PAINEWEBBER R&D PARTNERS II LP, 10-K, 1999-03-30

PAINEWEBBER R&D PARTNERS II LP
10-K, 1999-03-30
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, 1998
or
( ) Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
For the transition period from ______ to ______

Commission File Number 33-14582
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 [ ]

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

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 has
been 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 were 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.

During the year ended December 31, 1998, the Partnership had current
activity with three Sponsor Companies: 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, 1998, the Partnership owned marketable securities as described in
Note 3 of the "Notes to Financial Statements" on pages F-9 through F-15 included
in this filing on Form 10-K.

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. As of July 1, 1996, the Manager elected to discontinue charging the
management fee for services rendered to the Partnership.
<PAGE>

(Item 1 Continued)

Distributions

All distributions to the General Partner and the limited partners of the
Partnership (the "Limited Partners"; collectively, the "Partners") have been
made pro rata in accordance with their respective 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:

Limited General
Partners Partner
-------- -------
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, 1998, Contribution Payout
ranged from $14,750 per Unit to $17,875 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%

At December 31, 1998, the Partnership has made cash and security
distributions, as valued on the dates of distribution, since inception of $3,332
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, 1998, the cumulative losses for the Partnership were $1,573 per Unit.

Other

On February 8, 1999, SkyRise Investors LLC commenced an offer to purchase
(the "Offer") up to 4.9% of the total Units (404 Units) of the Partnership at a
cash price of $2,200 per Unit subject to reduction for certain distributions and
expenses. The Offer expired on March 5, 1999. On March 3, 1999, PharmaInvest,
L.L.C., on behalf of Pharmaceutical Royalties, L.L.C. and Pharmaceutical Royalty
Investments Ltd. (collectively, the "Purchasers") commenced a tender offer to
purchase (the "Tender Offer") up to 3,000 Units of the Partnership at a cash
price per Unit of $6,000 subject to reduction for certain distributions. The
Tender Offer will expire on March 31, 1999, unless otherwise extended. The
Purchasers and their affiliates currently own 18.2% of the Units. If the
Purchasers acquire 2,624 Units pursuant to the Tender Offer, the Purchasers and
their affiliates would own 50% of the Units and could effectively control the
management, policies and affairs of the Partnership. The General Partner has
recommended that the Partners reject the offer and not tender their Units
pursuant to the Tender Offer.

At December 31, 1998, 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 has been engaged in one
primary business segment, the management of investments in technology products
and companies.
<PAGE>

Item 2. Properties.

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

Item 3. Legal Proceedings.

Action Against Centocor, Inc.

As previously disclosed on the Partnership's Form 10-K for the year ended
December 31, 1997, 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. The Partnership owned
approximately 25% of the limited partnership interests of CP III.

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 alleged, 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 sought 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 did not rule 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)

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. 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 II, L.P., another former limited
partner of CP III, have objected to the proposed settlement. They asserted,
among other things, that the consideration was 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. On March 15, 1999, the Court
issued a memorandum opinion and order approving the settlement as fair and
reasonable.

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.

As previously disclosed on the Partnership's Form 10-K for the year ended
December 31, 1997, 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 owned 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.
<PAGE>

(Item 3 Continued)

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.

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). If remitted, all additional payments will be made to the
Partners as part of the class and not the Partnership.

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 March 1998,
SCP distributed the initial settlement payment to the class. The Partnership
received $1.249 million which it distributed to the Partners in April 1998.

In re: PaineWebber Limited Partnership Litigation

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 70 direct
investment offerings, including the offering of interests in the Partnership. As
previously disclosed on the Partnership's Form 10-K for the year ended December
31, 1997, the litigation was settled prior to January 1, 1998, and
administration of the settlement is ongoing.

