<PAGE>
                                                          1998
--------------------------------------------------------------------------------
PruTech Research and                                      Annual
Development Partnership III                               Report

<PAGE>
                            LETTER TO UNITHOLDERS FOR
                PRUTECH RESEARCH AND DEVELOPMENT PARTNERSHIP III
                            (a limited partnership)
 
 
                                       1
<PAGE>
                            PRUTECH III INVESTMENTS
 
The Partnership had a position in the following investments and/or royalty
rights as of December 31, 1998.
 
                       CREATIVE BIOMOLECULES, INC. (CBMI)
 
Position: 20,000 shares of common stock; royalty rights on soft tissue growth
          factor products which expire December 1999
 
   During the fourth quarter of 1998, the Partnership sold 4,484 shares of CBMI
common stock for approximately $12,000. The stock price of CBMI was $2.50 per
share as of March 24, 1999.
 
   It appears unlikely that the Partnership's projects will produce sales
royalties for the Partnership as the Partnership's royalty rights expire in
1999.
 
                        FOREST LABORATORIES, INC. (FRX)
 
Position: Royalty rights to a drug treatment for Alzheimer's disease which
          expire December 1999
 
   The filing of a New Drug Application with the Food and Drug Administration,
seeking approval of Synapton, a drug developed by FRX for the treatment of
Alzheimer's disease, was made on November 18, 1997. On November 18, 1998, FRX
announced that it was evaluating and would be preparing a response to a
non-approvable letter received from the Food and Drug Administration on its new
drug application for Synapton. Forest has recently advised the Partnership that
it will be meeting with the FDA to discuss the status of Synapton.
 
                                       2

<PAGE>
PricewaterhouseCoopers (LOGO)
 
                                            PricewaterhouseCoopers LLP
                                            1177 Avenue of the Americas
                                            New York, NY 10036
                                            Telephone (212) 596 8000
                                            Facsimile (212) 596 8910
 
                       Report of Independent Accountants
 
February 12, 1999
 
To the Partners of
PruTech Research and Development Partnership III
 
In our opinion, the accompanying statements of financial condition and the
related statements of operations, changes in partners' capital and cash flows
present fairly, in all material respects, the financial position of PruTech
Research and Development Partnership III at December 31, 1998 and 1997, and the
results of its operations and the changes in its cash flows for each of the
three years in the period ended December 31, 1998 in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the general partner; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards 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 the general
partner, and evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for the opinion expressed above.
 
/s/ PricewaterhouseCoopers LLP
 
                                       3
<PAGE>
                PRUTECH RESEARCH AND DEVELOPMENT PARTNERSHIP III
                            (a limited partnership)
                       STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
                                                                               December 31,
                                                                       -----------------------------
<S>                                                                    <C>              <C>
                                                                           1998             1997
----------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents                                               $1,157,931       $3,668,595
Investments in equity securities                                            73,760          552,790
                                                                       ------------     ------------
Total assets                                                            $1,231,691       $4,221,385
                                                                       ------------     ------------
                                                                       ------------     ------------
LIABILITIES AND PARTNERS' CAPITAL
Liabilities
Accrued management fee                                                  $   62,500       $   62,500
Accrued expenses and other liabilities                                      57,698           84,357
                                                                       ------------     ------------
Total liabilities                                                          120,198          146,857
                                                                       ------------     ------------
 
Contingencies
Partners' capital
Unitholders (40,934 units issued and outstanding)                          985,900        3,405,966
General partner                                                            117,283          386,179
Accumulated other comprehensive income                                       8,310          282,383
                                                                       ------------     ------------
Total partners' capital                                                  1,111,493        4,074,528
                                                                       ------------     ------------
Total liabilities and partners' capital                                 $1,231,691       $4,221,385
                                                                       ------------     ------------
                                                                       ------------     ------------
----------------------------------------------------------------------------------------------------
                  The accompanying notes are an integral part of these statements.
</TABLE>
                                       4
<PAGE>
                PRUTECH RESEARCH AND DEVELOPMENT PARTNERSHIP III
                            (a limited partnership)
                            STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                                    Year ended December 31,
                                                             --------------------------------------
<S>                                                          <C>          <C>            <C>
                                                               1998          1997           1996
---------------------------------------------------------------------------------------------------
REVENUES
Gain on sale of investments in equity securities             $243,595     $7,888,065     $5,194,202
Interest and other income                                     116,202        135,893         38,019
Royalty income                                                  --            --            216,665
                                                             --------     ----------     ----------
                                                              359,797      8,023,958      5,448,886
                                                             --------     ----------     ----------
EXPENSES
Management fee                                                250,000        534,340        818,680
General and administrative                                     69,826        138,378         95,688
Write-down of investments in equity securities                  --           295,000         --
                                                             --------     ----------     ----------
                                                              319,826        967,718        914,368
                                                             --------     ----------     ----------
Net income                                                   $ 39,971     $7,056,240     $4,534,518
                                                             --------     ----------     ----------
                                                             --------     ----------     ----------
ALLOCATION OF NET INCOME
Unitholders                                                  $ 35,974     $6,350,616     $4,081,066
                                                             --------     ----------     ----------
                                                             --------     ----------     ----------
General partner                                              $  3,997     $  705,624     $  453,452
                                                             --------     ----------     ----------
                                                             --------     ----------     ----------
Net income per unit                                          $    .88     $   155.14     $    99.70
                                                             --------     ----------     ----------
                                                             --------     ----------     ----------
---------------------------------------------------------------------------------------------------
</TABLE>
 
