATA:
Net assets at end of year $242,005,778 $329,373,206 $485,582,570 $209,519,627 $157,976,073
Ratio of operating expenses
to average net assets 1.64% 1.42% 1.45% 1.46% 1.46%
Ratio of net investment loss
to average net assets (1.16%) (0.62%) (0.86%) (0.91%) (1.11%)
Portfolio turnover rate 17.40% 16.17% 12.90% 24.88% 17.15%
Number of shares outstanding
at end of year 13,323,483 12,042,064 10,522,490 9,623,524 9,453,317
(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
$.009, an increase in net realized and unrealized loss on investments per
share of $.009 and a decrease in the ratio of net investment loss to
average net assets from (1.20%) to (1.16%). 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.
The accompanying notes are an integral part of these financial statements.
14
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
(1) ORGANIZATION
H&Q Healthcare 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
October 31, 1986 and commenced operations on April 22, 1987.
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 $154,040 based on securities held as of
September 30, 2001. The effect of this change for the fiscal year ended
September 30, 2002 was to decrease net investment loss by $112,751 with a
corresponding decrease in the change in net unrealized gain on investments
of $112,751.
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. The
Fund has adjusted for the effect of certain permanent book/tax differences
by reclassifying the net operating loss against capital, in the amount of
$3,439,184, for the year ended September 30, 2002. This adjustment has no
effect on the Fund's net
15
assets, net investment loss or net realized gain. The calculation of net
investment loss per share in the financial highlights excludes this
adjustment. At September 30, 2002, the Fund's undistributed net realized
gain on a tax basis was $14,674,239 and differs from accumulated net
realized gain on investments due to the timing of recording certain gains.
Pursuant to Section 852 of the Internal Revenue Code, the Fund has
designated $39,468,231 as a long-term capital gain distribution for its
taxable year ended September 30, 2002.
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 September 30, 2002.
(2) SECURITIES TRANSACTIONS
The aggregate cost of purchases and proceeds from sales of investment
securities (other than temporary cash investments) for the year ended
September 30, 2002 totaled $44,758,165 and $57,582,430, respectively.
At September 30, 2002, the total cost of securities for Federal income
tax purposes was $229,799,527. The net unrealized gain on securities held
by the Fund was $10,861,629, including gross unrealized gain of $60,162,966
and gross unrealized loss of $49,301,337.
(3) INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
Effective July 1, 2002, 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%. The terms of the agreement prior to July 1, 2002 with
the former advisor, Hambrecht & Quist Capital Management Incorporated, an
indirect wholly-owned subsidiary of J.P. Morgan Chase & Co., were
substantially identical to those in the current Advisory Agreement. 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.
16
(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 30% of the Fund's net assets at
September 30, 2002.
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 $1,647,054 at September 30, 2002 has also been
determined by the Trustees and which is included in the 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 September 30, 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 $1,461,200 $0.010 $6,364
12% Promissory Note 2/26/98 - 3/26/98 180,000 1.000 180,000
ACADIA Pharmaceuticals
Series E Cvt. Pfd. 5/2/00 3,000,594 5.000 2,000,000
Agensys
Series C Cvt. Pfd. 2/14/02 3,005,073 3.150 3,000,000
Agilix
Series B Cvt. Pfd. 11/8/01 3,014,260 1.260 3,000,001
Avalon Pharmaceuticals
Series B Cvt. Pfd. 10/22/01 3,008,325 3.528 2,999,998
Biofield
Common 12/15/00 302,984 0.320 192,000
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 1.020 1,173
CardioNet^
Series C Cvt. Pfd. 5/3/01 4,823,823 3.500 4,800,002
Ceres
Series C Cvt. Pfd. 12/23/98 1,502,620 6.000 2,250,000
Series C-1 Cvt. Pfd.* 1/4/01 111,488 6.000 164,658