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

None.
<PAGE>

PART II

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

There is no existing public market for the Units, and no such market is
expected to develop. Units are transferable subject to certain restrictions as
set forth in the Partnership Agreement and applicable securities laws. As of
December 31, 1998, there were 5,527 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 $6,305,344 ($756 per Unit; $63,052 to
the general partnership interest) for the year ended December 31, 1998. For the
years ended December 31, 1997 and 1996, cash distributions to the Partners were
$5,921,686 ($710 per Unit; $59,216 to the general partnership interest) and
$2,341,597 ($281 per Unit; $21,380 to the general partnership interest),
respectively.

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, 1998 was $2.8 million compared to $6.2
million at December 31, 1997. The decrease in partners' capital of $3.4 million
was a result of net income of $2.9 million (as discussed in Results of
Operations below) offset by cash distributions to the Partners of $6.3 million.

The Partnership's funds are invested in marketable securities until cash is
needed to pay for the ongoing management and administrative expenses of the
Partnership or for distribution to the Partners. Liquid assets at December 31,
1998, were $1.4 million compared to $5.2 million at December 31, 1997. The
decrease in liquid assets of $3.8 million is primarily due to a decrease of $3.6
million in the market value of securities held by the Partnership from December
31, 1997 to December 31, 1998.
<PAGE>

(Item 7 Continued)

Results of Operations

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

Net income for the years ended December 31, 1998 and 1997 was $2.9 million
and $9.1 million, respectively. The decrease of $6.2 million resulted from
decreases in revenues of $6.4 million and expenses of $0.2 million.

Revenues for the year ended December 31, 1998 were $3.0 million as compared
to $9.4 million for the year ended December 31, 1997. The decrease of $6.4
million resulted from an unfavorable change in unrealized appreciation
(depreciation) of marketable securities of $5.0 million, and decreases in income
from product development projects and realized gain on sale of investments and
marketable securities of $0.8 million and $0.6 million, respectively. Unrealized
(depreciation) appreciation of marketable securities for the years ended
December 31, 1998 and 1997 was $(3.6) million and $1.4 million, respectively,
resulting primarily from the Partnership's investment in Cygnus, Inc.
("Cygnus"). For the year ended December 31, 1998, the Partnership recorded its
investment of 0.24 million Cygnus shares at a market value of $1.2 million
($4.875 per share) as compared to a market value of $4.8 million ($19.875 per
share) at December 31, 1997. The market value of Cygnus increased from $14.50
per share at December 31, 1996 to $19.875 per share at December 31, 1997. The
Partnership recognized unrealized appreciation of $1.4 million on its investment
of 0.255 million Cygnus shares for the year ended December 31, 1997. Income from
product development projects was $6.6 million and $7.4 million for the years
ended December 31, 1998 and 1997, respectively. 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 years ended December 31, 1998 and 1997 the
Partnership received and/or accrued income due in connection with its investment
in CP III of $5.4 and $7.4 million, respectively. Also, during the year ended
December 31, 1998, the Partnership recognized income of $1.2 million in
connection with its investment in SCP representing the Partnership's share of a
settlement payment as a former partner of SCP. 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.

Expenses decreased from $0.4 million for the year ended December 31, 1997
to $0.2 million for the year ended December 31, 1998 resulting from the
decreased activity of the Partnership.

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. On January 31, 1997, Centocor
<PAGE>

(Item 7 Continued)

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 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 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. 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 the Partnership's
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 Cygnus
increased from $14.50 per share as of December 31, 1996 to $19.875 per share at
December 31, 1997. For the year ended December 31, 1996, the Partnership
recognized unrealized depreciation of $1.5 million resulting 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 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. 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.

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

Year 2000

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

(Item 7 Continued)

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

Item 8. Financial Statements and Supplementary Data.

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

Report of Independent Auditors (Page F-4)
Statements of Financial Condition (Page F-5)
Statements of Operations (Page F-6)
Statements of Changes in Partners' Capital (Page F-7)
Statements of Cash Flows (Page F-8)
Notes to Financial Statements (Pages F-9 to F-15)

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

None.
<PAGE>

PART III

Item 10. Directors and Executive Officers of the Registrant.