                   STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
<TABLE>
<CAPTION>
                                                                          ACCUMULATED
                                                                             OTHER
                                                            GENERAL      COMPREHENSIVE
                                          UNITHOLDERS       PARTNER      INCOME (LOSS)        TOTAL
<S>                                       <C>             <C>            <C>               <C>
-------------------------------------------------------------------------------------------------------
Partners' capital--December 31, 1995      $  7,505,854    $   841,722     $ 11,254,503     $ 19,602,079
Comprehensive loss:
  Net income                                 4,081,066        453,452                         4,534,518
  Net unrealized losses on investments
  in equity securities                                                      (5,118,761)      (5,118,761)
                                                                                           ------------
  Comprehensive loss                                                                           (584,243)
                                                                                           ------------
Distributions                               (3,274,720)      (363,858)                       (3,638,578)
                                          ------------    -----------    --------------    ------------
Partners' capital--December 31, 1996         8,312,200        931,316        6,135,742       15,379,258
Comprehensive income:
  Net income                                 6,350,616        705,624                         7,056,240
  Net unrealized losses on investments
  in equity securities                                                      (5,853,359)      (5,853,359)
                                                                                           ------------
  Comprehensive income                                                                        1,202,881
                                                                                           ------------
Distributions                              (11,256,850)    (1,250,761)                      (12,507,611)
                                          ------------    -----------    --------------    ------------
Partners' capital--December 31, 1997         3,405,966        386,179          282,383        4,074,528
Comprehensive loss:
  Net income                                    35,974          3,997                            39,971
  Net unrealized losses on investments
  in equity securities                                                        (274,073)        (274,073)
                                                                                           ------------
  Comprehensive loss                                                                           (234,102)
                                                                                           ------------
Distribution                                (2,456,040)      (272,893)                       (2,728,933)
                                          ------------    -----------    --------------    ------------
Partners' capital--December 31, 1998      $    985,900    $   117,283     $      8,310     $  1,111,493
                                          ------------    -----------    --------------    ------------
                                          ------------    -----------    --------------    ------------
-------------------------------------------------------------------------------------------------------
                   The accompanying notes are an integral part of these statements.
</TABLE>
                                       5
<PAGE>
                PRUTECH RESEARCH AND DEVELOPMENT PARTNERSHIP III
                            (a limited partnership)
                            STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                                   Year ended December 31,
                                                         --------------------------------------------
<S>                                                      <C>             <C>              <C>
                                                            1998             1997            1996
-----------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Interest and other income received                       $   116,202     $    135,893     $    38,019
Management fee paid                                         (250,000)        (676,510)       (818,680)
General and administrative expenses paid                     (96,485)        (134,459)        (88,341)
Royalty income received                                      --               --              216,665
Cash received for other assets                               --               --              216,669
                                                         -----------     ------------     -----------
Net cash used in operating activities                       (230,283)        (675,076)       (435,668)
                                                         -----------     ------------     -----------
 
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from the sale of investments in equity
  securities                                                 448,552       14,567,491       5,935,995
Purchase of investments in equity securities                 --               (58,650)        --
                                                         -----------     ------------     -----------
Net cash provided by investing activities                    448,552       14,508,841       5,935,995
                                                         -----------     ------------     -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Distributions                                             (2,728,933)     (12,507,611)     (3,638,578)
                                                         -----------     ------------     -----------
Net (decrease) increase in cash and cash equivalents      (2,510,664)       1,326,154       1,861,749
Cash and cash equivalents at beginning of year             3,668,595        2,342,441         480,692
                                                         -----------     ------------     -----------
Cash and cash equivalents at end of year                 $ 1,157,931     $  3,668,595     $ 2,342,441
                                                         -----------     ------------     -----------
                                                         -----------     ------------     -----------
-----------------------------------------------------------------------------------------------------
</TABLE>
                                                        (continued on next page)
 