Series D Cvt. Pfd.* 3/14/01 1,668,122 6.000 1,667,801
Concentric Medical
Series B Cvt. Pfd. 5/7/02 3,028,055 0.680 3,000,000
Cubist Pharmaceuticals
Common Warrants (expire 9/23/03) 9/23/98 235 2.431 486,202
CytoLogix^
Series A Cvt. Pfd. 1/13/98 - 7/21/99 2,332,441 0.825 400,178
Series B Cvt. Pfd.* 1/11/01 1,153,451 0.825 187,472
Cvt. Note 5/29/02 212,636 1.000 212,636
EPR
Series A Cvt. Pfd. 3/9/94 1,000,409 1.500 333,333
FitForAll.com
10% Promissory Note* 2/22/00 - 9/18/00 1,613,493 0.010 158
17
ACQUISITION CARRYING VALUE
SECURITY DATE COST PER UNIT VALUE
------------------------------------ ------------------ ----------- -------------- -----------
Galileo Laboratories
Series F Cvt. Pfd. 8/18/00 $3,002,319 $2.145 $2,999,986
KVM Technologies^
Series B Cvt. Pfd.* 2/19/98 1,501,320 0.010 3,390
Adj. Cvt. Demand Note* 6/21/99 - 6/13/02 1,426,607 0.010 14,260
LocalMed
Series D Cvt. Pfd. 2/9/96 1,376,970 0.010 3,438
Masimo
Series D Cvt. Pfd. 8/14/96 1,120,040 11.000 1,760,000
Masimo Labs
Common 8/14/96 0 0.010 1,600
Novacept
Series G Cvt. Pfd.* 3/27/01 3,001,927 3.450 2,178,951
Series H Cvt. Pfd. 4/25/02 1,200,000 3.450 1,200,000
Omnisonics Medical Technologies^
Series B Cvt. Pfd. 5/24/01 2,404,472 1.470 2,400,000
PHT^
Series D Cvt. Pfd. 7/23/01 4,200,000 0.780 4,200,000
Raven biotechnologies^
Series B Cvt. Pfd. 12/12/00 3,000,833 1.650 3,000,000
Senomyx
Series E Cvt. Pfd. 2/19/02 3,003,903 2.900 3,000,002
Songbird Hearing
Series D Cvt. Pfd. 12/14/00 3,004,861 0.010 6,397
Sontra Medical^
Common 6/24/02 1,679,491 3.120 2,139,138
Syntiro Healthcare Services
Common 2/5/97 1,200,325 3.920 1,200,473
Warrants (expire 10/15/04) 10/15/98 0 0.100 18,810
Theravance
Series C Cvt. Pfd. 2/5/99 1,800,123 9.000 1,905,885
Series D-1 Cvt. Pfd. 8/28/00 1,800,900 9.000 1,800,000
Therion Biologics
Common 7/12/90 - 10/16/96 511,365 3.750 850,350
Series A Cvt. Pfd. 8/20/96 - 10/16/96 444,850 3.750 177,776
Series B Cvt. Pfd.* 2/24/99 - 6/22/99 900,914 3.750 900,000
Series C Cvt. Pfd.* 9/26/01 1,528,922 3.750 1,528,920
Sinking Fund Cvt. Pfd. 10/17/94 - 4/3/96 721,291 3.750 135,344
TherOx
Series H Cvt. Pfd. 9/11/00 3,001,873 4.600 2,999,996
Triad Therapeutics
Series A Cvt. Pfd. 6/8/99 1,750,860 2.000 3,500,000
Series B Cvt. Pfd. 12/20/00 1,653,135 2.000 1,650,000
Versicor
Warrants (expire 8/3/05) 6/28/99 905 3.040 56,836
VNUS Medical Technologies^
Series E Cvt. Pfd. 8/20/01 4,200,003 5.120 4,200,003
Zyomyx
Series B Cvt. Pfd. 2/19/99 1,200,550 2.000 1,846,153
Series C Cvt. Pfd. 3/2/00 1,200,690 2.000 1,200,000
Series E Cvt. Pfd. 7/22/02 1,200,000 2.000 1,200,000
----------- -----------
$84,458,658 $72,959,684
=========== ===========
* With warrants attached.
^ Affiliated issuers.
18
TRUSTEES
H & Q HEALTHCARE INVESTORS
30 ROWES WHARF, SUITE 430
BOSTON, MASSACHUSETTS 02110
(617) 772-8500
NUMBER OF
POSITION(S) HELD WITH PRINCIPAL OCCUPATION(S) PORTFOLIOS IN FUND
NAME, ADDRESS(1) FUND, TERM OF OFFICE(2) AND DURING PAST 5 YEARS AND COMPLEX OVERSEEN
AND AGE LENGTH OF TIME SERVED OTHER DIRECTORSHIPS HELD BY TRUSTEE
------------------------------------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEES:
Lawrence S. Lewin Trustee (since 1987) and Executive Consultant. Formerly Chief 2
63 Chairman (since 2000) Executive Officer (from 1970-1999) of
The Lewin Group (healthcare public policy
and management consulting), a subsidiary
of Quintiles Transnational Corp.
Robert P. Mack Trustee (since 1991) Consultant in Orthopedic Surgery to 2
67 Orthopedic Associates of Aspen (since
2001). Formerly Orthopedic Surgeon (from
1996-1998) at the Steadman- Hawkins
Orthopedic Clinic and (from 1977-1996) at
the Denver Orthopedic Clinic; and Director
of the Department of Orthopedic Surgery at
Metropolitan General Hospital and
Assistant Professor of Orthopedics at Case
Western Reserve University, Cleveland, OH
(from 1968-1977).
Eric Oddleifson Trustee (since 1992) Partner (since 2001) and Managing 2
67 Director (from 1997-2000) of
Renewable Resources LLC (forest properties
investment). Formerly Managing Director
(from 1995-1997) of UBS Asset Management
(forest properties investment); and
President, Director and Chief Investment
Officer (from 1984-1995) of Resource
Investments, Inc. (forest properties
investment).