The Registrant has no directors or executive officers. The Registrant is
managed by PWDC 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, 1998:

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

Executive Officers
Dhananjay M. Pai 36 President since December 1996
William J. Nolan 51 Treasurer since February 1997
Dorothy F. Haughey 74 Secretary since July 1985 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, Inc. 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-15 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, 1999 of more than five percent of the Registrant's
Units.

Percent of
Class Name and Address Amount Class
- ------ ---------------- ------ -----
Limited Bioventure Investments, KFT 1,188.5 Units 14.39%
Partnership Budapest, Hungary
Units

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-15 included in this filing on Form 10-K.
<PAGE>

PART IV

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

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

Financial Statements

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

Report on Form 8-K

None.
<PAGE>

SIGNATURES

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

PAINEWEBBER R&D PARTNERS 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 1999.

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

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

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

* The capacities listed are with respect to PWDC 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, 1998 and 1997 F-5

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

Statements of Changes in Partners' Capital,
for the years ended December 31, 1998, 1997 and 1996 F-7

Statements of Cash Flows,
for the years ended December 31, 1998, 1997 and 1996 F-8

Notes to Financial Statements F-9 to F-15

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

F-1
<PAGE>

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

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

Revenues $ 3,059,554 $ 9,430,203 $ 583,230 $ 7,133,197 $ 10,743,055

Net income (A) $ 2,887,660 $ 9,073,034 $ 226,748 $ 6,431,753 $ 9,385,257

Net income per partnership unit (A):

Limited partners (B) $ 346.23 $ 1,087.84 $ 27.19 $ 771.16 $ 1,125.27

General partner $ 28,876.60 $ 90,730.34 $ 2,267.48 $ 64,317.53 $ 93,852.57

Financial Condition:

Total assets $ 2,866,048 $ 6,283,508 $ 3,447,578 $ 5,265,725 $ 12,875,809

Partners' capital $ 2,787,054 $ 6,204,738 $ 3,053,390 $ 5,168,239 $ 12,724,367

Distributions to partners:
Cash $ 6,305,344 $ 5,921,686 $ 2,341,597 $ 1,084,252 $ 417,020
Cygnus, Inc. common
stock (at market
value) (C) $ - $ - $ - $ 12,903,629 $ -
Alkermes, Inc. common
stock (at market
value) (C) $ - $ - $ - $ - $ 1,985,385

- ---------------------------------------------------------------------------------------------------------------
</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.

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 1998

4th Quarter $ 1,813,835 $ 1,777,136 $ 213.08 $ 17,771.38

3rd Quarter (175,308) (218,039) (26.14) (2,180.39)

2nd Quarter (201,368) (246,384) (29.54) (2,463.84)

1st Quarter 1,622,395 1,574,947 188.83 15,749.45

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

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)

- -----------------------------------------------------------------------------------------------------
</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.

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, 1998 and 1997, and the
related statements of operations, changes in partners' capital, and cash flows
for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Partnership's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

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

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

New York, New York
March 20, 1999

F-4
<PAGE>

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

Statements of Financial Condition
December 31, December 31,
1998 1997
- --------------------------------------------------------------------------------
Assets:

Cash $ 6,998 $ 6,998

Marketable securities, at market value 1,433,536 5,166,462

Royalty income receivable 1,425,514 1,105,048

Other asset - 5,000

--------------- --------------
Total assets $ 2,866,048 $ 6,283,508
=============== ==============

Liabilities and partners' capital:

Accrued liabilities $ 78,994 $ 78,770

Partners' capital 2,787,054 6,204,738

--------------- --------------
Total liabilities and partners' capital $ 2,866,048 $ 6,283,508
=============== ==============

