United States
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                -----------------
                                    Form 10-K

            (X) Annual Report Pursuant to Section 13 or 15(d) of the
                        Securities Exchange Act of 1934.
                   For the fiscal year ended December 31, 1998
                                       or
          ( ) Transition Report Pursuant to Section 13 or 15(d) of the
                        Securities Exchange Act of 1934.
                 For the transition period from ______ to ______

                         Commission File Number 33-35938
                       PAINEWEBBER R&D PARTNERS III, L.P.
             (Exact name of registrant as specified in its charter)

           Delaware                                              13-3437420
(State or other jurisdiction of                               (I.R.S. Employer
incorporation or organization)                               Identification No.)

1285 Avenue of the Americas, New York, New York                     10019
   (Address of principal executive offices)                       (Zip code)

       Registrant's telephone number, including area code: (212) 713-2000

                                -----------------

           Securities registered pursuant to Section 12(b) of the Act:

                                -----------------

                                                       Name of each exchange on
Title of each class                                         which registered
-------------------                                         ----------------
       None                                                       None

           Securities registered pursuant to Section 12(g) of the Act:

                            Limited Partnership Units

      No voting stock has been issued by the Registrant. Neither a public nor
other market exists for the Units, and no such market is expected to develop,
therefore there was no quoted market price for the 50,000 Units.

      Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

                                -----------------

      Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K (X).
<PAGE>

                             SPECIAL NOTE REGARDING
                           FORWARD LOOKING STATEMENTS

      The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. Except for the historical information
contained herein, the matters discussed herein are forward-looking statements.
Such forward-looking statements involve known and unknown risks, uncertainties
and other factors that may cause the actual results, performance or achievements
of the Partnership or industry results to be materially different from any
future results, performance or achievements expressed or implied by such
forward-looking statements. Such factors include, among others, the following:
general economic and business conditions; fluctuations in the value of
securities for which only a limited, or no, public market exists; dependence on
the development of new technologies; dependence on timely development and
introduction of new and competitively priced products; the need for regulatory
approvals; the Sponsor Companies having insufficient funds to commercialize
products to their maximum potential; the restructuring of Sponsor Companies; the
dependence of the Partnership on the skills of certain scientific personnel; and
the dependence of the Partnership on the General Partner.
<PAGE>

                                     PART I

Item 1.  Business.

      PaineWebber R&D Partners III, L.P. (the "Partnership" or "Registrant") is
a Delaware limited partnership that commenced operations on June 3, 1991, with a
total of $43.1 million available for investment. Paine Webber Development
Corporation ("PWDC" or "General Partner"), an indirect, wholly-owned subsidiary
of Paine Webber Group Inc. ("PWG"), is the general partner and manager of the
Partnership. The principal objective of the Partnership has been to provide
long-term capital appreciation to investors through investing in the development
and commercialization of new products (the "Projects") with technology and
biotechnology companies ("Sponsor Companies"), which have been expected to
address significant market opportunities. The Partnership will terminate on
December 31, 2015, unless its term is extended or reduced by the General
Partner.

      The Partnership has completed the funding of its seven Projects at an
aggregate investment since inception of $32.5 million. As of December 31, 1998,
the Partnership had ongoing Projects with Alkermes, Inc., Cephalon, Inc. and
Gensia, Inc. The remaining Projects have either terminated or are near
termination. (See Exhibit B, the Annual Letter to the Limited Partners, for a
detailed discussion of the current status of the Partnership's active Projects.)
In addition to the investments in Projects, as of December 31, 1998, the
Partnership owned equity investments, warrants and marketable securities as
described in Notes 3 and 5 of the "Notes to Financial Statements" included in
this filing on Form 10-K.

Partnership Management

      The Partnership has contracted with the General Partner, pursuant to a
management agreement (the "Management Contract"), responsibility for management
and administrative services necessary for the operation of the Partnership. An
Advisory Board, which has acted as special advisor to the General Partner, is
periodically provided with updates regarding the status of the Partnership's
Projects (see Exhibit A for a brief biography of the current Advisory Board
members). All fees and expenses of the Advisory Board are paid for by the
General Partner.

      Under the Management Contract, the General Partner is entitled to receive
an annual management fee for management and administrative services provided to
the Partnership. As of January 1, 1997, the General Partner has eliminated
charging a management fee for services rendered to the Partnership.
<PAGE>

(Item 1 Continued)

Distributions

      All distributions to the General Partner and the limited partners of the
Partnership (the "Limited Partners"; collectively, the "Partners") have been
made pro rata in accordance with their respective capital contributions. The
following table sets forth the proportion of each distribution to be received by
the Limited Partners and the General Partner, respectively:

<TABLE>
<CAPTION>
                                                                                 Limited    General
                                                                                 Partners   Partner
                                                                                 --------   -------
<S>                                                                              <C>        <C>
    I.         Until the value of the aggregate distributions for each
               limited partnership unit ("Unit") equals $1,000 plus simple
               interest on such amount accrued at 5% per annum
               ("Contribution Payout"); At December 31, 1998, Contribution
               Payout was $1,375 per Unit .....................................    99%         1%

    II.        After Contribution Payout and until the value of the
               aggregate distributions for each Unit equals $5,000 ("Final
               Payout")........................................................    80%        20%

    III.       After Final Payout..............................................    75%        25%
</TABLE>

      At December 31, 1998, the Partnership has made cash and security
distributions, as valued on the dates of distribution, since inception of $1,143
and $98 per Unit, respectively.

Profit and Loss Allocation

      Profits and losses of the Partnership are allocated as follows: (i) until
cumulative profits and losses for each Unit equals Contribution Payout, 99% to
Limited Partners and 1% to the General Partner, (ii) after Contribution Payout
and until cumulative profits and losses for each Unit equals Final Payout, 80%
to Limited Partners and 20% to the General Partner, and (iii) after Final
Payout, 75% to Limited Partners and 25% to the General Partner. As of December
31, 1998, the cumulative profits of the Partnership were $558 per Unit.

Other

      At December 31, 1998, the Partnership had no employees, and PWDC, the
General Partner, had no employees other than its executive officers (see Item
10. Directors and Executive Officers of the Registrant). The Partnership is
engaged in one primary business segment, the management of investments in
technology products and companies.

Item 2.  Properties.

      The Partnership does not own or lease any office, manufacturing or
laboratory facilities.
<PAGE>

Item 3.  Legal Proceedings.