Oleg M. Pohotsky Trustee (since 2000) Most recently, Senior Vice President 2
55 (from 1991-2001) of FAC/Equities, a division of First
Albany Corporation (investment bank).
Formerly General Partner (from 1989-1991)
of Strategic Capital Associates (financial
advisory firm); and General Partner (from
1986-1989) of Capital Growth Partners
(private mezzanine capital institutional
investment partnership).
19
NUMBER OF
POSITION(S) HELD WITH PRINCIPAL OCCUPATION(S) PORTFOLIOS IN FUND
NAME, ADDRESS(1) FUND, TERM OF OFFICE(2) AND DURING PAST 5 YEARS AND COMPLEX OVERSEEN
AND AGE LENGTH OF TIME SERVED OTHER DIRECTORSHIPS HELD BY TRUSTEE
------------------------------------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEES: (continued)
Uwe E. Reinhardt, Trustee (since 1988) Professor of Economics (since 1968) at 2
Ph.D. Princeton University. Director (from
64 2000) of Triad Hospitals; Boston
Scientific (since 2002); Amerigroup
since (2002); Duke University
(since 2001); The Duke University
Health System (since 2001) and the
National Bureau of Economic Research
(since 2002).
Henri A. Termeer Trustee (since 1989) Chairman (since 1988), Chief Executive 2
55 Officer (since 1985) and President
(since 1983) of Genzyme Corporation (human
healthcare products); Director (since
1987) of ABIOMED, Inc.; Director (since
1992) of AutoImmune, Inc.; Director (from
1993-2002) of Genzyme Transgenics; and
Director (since 1996) of Diacrin, Inc.
INTERESTED TRUSTEES:
Alan G. Carr(3) President Emeritus Chairman (since July 2002) of 2
68 (since 2001), President Hambrecht & Quist Capital Management
(from 1987-2001) and LLC; Chairman (from 2001 - July 2002),
Trustee (since 1987) President (from 1992-2001), Director
(from 1986 to July 2002) and Senior
Vice President (from 1986-1992) of
Hambrecht & Quist Capital Management,
Inc.; and Managing Director (from 1992-
1999) of Hambrecht & Quist Group.
(1) The address for each Trustee is c/o the Fund at the Fund's address as set
forth above.
(2) Each Trustee currently is serving a three year term.
(3) Trustee considered to be an "interested person" within the meaning of the
Investment Company Act of 1940, as amended (the "1940 Act") through
position or affiliation with Hambrecht & Quist Capital Management LLC, the
Fund's investment adviser.
20
OFFICERS
POSITION(S) HELD WITH
NAME, ADDRESS(1) FUND, TERM OF OFFICE(2) AND
AND AGE LENGTH OF TIME SERVED PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS
------------------------------------------------------------------------------------------------------------------------------------
OFFICERS:
Alan G. Carr President Emeritus (since 2001) Manager (since July 2002) of Hambrecht & Quist
68 Capital Management LLC; Chairman (from 2001-
July 2002), President (from 1992-2001), Director
(From 1986 to July 2002) and Senior Vice President
(from 1986-1992) of Hambrecht & Quist Capital
Management, Inc.; Managing Director (from
1992-1999) of Hambrecht & Quist Group; and
President Emeritus (since 2001), President
(from 1987-2001) and Trustee (since 1987) of
H&Q Healthcare Investors (HQH) and (since 1992)
of H&Q Life Sciences Investors (HQL).
Daniel R. Omstead, President (since 2001) Manager (since July 2002) of Hambrecht & Quist
ENGSCD Capital Management LLC; President of HQH and
49 of HQL (since 2001); President, Chief Executive
Officer (from 2001 to July 2002)
and Managing Director (from 2000 to
July 2002) of Hambrecht & Quist
Capital Management Inc.; formerly
President and Chief Executive
Officer (from 1997-2000) and Chief
Operating Officer (1997) of
Reprogenesis, Inc.
Kimberley L. Carroll Treasurer (since 1987) Treasurer and Chief Financial Officer (since 1987)
46 of HQH and (since 1992) of HQL; and Vice
President (from 1991-July 2002) and
Treasurer (from 2000 - July 2002)
of Hambrecht & Quist Capital
Management Inc.
Jennifer L. Morris Secretary (since 2001) Secretary (since 2001) of HQH and of HQL; and
34 Assistant Vice President (from 1999-July 2002) and
Manager, Corporate Communications (from
1996-1999) of Hambrecht & Quist Capital
Management Inc.
(1) The address for each officer is c/o the Fund at the Fund's address as set
forth above.
(2) Each officer serves in such capacity for an indefinite period of time at
the pleasure of the Trustees.
21
H&Q HEALTHCARE INVESTORS
New York Stock Exchange Symbol: HQH
30 Rowes Wharf, 4th Floor
Boston, Massachusetts 02110-3328
www.hqcm.com
PLEASE NOTE OUR NEW PHONE NUMBER:
(617) 772-8500
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 Price & Rhoads
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.
HQHCM-AR-02