PAINEWEBBER R&D PARTNERS II LP, 10-K, 1998-03-31

PAINEWEBBER R&D PARTNERS II LP
10-K, 1998-03-31
COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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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, 1997
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 33-14582
PAINEWEBBER R&D PARTNERS II, 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

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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:

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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 8,257 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 [ ]

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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 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 II, L.P. (the "Partnership" or "Registrant") is a
Delaware limited partnership that commenced operations on September 30, 1987.
PWDC Holding Company (the "Manager") is the general partner of PaineWebber
Technologies II, L.P. (the "General Partner"), which is the general partner of
the Partnership. PWDC Holding Company is a wholly-owned subsidiary of Paine
Webber Development Corporation ("PWDC"), an indirect, wholly-owned subsidiary of
Paine Webber Group Inc. ("PWG"). The principal objective of the Partnership is
to provide long-term capital appreciation to investors through investing in the
development and commercialization of new products (the "Projects") with
technology companies ("Sponsor Companies") which are expected to address
significant market opportunities. The Partnership will terminate on December 31,
2012, unless its term is extended or reduced by the General Partner.

The Partnership has completely funded its ten Projects at an aggregate
investment of $65.2 million. During the year ended December 31, 1997, the
Partnership had ongoing Projects with Centocor, Inc., Genzyme Corporation and
Amgen Boulder, Inc. (formerly, Synergen, 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 investments in Projects, as of
December 31, 1997, the Partnership owned marketable securities as described in
Note 3 of the "Notes to the Financial Statements" on pages F-9 through F-16
included in this filing on Form 10-K.

At a meeting of the Board of Directors of PWDC in January 1997, the Policy
Regarding Requests for Partner Lists attached as Exhibit C was adopted for the
Partnership.

PARTNERSHIP MANAGEMENT

The Partnership has contracted with the Manager, 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 Manager, 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). Fees and expenses of the Advisory Board are paid for by PWDC.

Under the Management Contract, the Manager is entitled to receive an
annual management fee for management and administrative services provided to the
Partnership calculated pursuant to the provisions of the Management Contract. As
of July 1, 1996, the Manager elected to discontinue charging the management fee
for services rendered to the Partnership.

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 net capital contributions. The
following table sets forth the proportion of each distribution to be received by
the Limited Partners and the General Partner, respectively:

<PAGE>

(ITEM 1 CONTINUED)
<TABLE>
<CAPTION>

Limited General
Partners Partner
-------- -------
<S> <C> <C>
I. Until the value of the aggregate distributions for each
limited partnership unit ("Unit") equals $10,000 plus
simple interest on such amount accrued at 7% per annum for
each Unit sold at the Initial Closing (6% per annum for
each subsequent Unit sold up to the 5,000th Unit and 5%
per annum for each Unit sold thereafter) ("Contribution
Payout"). At December 31, 1997, Contribution Payout
ranged from $14,250 per Unit to $17,175 per
Unit............................................................ 99% 1%

II. After Contribution Payout and until the value of the
aggregate distributions for each Unit equals $50,000
("Final Payout")................................................ 80% 20%

III. After Final Payout.............................................. 75% 25%

</TABLE>

At December 31, 1997, the Partnership has made cash and security
distributions, as valued on the dates of distribution, since inception of $2,576
and $7,206 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, 1997, the cumulative losses for the Partnership were $1,919 per Unit.

OTHER

On August 15, 1997, BioRoyalties, L.L.C., on behalf of Pharmaceutical
Royalties, L.L.C. and Pharmaceutical Royalty Investments Ltd., commenced a
tender offer to purchase any and all Units at a cash price per Unit of $3,650,
subject to reduction for certain distributions (as thereafter amended, the
"Tender Offer"). Holders of 856.5 Units (representing approximately 10.4% of the
total Units) tendered their interests pursuant to the Tender Offer.

At December 31, 1997, the Partnership and the General Partner had no
employees, and PWDC Holding Company, the general partner of 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.

ACTION AGAINST CENTOCOR, INC.

As previously disclosed on the Partnership's Form 10-K for the year ended
December 31, 1996, the Partnership commenced a derivative action in the Chancery
Court of Delaware (the "Court") in July 1995 against Centocor, Inc. ("Centocor")
and Centocor Development Corporation III ("CDC III"), a wholly-owned subsidiary
of Centocor, arising from certain agreements entered into by Centocor and Eli
Lilly & Company ("Lilly") in July 1992.

In 1987 and 1988, the Partnership and others purchased limited partnership
interests in Centocor Partners III, L.P. ("CP III"), a limited partnership of
which CDC III is the general partner, which was established to develop and sell
CentoRx, a Centocor drug now known as ReoPro.

In July 1992, Centocor entered into a set of agreements with Lilly for the
stated purposes of Lilly making an equity investment in Centocor and furthering
the testing and eventual distribution of Centoxin, another Centocor drug.
Pursuant to those agreements, Lilly paid Centocor a total of $100 million and
Centocor conveyed to Lilly, among other things, two million shares of Centocor
common stock, exclusive marketing rights to Centoxin and an option to acquire
exclusive marketing rights to ReoPro. In 1993, Lilly became the distributor of
ReoPro.

The Partnership's complaint alleges, among other things that: at least $25
million of the $100 million paid by Lilly represents profits from the sale of
ReoPro that Centocor is required to share with CP III; and because of the Lilly
transaction, Centocor was required to increase the percentages of profits and
revenues from ReoPro that it pays to CP III investors. Centocor, however, had
taken the position that only $500,000 of the $100 million must be shared with CP
III and that Centocor had no obligation to increase the percentages of ReoPro
profits and revenues that it pays to CP III investors. The Partnership sought to
proceed on behalf of CP III. The complaint seeks to require Centocor and CDC III
to pay damages to CP III and to increase the percentages of future ReoPro
profits and revenues that Centocor must pay to CP III and its investors.

Centocor answered the Partnership's complaint, as well as a similar
complaint filed by John E. Abdo, another limited partner of CP III, denying the
material allegations of those complaints and asserting purported affirmative
defenses, and third-party claims against PWG, PWDC and PaineWebber Incorporated
("PWI").

In April 1996, Mr. Abdo moved to amend his complaint to assert claims on
behalf of CP III against two of PWDC's nominees to the CDC III Board of
Directors. In July 1996, counsel chosen by Centocor to represent CP III moved to
disqualify the Partnership from serving as a plaintiff in this action, alleging
that Mr. Abdo should be the sole plaintiff because the Partnership has conflicts
of interest with CP III and its other limited partners, including conflicts
arising out of the alleged claims against the PWDC nominees. Mr. Abdo and
Centocor also moved to disqualify the Partnership. In January 1997, the Court
granted Mr. Abdo's motion to amend his complaint to assert claims against the
PWDC nominees. The Court has not ruled on the motions to disqualify.

In June 1997, the parties to the Partnership's action entered into an
agreement to settle the action. The agreement provides, among other things, for
Centocor to pay to CP III investors (including the Partnership, a former limited
partner in CP III) in the aggregate: $10.8 million, net of attorneys' fees and
expenses as may be awarded by the Court; an additional $5.0 million, if and when
cumulative world-wide sales of ReoPro exceed $600 million; and possible
additional payments totaling $2.2 million, depending upon regulatory
developments in Japan. The Partnership will only receive its allocable share of
these amounts if, and when, payments under the agreement are remitted by
Centocor.

<PAGE>

(ITEM 3 CONTINUED)

end-sale revenues, 3.25% of such revenues above $175 million, and 3.25% of
foreign end-sales revenues. For 1999 through 2007, Centocor would pay an
aggregate of 6.5% of the first $250 million of United States end-sale revenues,
4% of such revenues above $250 million, and 3.25% of foreign end-sales revenues.
Depending upon the future success of ReoPro, PWDC believes that the adjustments
may result in an increase over what Centocor would have paid in the absence of
the litigation and settlement. In any event, the agreement provides that
investors will not receive less than Centocor would otherwise have paid based on
Centocor's sales of ReoPro.

On June 27, 1997, the Court entered an order: preliminarily approving the
settlement; providing for notice to a class consisting of all holders of CP III
Class A and C limited partnership interests as of the close of business on
January 31, 1997, and all holders of CP III Class B limited partnership
interests as of the close of business on May 31, 1997, and their transferees,
successors, and assigns, other than defendants; and designating the
Partnership's counsel as counsel for the class.

Mr. Abdo and Pharmaceutical Partners, L.P., another former limited partner
of CP III, have objected to the proposed settlement. They have asserted, among
other things, that the consideration is inadequate and that the proposed
allocations of the consideration among the classes of former limited partners of
CP III improperly favors the Partnership. On September 4, 1997, the Court held a
hearing on the objections and reserved decision.

PWDC has been advancing, and may continue to advance, the funds necessary
to pay the Partnership's legal fees and expenses relating to this litigation. In
the event of a recovery on behalf of CP III, the Court may award legal fees and
expenses to the Partnership's counsel, and/or Mr. Abdo's counsel, to be paid out
of the CP III recovery. Counsel for the Partnership has stated that they intend
to apply to the Court for an award of fees and expenses in an amount up to $1.5
million. Counsel for Mr. Abdo has stated that he intends to object to any such
application, and, if the settlement is approved, will himself apply for an award
of fees and expenses. It is anticipated that: the net proceeds of any recovery
will be distributed to the limited partners of CP III, including the
Partnership, on a pro rata basis; the Partnership and/or its counsel will
reimburse PWDC; and any remaining Partnership proceeds will be distributed to
the Partners of the Partnership in accordance with the distribution criteria as
outlined in the section entitled "Distributions" included in this filing on
Form 10-K.