In re:  PaineWebber Limited Partnership Litigation

      PWDC, the General Partner of the Partnership, was named as a defendant in
a class action lawsuit against PaineWebber Incorporated ("PWI") and a number of
its affiliates in the United States District Court for the Southern District of
New York (the "Court") relating to PWI's sale of approximately 70 direct
investment offerings, including the offering of interests in the Partnership. As
previously disclosed on the Partnership's Form 10-K for the year ended December
31, 1997, the litigation was settled prior to January 1, 1998, and
administration of the settlement is ongoing.

Item 4.  Submission of Matters to a Vote of Security Holders.

      None.
<PAGE>

                                     PART II

Item 5.  Market for Registrant's Common Equity and Related Stockholder Matters.

      There is no existing public market for the Units, and no such market is
expected to develop. Units are transferable subject to certain restrictions as
set forth in the Partnership Agreement and applicable securities laws. As of
December 31, 1998, there were 4,710 Limited Partners.

      The Partnership distributes to the Partners, when available, the net
proceeds from royalty distributions, interest payments on portfolio securities
and net proceeds from dispositions of portfolio securities and any other cash in
excess of amounts that are necessary for the operation of the Partnership's
business. During the year ended December 31, 1998, the Partnership made no
distributions to the Partners. During the years ended December 31, 1997 and
1996, the Partnership made cash distributions to its Partners of $27,777,777
($550 per Unit; $277,777 to the general partnership interest) and $24,895,837
($493 per Unit; $245,837 to the general partnership interest), respectively.

Item 6.  Selected Financial Data.

      See the "Selected Financial Data" on Page F-2 included in this filing on
Form 10-K.

Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations.

Liquidity and Capital Resources

      Partners' capital of $10.6 million at December 31, 1997, decreased to $9.1
million at December 31, 1998, resulting from the Partnership's recognition of a
net loss of $1.5 million (as discussed in Results of Operations below).

      The Partnership's funds are invested in marketable securities until cash
is needed to pay for the ongoing management and administrative expenses of the
Partnership or for distribution to the Partners. Liquid assets increased from
$8.5 million at December 31, 1997 to $9.1 million at December 31, 1998,
resulting primarily from a decrease in the market values of marketable
securities held as of these dates of $5.6 million offset by the receipt of
additional shares of Medarex, Inc. ("Medarex") with a market value at December
31, 1998 of $1.3 million, the reclassification of securities from investments to
marketable securities with an aggregate carrying value of $4.5 million and the
receipt of $0.6 in income from Projects. The balance of the liquid assets at
December 31, 1998, is to be used for the payment of administrative costs related
to managing the Partnership's business and future distributions to the Partners.

Results of Operations

      Year ended December 31, 1998 compared to the year ended December 31, 1997:

      The Partnership recognized a net loss for the year ended December 31, 1998
of $1.5 million as compared to net income of $5.9 million for the year ended
December 31, 1997. The unfavorable variance of $7.4 million resulted from
decreases in revenues of $7.7 million and expenses of $0.3 million.

      Revenues for the years ended December 31, 1998 and 1997 were $(1.4)
million and $6.3 million, respectively. The decrease in revenues resulted
primarily from decreases in (i) net realized gain on sale of marketable
securities and (ii) income from product development projects of $10.1 million
and $0.3

<PAGE>

(Item 7 Continued)

million, respectively, offset by a favorable change in net unrealized
depreciation of marketable securities of $2.9 million. During the year ended
December 31, 1997 the Partnership sold 1.285 million shares of Biocompatibles
for proceeds of $28.0 million. The carrying value of the shares as of December
31, 1996 was $17.9 million resulting in a realized gain upon the sale of $10.1
million. Income from product development projects for the year ended December
31, 1998 was $0.6 million. The Partnership assigned its interest in contingent
payment rights as a former shareholder of GenPharm International, Inc. for
proceeds of this amount and recognized income. During the year ended December
31, 1997, the Partnership recognized income from product development projects of
$0.9 million (see Results of Operations for the year ended December 31, 1997 as
compared to the year ended December 31, 1996). Unrealized depreciation for the
year ended December 31, 1998 was $2.0 million resulting primarily from the
Partnership's investments of 0.815 million shares of Biocompatibles
International plc ("Biocompatibles"), 0.723 million shares of Medarex and 0.713
million shares of Genzyme Molecular Oncology ("GMO"). The market value of
Biocompatibles decreased from $8.124 per share at December 31, 1997 to $1.427
per share as of December 31, 1998, resulting in unrealized depreciation for the
year ended December 31, 1998 of $5.5 million. During the year ended December 31,
1998, in accordance with Statement No. 115, the Partnership recorded its
investment in 0.282 million Medarex restricted shares (with a restriction period
of less than one year) at a market value of $3.03125 per share at December 31,
1998 and, accordingly, recognized unrealized appreciation of $0.9 million.
Previously, such shares were recorded at zero value. Also, the Partnership
recorded its investment of 0.441 million Medarex shares received in 1998 at $1.3
million and recognized unrealized appreciation of this amount. In November 1998,
GMO shares began trading on the Nasdaq National Market. Accordingly the
Partnership recorded its investment at the market value as of December 31, 1998
of $2.3 million ($3.25 per share) as compared to its cost basis of $1.0 million.
The Partnership recognized unrealized appreciation of $1.3 million as of this
date. Unrealized depreciation for the year ended December 31, 1997 was $4.9
million (see Results of Operations for the year ended December 31, 1997 as
compared to the year ended December 31, 1996).

      Expenses decreased from 1997 to 1998 primarily due to the write-off in
1997 of the Partnership's investment in Repligen Clinical Partners, L.P. with a
carrying value of $0.2 million which was determined to be worthless.

      Year ended December 31, 1997 compared to the year ended December 31, 1996:

      Net income for the years ended December 31, 1997 and 1996 was $5.9 million
and $39.5 million, respectively. The decrease of $33.6 million was a result of a
decrease in revenues of $34.5 million offset by a decrease in expenses of $0.9
million.