                                       6
<PAGE>
                PRUTECH RESEARCH AND DEVELOPMENT PARTNERSHIP III
                            (a limited partnership)
                       STATEMENTS OF CASH FLOWS (Cont'd)
<TABLE>
<CAPTION>
                                                                   Year ended December 31,
                                                         --------------------------------------------
<S>                                                      <C>             <C>              <C>
                                                            1998             1997            1996
-----------------------------------------------------------------------------------------------------
RECONCILIATION OF NET INCOME TO NET CASH USED IN
OPERATING ACTIVITIES
Net income                                               $    39,971     $  7,056,240     $ 4,534,518
                                                         -----------     ------------     -----------
Adjustments to reconcile net income to net cash used
  in operating activities:
Gain on sale of investments in equity securities            (243,595)      (7,888,065)     (5,194,202)
Write-down of investments in equity securities               --               295,000         --
Changes in:
  Accrued expenses and other liabilities                     (26,659)           3,919           7,347
  Accrued management fee                                     --              (142,170)        --
  Other assets                                               --               --              216,669
                                                         -----------     ------------     -----------
Total adjustments                                           (270,254)      (7,731,316)     (4,970,186)
                                                         -----------     ------------     -----------
Net cash used in operating activities                    $  (230,283)    $   (675,076)    $  (435,668)
                                                         -----------     ------------     -----------
                                                         -----------     ------------     -----------
-----------------------------------------------------------------------------------------------------
 
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES

1997
At March 31, 1997, the General Partner concluded that an impairment in value that was not temporary
  had occurred for the Partnership's equity investment in Somatix Therapy Corporation. As a result,
  the value of the Partnership's 295,000 shares of Somatix Therapy Corporation common stock was
  written down by $295,000.
On June 2, 1997, Cell Genesys Corporation acquired Somatix Therapy Corporation. As a result, the
  Partnership received 111,265 of Cell Genesys Corporation common stock or 0.385 shares for each of
  its 289,000 shares of Somatix Therapy Corporation common stock.
-----------------------------------------------------------------------------------------------------
                  The accompanying notes are an integral part of these statements.
</TABLE>
 
                                       7
<PAGE>
                PRUTECH RESEARCH AND DEVELOPMENT PARTNERSHIP III
                            (a limited partnership)
                         NOTES TO FINANCIAL STATEMENTS
 
A. General
 
   PruTech Research and Development Partnership III (the 'Partnership'), a
California limited partnership, was formed on June 2, 1986 and will terminate on
December 31, 2006 unless terminated sooner (see discussion below) under the
provisions of the Agreement of Limited Partnership, as amended (the 'Partnership
Agreement'). Capital resources were originally provided by the sale of
depositary units and by contributions of the General Partner equal to ten
percent of depositary contributions. The Partnership was formed to seek cash
flow from the research and development of new technologies with potential
commercial applications. The general partner of the Partnership is R&D Funding
Corp (the 'General Partner'), an affiliate of Prudential Securities Incorporated
('PSI'). Both the General Partner and PSI are wholly owned subsidiaries of
Prudential Securities Group Inc. ('PSGI'). The assignor limited partner is
Prudential-Bache Investor Services Inc., an affiliate of the General Partner,
which has assigned substantially all the rights attributable to its limited
partnership interest to investors.
 
   At December 31, 1998, the Partnership has an investment in the common stock
of Creative BioMolecules, Inc. (OTC-CBMI) and royalty positions with Forest
Laboratories, Inc. ('Forest') and Creative BioMolecules, Inc., that will expire
in December 1999. The Partnership's royalty position with Creative BioMolecules,
Inc. is believed to have little to no value and the equity position's value is
easily determinable and is salable. The Partnership's royalty position in
Synapton, a drug developed by Forest for the treatment of Alzheimer's disease,
is illiquid, and any estimate of its value is subject to significant uncertainty
due to a number of factors including, among other things, (i) whether the Food
and Drug Administration (the 'FDA') will approve Synapton for sale, which would
require that the FDA reverse its non-approval position issued in November
1998,(ii) the difficulty, in light of the fact that FDA approval is yet to be
obtained, in manufacturing and distributing the product prior to the expiration
of the Partnership's royalty position and (iii) market acceptance of the
product. Due to the nature of the Forest royalty, the General Partner is not
able at this time to predict with any degree of certainty, the value, if any, of
the royalty position. Forest has advised the Partnership that it will be meeting
with the FDA to discuss the status of Synapton. Depending on the timing and
results of that meeting, the General Partner may determine that the royalty
interest in Synapton does not warrant the continuing operation of the
Partnership through the end of the royalty period at which point the General
Partner will liquidate and distribute any remaining assets (reduced by a reserve
to satisfy any liabilities of the Partnership) and dissolve the Partnership. In
the event that the General Partner determines that continuing operations through
the expiration date of the Synapton royalty position may be in the best interest
of the Partnership, the General Partner will proceed to dissolve the Partnership
as soon as practicable thereafter.
 