ACTION AGAINST AMGEN BOULDER, INC.

In 1991, Synergen, Inc. (now Amgen Boulder, Inc.) formed Synergen Clinical
Partners, L.P. ("SCP") to fund the research and development of
Interleukin-Receptor Antagonist ("IL-lra") as a potential treatment of various
inflammatory diseases, with an emphasis on sepsis and rheumatoid arthritis. The
Partnership owns approximately 11% of the Class A limited partnership interests
of SCP. Synergen, Inc. terminated its research and development program for
sepsis in August 1994, and, in December 1994, Synergen, Inc. was acquired by
Amgen Inc. ("Amgen"). Research into the potential use of IL-lra for rheumatoid
arthritis is ongoing.

In February 1995, a Class A limited partner commenced an action against
the general partner of SCP and others, Johnson v. Amgen Boulder, Inc., No.
C95-0204R (W.D. Wash.). The complaint alleged that the defendants caused or
permitted the release of misleading statements regarding the potential market
for IL-lra, preclinical and clinical trial results, and the possibility of
IL-lra becoming licensed for sale either in the United States or Europe. The
complaint sought damages on behalf of a class including limited partners of SCP
and limited partners of the Partnership.

<PAGE>

(ITEM 3 CONTINUED)

In February 1997, the parties announced a proposed settlement of the
Johnson action, pursuant to which the defendants would pay $14.55 million, less
attorney's fees and costs, to class members, and the limited partners' interests
in SCP would be terminated. The settlement was conditioned on, among other
things, the approval of two-thirds of the current limited partnership interests
in SCP and final court approval.

On May 8, 1997, PWDC, on behalf of the Partnership, objected to the
proposed settlement and advised the parties that PWDC and the Partnership would
not approve the settlement. Thereafter, PWDC entered into negotiations with
Amgen and class counsel in an effort to improve the settlement.

On December 2, 1997, the parties and PWDC entered into an agreement
revising the proposed settlement. The agreement provided, among other things:
Amgen would increase the initial settlement payment to $16.5 million; class
counsel would limit their request for attorney's fees and costs to $3.0 million;
and Amgen would provide the class with rights to additional payments of $9.0
million (if the Food and Drug Administration approves an IL-1ra product for
market) and $50.0 million (if IL-1ra product sales exceed $650 million before
the year 2020). The revised settlement was subject to final court approval.

On January 16, 1998, the court granted final approval of the revised
settlement. On January 26, 1998, the court awarded class counsel $3.0 million in
fees and costs to be paid out of the initial settlement payment.

IN RE: PAINEWEBBER LIMITED PARTNERSHIP LITIGATION

As previously disclosed on the Partnership's Form 10-K for the year ended
December 31, 1996, PaineWebber Technologies II, L.P., the General Partner of the
Partnership, was named as a defendant in a class action lawsuit against PWI and
a number of its affiliates in the United States District Court for the Southern
District of New York ("U.S. Court") relating to PWI's sale of approximately 50
direct investment offerings, including the offering of interests in the
Partnership. In January 1996, PWI signed a memorandum of understanding with the
plaintiffs in the class action outlining the terms under which the parties
agreed to settle the case. Under a settlement, PWI agreed to pay the class $125
million and certain additional consideration. The additional consideration
included the assignment of fees and income attributable to the general
partnership interest in the Partnership as well as guarantees of certain minimum
returns to class members. In March 1997, the U.S. Court approved the settlement
as fair and that order was affirmed by the United States Court of Appeals for
the Second Circuit in July 1997. Distribution of the settlement fund to the
class awaits the U.S. Court's determination of the amount of plaintiffs'
counsel's fees and disbursement to be awarded from the settlement fund.

In February 1996, approximately 150 plaintiffs filed an action entitled
ABBATE V. PAINEWEBBER INC. in Sacramento, California Superior Court against PWI
and various affiliated entities, including the General Partner of the
Partnership, concerning the plaintiffs' purchases of various limited partnership
interests. The complaint alleged, among other things, that PWI and its related
entities committed fraud and misrepresentation and breached fiduciary duties
allegedly owed to the plaintiffs by selling or promoting limited partnership
investments that were unsuitable for the plaintiffs and by overstating the
benefits, understating the risks and failing to state material facts concerning
the investments. The complaint sought compensatory damages of $15 million plus
punitive damages. In June 1996, additional complaints similar to the ABBATE
action, but involving fewer plaintiffs, were filed in Sacramento, San Diego and
Arizona. In September 1996, the California Superior Court dismissed many of the
ABBATE plaintiffs' claims as barred by the applicable statutes of limitation.
Certain of the other complaints were also dismissed with prejudice while others
remained pending. In March 1997, all of these actions were settled. The
settlement had no effect on the Partnership or the General Partner.

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, 1997, there were 5,568 Limited Partners.

The Partnership distributes to its Partners, when available, the net
proceeds from royalty distributions, interest payments on portfolio securities,
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. The Partnership's policy has been to distribute common stock (or cash
from the sale of common stock) to the Partners once the restriction period on
saleability has lapsed and market conditions are favorable. The Partnership's
cash distributions to its Partners totaled $5,921,686 ($710 per Unit; $59,216 to
the general partnership interest) for the year ended December 31, 1997. For the
years ended December 31, 1996 and 1995, cash distributions to the Partners were
$2,341,597 ($281 per Unit; $21,380 to the general partnership interest), and
$1,084,252 ($130 per Unit; $10,842 to the general partnership interest),
respectively. For the year ended December 31, 1995, the Partnership distributed
1,518,074 shares of Cygnus, Inc. ("Cygnus") common stock (182 shares per Unit;
15,300 shares to the general partnership interest) valued at $12,903,629 ($1,547
per Unit; $130,050 to the general partnership interest) on the date of
distribution.

ITEM 6. SELECTED FINANCIAL DATA.

See the "Selected Financial Data" on Page F-2 in this filing.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

LIQUIDITY AND CAPITAL RESOURCES

Partners' capital at December 31, 1997 was $6.2 million compared to $3.0
million at December 31, 1996. The increase in partners' capital of $3.2 million
was a result of net income from operations of $9.1 million (as discussed in
Results of Operations below) offset by cash distributions to the Partners of
$5.9 million.

The Partnership's funds are invested in marketable securities and a money
market fund until cash is needed to pay for the ongoing management and
administrative expenses of the Partnership or for distribution to the Partners.
Liquid assets at December 31, 1997, were $5.2 million compared to $0.9 million
at December 31, 1996. The increase in liquid assets of $4.3 million is primarily
due to (i) proceeds received from a Project of $7.2 million, (ii) the sale of an
investment for proceeds of $1.0 million, and (iii) the exercise of a warrant and
the classification, at market value, of the common shares as marketable
securities for a net increase of $2.5 million offset by a cash distribution of
$5.9 million and a payment to a Project of $0.3 million. The balance of working
capital will be used for the payment of administrative costs related to the
Partnership's business and future cash distributions to the Partners.

<PAGE>

(ITEM 7 CONTINUED)

RESULTS OF OPERATIONS

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

Net income increased from $0.2 million for the year ended December 31,
1996 to $9.1 million for the year ended December 31, 1997. The increase of $8.9
million was attributable to an increase in revenues of this amount.

Revenues for the years ended December 31, 1997 and 1996 were $9.5 million
and $0.6 million, respectively. The increase of $8.9 million was due primarily
to increases of $5.5 million in income from product development projects; $0.9
million in realized gain on the sale of investments and marketable securities;
and change in unrealized appreciation of investments of $2.9 million offset by a
decrease of $0.5 million in realized gain on sale of product development
projects (see Results of Operations for the year ended December 31, 1996
compared to the year ended December 31, 1995). On January 31, 1997, Centocor
exercised its option to purchase the limited partnership interests of CP III
(including those owned by the Partnership). The Partnership received an initial
payment and the right to receive future payments based upon sales of certain
products developed by CP III. For the year ended December 31, 1997, the
Partnership received and/or accrued income due in connection with its investment
in CP III of $7.4 million. During the same period in 1996 the Partnership
accrued income from product development projects of $1.9 million. During the
year ended December 31, 1997, the Partnership sold its warrant to purchase 0.2
million shares of OEC Medical Systems, Inc. ("OEC") with a carrying value as of
December 31, 1996, of $0.5 million for proceeds of $1.0 million and recognized a
gain of $0.5 million from the sale. During this same period in 1996, the
Partnership sold its equity position in Cygnus and realized an aggregate loss of
$0.4 million (see Results of Operations for the year ended December 31, 1996
compared to the year ended December 31, 1995). Unrealized appreciation
(depreciation) of investments and marketable securities for the years ended
December 31, 1997 and 1996 was $1.3 million and $(1.6) million, respectively,
resulting primarily from its investments in Cygnus. For the year ended December
31, 1997, the Partnership recognized unrealized appreciation of $1.3 million
with respect to its investment of 0.255 million common shares of Cygnus. The
market value of the shares increased from $14.50 per share as of December 31,
1996 to $19.875 per share at December 31, 1997. As of December 31, 1996, the
Partnership recognized unrealized depreciation of $1.6 million on a warrant to
purchase Cygnus shares (see Results of Operations for the year ended December
31, 1996 compared to the year ended December 31, 1995).