      Revenues for the years ended December 31, 1997 and 1996 were $6.3 million
and $40.8 million, respectively. The decrease in revenues of $34.5 million is
due to an unfavorable change in unrealized appreciation (depreciation) of
marketable securities and investments of $32.1 million and a decrease in gain on
sale of product development projects of $6.0 million offset by an increase in
realized gain on sale of marketable securities and investments of $2.7 million
and an increase in income from product development projects of $0.9 million.
Unrealized (depreciation) appreciation for the years ended December 31, 1997 and
1996 was $(4.9) million and $27.2 million, respectively. The Partnership
recognized unrealized depreciation of $4.9 million during 1997 primarily from
its investment in 0.815 million shares of Biocompatibles to reflect a decrease
in the market value from $13.94 per share at December 31, 1996 to $8.124 per
share at December 31, 1997. During 1996, in accordance with Statement No. 115,
the Partnership recorded its investment in 2.1 million restricted shares of
Biocompatibles at a market value of $29.3 million ($13.94 per share) as compared
to its cost basis of $2.1 million. Accordingly, the Partnership recognized
unrealized appreciation of $27.2 million for the year ended December 31, 1996.
Realized gain on sale of marketable securities and investments was $10.1
<PAGE>

(Item 7 Continued)

million for the year ended December 31, 1997, resulting from the sale by the
Partnership of 1.285 million shares of Biocompatibles with an aggregate carrying
value at December 31, 1996, of $17.9 million for proceeds of $28.0 million.
Realized gain on sale of marketable securities and investments for the year
ended December 31, 1996, was $7.4 million. During 1996, the Partnership sold its
investments of (i) 0.65 million shares of Biocompatibles for proceeds of $5.3
million with a carrying value of $4.8 million resulting in a gain of $0.5
million; (ii) 0.36 million shares of GelTex for proceeds of $6.8 million with a
carrying value of $4.4 million resulting in a gain of $2.4 million; (iii) 0.024
million shares of Alkermes for net proceeds of $0.3 million with a carrying
value of $0.2 million resulting in a gain of $0.1 million; and (iv) 0.3 million
shares of Elan Corporation, plc for proceeds of $8.3 million and a carrying
value of $6.1 million resulting in a gain of $2.2 million. In addition, the
Partnership sold its entitlement to Biocompatibles Rights for total proceeds of
$2.2 million and recognized a gain on the sale of this amount. During the year
ended December 31, 1997, the Partnership recognized income from product
development projects of $0.9 million resulting from its limited partnership
investment in Gensia Clinical Partners, L.P. ("GCP"). During 1997 the
Partnership received 0.13 million common shares of Gensia with a market value on
the date of distribution of $0.9 million as a payment made pursuant to certain
product agreements between Gensia Sicor, Inc. and GCP. In 1996, the Partnership
sold its rights, title and interest in its callable warrant to purchase 0.5
million shares of Athena as well as its various product program agreements with
Athena for a purchase price of $6.0 million and recognized a gain of this amount
from the sale.

      Expenses decreased from $1.3 million at December 31, 1996 to $0.4 million
at December 31, 1997, primarily as a result of the General Partner's decision to
discontinue charging a management fee to the Partnership.

Year 2000

      The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Calculations
performed with these abbreviated date fields may misinterpret the Year 2000 as
1900 resulting in erroneous calculations or program failures. Currently, the
Partnership utilizes computer programs, through services provided by a
third-party servicing agent, that can adversely affect the Partnership's
operations if they are not Year 2000 compliant. The servicing agent has informed
the Partnership that it is executing a plan to modify or replace significant
applications as necessary to ensure Year 2000 compliance. Programming changes
and initial testing were completed at year-end. Final testing is expected to be
completed by May 1999. Conversion of client databases will commence in May 1999.
The servicing agent has not quantified the extent to which their plan has been
completed to date. Incremental costs associated with the development and
implementation of the above plan have been, and will continue to be, borne by
the servicing agent.

      The status of the Partnership's investments in Sponsor Companies could be
adversely affected if the computer systems of the Sponsor Companies are not Year
2000 compliant. Based on the most recent available public disclosures of those
Sponsor Companies in which the Partnership has investments of value, the Sponsor
Companies have stated that they have undertaken programs to insure Year 2000
compliance. As of the dates of disclosure, these Sponsor Companies have stated
that they do not expect the Year 2000 Issue to adversely affect their future
financial condition. However, they cannot provide assurances that unanticipated
problems and costs will not arise. The success of Sponsor Companies in achieving
Year 2000 compliance cannot be adequately gauged at this time. To date, the
Partnership has no contingency plan in place but intends to evaluate in May 1999
the status of the Year 2000 Issue with third parties to determine whether such a
plan is necessary.

Item 8.  Financial Statements and Supplementary Data.

      The information in response to this item may be found under the following
captions included in this filing on Form 10-K:

         Report of Independent Auditors (Page F-4) 
         Statements of Financial Condition (Page F-5) 
         Statements of Operations (Page F-6) 
         Statements of Changes in Partners' Capital (Page F-6)
         Statements of Cash Flows (Page F-7) 
         Notes to Financial Statements (Pages F-8 to F-15)

Item 9.  Changes in and Disagreements with Accountants on Accounting and 
         Financial Disclosure.

      None.
<PAGE>

                                    PART III

Item 10. Directors and Executive Officers of the Registrant.

      The Registrant has no directors or executive officers. The Registrant is
managed by PWDC, which is the General Partner of the Partnership.

      Pursuant to the Management Contract, the General Partner is responsible
for the management and administrative services necessary for the operation of
the Partnership. Based in part on discussions with the Advisory Board, the
General Partner assesses and manages the Partnership's Projects. As part of its
ongoing role in all Projects, the General Partner participates as a member of
the board of directors of the corporate general partner of certain Projects or
similar body with the Sponsor Companies with overall responsibility for each
Project during the development phase. The General Partner makes regular visits
to the facilities of Sponsor Companies in order to monitor the progress of
Projects, and its representatives take part in important decisions with respect
to development and commercial strategies. During the commercialization phase,
the General Partner continues to review the Sponsor Companies' performance. In
addition, the General Partner monitors the industries in which it undertakes
Projects by attending trade shows, screening trade journals and reviewing
changes in legislative and regulatory conditions.

      The following table sets forth certain information with respect to the
persons who are directors and executive officers of the General Partner as of
December 31, 1998:

            Name                  Age          Position and Date Appointed
-----------------------------     ---    ---------------------------------------
Directors
     Dhananjay M. Pai             36     Director since December 1996
     Gerald F. Goertz, Jr.        41     Director since April 1995
     William J. Nolan             51     Director since February 1997

Executive Officers
     Dhananjay M. Pai             36     President since December 1996
     William J. Nolan             51     Treasurer since February 1997
     Dorothy F. Haughey           74     Secretary since July 1985 

      The directors have a one-year term of office. The officers are elected by
a majority of the directors and hold office until their successors are chosen by
the directors.
<PAGE>

(Item 10 Continued)

Directors

      Mr. Pai is a Managing Director of PWI. Before joining the Principal
Transactions Group of PWI in 1990, Mr. Pai was a Vice President in the
Investment Banking Division of Drexel Burnham Lambert from 1988 to 1990. From
1983 to 1988, Mr. Pai held various positions within the Finance Division of
Drexel Burnham Lambert. Mr. Pai is a Director and President of PaineWebber
Capital, an Advisory Board Member of Rifkin Acquisition Partners LLLP, and
either a Director or Officer of certain affiliates of PWI. He holds a Bachelor
of Science degree from Wharton School of Business and a Master of Business
Administration from New York University.