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

F-5
<PAGE>

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

Statements of Operations

For the years ended December 31, 1998 1997 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Interest income $ 33,528 $ 74,879 $ 40,989
Net realized gain on sale of product
development projects - - 552,001
Income from product development projects 6,627,965 7,412,556 1,908,249
Unrealized (depreciation) appreciation of
investments and marketable securities (3,600,000) 1,370,627 (1,534,475)
Net realized (loss) gain on sale of
investments and marketable securities (1,939) 572,141 (383,534)
--------------- -------------- -------------
3,059,554 9,430,203 583,230
--------------- -------------- -------------
Expenses:
Expenditures under product development
projects - 20,483 -
Management fee - - 137,010
General and administrative costs 171,894 336,686 219,472
--------------- -------------- -------------
171,894 357,169 356,482
--------------- -------------- -------------

Net income $ 2,887,660 $ 9,073,034 $ 226,748
=============== ============== =============

Net income per partnership unit:
Limited partners (based on 8,257 units) $ 346.23 $ 1,087.84 $ 27.19
General partner $ 28,876.60 $ 90,730.34 $ 2,267.48
- ----------------------------------------------------------------------------------------------------
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, 1998, 1997 and 1996 Partners Partner Total
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at January 1, 1996 $ 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

Net income 2,858,783 28,877 2,887,660
Cash distributions to partners (6,242,292) (63,052) (6,305,344)
--------------- -------------- -------------

Balance at December 31, 1998 $ 2,755,101 $ 31,953 $ 2,787,054
=============== ============== =============

- ----------------------------------------------------------------------------------------------------
See notes to financial statements.
</TABLE>

F-7
<PAGE>

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

Statements of Cash Flows
<TABLE>
<CAPTION>

For the years ended December 31, 1998 1997 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2,887,660 $ 9,073,034 $ 226,748
Adjustments to reconcile net income to cash
provided by operating activities:
Unrealized depreciation (appreciation) of
investments and marketable securities 3,600,000 (1,370,627) 1,534,475

Decrease (increase) in operating assets:
Marketable securities 132,926 (1,723,638) 361,762
Investments - 460,000 610,501
Interest receivable - - 5,518
Advances to product development projects - 135,519 33,770
Royalty income receivable (320,466) (330,214) (728,709)
Other asset 5,000 (5,000) -

(Decrease) increase in operating liabilities:
Due to product development company - (297,000) 297,000
Accrued liabilities 224 (18,418) (298)
--------------- -------------- -------------
Cash provided by operating activities 6,305,344 5,923,656 2,340,767
--------------- -------------- -------------

Cash flows from financing activities:
Distributions to partners (6,305,344) (5,921,686) (2,341,597)
--------------- -------------- -------------

Increase (decrease) in cash - 1,970 (830)

Cash at beginning of year 6,998 5,028 5,858
--------------- -------------- -------------

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

- ----------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
The Partnership paid no cash for interest or taxes during the years ended December 31, 1998, 1997
and 1996.
- ----------------------------------------------------------------------------------------------------
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, 1998, Contribution Payout ranged from $14,750 per Unit to
$17,875 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>

The Partnership made cash distributions during the year ended December 31,
1998 totaling $6,305,344 ($756 per Unit; $63,052 to the General Partner). At
December 31, 1998, the Partnership has made cash and security distributions, as
valued on the dates of distribution, since inception of $3,332 and $7,206 per
Unit, respectively.

Profits and losses of the Partnership are allocated as follows: (i) until
cumulative profits and losses for each Unit equals Contribution Payout, 99% to
Limited Partners and 1% to the General Partner, (ii) after Contribution Payout
and until cumulative profits and losses for each Unit equals Final Payout, 80%
to Limited Partners and 20% to the General Partner, and (iii) after Final
Payout, 75% to Limited Partners and 25% to the General Partner. As of December
31, 1998, the cumulative losses for the Partnership were $1,573 per Unit.