B. Summary of Significant Accounting Policies
 
Basis of accounting
 
   The books and records of the Partnership are maintained on the accrual basis
of accounting in accordance with generally accepted accounting principles.
 
   The preparation of financial statements in conformity with generally accepted
accounting principles requires the General Partner to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements as well as the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
   Certain balances from prior years have been reclassified to conform with the
current financial statement presentation.
 
   Effective January 1, 1998, the Partnership adopted the provisions of
Statement of Financial Accounting Standards ('SFAS') No. 130, 'Reporting
Comprehensive Income.' This Statement establishes standards for reporting and
display of comprehensive income and its components within financial statements.
Comprehensive income includes net income as well as certain revenues, expenses,
gains and losses that are excluded from net income under generally accepted
accounting principles ('other comprehensive
 
                                       8
 <PAGE>
<PAGE>
income/loss'). During each of the three years ended December 31, 1998, the
Partnership's only source of other comprehensive income/loss was net unrealized
losses on investments in marketable equity securities, which are included in the
statements of changes in partners' capital and are more fully described in Note
D. The adoption of SFAS No. 130 has had no impact on earnings or total partners'
capital.
 
Cash and cash equivalents
 
   Cash and cash equivalents include money market funds.
 
Investments
 
   The Partnership's equity securities that have readily determinable fair
values are classified as available-for-sale securities. These securities are
measured at fair value in the statements of financial condition and unrealized
gains and losses are reported as a separate component of partners' capital under
the caption 'Accumulated Other Comprehensive Income'. Equity securities traded
on a national securities exchange or the Nasdaq national market are valued at
the last reported sales price on the primary exchange on which they are traded.
Equity securities traded in the over-the-counter market and thinly traded
securities are valued at the mean between the last reported bid and asked
prices.
 
   The carrying value of an investment is written down to its fair value when a
decline in value is considered to be other than temporary. The Partnership uses
the average cost method to determine gains or losses on the sale of securities.
 
Royalty income
 
   Royalty income represents revenue generated from licenses granted by the
Partnership.
 
Management fee
 
   This fee provides for the cost of overseeing, supervising and monitoring the
conduct of the development projects and for overseeing and monitoring product
exploitation resulting from the development projects.
 
   The General Partner was paid an annual management fee equal to two percent of
the unitholders' original capital contributions through June 30, 1997. Effective
July 1, 1997, the General Partner reduced its management fee to the greater of
(a) $250,000 annually or (b) ten percent of the aggregate amount received from
the Partnership's royalty position in Synapton after July 1, 1997 until the
dissolution and liquidation of the Partnership, not to exceed the aggregate
management fee payable under the terms of the Partnership Agreement ($818,680
per annum).
 
Income taxes
 
   The Partnership is not required to provide for, or pay, any Federal or state
income taxes. Income tax attributes that arise from its operations are passed
directly to the individual partners. The Partnership may be subject to other
state and local taxes in jurisdictions in which it operates.
 
Profit and loss allocations and distributions
 
   Profits and losses are allocated ninety percent to the unitholders and ten
percent to the General Partner until such time as the total net profits
allocated to each unitholder equal all losses previously allocated whereupon the
General Partner will be allocated net profits in an additional amount of
twenty-five percent with a corresponding reduction to the unitholders to be
shared in proportion to their capital contributions.
 
   Distributions of cash are made in accordance with the Partnership Agreement
and are allocated ninety percent to the unitholders and ten percent to the
General Partner.
 
C. Royalties
 
   At December 31, 1998 and 1997, the Partnership retains certain royalty rights
with Forest and Creative BioMolecules, Inc. whose carrying values for financial
reporting purposes are zero. The royalty rights with Forest relate to Synapton.
Forest filed a new drug application with the FDA, seeking approval of Synapton,
on November 18, 1997. On November 18, 1998, Forest announced that it was
evaluating and would be preparing a response to a non-approvable letter received
from the FDA on its new drug application for Synapton. Forest has recently
advised the Partnership that it will be meeting with the FDA to discuss the
status of Synapton. The Partnership's royalty rights with Forest and Creative
BioMolecules, Inc. will expire in December 1999 (Refer to Note A for further
discussion).
 