      Mr. Goertz is a Senior Vice President and Director of Specialized
Investment Services of PWI. Prior to joining PWI in December 1990, Mr. Goertz
was with CG Realty Advisors and the Freeman Company. Mr. Goertz received his
Bachelor of Arts degree in Business Administration in 1979 from Vanderbilt
University and his Juris Doctorate and Master of Business Administration from
Memphis State University in 1982.

      Mr. Nolan is Treasurer of Paine Webber Group Inc. and Executive Vice
President and Treasurer of PWI. He is a member of PaineWebber's Asset/Liability
Management Committee. Prior to his employment with PWI in 1984, Mr. Nolan was
with Becker-Paribas and Bankers Trust Company. Mr. Nolan received a Bachelor of
Arts degree from Colgate University and a Master of Business Administration from
Stanford University Graduate School of Business.

Executive Officers

      Mr. Pai, President, see "Directors" above.

      Mr. Nolan, Treasurer, see "Directors" above.

      Ms. Haughey, Secretary, joined PWI in 1962. She is the Secretary of PWI.
<PAGE>

Item 11. Executive Compensation.

      No compensation was paid directly to executive officers of PWDC by the
Registrant. PWDC serves as General Partner for the Registrant, and pursuant to a
Management Contract, is entitled to receive an annual management fee for
management and administrative services provided to the Partnership. As of
January 1, 1997, the General Partner elected to discontinue the management fee
charged to the Partnership. See the section entitled "Related Party
Transactions" under the caption "Notes to Financial Statements" on pages F-8
through F-15 included in this filing on Form 10-K.

Item 12. Security Ownership of Certain Beneficial Owners and Management.

      None.

Item 13. Certain Relationships and Related Transactions.

      Information in response to this item may be found in the section entitled
"Related Party Transactions" under the caption "Notes to Financial Statements"
on pages F-8 through F-15 included in this filing on Form 10-K.
<PAGE>

                                     PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

      The following documents are filed as part of the filing on Form 10-K.

Financial Statements

      The financial statements, together with the report of Ernst & Young LLP,
are listed in the accompanying index to financial statements and notes to
financial statements appearing on page F-1.

         Report of Independent Auditors (Page F-4) 
         Statements of Financial Condition (Page F-5) 
         Statements of Operations (Page F-6) 
         Statements of Changes in Partners' Capital (Page F-6)
         Statements of Cash Flows (Page F-7) 
         Notes to Financial Statements (Pages F-8 to F-15)

Reports on Form 8-K

      None.
<PAGE>

                                   SIGNATURES


Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on this 31st day of March
1999.

         PAINEWEBBER R&D PARTNERS III, L.P.

         By: PaineWebber Development Corporation
             (General Partner)

         By: /s/ Dhananjay M. Pai
             --------------------
             Dhananjay M. Pai
             President and Principal Executive Officer

         By: /s/ Anthony M. DiIorio
             ----------------------
             Anthony M. DiIorio
             Principal Financial and Accounting Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated*, each on this 31st day of March 1999.

             /s/ Dhananjay M. Pai
             --------------------
             Dhananjay M. Pai
             President (principal executive officer) and Director


             /s/ William J. Nolan
             --------------------
             William J. Nolan
             Director


             /s/ Gerald F. Goertz, Jr.
             -------------------------
             Gerald F. Goertz, Jr.
             Director

* The capacities listed are with respect to PWDC, the General Partner of the
Registrant.
<PAGE>

                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (a Delaware Limited Partnership)

                          Index to Financial Statements

Description                                                         Page
-----------                                                         ----

Index to Financial Statements                                       F-1

Selected Financial Data                                             F-2

Quarterly Financial Information (Unaudited)                         F-3

Report of Independent Auditors                                      F-4

Statements of Financial Condition,
  at December 31, 1998 and 1997                                     F-5

Statements of Operations,
  for the years ended December 31, 1998, 1997 and 1996              F-6

Statements of Changes in Partners' Capital,
  for the years ended December 31, 1998, 1997 and 1996              F-6

Statements of Cash Flows,
  for the years ended December 31, 1998, 1997 and 1996              F-7

Notes to Financial Statements                                       F-8 to F-15


All schedules are omitted either because they are not applicable or the
information required to be submitted has been included in the financial
statements or notes thereto.

                                       F-1
<PAGE>

PAINEWEBBER R&D PARTNERS III, L.P.
(a Delaware Limited Partnership)

<TABLE>
<CAPTION>

Selected Financial Data
-----------------------------------------------------------------------------------------------------
Years ended December 31,            1998          1997          1996          1995          1994
-----------------------------------------------------------------------------------------------------
<S>                            <C>           <C>           <C>           <C>           <C>         
Operating Results:

   Revenues                    $ (1,331,137) $  6,351,971  $ 40,810,648  $ 14,856,172  $  3,751,749
   Net income (loss)           $ (1,500,762) $  5,930,581  $ 39,513,429  $  5,306,891  $ (7,819,966)

Net income (loss) per partnership unit:

   Limited partners (A)        $     (29.72) $     117.43  $     782.37  $     105.08  $    (154.84)
   General partner             $ (15,007.62) $  59,305.81  $ 395,134.29  $  53,068.91  $ (78,199.66)

Financial Condition:

   Total assets                $  9,169,050  $ 10,675,272  $ 32,633,103  $ 17,914,426  $ 19,508,779
   Partners' capital           $  9,094,845  $ 10,595,607  $ 32,442,803  $ 17,825,211  $ 17,872,217

Distributions to partners:
   Cash                        $          -  $ 27,777,777  $ 24,895,837  $  5,050,505  $          - 
   Alkermes, Inc. warrants
    (at intrinsic value) (B)   $          -  $          -  $          -  $    303,392  $          -
   Cephalon, Inc. warrants
    (at intrinsic value) (B)   $          -  $          -  $          -  $          -  $  3,121,642

-----------------------------------------------------------------------------------------------------
</TABLE>

(A) Based on 50,000 limited partnership units.
(B) The excess of market value per share at the date of distribution over the
    exercise price per share.