Expenses for the years ended December 31, 1997 and 1996 were comparable at
$0.3 million each year.

Year ended December 31, 1996 compared to the year ended December 31, 1995:

Net income for the years ended December 31, 1996 and 1995 was $0.2 million
and $6.4 million, respectively. The decrease of $6.2 million resulted from a
decrease in revenues of $6.5 million offset by a decrease in expenses of $0.3
million.

Revenues for the year ended December 31, 1996 were $0.6 million as
compared to $7.1 million for the year ended December 31, 1995. The decrease of
$6.5 million resulted primarily from an increase in loss upon the sale of
investments and marketable securities of $0.4 million and decreases in
unrealized appreciation of marketable securities and investments of $5.6 million
and gain on distribution of marketable securities and investments of $2.6
million offset by increases in gain from the sale of product development
projects of $0.5 million and income from product development projects of $1.5
million. During 1996, the Partnership sold 0.056 million shares of Cygnus for
proceeds of $0.9 million with a carrying value of $1.3 million ($22.375 per
share) at December 31, 1995 and realized a loss of $0.4 million. The Partnership
recognized unrealized (depreciation) appreciation for the years ended December
31, 1996 and 1995 of $(1.6) million and $4.0 million, respectively. Unrealized
depreciation in 1996 of $1.6 million resulted primarily from a decrease of $2.0
million in the intrinsic value of its warrant to purchase 0.255 million shares
of Cygnus stock offset by the

<PAGE>

(ITEM 7 CONTINUED)

recording of its warrant to purchase 0.2 million shares of OEC stock at $0.5
million. The market value of Cygnus stock decreased from $5.7 million ($22.375
per share) at December 31, 1995 to $3.7 million ($14.50 per share) at December
31, 1996. At December 31, 1996, the market value of OEC stock of $15.00 per
share exceeded the exercise price of the warrant of $12.70 per share. The
Partnership recorded its investment in the OEC warrant at its intrinsic value of
$0.5 million. Unrealized appreciation for 1995 was attributable primarily to the
Partnership's investment in a warrant to purchase 0.3 million shares of Cygnus.
As of December 31, 1995, the market value of Cygnus stock of $22.375 per share
exceed the exercise price of the warrant of $9.90 per share. Accordingly, the
Partnership recorded the warrant at its intrinsic value of $3.8 million and
recognized unrealized appreciation of this amount. In May 1995 the Partnership
distributed 1.5 million shares of Cygnus common stock to its Partners. The
market value of the shares on the date of distribution was $12.9 million ($8.50
per share) as compared to the carrying value at December 31, 1994, of $10.3
million ($6.75 per share). Accordingly, the Partnership recognized a gain of
$2.6 million upon the distribution. On July 2, 1996, the Partnership and FOCUS
Surgery, Inc. ("FOCUS") entered into a Letter Agreement whereby the Partnership
consented to the sale by FOCUS of the technology developed under the product
development agreement between FOCUS and the Partnership. The Partnership
received $0.5 million and recognized a gain of this amount. The Partnership
recognized income from product development projects of $1.9 million and $0.4
million, respectively, for the years ended December 31, 1996 and 1995.

Expenses for the years ended December 31, 1996 and 1995 were $0.4 million
and $0.7 million, respectively. The decrease is a result primarily of the
Manager's decision to discontinue charging the Partnership a management fee
effective July 1, 1996.

YEAR 2000

Like other financial and business organizations around the world, the
Partnership could be adversely affected if the computer systems utilized by the
Partnership and other service providers do not properly process and calculate
date-related information from and after January 1, 2000. This is commonly known
as the "Year 2000 Problem." The Partnership intends to work with the software
vendors to ensure that the Partnership's software is year 2000 compliant. The
Partnership does not expect the incremental expenses associated with the year
2000 and the potential disruption to operations to be significant.

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-7)
Statements of Cash Flows (Page F-8)
Notes to Financial Statements (Pages F-9 to F-16)

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 Holding Company (the "Manager"), the general partner of
PaineWebber Technologies II, L.P. (the "General Partner"), which is the general
partner of the Partnership.

The Partnership has delegated to the Manager, pursuant to the Management
Contract, responsibility for management and administrative services necessary
for the operation of the Partnership. Based in part on discussions with the
Advisory Board, the Manager assesses and manages the Partnership's Projects. As
part of its ongoing role in all Projects, the Manager participates as a member
of the board of directors of the corporate general partner of certain Projects
or a similar body with the Sponsor Companies with overall responsibility for
each Project during the development phase. The Manager makes regular visits to
the facilities of each Sponsor Company in order to monitor the progress of its
Projects, and its representatives take part in important decisions with respect
to development and commercial strategies. During the commercialization phase,
the Manager continues to review each Sponsor Company's performance. In addition,
the Manager actively 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 Manager, as well as
PWDC, the parent company of the Manager. On December 31, 1991, the Manager
succeeded PWDC as the general partner of the General Partner. The following
table sets forth such persons' positions as directors and executive officers of
PWDC and PWDC Holding Company at December 31, 1997:

NAME AGE POSITION AND DATE APPOINTED
---- --- ---------------------------
DIRECTORS
Dhananjay M. Pai 35 Director since December 1996
Gerald F. Goertz, Jr. 40 Director since April 1995
William J. Nolan 50 Director since February 1997

EXECUTIVE OFFICERS
Dhananjay M. Pai 35 President since December 1996
William J. Nolan 50 Treasurer since February 1997
Dorothy F. Haughey 73 Secretary since July 1985 for PWDC
Secretary since December 1991 for PWDC
Holding Company

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 Commitee. 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 to executive officers of PWDC Holding Company by
the Registrant. PWDC Holding Company serves as the Manager 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 July 1, 1996, the Manager 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-9 through F-16 included in this filing on Form 10-K.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The table below lists all investors who are known to the Partnership to be
beneficial owners at March 1, 1998 of more than five percent of the Registrant's
Units.

PERCENT OF
CLASS NAME AND ADDRESS AMOUNT CLASS
- ------ ---------------- ------ -----
Limited Bioventure Investments, KFT 683 Units 8.27%
Partnership Budapest, Hungary
Units

Limited Libby Owens Ford Co. 559 Units 6.77%
Partnership Pension Plan & Trust
Units Mellon Bank, N.A.
One Mellon Bank Center
Pittsburgh, PA 15258

No member of management of the Manager or PWDC had any beneficial interest
in the Registrant's Units.

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-9 through F-16 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 (F-6)
Statements of Changes in Partners' Capital (Page F-7)
Statements of Cash Flows (Page F-8)
Notes to Financial Statements (Pages F-9 to F-16)

REPORT 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
1998.

PAINEWEBBER R&D PARTNERS II, L.P.

By: PaineWebber Technologies II, L.P.
(General Partner)

By: PWDC Holding Company
(General partner of the 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 1998.

/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 Holding Company, the Manager,
as well as the general partner of the General Partner of the Registrant.

<PAGE>

PAINEWEBBER R&D PARTNERS II, 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, 1997 and 1996 F-5

Statements of Operations,
for the years ended December 31, 1997, 1996 and 1995 F-6

Statements of Changes in Partners' Capital,
for the years ended December 31, 1997, 1996 and 1995 F-7

Statements of Cash Flows,
for the years ended December 31, 1997, 1996 and 1995 F-8

Notes to Financial Statements F-9 to F-16

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 II, L.P.
(a Delaware Limited Partnership)

Selected Financial Data
- ------------------------------------------------------------------------------------------------------------------------------------
Years ended December 31, 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operating Results:

Revenues $ 9,430,203 $ 583,230 $ 7,133,197 $ 10,743,055 $ 8,957,023

Net income (A) $ 9,073,034 $ 226,748 $ 6,431,753 $ 9,385,257 $ 1,429,144

Net income per partnership unit (A):

Limited partners (B) $ 1,087.84 $ 27.19 $ 771.16 $ 1,125.27 $ 171.36

General partner $ 90,730.34 $ 2,267.48 $ 64,317.53 $ 93,852.57 $ 14,291.44

Financial Condition:

Total assets $ 6,283,508 $ 3,447,578 $ 5,265,725 $ 12,875,809 $ 7,121,082

Partners' capital $ 6,204,738 $ 3,053,390 $ 5,168,239 $ 12,724,367 $ 5,741,515

Distributions to partners:
Cash $ 5,921,686 $ 2,341,597 $ 1,084,252 $ 417,020 $ 4,628,895
Cygnus, Inc. common stock
(at market value) (C) $ - $ - $ 12,903,629 $ - $ -
Alkermes, Inc. common stock
(at market value) (C) $ - $ - $ - $ 1,985,385 $ 6,326,608
Centocor, Inc. common stock
(at market value) (C) (D) $ - $ - $ - $ - $ 13,629
Compression Labs, Inc. warrants
(at intrinsic value) (C) $ - $ - $ - $ - $ 5,525,888

</TABLE>

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

(A) In 1994, amounts are reflective of the cumulative effect of adopting
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities."
(B) Based on 8,257 partnership units.
(C) At date of distribution.
(D) In 1993, the distribution was made to the General Partner only; the
distribution to the Limited Partners was made in 1992.