                                       9
 <PAGE>
<PAGE>
   On April 1, 1990, the Partnership entered into a Technology Development
Investment Agreement with Kopin Corporation ('Kopin') for the development of LED
technology. Pursuant to the Agreement, Kopin was obligated to pay to the
Partnership royalties on the sale of products containing the technology through
April 1, 1996, with a minimum royalty payment of $433,334 due April 1, 1996
(payable in cash or by the delivery of a promissory note). Kopin agreed to pay
cash for the minimum royalty because the Partnership also agreed to transfer to
Kopin its GaAs technology developed under an earlier contract. During the second
quarter of 1996, the Partnership received the $433,334 minimum royalty payment
of which $216,669 represented a reduction of its receivable from Kopin and
$216,665 was recorded as royalty income. As a result, the Partnership holds no
technology or royalty positions with Kopin and, therefore, no further royalties
will be received by the Partnership from Kopin.
 
D. Investments
 
   In connection with certain of its research and development contracts, the
Partnership has exercised its warrants or has converted its technology, royalty
rights, warrants or notes receivable into an equity position in the companies
performing the research and development.
 
   Investments in equity securities available-for-sale at December 31, 1998 and
1997 include the following:
 
<TABLE>
<CAPTION>
                                                1998                                                  1997
                         --------------------------------------------------    --------------------------------------------------
                                              Gross unrealized   Carrying                           Gross unrealized   Carrying
                         Shares   Cost basis        gain           value       Shares   Cost basis       gains           value
<S>                      <C>      <C>         <C>               <C>            <C>      <C>         <C>               <C>
------------------------------------------------------------------------       --------------------------------------------
Creative BioMolecules,
  Inc.-Common Stock       20,000   $ 65,450       $  8,310       $  73,760      24,484  $   80,124     $  100,446     $   180,570
Kopin Corporation-
  Common Stock             --        --            --               --          13,310      99,556        124,212         223,768
Cell Genesys
  Corporation-
  Common Stock             --        --            --               --          17,465      90,727         57,725         148,452
                                  ----------  ----------------  -----------             ----------  ----------------  -----------
                                   $ 65,450       $  8,310       $  73,760              $  270,407     $  282,383     $   552,790
                                  ----------  ----------------  -----------             ----------  ----------------  -----------
                                  ----------  ----------------  -----------             ----------  ----------------  -----------
</TABLE>
 
   If upon the sale of the Partnership's remaining equity investment the gross
unrealized gain is realized, such gain would be allocated ninety percent to the
unitholders and ten percent to the General Partner; however, there is no
assurance that the Partnership would receive such amount in the event of the
sale of its remaining equity position.
 
Creative BioMolecules, Inc.
 
   During the fourth quarter of 1998, the Partnership sold 4,484 shares of
Creative BioMolecules, Inc. common stock with a cost basis of approximately
$15,000 resulting in a loss of approximately $3,000.
 
   During the first quarter of 1997, the Partnership sold 441,898 shares of
Creative BioMolecules, Inc. common stock with a cost basis of approximately
$1,446,000 resulting in a gain of approximately $3,573,000, and the Partnership
exercised its option to purchase 6,900 shares of Creative BioMolecules, Inc.
common stock at an exercise price of $8.50 per share for a total cost of
approximately $59,000. During the remainder of 1997, the Partnership sold 49,900
shares of Creative BioMolecules, Inc. common stock with a cost basis of
approximately $199,000 resulting in a gain of approximately $307,000. During
1997, revenues from the Partnership's investment in Creative BioMolecules, Inc.
represented approximately 48% of the Partnership's total 1997 revenues.
 
   During December 1996, the Partnership sold 214,900 shares of Creative
BioMolecules, Inc. common stock with a cost basis of approximately $703,000
resulting in a gain of approximately $1,573,000. During 1996, revenues from the
Partnership's investment in Creative BioMolecules, Inc. represented
approximately 29% of the Partnership's total 1996 revenues.
 
Kopin Corporation
 
   During the second quarter of 1998, the Partnership sold its remaining 13,310
shares of Kopin Corporation common stock for approximately $286,000 resulting in
a gain of approximately $186,000. During 1998, revenues relating to the
Partnership's investment in Kopin Corporation represented approximately 52% of
the Partnership's total revenues.
 
                                       10
 <PAGE>
<PAGE>
   During 1997, the Partnership sold 524,023 shares of Kopin Corporation common
stock with a cost basis of approximately $3,920,000 resulting in a gain of
approximately $3,932,000. During 1997, revenues from the Partnership's
investment in Kopin Corporation represented approximately 49% of the
Partnership's total 1997 revenues.
 