                                       F-2
<PAGE>

PAINEWEBBER R&D PARTNERS III, L.P.
(a Delaware Limited Partnership)

<TABLE>
<CAPTION>

Quarterly Financial Information (Unaudited)
---------------------------------------------------------------------------------------------------
                                                                       Net Income (Loss)
                                          Net Income                Per Partnership Unit (A)
                      Revenues              (Loss)             Limited Partners    General Partner
----------------------------------------------------------    -------------------------------------
<S>               <C>                <C>                  <C>                   <C>             
 Calendar 1998

 4th Quarter      $      317,820     $        266,757     $              5.27   $       2,667.57

 3rd Quarter           1,707,607            1,669,150                   33.05          16,691.50

 2nd Quarter            (344,621)            (386,987)                  (7.66)         (3,869.87)

 1st Quarter          (3,011,943)          (3,049,682)                 (60.38)        (30,496.82)

---------------------------------------------------------------------------------------------------

 Calendar 1997

 4th Quarter      $   (1,756,963)     $    (2,052,718)     $           (40.64)  $     (20,527.18)

 3rd Quarter          (8,334,209)          (8,374,462)                (165.81)        (83,744.62)

 2nd Quarter           5,755,092            5,711,687                  113.09          57,116.87

 1st Quarter          10,688,051           10,646,074                  210.79         106,460.74

---------------------------------------------------------------------------------------------------

Calendar 1996

 4th Quarter      $   14,014,291      $    13,844,845      $           274.14   $     138,448.45

 3rd Quarter           2,874,006            2,702,018                   53.50          27,020.18

 2nd Quarter          17,562,388           17,134,012                  339.25         171,340.12

 1st Quarter           6,359,963            5,832,554                  115.48          58,325.54

---------------------------------------------------------------------------------------------------
</TABLE>

(A) Based on 50,000 partnership units and a 1% general partnership interest.

                                       F-3
<PAGE>

Report of Independent Auditors


To the Partners of PaineWebber R&D Partners III, L.P.

We have audited the accompanying statements of financial condition of
PaineWebber R&D Partners III, L.P. as of December 31, 1998 and 1997, and the
related statements of operations, changes in partners' capital, and cash flows
for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Partnership's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of PaineWebber R&D Partners III,
L.P. at December 31, 1998 and 1997, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.


/s/ Ernst & Young LLP
---------------------
Ernst & Young

New York, New York
March 20, 1999

                                       F-4
<PAGE>

PAINEWEBBER R&D PARTNERS III, L.P.
(a Delaware Limited Partnership)

Statements of Financial Condition

                                               December 31,      December 31,
                                                       1998              1997
--------------------------------------------------------------------------------
Assets:

     Marketable securities, at market value    $  9,147,266      $  8,479,372

     Investments, at fair value                           -         2,150,000

     Advances to product development projects        21,784            35,972

     Royalty income receivable                            -             9,928

                                                -----------       -----------
Total assets                                   $  9,169,050      $ 10,675,272
                                                ===========       ===========

Liabilities and partners' capital:

     Accrued liabilities                       $     74,205      $     76,052

     Payable to Paine Webber Development Corp.            -             3,613
                                                -----------       -----------

                                                     74,205            79,665

     Partners' capital                            9,094,845        10,595,607

                                                -----------       -----------
Total liabilities and partners' capital        $  9,169,050     $  10,675,272
                                                ===========       ===========
--------------------------------------------------------------------------------
See notes to financial statements.

                                       F-5
<PAGE>

PAINEWEBBER R&D PARTNERS III, L.P.
(a Delaware Limited Partnership)

Statements of Operations
<TABLE>
<CAPTION>
For the years ended December 31,                       1998              1997               1996
------------------------------------------------------------------------------------------------
<S>                                            <C>               <C>                <C>         
Revenues:
     Interest income                           $     59,496      $    176,464       $    170,677
     Income from product development projects       598,750           946,778             19,500
     Unrealized (depreciation) appreciation of
       marketable securities and investments     (1,989,383)       (4,876,389)        27,169,770
     Realized gain from sale of product 
       development project                                -                 -          6,000,000
     Net realized gain on sale of marketable
       securities and investments                         -        10,105,118          7,450,701
                                                -----------       -----------        -----------
                                                 (1,331,137)        6,351,971         40,810,648
                                                -----------       -----------        -----------
Expenses:
     Expenditures under product development 
       projects                                      24,116           262,002            528,193
     Management fee                                       -                 -            569,334
     General and administrative costs               145,509           159,388            189,072
     Amortization of organization costs                   -                 -             10,620
                                                -----------       -----------        -----------
                                                    169,625           421,390          1,297,219
                                                -----------       -----------        -----------

Net income (loss)                              $ (1,500,762)     $  5,930,581       $ 39,513,429
                                                ===========       ===========        ===========

Net income (loss) per partnership unit:
     Limited partners (based on 50,000 units)  $     (29.72)     $     117.43       $     782.37
     General partner                           $ (15,007.62)     $  59,305.81       $ 395,134.29

------------------------------------------------------------------------------------------------


Statements of Changes in Partners' Capital
                                                  
For the years ended December 31, 1998, 1997       Limited           General
and 1996                                          Partners          Partner             Total  
------------------------------------------------------------------------------------------------
Balance at January 1, 1996                     $ 17,648,545      $    176,666       $ 17,825,211

Cash distributions to partners                  (24,650,000)         (245,837)       (24,895,837)
Net income                                       39,118,295           395,134         39,513,429
                                                -----------       -----------        -----------

Balance at December 31, 1996                     32,116,840           325,963         32,442,803

Cash distributions to partners                  (27,500,000)         (277,777)       (27,777,777)
Net income                                        5,871,275            59,306          5,930,581
                                                -----------       -----------        -----------

Balance at December 31, 1997                     10,488,115           107,492         10,595,607

Net loss                                         (1,485,754)          (15,008)        (1,500,762)
                                                -----------       -----------        -----------

Balance at December 31, 1998                   $  9,002,361     $      92,484       $  9,094,845
                                                ===========       ===========        ===========
------------------------------------------------------------------------------------------------
See notes to financial statements.
</TABLE>
                                       F-6
<PAGE>

PAINEWEBBER R&D PARTNERS III, L.P.
(a Delaware Limited Partnership)

Statements of Cash Flows

<TABLE>
<CAPTION>
For the years ended December 31,                       1998              1997               1996
------------------------------------------------------------------------------------------------
<S>                                            <C>               <C>                <C>         
Cash flows from operating activities:
Net income (loss)                              $ (1,500,762)     $  5,930,581       $ 39,513,429
Adjustments to reconcile net income (loss) to
  cash provided by operating activities:
  Amortization of organization costs                      -                 -             10,620
  Unrealized depreciation (appreciation)
   of marketable securities and investments       1,989,383         4,876,389        (27,169,770)

(Increase) decrease in operating assets:
  Marketable securities                            (507,277)       16,829,368            517,023
  Investments                                             -                 -         11,264,892
  Interest receivable                                     -                 -             37,739
  Advances to product development projects           14,188           262,002            528,193
  Royalty income receivable                           9,928            (9,928)                 -
  Other assets                                            -                 -             35,723