F-2

<PAGE>

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

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 1997

4th Quarter $ 894,589 $ 780,511 $ 93.57 $ 7,805.11

3rd Quarter 2,198,066 2,072,731 248.52 20,727.31

2nd Quarter 1,640,623 1,595,736 191.33 15,957.36

1st Quarter 4,696,925 4,624,056 554.42 46,240.56

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

Calendar 1996

4th Quarter $ 1,124,684 $ 1,055,418 $ 126.55 $ 10,554.18

3rd Quarter 1,240,669 1,193,791 143.13 11,937.91

2nd Quarter (1,378,241) (1,488,265) (178.44) (14,882.65)

1st Quarter (B) (403,882) (534,196) (64.05) (5,341.96)

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

Calendar 1995

4th Quarter $ 1,384,756 $ 1,207,265 $ 144.75 $ 12,072.65

3rd Quarter 2,782,417 2,664,366 319.45 26,643.66

2nd Quarter 1,382,161 1,169,535 140.23 11,695.35

1st Quarter (C) 1,583,863 1,390,587 166.73 13,905.87

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

</TABLE>

(A) Based on 8,257 limited partnership units and a 1% general partnership
interest.
(B) Revenues have been restated from the reported amount at March 31, 1996,
in the amount of $3,013.
(C) Revenues have been restated from the reported amount at March 31, 1995,
in the amount of $4,149.

F-3

<PAGE>

Report of Independent Auditors

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

We have audited the accompanying statements of financial condition of
PaineWebber R&D Partners II, L.P. as of December 31, 1997 and 1996, 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, 1997. 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 II,
L.P. at December 31, 1997 and 1996, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.

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

New York, New York
March 23, 1998

F-4

<PAGE>

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

Statements of Financial Condition
<TABLE>
<CAPTION>

December 31, December 31,
1997 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:

Cash $ 6,998 $ 5,028

Marketable securities, at market value 5,166,462 899,197

Investments, at fair value - 1,633,000

Advances to product development projects - 135,519

Royalty income receivable 1,105,048 774,834

Other asset 5,000 -

================== ================
Total assets $ 6,283,508 $ 3,447,578
================== ================

Liabilities and partners' capital:

Due to product development company $ - $ 297,000

Accrued liabilities 78,770 97,188

Partners' capital 6,204,738 3,053,390

================== ================
Total liabilities and partners' capital $ 6,283,508 $ 3,447,578
================== ================

- ----------------------------------------------------------------------------------------------------
See notes to financial statements.

</TABLE>

F-5

<PAGE>

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

Statements of Operations

For the years ended December 31, 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Interest income $ 74,879 $ 40,989 $ 85,565
Net realized gain on sale of product development
projects - 552,001 -
Income from product development projects 7,412,556 1,908,249 395,195
Unrealized appreciation (depreciation) of
investments and marketable securities 1,370,627 (1,534,475) 3,995,807
Net realized gain on distribution of
investments and marketable securities - - 2,656,630
Net realized gain (loss) on sale of investments and
marketable securities 572,141 (383,534) -
------------------ ----------------- ----------------
9,430,203 583,230 7,133,197
------------------ ----------------- ----------------

Expenses:
Expenditures under product development
projects 20,483 - -
Management fee - 137,010 347,070
General and administrative costs 336,686 219,472 354,374
------------------ ----------------- ----------------
357,169 356,482 701,444
------------------ ----------------- ----------------

Net income $ 9,073,034 $ 226,748 $ 6,431,753
================== ================= ================

Net income per partnership unit:
Limited partners (based on 8,257 units) $ 1,087.84 $ 27.19 $ 771.16
General partner $ 90,730.34 $ 2,267.48 $ 64,317.53

- --------------------------------------------------------------------------------------------------------------------------
See notes to financial statements.

</TABLE>

F-6

<PAGE>

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

Statements of Changes in Partners' Capital

Limited General
Years ended December 31, 1997, 1996 and 1995 Partners Partner Total
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at January 1, 1995 $ 12,594,066 $ 130,301 $ 12,724,367

Net income 6,367,435 64,318 6,431,753
Distributions to partners:
Cash (1,073,410) (10,842) (1,084,252)
Cygnus, Inc. common stock (12,773,579) (130,050) (12,903,629)
------------------ ----------------- ----------------

Balance at December 31, 1995 5,114,512 53,727 5,168,239

Net income 224,481 2,267 226,748
Cash distributions to partners (2,320,217) (21,380) (2,341,597)
------------------ ----------------- ----------------

Balance at December 31, 1996 3,018,776 34,614 3,053,390

Net income 8,982,304 90,730 9,073,034
Cash distributions to partners (5,862,470) (59,216) (5,921,686)
------------------ ----------------- ----------------

Balance at December 31, 1997 $ 6,138,610 $ 66,128 $ 6,204,738
================== ================= ================

- --------------------------------------------------------------------------------------------------------------------------
See notes to financial statements.

</TABLE>

F-7

<PAGE>

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

Statements of Cash Flows

For the years ended December 31, 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 9,073,034 $ 226,748 $ 6,431,753
Adjustments to reconcile net income to cash
provided by operating activities:
Unrealized (appreciation) depreciation of
investments and marketable securities (1,370,627) 1,534,475 (3,995,807)
Net realized gain on distribution of
investments and marketable securities - - (2,656,630)

(Increase) decrease in operating assets:
Marketable securities (1,723,638) 361,762 1,345,606
Investments 460,000 610,501 -
Interest receivable - 5,518 2,155
Advances to product development projects 135,519 33,770 13,939
Royalty income receivable (330,214) (728,709) (3,653)
Other asset (5,000) - -

(Decrease) increase in operating liabilities:
Due to product development company (297,000) 297,000 -
Accrued liabilities (18,418) (298) (53,956)
------------------ ----------------- ----------------
Cash provided by operating activities 5,923,656 2,340,767 1,083,407
------------------ ----------------- ----------------

Cash flows from financing activities:

Distributions to partners (5,921,686) (2,341,597) (1,084,252)
------------------ ----------------- ----------------

(Decrease) increase in cash 1,970 (830) (845)

Cash at beginning of year 5,028 5,858 6,703
------------------ ----------------- ----------------

Cash at end of year $ 6,998 $ 5,028 $ 5,858
================== ================= ================

- --------------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
The Partnership paid no cash for interest or taxes during the years ended December 31, 1997, 1996 and 1995.

Supplemental schedule of non-cash activities:

- --------------------------------------------------------------------------------------------------------------------------
For the years ended December 31, 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------

Distribution of investments to partners:
Cygnus, Inc. common stock $ - $ - $ 12,903,629

- --------------------------------------------------------------------------------------------------------------------------
See notes to financial statements.

</TABLE>

F-8
<PAGE>

PAINEWEBBER R&D PARTNERS II, L.P.
(A DELAWARE LIMITED PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS

1. ORGANIZATION AND BUSINESS

PaineWebber R&D Partners II, L.P. (the "Partnership") is a Delaware
limited partnership that commenced operations on September 30, 1987 with a total
of $72.0 million available for investment. PWDC Holding Company (the "Manager")
is the general partner of PaineWebber Technologies II, L.P. (the "General
Partner"), which is the general partner of the Partnership. PWDC Holding Company
is a wholly owned subsidiary of Paine Webber Development Corporation ("PWDC"),
an indirect, wholly owned subsidiary of Paine Webber Group Inc. ("PWG"). The
Partnership will terminate on December 31, 2012, 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 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 the Sponsor Companies.
Once the product development phase has been completed, the Sponsor Companies
have had the option to license and commercialize the products resulting from the
product development project, and the Partnership has had 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-9

<PAGE>

PAINEWEBBER R&D PARTNERS II, L.P.
(A DELAWARE LIMITED PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS

(NOTE 1 CONTINUED)

All distributions to the limited partners of the Partnership (the "Limited
Partners") and the General Partner (collectively, the "Partners") from the
Partnership have been made pro rata in accordance with their respective net
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 $10,000 plus simple interest on such
amount accrued at 7% per annum for each Unit sold at the Initial Closing
(6% per annum for each subsequent Unit sold up to the 5,000th Unit and
5% per annum for each Unit sold thereafter) ("Contribution Payout"). At
December 31, 1997, Contribution Payout ranged from $14,250 per Unit to
$17,175 per Unit ....................................................... 99% 1%

II. After Contribution Payout and until the value of the aggregate
distributions for each Unit equals $50,000 ("Final Payout")............. 80% 20%

III. After Final Payout...................................................... 75% 25%

</TABLE>

For the year ended December 31, 1997, the Partnership made cash
distributions totaling $5,921,686 ($710 per Unit; $59,216 to the General
Partner). At December 31, 1997, the Partnership has made cash and security
distributions, as valued on the dates of distribution, since inception of $2,576
and $7,206 per Unit, respectively.

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. Actual results could differ from those
estimates.

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.