   During the first quarter of 1996, the Partnership sold 4,334 shares of Kopin
Corporation common stock with a cost basis of approximately $32,000 resulting in
a gain of approximately $27,000.
 
Somatix Therapy Corporation/Cell Genesys Corporation
 
   During the second quarter of 1998, the Partnership sold its remaining 17,465
shares of Cell Genesys Corporation common stock for approximately $151,000
resulting in a gain of approximately $60,000. During 1998, revenues relating to
the Partnership's investment in Cell Genesys Corporation represented
approximately 17% of the Partnership's total revenues.
 
   During the first quarter of 1997, the Partnership sold 205,000 shares of
Somatix Therapy Corporation common stock with a cost basis of approximately
$615,000 resulting in a loss of approximately $98,000. At March 31, 1997, the
General Partner concluded that an impairment in value that was not temporary had
occurred for the Partnership's equity investment in Somatix Therapy Corporation.
As a result, the value of the Partnership's investment in Somatix Therapy
Corporation common stock was written down by $295,000. During the second quarter
of 1997, the Partnership sold 6,000 shares of Somatix Therapy Corporation common
stock with a cost basis of approximately $12,000 resulting in no gain or loss to
the Partnership.
 
   On June 2, 1997, Cell Genesys Corporation acquired Somatix Therapy
Corporation. As a result, the Partnership received 111,265 shares of Cell
Genesys Corporation common stock or 0.385 shares for each of its 289,000 shares
of Somatix Therapy Corporation common stock.
 
   During the second half of 1997, the Partnership sold 93,800 shares of Cell
Genesys Corporation common stock with a cost basis of approximately $487,000
resulting in a gain of approximately $174,000.
 
Forest Laboratories, Inc.
 
   During the first quarter of 1996, the Partnership sold its remaining 75,000
shares of Forest common stock with a cost basis of approximately $6,000
resulting in a gain of approximately $3,594,000. During 1996, revenues relating
to the Partnership's investment in Forest represented approximately 66% of the
Partnership's total 1996 revenues.
 
Net Unrealized Losses on Investment in Equity Securities
 
   For the three years ended December 31, 1998, the Partnership's net unrealized
losses on investments in equity securities were comprised as follows:
 
<TABLE>
<CAPTION>
                                                         1998           1997            1996
     <S>                                               <C>           <C>             <C>
                                                       -----------------------------------------
     Unrealized holding gain/loss                      $ (30,478)    $ 2,034,706     $    75,441
     Less: reclassification adjustment for realized
       gains included in net income                     (243,595)     (7,888,065)     (5,194,202)
                                                       ---------     -----------     -----------
     Net unrealized losses on investment in equity
       securities                                      $(274,073)    $(5,853,359)    $(5,118,761)
                                                       ---------     -----------     -----------
                                                       ---------     -----------     -----------
</TABLE>
 
                                       11
<PAGE>
E. Income Taxes
 
   The following is a reconciliation of net income for financial reporting
purposes to net income (loss) for tax reporting purposes:
 
<TABLE>
<CAPTION>
                                                               Year ended December 31,
                                                       ----------------------------------------
                                                         1998           1997           1996
     <S>                                               <C>           <C>            <C>
                                                       ----------------------------------------
     Net income per financial statements               $  39,971     $7,056,240     $ 4,534,518
     Gain on sale of investments in equity
       securities                                       (100,959)    (1,107,903)        --
     Write-down/write-off of investment in equity
       securities                                         --            295,000        (511,194)
     Royalty income                                       --             --             (76,698)
                                                       ---------     ----------     -----------
     Tax basis net income (loss)                       $ (60,988)    $6,243,337     $ 3,946,626
                                                       ---------     ----------     -----------
                                                       ---------     ----------     -----------
</TABLE>
 
   The differences between the tax basis and book basis of partners' capital are
primarily attributable to the cumulative effect of the book to tax income
adjustments.
 
F. Related Parties
 
   The General Partner and its affiliates perform certain services for the
Partnership (for which they are reimbursed through the management fee) which
include, but are not limited to: accounting and financial management; registrar,
transfer and assignment functions; asset management; investor communications and
other administrative services. The Partnership also reimburses an affiliate of
the General Partner for printing services. The costs and expenses were:
 
<TABLE>
<CAPTION>
                                                        Year ended December 31,
                                                   ----------------------------------
                                                     1998         1997         1996
     <S>                                           <C>          <C>          <C>
                                                   ----------------------------------
            Management fee                         $250,000     $534,340     $818,680
            Printing                                  6,444       13,448       11,849
                                                   --------     --------     --------
                                                   $256,444     $547,788     $830,529
                                                   --------     --------     --------
                                                   --------     --------     --------
</TABLE>
 
   Effective July 1, 1997, the General Partner reduced its management fee to the
greater of (a) $250,000 annually or (b) ten percent of the aggregate amount
received from the Partnership's royalty position in Synapton after July 1, 1997
until the dissolution and liquidation of the Partnership, not to exceed the
aggregate management fee payable under the terms of the Partnership Agreement
($818,680 per annum).
 