(Decrease) increase in operating liabilities:
  Payable to PaineWebber Development Corporation     (3,613)                -             (2,108)
  Accrued liabilities                                (1,847)          (23,368)            15,926
  Other liability                                         -           (87,267)            87,267
                                                -----------       -----------        -----------
Cash provided by operating activities                     -        27,777,777         24,838,934
                                                -----------       -----------        -----------

Cash flows from financing activities:
  Distributions to partners                               -       (27,777,777)       (24,895,837)
                                                -----------       -----------        -----------

Decrease in cash                                          -                 -            (56,903)

Cash at beginning of period                               -                 -             56,903
                                                -----------       -----------        -----------

Cash at end of period                          $          -      $          -       $          -
                                                ===========       ===========        ===========

--------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
The Partnership paid no cash for interest or taxes during the years ended
December 31, 1998, 1997 and 1996.
--------------------------------------------------------------------------------
</TABLE>

                                       F-7
<PAGE>

                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (a Delaware Limited Partnership)

                          NOTES TO FINANCIAL STATEMENTS


1.    Organization and Business

      PaineWebber R&D Partners III, L.P. (the "Partnership") is a Delaware
limited partnership that commenced operations on June 3, 1991. Paine Webber
Development Corporation ("PWDC" or the "General Partner"), an indirect,
wholly-owned subsidiary of Paine Webber Group Inc., is the general partner and
manager of the Partnership. The Partnership will terminate on December 15, 2015,
unless its term is extended or reduced by the General Partner.

      The principal objective of the Partnership has been to provide long-term
capital appreciation to investors through investing in the development and
commercialization of new products with technology and biotechnology companies
("Sponsor Companies"), which have been expected to address significant market
opportunities. The Partnership has been engaged in diverse product development
projects (the "Projects") including product development contracts, participation
in other partnerships and investments in securities of Sponsor Companies. Once
the product development phase has been completed, the Sponsor Companies have the
option to license and commercialize the products resulting from the product
development project, and the Partnership has the right to receive payments based
upon the sale of such products. The Partnership obtained warrants to purchase
the common stock of Sponsor Companies to provide additional capital appreciation
to the Partnership which was not directly dependent upon the outcome of the
Projects (see Note 5).

                                       F-8
<PAGE>

                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (a Delaware Limited Partnership)

                          NOTES TO FINANCIAL STATEMENTS

(Note 1 Continued)

      All distributions from the Partnership to the General Partner and the
limited partners of the Partnership (the "Limited Partners"; collectively, the
"Partners") have been made pro rata in accordance with their respective capital
contributions. The table below sets forth the proportion of each distribution to
be received by the Limited Partners and the General Partner, respectively:

<TABLE>
<CAPTION>
                                                                                 Limited    General
                                                                                 Partners   Partner
                                                                                 --------   -------
<S>                                                                              <C>        <C>
    I.         Until the value of the aggregate distributions for each
               limited partnership unit ("Unit") equals $1,000 plus simple
               interest on such amount accrued at 5% per annum
               ("Contribution Payout"); At December 31, 1998, Contribution
               Payout was $1,375 per Unit .....................................    99%         1%

    II.        After Contribution Payout and until the value of the
               aggregate distributions for each Unit equals $5,000 ("Final
               Payout")........................................................    80%        20%

    III.       After Final Payout..............................................    75%        25%
</TABLE>

      During the year ended December 31, 1998, the Partnership made no cash or
security distributions. At December 31, 1998, the Partnership has made cash and
security distributions, as valued on the dates of distribution, since inception
of $1,143 and $98 per Unit, respectively.

      Profits and losses of the Partnership are allocated as follows: (i) until
cumulative profits and losses for each Unit equals Contribution Payout, 99% to
Limited Partners and 1% to the General Partner, (ii) after Contribution Payout
and until cumulative profits and losses for each unit equals Final Payout, 80%
to Limited Partners and 20% to the General Partner, and (iii) after Final
Payout, 75% to Limited Partners and 25% to the General Partner. As of December
31, 1998, the cumulative profits of the Partnership were $558 per Unit.

2.    Summary of Significant Accounting Policies

      The financial statements are prepared in conformity with generally
accepted accounting principles which require management to make certain
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Such estimates and assumptions include the
carrying value of non-marketable securities. Actual results could differ from
those estimates.

      In accordance with the provisions of Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("Statement No. 115"), the Partnership accounts for its investments
in restricted common stock (where the restriction period expires in one year or
less) at market value with unrealized gains and losses reflected in the
Statements of Operations during the period in which the change in value occurs.
Investments in restricted common stock, whereby the restriction period exceeds
one year, are accounted for at the lower of cost or fair value.

                                       F-9
<PAGE>

                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (a Delaware Limited Partnership)

                          NOTES TO FINANCIAL STATEMENTS

(Note 2 Continued)

      Marketable securities consist of a money market fund and common stock
which are recorded at market value. Marketable securities are not considered
cash equivalents for the Statements of Cash Flows.

      The Partnership's investments in stock of non-public companies are subject
to fluctuations in value dependent on the underlying value of the issuing
company. Non-publicly traded securities are valued at cost. The carrying value
of these securities is adjusted when changes in their fair values are readily
ascertainable. Downward adjustments relating to such securities are made in the
event that the value as determined by the General Partner's evaluations of the
project technology or Sponsor Company is deemed less than the carrying value.
These evaluations of value are made based on currently available information and
may not necessarily represent the amount, if any, which may ultimately be
realized.

      Realized and unrealized gains or losses are determined on a specific
identification method and are reflected in the Statements of Operations during
the period in which the change in value occurs.

      The Partnership invests in product development contracts with Sponsor
Companies either directly or through product development limited partnerships.
The Partnership expenses product development costs when incurred by the Sponsor
Companies and such costs are reflected as expenditures under product development
projects in the accompanying Statements of Operations. Income received and/or
accrued from investments in Projects is reflected in the Statements of
Operations for the period in which the income is earned.

      The Partnership's warrants are currently exercisable and the Sponsor
Company's stock is publicly traded, therefore, the warrants are carried at
intrinsic value (the excess of market price per share over the exercise price
per share), which approximates fair value.