F-10

<PAGE>

PAINEWEBBER R&D PARTNERS II, L.P.
(A DELAWARE LIMITED PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS

(NOTE 2 CONTINUED)

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 carried warrants at a zero value in cases where the
Sponsor Company's stock was not publicly traded or the exercise period had not
been attained. To the extent that the Partnership's warrants were currently
exercisable and the Sponsor Company's stock was publicly traded, the warrants
were carried at intrinsic value (the excess of market price per share over the
exercise price per share), which approximated fair value.

3. MARKETABLE SECURITIES AND INVESTMENTS

MARKETABLE SECURITIES:

The Partnership held the following marketable securities:

DECEMBER 31, 1997 DECEMBER 31, 1996
----------------------------------------------------------------
MARKET COST MARKET COST
----------------------------------------------------------------
<S> <C> <C> <C> <C>
Money market fund $ 98,335 $ 98,335 $ 799,097 $ 799,097
Cygnus, Inc. (255,000 common shares) 5,068,127 2,524,500 ---- ----
Centocor, Inc. (2,800 common shares) ---- ---- 100,100 37,324
----------- ----------- ----------- -----------
$ 5,166,462 $ 2,622,835 $ 899,197 $ 836,421
=========== ============ =========== ===========

</TABLE>

In September 1997, the Partnership exercised its warrant for 255,000
shares of Cygnus, Inc. ("Cygnus") at an aggregate exercise price of $2,524,500
($9.90 per share). At December 31, 1997, the market price per share was $19.875
as compared to $14.50 as of December 31, 1996. Accordingly, the Partnership
recognized unrealized appreciation for the year ended December 31, 1997, of
$1,370,627.

In February 1996, the Partnership exercised its warrant to purchase 2,800
common shares of Centocor, Inc. ("Centocor") at an exercise price of $13.33 per
share. At December 31, 1996, the market value of Centocor shares was $35.75 per
share. In November 1997, the Partnership sold the shares for proceeds, net of
commissions, of $132,241 ($47.23 per share) and recognized a gain upon the sale
of $32,141.

F-11

<PAGE>

PAINEWEBBER R&D PARTNERS II, L.P.
(A DELAWARE LIMITED PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS

(NOTE 3 CONTINUED)

INVESTMENTS:

The Partnership held the following investments:

DECEMBER 31, 1997 DECEMBER 31, 1996
Cygnus, Inc.
Warrant to purchase:
255,000 common shares $ --- $ 1,173,000

OEC Medical Systems, Inc.
Warrant to purchase:
200,000 common shares --- 460,000
----------------- -----------------
$ --- $ 1,633,000
================= =================

The Partnership recorded its warrants to purchase common shares of Cygnus
(with an exercise price of $9.90 per share) and OEC Medical Systems, Inc.
("OEC") (with an exercise share of $12.70 per share) as investments with
carrying values equal to their intrinsic values (which approximate fair value);
(See Note 5). In 1996, the Partnership exercised its warrant to purchase 45,000
shares of Cygnus stock at an aggregate exercise price of $445,500 and
subsequently sold the shares for net proceeds of $676,762. The value of the
shares related to these warrants at December 31, 1995, was $1,006,875 ($22.375
per share). Accordingly, the Partnership recognized a loss upon the sale of
$330,113. The market value of Cygnus stock as of December 31, 1996 was $14.50
per share as compared to a market value of $22.375 per share as of December 31,
1995. Accordingly, the Partnership recognized unrealized depreciation of
$2,008,125 on its warrant to purchase 255,000 Cygnus shares for the year ended
December 31, 1996. In September 1997, the Partnership exercised the warrant for
255,000 Cygnus shares (see Marketable Securities). At December 31, 1996, the
market value of OEC stock of $15.00 per share exceed the exercise price of the
warrant of $12.70 per share. The Partnership recorded its investment in the OEC
warrant at its intrinsic value of $460,000 and recognized unrealized
appreciation of this amount. During 1997, the Partnership sold the OEC warrant
for proceeds of $1,000,000 and recognized a gain in the amount of $540,000.

At December 31, 1995, the Partnership recorded its investment in a warrant
to purchase 300,000 Cygnus shares at its intrinsic value of $3,742,500 and,
accordingly, recognized unrealized appreciation of this amount for the year then
ended. In addition, the Partnership recognized unrealized appreciation of
$185,422 on its investment of 11,867 Cygnus shares to reflect an increase in the
market value per share from $6.75 at December 31, 1994 to $22.375 at December
31, 1995.

Also, in 1995, the Partnership distributed to its Partners 1,518,074
shares of Cygnus common stock with a market value on the date of distribution of
$12,903,629 ($8.50 per share) as compared to a carrying value at December 31,
1994, of $10,246,999 ($6.75 per share). Accordingly, the Partnership recognized
a realized gain upon the distribution of $2,656,630 for the year ended December
31, 1995.

4. RELATED PARTY TRANSACTIONS

The Manager is entitled to receive a management fee for services rendered
to the Partnership. Commencing July 1, 1996, the Manager elected to discontinue
the management fee charged to the Partnership. The management fees paid by the
Partnership to the Manager were $137,010 and $347,070 for the years ended
December 31, 1996 and 1995, respectively.

F-12

<PAGE>

PAINEWEBBER R&D PARTNERS II, L.P.
(A DELAWARE LIMITED PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS

(NOTE 4 CONTINUED)

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
Projects as the Partnership.

5. PRODUCT DEVELOPMENT PROJECTS

Of the Partnership's ten original Projects, three are currently active:
Centocor Partners III, L.P. ("CP III"); Genzyme Development Partners, L.P.; and
Synergen Clinical Partners, L.P. ("SCP").

In February 1995, a Class A limited partner of SCP commenced an action
against the general partner of SCP and others. The complaint alleged that the
defendants caused or permitted the release of misleading statements regarding
the potential market for Interleukin-Receptor Antagonist ("IL-1ra") (a potential
treatment of inflammatory diseases), preclinical and clinical trial results, and
the possibility of IL-1ra becoming licensed for sale either in the United States
or Europe. The complaint sought damages on behalf of a class including limited
partners of SCP and limited partners of the Partnership (the "SCP Class"). On
December 2, 1997, the parties entered into a proposed settlement (the "SCP
Settlement") whereby the initial settlement payment to the SCP Class would
aggregate $16.5 million; class counsel would limit their request for attorney's
fees and costs to $3.0 million; and the SCP Class would be entitled to receive
rights to additional payments of $9.0 million (if the Food and Drug
Administration approves an IL-1ra product for market) and $50.0 million (if
IL-1ra product sales exceed $650 million before the year 2020). The proposed
settlement was subject to final court approval (see Note 8 - Subsequent Event).

On January 31, 1997, pursuant to the provisions of the Partnership
Purchase Option Agreement between Centocor and the Partnership, Centocor
exercised its option to purchase the limited partnership interests of CP III,
including those owned by the Partnership. The Partnership received an initial
payment and will receive future quarterly payments based on sales of ReoPro, a
drug developed by CP III. For the year ended December 31, 1997, the Partnership
received and/or accrued income from CP III in the amount of $7,377,329 which has
been included in the accompanying Statements of Operations.

On July 2, 1996, the Partnership and FOCUS Surgery, Inc. ("FOCUS") entered
into a Letter Agreement whereby the Partnership consented to the sale by FOCUS
to Takai Hospital Supply Co. of the technology developed under the product
development agreement between FOCUS and the Partnership free and clear of the
Partnership's interests therein. In exchange, the Partnership received $562,000
and recognized a gain upon the sale of the technology for this amount for the
year ended December 31, 1996.

On January 31, 1996, Genzyme Corporation ("Genzyme") made an offer (the
"Offer") to the general partner of Genzyme Development Partners, L.P. ("GDP")
(of which the Partnership owns a limited partnership interest) to acquire the
assets of GDP in exchange for common shares of Genzyme. The Offer was made in
lieu of Genzyme's existing option to purchase the outstanding partnership
interest in GDP for a lump-sum cash payment and certain future royalty payments.
On May 6, 1996, Genzyme withdrew its Offer to purchase the assets of GDP.

On August 20, 1996, the Partnership terminated the product development
program with Compression Labs, Incorporated.

F-13

<PAGE>

PAINEWEBBER R&D PARTNERS II, L.P.
(A DELAWARE LIMITED PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS

(NOTE 5 CONTINUED)

If the Projects produce any product for commercial sale, the Sponsor
Companies have had the option to enter into joint ventures or royalty agreements
with the Partnership to manufacture and market the products developed. In
addition, the Sponsor Companies have had the option to purchase the
Partnership's interest in the technology. In consideration for such purchase
options, the Partnership received warrants to purchase shares of common stock of
the Sponsor Companies. In September 1997, the Partnership exercised its warrant
to purchase Cygnus shares (see Note 3 - Marketable Securities). The
Partnership's warrant to purchase 193,000 shares of Cayenne Software, Inc. at an
exercise price of $16.19 per share expired in June 1997. The Partnership did not
exercise the warrant since, during the exercise period, the market price of the
stock never exceeded the exercise price of the warrant. As of December 31, 1997,
the Partnership held no warrants.

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
shares of realized income and loss on their individual federal and state income
tax returns.