   Printing costs payable to an affiliate of the General Partner (which are
included in accrued expenses) as of December 31, 1998 and 1997 were $5,025 and
$7,788, respectively.
 
   Prudential Securities Incorporated, an affiliate of R&D Funding Corp, owned
724 units in the Partnership at December 31, 1998.
 
   The Partnership maintains an account with the Prudential Institutional
Liquidity Portfolio Fund, an affiliate of R&D Funding Corp, for investment of
its available cash in short-term instruments pursuant to the guidelines
established by the Partnership Agreement.
 
   The Partnership has engaged in research and development co-investment
projects with PruTech Research and Development Partnership which was dissolved
and liquidated in December 1996, PruTech Research and Development Partnership II
which was dissolved and liquidated in December 1998 and PruTech Project
Development Partnership (collectively, the 'PruTech R&D Partnerships'), for
which R&D Funding Corp serves as the general partner. The allocation of the
co-investment projects' profits or losses among the PruTech R&D Partnerships is
consistent with the costs incurred to fund the research and development
projects.
 
G. Contingencies
 
   On April 15, 1994, a multiparty petition captioned Mack et al. v. Prudential
Securities Incorporated et al. (Cause No. 94-17695) was filed in the 80th
Judicial District Court of Harris County, Texas, purportedly on behalf of
investors in the Partnership against the Partnership, the General Partner, PSI,
The Prudential Insurance Company of America and a number of other defendants.
The petition alleged common law fraud
 
                                       12
<PAGE>
and fraud in the inducement and negligent misrepresentation in connection with
the offering of the Partnership; negligence and breach of fiduciary duty in
connection with the operation of the Partnership; civil conspiracy; and
violations of the federal Securities Act of 1933 (sections 11 and 12), and of
the Texas Securities and Deceptive Trade Practices statutes. The suit sought,
among other things, compensatory and punitive damages, costs and attorneys'
fees. The claims of all plaintiffs have been settled or dismissed. The
Partnership did not contribute to any settlement or pay any costs of the
litigation.
 
                                       13
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<PAGE>
                PRUTECH RESEARCH AND DEVELOPMENT PARTNERSHIP III
                            (a limited partnership)
          MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                           AND RESULTS OF OPERATIONS
 
Liquidity and Capital Resources
 
   At December 31, 1998, the Partnership has an investment in the common stock
of Creative BioMolecules, Inc. (OTC-CMBI) and royalty positions with Forest
Laboratories, Inc. ('Forest') and Creative BioMolecules, Inc., that will expire
in December 1999. The Partnership's royalty position with Creative BioMolecules,
Inc. is believed to have little to no value and the equity position's value
(approximately $74,000 at December 31, 1998) is easily determinable and is
salable. The Partnership's royalty position in Synapton, a drug developed by
Forest for the treatment of Alzheimer's disease, is illiquid, and any estimate
of its value is subject to significant uncertainty due to a number of factors
including, among other things, (i) whether the Food and Drug Administration (the
'FDA') will approve the Synapton for sale, which would require that the FDA
reverse its non-approval position issued in November 1998, (ii) the difficulty,
in light of the fact that FDA approval is yet to be obtained, in manufacturing
and distributing the product prior to the expiration of the Partnership's
royalty position and (iii) market acceptance of the product. Due to the nature
of the Forest royalty, the General Partner is not able at this time to predict
with any degree of certainty, the value, if any, of the royalty position. Forest
has advised the Partnership that it will be meeting with the FDA to discuss the
status of Synapton. Depending on the timing and results of that meeting, the
General Partner may determine that the royalty interest in Synapton does not
warrant the continuing operation of the Partnership through the end of the
royalty period at which point the General Partner will liquidate and distribute
any remaining assets (reduced by a reserve to satisfy any liabilities of the
Partnership) and dissolve the Partnership. In the event that the General Partner
determines that continuing operations through the expiration date of the
Synapton royalty position may be in the best interest of the Partnership, the
general partner will proceed to dissolve the Partnership as soon as practicable
thereafter.
 
   As of December 31, 1998, the Partnership had approximately $1,158,000 of cash
and cash equivalents which is a decrease of approximately $2,511,000 as compared
to December 31, 1997. The decrease in cash and cash equivalents was primarily
due to the payment of distributions and management fees, offset by proceeds from
the sales of certain investments in equity securities, as further discussed
below.
 