                                      F-10
<PAGE>

                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (a Delaware Limited Partnership)

                          NOTES TO FINANCIAL STATEMENTS

3.    Marketable Securities and Investments

      Marketable Securities

      The Partnership held the following marketable securities at:

<TABLE>
<CAPTION>
                                                     December 31, 1998                    December 31, 1997
                                             ---------------------------------    ---------------------------------
                                                 Carrying                             Carrying
                                                  Value              Cost              Value              Cost 
                                             ---------------   ---------------    ---------------   ---------------
<S>                                          <C>               <C>                <C>               <C>          
Money market fund                             $   1,565,184     $   1,565,184      $   1,057,907     $   1,057,907

Biocompatibles International plc
   (815,000 common shares)                        1,162,957           815,000          6,620,596           815,000

Gensia Sicor, Inc.
   (137,772 common shares)                          624,280           936,850            800,869           936,850

Genzyme Molecular Oncology
   (713,091 common shares)                        2,317,546         1,000,000               ----              ----

Medarex, Inc.
   (281,708 restricted common shares)               853,927              ----                  0              ----
   (441,207 unrestricted common shares)           1,337,409              ----                  0              ----

Pharming Group N.V.
   (129,555 ordinary shares)                      1,285,963         3,500,000               ----              ----
                                             ---------------   ---------------    ---------------   ---------------
                                              $   9,147,266     $   7,817,034      $   8,479,372     $   2,809,757
                                             ==============    ===============    ===============   ===============
</TABLE>

      Biocompatibles International plc ("Biocompatibles") is a development stage
company engaged in the research, development and commercialization of coatings
and new materials which reduce compatibility problems associated with certain
medical devices. The market value of the shares at December 31, 1998, was $1.427
per share as compared to $8.124 per share at December 31, 1997. Accordingly, the
Partnership recognized unrealized depreciation on its investment of 815,000
shares for the year ended December 31, 1998, of $5,457,916. During the year
ended December 31, 1997, the Partnership sold 1,285,000 shares of Biocompatibles
with a carrying value as of December 31, 1996 of $17,912,749 ($13.94 per share)
for total proceeds of $28,017,867. Accordingly, the Partnership recognized a
gain for the year ended December 31, 1997 of $10,105,118. The remaining
investment of 815,000 shares was recorded at the market value of $8.124 per
share as of December 31, 1997, and the Partnership recognized unrealized
depreciation on these shares for the year then ended of $4,740,408. At December
31, 1996, in accordance with Statement No. 115, the Partnership recorded its
investment of 2,100,000 restricted shares of Biocompatibles at the market value
of $13.94 per share as compared to a carrying value of $1.00 per share.
Accordingly, the Partnership recognized unrealized appreciation of $27,173,754
for the year then ended. In 1996, the Partnership sold 650,000 unrestricted
shares of Biocompatibles for proceeds of $5,291,129 (average price per share of
$8.14). The carrying value as of December 31, 1995 of the shares was $4,793,750
($7.375 per share). Accordingly, the Partnership recognized a realized gain of
$497,379. In connection with a Rights Issue by Biocompatibles in April 1996, the
Partnership was entitled to purchase one right for every six shares owned
(aggregating 458,333 Rights). In May 1996, the Partnership sold its entitlement
to the Rights at a price of (pound)1.25 per Right. The

                                      F-11
<PAGE>

                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (a Delaware Limited Partnership)

                          NOTES TO FINANCIAL STATEMENTS

(Note 3 Continued)

Partnership received aggregate proceeds, net of commissions of $865,798
((pound)571,484) and recognized a gain of this amount from the sale for the year
ended December 31, 1996. A second Rights Issue by Biocompatibles in November
1996 entitled the Partnership to purchase four Rights for every 23 shares owned
(aggregating 365,217 Rights). In December 1996, the Partnership sold its
entitlement to the rights at a price of (pound)2.20 per Right for aggregate
proceeds, net of commissions, of $1,339,815 ((pound)803,477). The Partnership
recognized a gain of this amount for the year ended December 31, 1996.

      During 1997, the Partnership received 137,772 common shares of Gensia
Sicor, Inc. ("Gensia") with a market value on the date of distribution of $6.80
per share as a distribution from its limited partnership investment in Gensia
Clinical Partners, L.P. ("GCP"). As of December 31, 1997 and 1998, the market
value of Gensia shares was $5.813 per share and $4.53125 per share. The
Partnership recognized unrealized depreciation for the years ended December 31,
1997 and 1998 of $135,981 and $176,589, respectively.

      In November 1998, Genzyme Molecular Oncology ("GMO") commenced trading on
the Nasdaq National Market. The Partnership reclassified its investment of
713,091 non-publicly traded common shares from investments to marketable
securities and recorded the investment at its market value of $2,317,545 ($3.25
per share) at December 31, 1998 as compared to a carrying value at December 31,
1997 of $1,000,000. The Partnership recognized unrealized appreciation of
$1,317,545 for the year ended December 31, 1998.

      In 1997, upon the acquisition of GenPharm International, Inc. ("GenPharm")
by Medarex, Inc. ("Medarex"), the Partnership's investment of 1,000,000 GenPharm
convertible preferred shares was converted to 281,708 restricted shares of
Medarex. The Partnership (as a former GenPharm shareholder) also received
certain contingent payment rights (the "Rights") entitling the Partnership to
additional Medarex shares to be received prior to December 31, 1998. The Medarex
shares received in 1997 are saleable on or after January 1, 1999. In accordance
with Statement No. 115, in 1998 the Partnership reclassified the securities from
investments (where they had been recorded at a zero value) to marketable
securities since the restriction period was less than one year and recorded its
investment in the Medarex shares at market value. The market value of the shares
at December 31, 1998, was $853,927 ($3.03125 per share). Accordingly, the
Partnership recognized unrealized appreciation of this amount for the year then
ended. In July 1998, pursuant to an Offer to Purchase by a third party, the
Partnership partially assigned its interest in the Rights for cash proceeds of
$598,750 and recognized income from the sale of this amount for the year ended
December 31, 1998. In September 1998, the Partnership received 441,207
unrestricted Medarex shares in connection with its remaining interest in the
Rights. The Partnership recorded the shares as of December 31, 1998, at the
aggregate market value of $1,337,409 and recognized unrealized appreciation of
this amount for the year ended December 31, 1998.

      A restructuring by GenPharm in 1995 resulted in the spin-off of its
European subsidiary, Pharming BV. In connection with this spin-off, the
Partnership (as a shareholder of GenPharm) received 14,395 shares of Pharming BV
Class A restricted stock which the General Partner valued at $1,150,000 based on
the current and future financial prospects of Pharming BV at that time. In
connection with an initial public offering in July 1998, the company was renamed
Pharming Group N.V. ("Pharming") and the

                                      F-12
<PAGE>

                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (a Delaware Limited Partnership)

                          NOTES TO FINANCIAL STATEMENTS

(Note 3 Continued)

Partnership's investment was converted into 129,555 ordinary shares (after a 9:1
stock split). The shares are not salable until January 1, 1999. In accordance
with Statement No. 115, in 1998 the Partnership reclassified the securities from
investments to marketable securities. At December 31, 1998, the market value of
the investment was 1,285,963 and accordingly the Partnership recognized
unrealized appreciation of $135,963.