7. LEGAL PROCEEDING

On July 12, 1995, the Partnership commenced a derivative action against
Centocor and Centocor Development Corporation III ("CDC III") in the Chancery
Court of Delaware (the "Court") arising from certain agreements entered into by
Centocor and Eli Lilly & Company ("Lilly") in July 1992. The Partnership's
complaint alleges, among other things that: at least $25 million of the $100
million paid by Lilly to Centocor represents profits from the sale of ReoPro, a
Centocor drug, that Centocor is required to share with CP III; and because of
the Lilly transaction, Centocor was required to increase the percentages of
profits and revenues from ReoPro that it pays to CP III investors. Centocor had
taken the position that only $500,000 of the $100 million had to be shared with
CP III and that Centocor had no obligation to increase the percentages of ReoPro
profits and revenues that it pays to CP III investors. The Partnership sought to
proceed on behalf of CP III. The complaint seeks to require Centocor and CDC III
to pay damages to CP III and to increase the percentages of future ReoPro
profits and revenues that Centocor must pay to CP III and its investors.

In April and July 1996, Mr. Abdo moved to amend his complaint to assert
claims on behalf of CP III against two of PWDC's nominees to the CDC III Board
of Directors. On July 12, 1996, counsel chosen by Centocor to represent CP III
moved to disqualify the Partnership from serving as a plaintiff in this action,
alleging that Mr. Abdo should be the sole plaintiff because the Partnership has
conflicts of interest with CP III and its other limited partners, including
conflicts arising out of the alleged claims against the PWDC nominees. Mr. Abdo
and Centocor also moved to disqualify the Partnership. In January 1997, the
Court granted, in part, Mr. Abdo's motion to amend his complaint to assert
claims against the PWDC nominees. The Court has not ruled on the motions to
disqualify.

F-14

<PAGE>

PAINEWEBBER R&D PARTNERS II, L.P.
(A DELAWARE LIMITED PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS

(NOTE 7 CONTINUED)

The agreement further provides for revisions to the ReoPro royalties
payable by Centocor to CP III investors through 2007. Under the agreement, those
royalties would be paid based on revenues from end-sales by Lilly and other
distributors, as opposed to Centocor's revenues on its sales to distributors.
For 1997 and 1998, Centocor would pay an aggregate of 6.5% of the first $175
million of United States end-sale revenues, 3.25% of such revenues above $175
million, and 3.25% of foreign end-sales revenues. For 1999 through 2007,
Centocor would pay an aggregate of 6.5% of the first $250 million of United
States end-sale revenues, 4% of such revenues above $250 million, and 3.25% of
foreign end-sales revenues. The agreement provides that investors will not
receive less than Centocor would otherwise have paid based on Centocor's sales
of ReoPro. As of December 31, 1997, the Partnership has not accrued income
related to the settlement.

PWDC has been advancing, and may continue to advance, the funds necessary
to pay the Partnership's legal fees and expenses relating to this litigation. In
the event of a recovery on behalf of CP III, the Court may award legal fees and
expenses to the Partnership's counsel to be paid out of the CP III recovery.
Counsel for the Partnership has stated that they intend to apply to the Court
for an award of fees and expenses in an amount up to $1.5 million. Counsel for
Mr. Abdo has stated that he intends to object to any such application, and, if
the settlement is approved, will himself apply for an award of fees and
expenses. It is anticipated that: the net proceeds of any recovery will be
distributed to the limited partners of CP III, including the Partnership, on a
pro rata basis; the Partnership and/or its counsel will reimburse PWDC; and any
remaining Partnership proceeds will be distributed to the Partners of the
Partnership in accordance with the distribution criteria outlined in Note 1.

F-15

<PAGE>

PAINEWEBBER R&D PARTNERS II, L.P.
(A DELAWARE LIMITED PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS

8. SUBSEQUENT EVENT

On January 16, 1998, the SCP Settlement received final approval from the
court. On January 26, 1998, class counsel was awarded $3.0 million in fees and
costs to be paid out of the initial settlement payment. On March 3, 1998, the
Partnership received and recorded as income the amount of $1.4 million
representing its share of the initial settlement payment as a Class A limited
partner of SCP and, simultaneously, SCP was terminated.

F-16

EXHIBIT A
ADVISORY BOARD BIOGRAPHIES

ADMIRAL BOBBY R. INMAN U.S. NAVY (RET.)
Chairman, Executive Committee of Science Applications International Corporation;
former Chairman and Chief Executive Officer, Westmark Systems, Inc.; former
Chairman, President and Chief Executive Officer, Microelectronics & Computer
Technology Corporation; Director, Fluor Corporation, Science Applications
International Corporation, Southwestern Bell Corporation, Temple-Inland and
Xerox Corporation.

ALFRED J. COYLE
Advisory Director, PaineWebber Incorporated; former Director, American DualVest
Fund, Cubic Corp., Leaseway Transportation Corp., Oilfield Services Corp. of
America and Radiation Dynamics.

RICHARD HODGSON
Co-founder and Director, Intel Corporation; Director, I-Stat Corp., Ibis
Technology Inc., McCowan Associates and several private technology companies.

EUGENE KLEINER
Founding partner, Kleiner, Perkins, Caufield & Byers; Co-founder, Fairchild
Semiconductor Corporation; Director, Andros Corporation, Resound, Inc. and
several private technology companies; Trustee, Polytechnic University in New
York.

ANTONIE T. KNOPPERS, M.D.
Former President, Chief Operating Officer and Vice Chairman, Merck & Co.;
Director, Centocor, Inc; former Chairman, U.S. Council of the International
Chamber of Commerce.

DR. GEORGE KOZMETSKY, D.C.S.
Executive Associate for Economic Affairs, The University of Texas System; IC
Senior Research Fellow; Chairman, IC Advisory Board.

JOSHUA LEDERBERG, PH.D.
Nobel Laureate; university professor and former President, Rockefeller
University; Director, Chemical Industry Institute for Toxicology, Dreyfus
Foundation and Council for Foreign Relations.

EXHIBIT B

PAINEWEBBER R&D PARTNERS II, L.P. ANNUAL REPORT 1997
- --------------------------------------------------------------------------------

LETTER TO LIMITED PARTNERS

To Our Limited Partners:

PaineWebber R&D Partners II, L.P. ("R&D Partners II" or the "Partnership")
continued to receive reports of developments in each of three active development
programs of the Partnership in 1997. R&D Partners II was structured as a
diversified portfolio of product development programs and equity investments
with the expectation that a portion of the programs would become commercially
successful. Of the three remaining active development programs, we expect the
programs with Centocor, Inc. ("Centocor") and Genzyme Corporation ("Genzyme") to
have the greatest likelihood of commercial success compared to the Partnership's
other programs. Centocor is seeing continued success with its ReoPro(TM)
antiplatelet agent with the FDA's approval for additional uses for the blood
thinner. The Cleveland Clinic, one of the leading institutions for colorectal
surgery, fully adopted Genzyme's Seprafilm(TM) for use in colorectal procedures
requiring abdominal surgery. R&D Partners II made cash distributions totaling
$710 per $10,000 investment in 1997. We expect cash distributions to continue if
the products from the ongoing development programs continue to meet with
commercial success.

Centocor's ReoPro, an anticlotting drug, received marketing approval from the
FDA in 1994 for use in angioplasty patients at high risk for complications. In
November 1997, the FDA expanded the product labeling to allow physicians to use
the drug in a much broader group of patients, including those that are at
short-term risk of heart attack in unstable angina patients not responding to
conventional therapy and who are scheduled for percutaneous coronary
intervention ("PCI") including balloon angioplasty, atherectomy and stent
replacement. The new labeling also allows ReoPro to be used 18 to 24 hours prior
to any PCI.

Genzyme received marketing approval for Seprafilm, a hyaluronic acid ("HA")
based bioresorbable film, in August 1996 for application after surgery around
traumatized tissue to prevent adhesions prior to closure of the surgical site.
Current usage of Seprafilm has been primarily used in general surgery involving
large and small bowel procedures and in a limited number of gynecological
procedures. In May 1997, a FDA panel recommended against Genzyme's
Sepracoat(TM), a second HA product developed to keep tissue surfaces moist and
lubricated during surgery, after a single pivotal trial showed only modest
reductions in adhesions following gynecological surgery. Although Sepracoat is
approved for sale in Europe, Genzyme has decided not to pursue further clinical
development in the U.S. Genzyme expects to begin pivotal trials with an HA "gel"
formulation in the first half of 1998. The HA "gel" would offer an alternative
product format for surgical situations where Seprafilm would be difficult to
apply.

The remaining active product development program, which is being sponsored by
Amgen Boulder, Inc. ("Amgen Boulder," formerly Synergen, Inc.) completed a
European Phase II clinical trial in 1996 of IL-1ra (previously Antril(TM)), a
product being developed for potential use in the treatment of rheumatoid
arthritis ("RA"). The results from this trial demonstrated sufficient safety and
efficacy to justify commencement of an additional Phase II trial. Amgen Inc.
("Amgen") is in Phase II trials with IL-1ra in combination with methotrexate,
with trial results expected in 1998. Amgen has announced that it is continuing
to seek a corporate partner for its inflammation products, including the future
development of IL-1ra.