2. Summary of Significant Accounting Policies

The financial statements are prepared in conformity with generally accepted
accounting principles which require management to make certain estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. 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 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:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
-------------------------------- ------------------------------
Market Cost Market Cost
-------------- ------------ -------------- ------------
<S> <C> <C> <C> <C>
Money market fund $ 263,534 $ 263,534 $ 98,335 $ 98,335
Cygnus, Inc.
(240,000 shares and 255,000 shares
at December 31, 1998 and 1997,
respectively) 1,170,002 2,376,000 5,068,127 2,524,500
--------- --------- --------- ---------

$ 1,433,536 $ 2,639,534 $ 5,166,462 $ 2,622,835
========= ========= ========= =========
</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). During the year ended December 31, 1998, the Partnership sold 15,000
Cygnus shares (with a carrying value of $298,125) for proceeds, net of
commissions, of $296,186 ($19.75 per share). The market value of Cygnus stock as
of December 31, 1998, was $4.875 per share as compared to a market value of
$19.875 per share as of December 31, 1997. Accordingly, the Partnership
recognized unrealized depreciation on its Cygnus shares of $3,600,000 for the
year ended December 31, 1998. The market value of the Cygnus stock at December
31, 1996, was $14.50 per share and, accordingly, the Partnership recognized
unrealized appreciation of $1,370,627 on its investment of 255,000 Cygnus shares
for the year ended December 31, 1997.

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:

As of December 31, 1996, 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). 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.

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 for the year ended December 31, 1996.

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 ongoing or have had
current activity: 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

F-12
<PAGE>

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

NOTES TO FINANCIAL STATEMENTS

(Note 5 Continued)

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 U.S. 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). 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 $1,248,624
representing its share of the initial settlement payment as a Class A limited
partner of SCP and, simultaneously, SCP was terminated. If remitted, all
additional payments pursuant to the SCP Settlement will be made to the Partners
as part of the SCP Class and not the Partnership.

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 is
entitled to receive future quarterly payments based on sales of ReoPro, a drug
developed by CP III. For the years ended December 31, 1998 and 1997, the
Partnership received and/or accrued income from CP III in the amount of
$5,365,598 and $7,377,329 respectively.

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.

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. As of December 31, 1998, 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

F-13
<PAGE>

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

NOTES TO FINANCIAL STATEMENTS

(Note 7 Continued)

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.

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, 1998, the Partnership has not accrued income
related to the settlement.

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 (see note 8).

F-14
<PAGE>

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

NOTES TO FINANCIAL STATEMENTS

(Note 7 Continued)

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.

8. Subsequent Event

On March 15, 1999, the Court issued a memorandum opinion and order
approving the proposed settlement in the derivative action against Centocor and
CDC III as fair and reasonable.

F-15

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 1998
- --------------------------------------------------------------------------------

Letter to Limited Partners

To Our Limited Partners:

PaineWebber R&D Partners II, L.P. ("R&D Partners II" or the "Partnership")
continued to announce positive results on products under development. Previously
in the year, Genzyme Corporation ("Genzyme") raised $250 million through a
private placement of 2.25 percent convertible notes due in 2005 to boost its
drug development pipeline, particularly in the area of cardiovascular gene
therapy, and its surgical product business. Sepra Products sales have increased
in Europe and are supported by growth in France and the United Kingdom.
Centocor, Inc. ("Centocor") continued to report favorable earnings growth
attributed to strong product sales of its ReoPro. Amgen Boulder, Inc's. ("Amgen
Boulder," formerly Synergen, Inc.) product IL-1ra (previously Antril), is in a
Phase I/II trial in patients with rheumatoid arthritis.

Cash distributions since the inception of the Partnership total $3,332 per
$10,000 investment through December 31, 1998. We expect cash distributions to
continue provided that products from the ongoing product development programs
continue to meet with commercial success.

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.