Investments

      The Partnership held the following investments at:

<TABLE>
<CAPTION>
                                                     December 31, 1998                    December 31, 1997
                                             ---------------------------------    ---------------------------------
                                                 Carrying                             Carrying
                                                  Value              Cost              Value              Cost 
                                             ---------------   ---------------    ---------------   ---------------
<S>                                          <C>               <C>                <C>               <C>          
Genzyme Molecular Oncology Division
   713,091 restricted common shares           $        ----     $        ----      $   1,000,000     $   1,000,000

Medarex, Inc.
   281,708 restricted common shares                    ----              ----                  0              ----

Pharming BV
   14,395 restricted shares of Class A
   stock (see Marketable Securities)                   ----              ----          1,150,000         3,500,000
                                             ---------------   ---------------    ---------------   ---------------
                                              $        ----     $        ----      $   2,150,000     $   4,500,000
                                             ===============   ===============    ===============   ===============
</TABLE>

      In 1997, upon the acquisition by Genzyme Corporation ("Genzyme") of
PharmaGenics, Inc. ("PharmaGenics") to form GMO, the Partnership's total
investment in PharmaGenics preferred shares was converted into 713,091
restricted common shares of GMO, subject to certain adjustments. GMO common
stock was not publicly traded at that time; therefore, the Partnership recorded
its investment in GMO stock at the carrying value attributable to its original
investment in PharmaGenics preferred stock of $1,000,000. As of December 31,
1998, the Partnership reclassified its investments in GMO, Medarex and Pharming
to marketable securities (see section entitled "Marketable Securities").

      In 1996, the Partnership sold its investment of 357,233 common shares of
GelTex Pharmaceuticals Inc. for proceeds of $6,805,351 (average price per share
of $19.05). The Partnership recorded the shares at December 31, 1995, at their
market value of $4,376,104 ($12.25 per share). Accordingly, the Partnership
recognized a gain of $2,429,247 for the year ended December 31, 1996. In 1996,
the Partnership exercised a warrant to purchase 295,600 shares of Elan
Corporation, plc at an aggregate exercise price of $4,099,972 ($13.87 per share)
and subsequently sold the shares for proceeds of $8,320,588 (average price per
share of $28.15). The Partnership recognized a gain of $2,195,616 upon the sale
for the year ended December 31, 1996.

                                      F-13
<PAGE>

                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (a Delaware Limited Partnership)

                          NOTES TO FINANCIAL STATEMENTS

4.    Related Party Transactions

      The General Partner is entitled to receive an annual management fee for
management and administrative services provided to the Partnership. As of
January 1, 1997, the General Partner elected to discontinue the management fee
charged to the Partnership. The management fee paid to the General Partner for
the year ended December 31, 1996 was $569,334.

      The money market fund invested in by the Partnership is managed by an
affiliate of PaineWebber Incorporated ("PWI").

      PWDC and PWI, and its affiliates, have acted in an investment banking
capacity for several of the Sponsor Companies. In addition, PWDC and its
affiliates have direct limited partnership interests in some of the same product
development limited partnerships as the Partnership.

5.    Product Development Projects

      Of the Partnership's seven original Projects, the following two Projects
are currently active: a $6.0 million investment in Alkermes Clinical Partners,
L.P., a $46.0 million limited partnership formed to fund the development,
clinical testing, manufacturing and marketing of Receptor-Mediated
Permeabilizers for use in the treatment of diseases of the brain and central
nervous system by enabling the delivery of drugs across the blood brain barrier;
and a $6.0 million investment in Cephalon Clinical Partners, L.P., a $45.0
million limited partnership formed to fund the development, clinical testing,
manufacturing and marketing of Myotrophin(TM) for use in the treatment of
amyotrophic lateral sclerosis and certain other peripheral neuropathies.

      Pursuant to certain product agreements between GCP and Gensia, Gensia was
required to remit a milestone payment to GCP upon the approval of the GenESA(TM)
System by the U.S. Food and Drug Administration. Such approval was received in
September 1997 and, as part of the agreements, Gensia remitted payment to GCP in
shares of Gensia common stock. The Partnership, as a limited partner in GCP,
received 137,772 shares of Gensia with a market value on the date of
distribution of $6.80 per share and, accordingly recognized income from product
development projects in the amount of $936,850 for the year ended December 31,
1997 (see Note 3 - Marketable Securities).

      On May 31, 1996, the Partnership sold, transferred and assigned its
rights, title, an interest in the callable warrant to purchase 500,000 shares of
Athena Neurosciences, Inc. ("Athena") as well as its various program agreements
with Athena for the development of Diastat(R) for a purchase price of $6,000,000
and recognized a gain of this amount from the sale of this product development
project for the year ended December 31, 1996.

If the Projects produce any product for commercial sale, the Sponsor Companies
have the option to license the Partnership's technology to manufacture and
market the products developed. In addition, the Sponsor Companies have the
option to purchase the Partnership's interest in the technology. In
consideration for granting such purchase options, the Partnership has received
warrants to purchase shares of common stock of certain of the Sponsor Companies.
At December 31, 1998, the Partnership owned warrants to purchase 133,000 shares
and 252,700 shares of Repligen Corporation at an exercise price of $2.50 per
share and $3.50 per share, respectively. The exercise period expires March 2001.
The market price of Repligen Corporation stock at December 31, 1998 was $1.28125
per share. The Partnership's warrant to purchase 35,512 shares of Cayenne
Software, Inc. at an exercise price of $25.91 per share expired in July 1998.
The Partnership did not exercise the warrant since, during the exercise 

                                      F-14
<PAGE>

                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (a Delaware Limited Partnership)

                          NOTES TO FINANCIAL STATEMENTS

(Item 5 Continued)

period, the market price of the stock never exceeded the exercise price.

      Upon the exercise by the Partnership of its exchange option with
PharmaGenics in 1997, the Partnership's warrant to purchase 1,000,000 shares of
PharmaGenics at an exercise price of $2.15 per share was terminated. In
addition, the Partnership's purchase option warrant to purchase 666,667
PharmaGenics' shares was canceled upon the closing of the acquisition of
PharmaGenics by Genzyme.

6.    Income Taxes

      The Partnership is not subject to federal, state or local income taxes.
Accordingly, the individual partners are required to report their distributive
share of realized income or loss on their individual federal and state income
tax returns.

                                      F-15