<PAGE>

The following development programs of R&D Partners II have concluded and
generated returns to the partners. R&D Partners II invested $5.5 million in the
Cygnus, Inc. ("Cygnus") development program. In 1994, Cygnus elected to purchase
the glucose monitoring technology from R&D Partners II for approximately 1.53
million shares of Cygnus common stock, representing approximately $13.0 million
in value on the date of distribution. (1) The 182 shares of Cygnus common stock
distributed by R&D Partners II per $10,000 investment in 1995 has had a value
ranging from $1,547 at distribution to a peak of $4,709. Also, R&D Partners II
exercised the Cygnus warrant in September 1997 and is currently holding 255,000
common shares. The Partnership intends to sell the common shares and distribute
cash at a future date.

R&D Partners II invested $5.9 million in the restricted common stock of
Alkermes, Inc. ("Alkermes") which was distributed to investors as it became
unrestricted in 1993 and 1994. The available gain from the 118 shares of
distributed Alkermes common stock has ranged from $997 at distribution to $3,496
per $10,000 investment in R&D Partners II.

The development programs with Cayenne Software, Inc. ("Cayenne") (formerly
Bachman Information Systems, Inc. and/or Cadre Technologies, Inc.), Compression
Labs, Inc. ("CLI"), Focus Surgery, Inc. ("Focus"), Genentech, Inc. ("Genentech")
and Rogers Corporation ("Rogers") have been either terminated or, are near
termination, and will not generate any significant returns to the Partnership.

R&D Partners II committed $5.4 million to the development program for
Ensemble(TM), a computer software program, being developed by Cayenne Software,
Inc. ("Cayenne," formerly Cadre Technologies Inc.). R&D II has received
approximately $248,510 from product sales through December 31, 1997 but does not
expect to receive any significant future payments as product sales continue to
decline sharply. The Cayenne warrants held by the Partnership expired worthless
in June 1997.

In 1996, the product development program with CLI was terminated. R&D Partners
II committed $12.5 million to the development of high performance compression
and decompression devices ("codecs") for the video-phone market. Codecs compress
and decompress data required to transmit a digital video signal over several
medium. CLI terminated its video-phone marketing agreement with AT&T because of
pricing and functionality problems of the product. Limited partners received CLI
warrants which expired December 19, 1996. The available gain ranged from $663 at
distribution to $1,153 per $10,000 investment in R&D Partners II.

During 1996, Focus(2) announced the signing of a Letter of Intent with Takai
Hospital Supply Co. for the sale of its assets for $1.25 million and
simultaneously filed for protection under Chapter 11 of the U.S. Bankruptcy
Code. In August 1996, R&D Partners II received $562,000 for its technology
rights under the development program. R&D Partners II received a warrant to
purchase the common stock of OEC Medical Systems, Inc. ("OEC") in connection
with the Focus program. During 1997 the Partnership sold the OEC warrant for
proceeds of $1,000,000 and distributed the proceeds to the limited partners.

The product development program with Genentech was terminated in 1991 when the
product development program was determined not to be commercially viable. R&D
Partners II invested approximately $5.0 million in the Genentech program. The
Partnership received a warrant to purchase

- --------
1 In 1995, R&D Partners II distributed to limited partners 182 shares of Cygnus
common stock for every $10,000 unit. The cost basis of the Cygnus stock is
$5.875 per share and the acquisition date was December 29, 1994. 2 R&D Partners
II originally invested in Diasonics, Inc. which completed a restructuring in
1993 resulting in three separate public companies: Focus, Inc., OEC Medical
Systems, Inc. and Diasonics Ultrasound. As a result of the restructuring, R&D
Partners II's product development program was with Focus Surgery, Inc. and it
received a warrant to purchase the common stock of OEC Medical Systems, Inc. 3
The revised settlement was subject to court approval, which was granted on
January 16, 1998. Further information concerning the litigation will be included
in the first quarter 1998 report.

<PAGE>

the common stock of Genentech which had an aggregate value of $5.4 million when
it was distributed to investors in 1992. The available gain from the distributed
Genentech warrant has ranged from $1,003 at distribution to $1,883 per $10,000
investment in R&D Partners II.

R&D Partners II's program with Rogers to develop multichip modules was
terminated in 1990. In 1994, the Partnership sold the Rogers warrant for
$723,900 and distributed proceeds to limited partners.

In addition to the potential of returns from the product development programs,
investors have received common stock and warrants from R&D Partners II. The
total value of the distributed common stock and warrants from the Partnership
ranged from $7,206 as valued on the distribution dates to $15,900 per $10,000
investment.

Cash distributions since the inception of the Partnership total $2,576 per
$10,000 investment through December 31, 1997, including $710 distributed in
1997.

Included in the Product Portfolio Status and Equity Investment sections are more
detailed discussions on the companies, status of the product development
programs and specific information concerning the securities associated with each
investment. Please refer to prior annual reports for information pertaining to
the Partnership's terminated or concluded investments.

Thank you for your continued interest in R&D Partners II.

Sincerely,

Robin Stanley
Vice President
PaineWebber Development Corporation

<PAGE>

PRODUCT PORTFOLIO STATUS

AMGEN BOULDER, INC.
- --------------------------------------------------------------------------------

Amgen Boulder, Inc. ("Amgen Boulder," formerly Synergen, Inc. or "Synergen"), a
wholly-owned subsidiary of Amgen Inc. ("Amgen"), was formed as a result of
Amgen's acquisition of Synergen in December 1994. The company's research is
targeted toward products for inflammatory disorders and neurological diseases.
Amgen acquired Synergen through a cash tender offer of $9.25 per share for all
outstanding shares of Synergen common stock. Amgen Boulder has continued the
clinical development of IL-1ra (previously Antril(TM)) for treatment of
rheumatoid arthritis ("RA") which was being conducted by Synergen before the
acquisition took place. Amgen announced in September 1997 it is seeking a
corporate partner for its ongoing inflammation research and development program
including IL-1ra.

A revised settlement was reached in December3 in connection with the class
action litigation involving Synergen Clinical Partners, L.P. ("SCP," the
"Class"). Under the original settlement, Class members would have received lump
sum payments from a $14.55 million fund in exchange for dismissing the lawsuit
and the termination of SCP. The revised agreement provides that Amgen will
increase its payment to the settlement fund by $1.95 million, resulting in a
total fund of $16.5 million, with the Class receiving at least $13.5 million
after attorneys' fees and costs. Under the original settlement, Class members
had no right to future payments based on future development of any IL-1ra
molecule. Under the revised settlement, the Class may receive additional
payments of $9 million if the FDA approves an IL-1ra Product for market and
another $50 million if IL-1ra Product sales exceed $650 million before the
year 2020.

PROGRAM

R&D Partners II committed $4.5 million to SCP, a $52.5 million limited
partnership, formed to fund the development and human clinical trials of IL-1ra,
the recombinant form of Interleukin-1ra, a naturally occurring anti-inflammatory
human protein that may play a significant role in the treatment of RA. SCP's
interests in IL-1ra are now held by Amgen as a result of the litigation
settlement.

In October 1996, the results from the IL-1ra Phase II clinical trial were
presented at the American College of Rheumatology in Orlando. Findings from the
study demonstrated that IL-1ra has mild to moderate anti-inflammatory activity
which may have a clinical benefit in patients with severe RA. IL-1ra also slowed
disease progression when compared to placebo as measured by radiographic
assessment. An additional dose evaluation study for RA is currently ongoing in
Europe and a U.S. combination study with methotrexate, commenced in January
1997, is ongoing.

WARRANT

R&D Partners II distributed the Synergen warrant to investors in March 1993. As
a consequence of the acquisition of Synergen by Amgen, the warrant was rendered
valueless.

<PAGE>

CENTOCOR, INC.
- --------------------------------------------------------------------------------

COMPANY

Centocor, Inc. ("Centocor") is a biotechnology company committed to developing
innovative therapeutic and diagnostic products to advance medical practice.
Centocor concentrates on research, development and manufacturing, with a
technological emphasis on monoclonal antibodies and peptides. It collaborates
extensively with academic institutions and other biotechnology companies, which
provide product development, and with major healthcare corporations, which
commercialize Centocor products.

PROGRAM

R&D Partners II committed $12.0 million to Centcor Partners III, L.P. ("CP
III"), a $54.2 million limited partnership formed to conduct the development and
human clinical trials of two monoclonal antibody-based products: ReoPro and
Capiscint(TM). Development efforts for Capiscint have ceased. ReoPro is
currently being sold in the U.S. by Centocor's marketing partner, Eli Lilly &
Co. ("Lilly").

In 1997, Centocor continued to release favorable information on ReoPro, an
anticlotting drug intended to reduce acute cardiac ischemic complications in
patients undergoing angioplasty. In November, the FDA expanded the product
labeling to allow physicians to use the drug in a much broader group of
patients. The expanded label allows physicians to use the drug to reduce the
short-term (one-month) risk of heart attack in unstable angina patients not
responding to full conventional therapy and who are scheduled for PCI (including
balloon angioplasty, atherectomy and stent replacement). Previously, ReoPro was
indicated for use only in angioplasty patients at high risk for complications.
The new labeling also allows ReoPro to be administered 18 to 24 hours prior to
any PCI.