   The amount to be distributed by the Partnership in future quarters will be
based on the extent to which the market value of its remaining investment in
Creative BioMolecules, Inc. can be realized and from the revenue stream from
royalties, if any, and interest income. It is not expected that the
Partnership's eventual total distributions will equal the Unitholders' initial
investments.
 
   During May 1998, the Partnership made a $2,728,933 distribution. Unitholders
received a total of $2,456,040 ($60 per unit) and the General Partner received
its 10% share.
 
   During the second quarter of 1998, the Partnership sold its remaining 13,310
shares of Kopin Corporation common stock for approximately $286,000, and its
remaining 17,465 shares of Cell Genesys Corporation common stock for
approximately $151,000.
 
   During the fourth quarter of 1998, the Partnership sold 4,484 shares of
Creative BioMolecules, Inc. common stock for approximately $12,000.
 
Results of Operations
 
   Net income for the years ended December 31, 1998, 1997 and 1996 was
approximately $40,000, $7,056,000 and $4,535,000, respectively. The primary
reasons for the fluctuations in operating results are discussed below.
 
   During 1998, the Partnership recorded gains of approximately $186,000 and
$60,000, respectively on the sale of its remaining 13,310 shares of Kopin
Corporation common stock and its remaining 17,465 shares of Cell Genesys
Corporation common stock. During 1997, the Partnership recorded gains on the
sale of common stock totalling approximately $7,888,000, including gains of
$3,932,000 and $3,880,000 on the sale of common stock of Kopin Corporation and
Creative BioMolecules, Inc., respectively. During 1996, the Partnership recorded
gains of approximately $3,594,000 and $1,573,000 on the sale of 75,000 shares of
 
                                       14
 <PAGE>
<PAGE>
Forest Laboratories, Inc. common stock and 214,900 shares of Creative
BioMolecules, Inc. common stock, respectively.
 
   At March 31, 1997, the General Partner concluded that an impairment in value
that was not temporary had occurred for the Partnership's equity investment in
Somatix Therapy Corporation. As a result, the value of the Partnership's
investment in Somatix Therapy Corporation common stock was written down by
$295,000.
 
   No royalties were earned by the Partnership in 1998 and 1997. Royalty income
for the year ended December 31, 1996 was approximately $217,000 and related to
an agreement in which the Partnership received a minimum royalty payment from
Kopin Corporation and transferred to Kopin Corporation its rights to certain
technologies and royalties. As a result of the agreement, the Partnership holds
no technology or royalty positions with Kopin Corporation.
 
   Interest and other income for the year ended December 31, 1998 decreased by
approximately $20,000 as compared to 1997 and increased by approximately $98,000
for the year ended December 31, 1997 as compared to 1996. These fluctuations in
interest and other income largely reflect the level of Partnership funds
invested in short-term instruments which has varied with the timing of sales of
investments in equity securities and subsequent distributions to unitholders.
 
   Management fees for the years ended 1998 and 1997 each decreased by
approximately $284,000 as compared to prior years. Effective July 1, 1997, the
General Partner reduced its management fee to the greater of (a) $250,000
annually or (b) ten percent of the aggregate amount received from the
Partnership's royalty position in Synapton after July 1, 1997 until 
the dissolution and liquidation of the Partnership, not to exceed 
the aggregate management fee payable under the terms of the Agreement 
of Limited Partnership ($818,680 per annum.)
 
   General and administrative expenses for the year ended December 31, 1998
decreased by approximately $69,000 as compared to 1997 but increased by
approximately $43,000 for the year ended December 31, 1997 as compared to 1996.
The 1997 increase was due primarily to professional and other costs incurred in
1997 in considering alternatives for the orderly liquidation of the Partnership.
Such costs did not recur at the same level during 1998. Additionally, the 1998
decrease reflects lower evaluation and monitoring expenses as overall activity
decreased in the Partnership's R&D projects and license agreements.
 
Inflation
 
   Inflation has had no direct material impact on operations or on the financial
condition of the Partnership from inception through December 31, 1998.
 
                                       15
<PAGE>
                               OTHER INFORMATION
 
   The Partnership's Annual Report on Form 10-K as filed with the Securities and
Exchange Commission is available to Unitholders without charge upon written
request to:
 
        PruTech Research and Development Partnership III
        P.O. Box 2016
        Peck Slip Station
        New York, New York 10272-2016
 
                                       16
 <PAGE>
<PAGE>
Peck Slip Station                                  BULK RATE
P.O. Box 2016                                     U.S. POSTAGE
New York, NY 10272                                    PAID
                                                 Automatic Mail
PRUTEC386/170864