In July 1995, the Partnership commenced a derivative action against Centocor and
Centocor Development Corporation III in the Chancery Court of Delaware (the
"Court") arising from certain agreements entered into by Centocor and Lilly in
July 1993. In June 1997, the parties to the Partnership's actions entered into
an agreement to settle the action (the "Settlement Agreement"). The Settlement
Agreement provides, among other things, for Centocor to pay to CP III investors
(including the Partnership, a former limited partner in CP III) in the
aggregate: $10.8 million, net of attorneys' fees and expenses as may be awarded
by the Court; an additional $5.0 million, if and when cumulative world-wide
sales of ReoPro exceed $600 million; and possible additional payments totaling
$2.2 million, depending upon regulatory developments in Japan. The Settlement
Agreement further provides for revisions to the ReoPro royalties payable by
Centocor to CP III investors through 2007. Certain former limited partners of CP
III, including Pharmaceutical Partners, L.P., have objected to the proposed
settlement. The settlement is conditioned on Delaware Chancery Court approval
and is pending.

Under the Settlement Agreement, the royalties would be paid based on revenues
from end-sales by Lilly and other distributors, as opposed to Centocor's
revenues on its sales to distributors. For 1997 and 1998, Centocor would pay an
aggregate of 6.5% of the first $175 million of the United States end-sale
revenues. For 1999 through 2007, Centocor would pay an aggregate of 6.5% of the
first $250 million of the United States end-sales revenues, 4.0% of such
revenues above $250 million, and 3.25% of foreign end-sales revenues. Centocor
has agreed that investors will not receive less than Centocor would otherwise
have paid based on Centocor's sales of ReoPro.

<PAGE>

In January, 1997, pursuant to the purchase option agreement between Centocor and
CP III, Centocor exercised its option to purchase the limited partnership
interests of CP III, including those owned by R&D Partners II. The Partnership
received a cash advance payment of $3,325,000 and will receive future quarterly
payments based on the sales of ReoPro. The Partnership distributed the proceeds
of the advance payment to the limited partners in March 1997.

WARRANT

R&D Partners II distributed the Centocor warrant in March 1992. Investors
received a warrant to purchase 116 shares of Centocor common stock per $10,000
investment in R&D Partners II with an exercise price of $14.155 per share
through February 1993 and $16.655 per share from March 1993 through February
1995. Based on the closing price of $31.75 per share on the date of distribution
and the initial exercise price of $14.155 per share, a warrant to purchase 116
shares of Centocor common stock had a value of approximately $2,041 per $10,000
unit. In June 1992, R&D Partners II distributed 22 shares of Centocor common
stock per $10,000 investment which had a value of approximately $305 on the date
of distribution. The available gain from the distributed Centocor warrant and
common stock has ranged from $2,346 on the date of distribution to $3,560 per
$10,000 investment in R&D Partners II.

<PAGE>

GENZYME CORPORATION
- --------------------------------------------------------------------------------

COMPANY

Genzyme Corporation ("Genzyme") is an international, diversified health care
products company with a focus on developing innovative products and services for
major unmet medical needs. The company's General Division markets Ceredase(R)
and Cerezyme(R) replacement enzymes for the treatment of Gaucher disease. It
also develops and markets surgical and diagnostic products, genetic diagnostic
services and pharmaceuticals.

Genzyme received marketing approval for Seprafilm(TM), a hyaluronic acid ("HA")
based bioresorbable film in 1996. Sales of Seprafilm continue to grow each
quarter. Seprafilm marketing is focused on high-risk colorectal surgeries, where
adhesions are a particular concern. In the United States, Genzyme is targeting
the top 350 hospitals, which perform 27 percent of the colorectal and abdominal
surgeries in which Seprafilm could be used. As of December 31, 1997, Seprafilm
had been sold to 258 of those hospitals, with 90 percent reordering. In April,
Genzyme announced that the Cleveland Clinic, one of the leading institutions for
colorectal surgery, had fully adopted Seprafilm for use in colorectal procedures
requiring abdominal surgery.

In September, Genzyme announced that Seprafilm was approved for marketing by the
Ministry of Health and Welfare in Japan. It is the first bioresorbable medical
device to be approved in Japan without first undergoing additional clinical
trials there. Genzyme will co-market Seprafilm with Kaken Pharmaceutical Co.,
Ltd., Tokyo, a leading pharmaceutical company in Japan. Genzyme expects it will
launch the product in Japan in the first quarter of 1998. Genzyme currently
markets Seprafilm in the United States, Canada and Europe.

In May, the FDA did not grant approval to Genzyme to market its Sepracoat(TM)
coating solution for the reduction of adhesions in abdominal and pelvic surgery.
The General and Plastic Surgery Devices Panel of the FDA's Medical Devices
Advisory Committee agreed that the product appeared to be safe, but said not
enough evidence was presented to prove clinical effectiveness. Although
Sepracoat is approved for sale in Europe, Genzyme reported it would not pursue
further clinical development of the product in the U.S.

PROGRAM

R&D Partners II committed $5.0 million to Genzyme Development Partners, L.P.
("GDP"), a $36.8 million limited partnership formed to conduct the development
and human clinical trials of surgical products based on HA. The products are
designed to reduce the incidence and severity of adhesions, a serious
post-operative complication.

Under the terms of the GDP agreement, upon the triggering of certain events,
Genzyme has the option to purchase the GDP interests under which GDP is entitled
to receive 10% of revenues from sales of the products in the U.S. and Canada
and, under certain conditions, 6% of sales in Europe, for ten years following
the exercise of the purchase option.

WARRANT

R&D Partners II distributed the Genzyme warrant in June 1992. Per $10,000
investment, investors received a warrant to purchase 22 shares at $16.01 per
share and a warrant to purchase 10 shares at $22.91 per share. Both warrants
expired October 31, 1996. Due to the stock split in July 1996, for every one
warrant exercised, investors received two shares of Genzyme common stock. Based
on the closing price of $24.75 per share on the date of distribution (as
adjusted for the stock split), the distributed warrants to purchase Genzyme
common stock had a value of approximately $1,003. The available gain from the
distributed Genzyme warrants has ranged from $1,003 at distribution to $1,883
per $10,000 investment in R&D Partners II.

EXHIBIT C PAINEWEBBER R&D PARTNERS II, L.P.
(A DELAWARE LIMITED PARTNERSHIP)

POLICY REGARDING REQUESTS FOR PARTNER LISTS

In accordance with the provisions of the Delaware Revised Uniform Limited
Partnership Act (the "Act"), and without limiting its rights under the
Partnership Agreement or the Act, as each may be amended from time to time, the
General Partner of the Partnership has established standards applicable to
requests for lists of Limited Partners. These standards have been established in
order to assure (1) that the lists are not used for an improper or inappropriate
purpose or in any way that might be detrimental to the Partnership or the
Limited Partners; (2) that the Limited Partners have sufficient information and
opportunity to decide how they should react in response to any solicitation or
other communication addressed to them; and (3) that the Partnership and the
Limited Partners do not face an increased risk of adverse tax consequences as a
direct or indirect result of any such solicitation or communication.

The General Partner requires any request to be made in writing by a record
holder of limited partner interests with standing to request the list, to comply
strictly with all applicable requirements of law and the Partnership Agreement,
to state the purpose for which the request is made with sufficient specificity
to enable the General Partner to make the determinations specified above, and to
include an undertaking under oath by the person requesting the list and the
persons or entities on whose behalf it is requested (1) to hold the list in
strict confidence, and not to give any information derived from the list to any
third party for any purpose whatsoever, (2) to reimburse the Partnership for
costs incurred in connection with the request and for a list, including
confirming compliance with the undertakings required hereby and (3) to submit to
the jurisdiction of the courts of the State of Delaware in any dispute arising
in connection with such request and to appoint and maintain RL&F Service Corp.,
One Rodney Square, Tenth Floor, Wilmington, New Castle County, Delaware 19801
(whose reasonable fees and expenses will be paid by the Partnership) as such
person's or entity's agent in the State of Delaware for acceptance of legal
process in connection therewith. In addition, in the case of requests made for
the purpose of soliciting tenders of the Limited Partners' interests or units in
the Partnership or soliciting proxies or consents from Limited Partners or
facilitating, assisting or supporting any such solicitation, the General Partner
will, if and to the extent required by applicable law and the Partnership
Agreement, make lists available or agree to disseminate such solicitations on
behalf of requesting Limited Partners only upon receipt of an undertaking under
oath by the person requesting the list and the persons or entities on whose
behalf it is requested (1) to conduct the solicitation in accordance with the
requirements of the Securities and Exchange Act of 1934 and the rules of the
Securities and Exchange Commission thereunder, including full disclosure of all
material facts and, in the case of any tender offer, rights of proration and
withdrawal rights, irrespective of the number of interests or units sought, and
(2) to refrain from acquiring interests or units of any number if the General
Partners, based upon advice from counsel, conclude that such acquisition would
increase the risk of adverse tax consequences to the Partnership or the
Partners.

The General Partner shall endeavor to inform the requesting party within
30 days of receipt of the requisite undertakings whether they consider that the
proposed use of the list is improper or inappropriate or would increase the risk
of such adverse tax consequences, and may request such further assurances as may
be necessary in order to enable them to make any of the determinations specified
above.

<ARTICLE> 5
<CIK> 0000814576
<NAME> PAINEWEBBER R&D PARTNERS II, L.P.

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