Seprafilm received approval in August 1996 for application after surgery around
traumatized tissue to prevent adhesions prior to closure of the surgical site.
Usage of Seprafilm was primarily in general surgery involving large and small
bowel procedures and in a limited number of gynecological procedures. At the
start of the third quarter, Genzyme reorganized its surgical products business
by combining marketing and sales personnel to focus on three markets;
cardiovascular, general and gynecological, and plastic surgery.
<PAGE>

Centocor announced last October it is expanding its clinical development program
to aggressively pursue additional indications in new treatment areas for
existing products. ReoPro is being studied in a Phase III clinical trial for
unstable angina and is in a Phase II trial for stroke. Preliminary trials should
be available in 1999.

R&D Partners II continues to hold 240,000 shares of Cygnus, Inc. common stock
which it intends to sell and distribute cash at a later date.

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.

In addition to the potential 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 a valued on the distribution dates to $15,919 per $10,000
investment.

On or about March 3, 1999, an entity by the name of PharmaInvest, L.L.C. made an
offer to purchase up to 3,000 limited partnership units in R&D Partners II at a
price of $6,000 in cash per unit, subject to reduction. PharmaInvest is not
affiliated with the Partnership, the General Partner or PaineWebber.

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

Sincerely,

Robin Stanley
Vice President
PaineWebber Development
<PAGE>

Amgen Boulder, Inc.

Company
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) for treatment of rheumatoid
arthritis ("RA") which was being conducted by Synergen before the acquisition
took place. Following an approximate six month period during which Amgen
considered a number of corporate partnering alternatives, the company announced
in April 1998 that it had decided to retain its principal product candidates,
STNF-RI and IL-1ra, and relocated their respective development programs to
Thousand Oaks. Amgen discontinued the discovery research programs.

Program
R&D Partners II committed $4.5 million Synergen Clinical Partners ("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 interest in IL-1ra are now held by Amgen Boulder.

Under the terms of a court-approved settlement agreement dated January 16, 1998,
in connection with the class action litigation on behalf of limited partners in
SCP (the "Class"), the Class, as a whole, received approximately $13.8 million.
The limited partners of R&D Partners II received approximately $1.2 million in
the aggregate, which resulted in a payment of $150 per $10,000 unit and was
included in the April 1998 distribution. In addition, the Class received rights
to contingent payments in the future if the FDA approves an IL-1ra product for
the market and also if sales of an IL-1ra product exceed $650 million before
2020.

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 Centocor 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. Development efforts for Capiscint have ceased. ReoPro is currently
being sold in the U.S. by Centocor's marketing partner, Eli Lilly & Co.
("Lilly"). It is anticipated Fujisawa Pharmaceutical Co., Ltd. will distribute
ReoPro upon approval in Japan.

ReoPro received marketing approval from the FDA in 1994 for use in the reduction
of acute cardiac complications, but only in the patients undergoing angioplasty
procedures who are at risk for abrupt artery closure. In 1996, researchers from
two separate symposiums were able to demonstrate through their research that
ReoPro made a positive impact in patients undergoing angioplasty.

At the one-year follow-up of the largest coronary stent trial ever conducted,
patients with ischemic heart disease who received the combination of ReoPro with
stent placement reduced their risk of death by 57 percent, compared with
patients undergoing stenting alone. Analysis of these initial results, presented
last November at the 71st Scientific Sessions of the American Heart Association,
suggested this may be the first trial where the combined use of ReoPro and a
device (stents) provide a mortality benefit at one-year.

Also presented for the first time were the results of an angiographic substudy
which provided additional data to suggest an anti-restenotic effect of ReoPro
when used with stents, particularly in patients with diabetes, in whom a greater
than 50 percent reduction was observed in the need for repeat revascularization
procedures.

Six-month results from the Phase III EPISTENT trial, released during the third
quarter, showed that the combination of ReoPro and stents in patients undergoing
coronary interventions reduced the risk of death or heart attack by 57% compared
with stents alone. The six-month data also was presented at two medical
meetings, the European Society of Cardiology in August and the Transcatheter
Cardiovascular Therapeutics Conference last October. The unstable angina segment
of the GUSTO IV trial, which will evaluate ReoPro in the medical treatment of
unstable angina, began enrolling patients during the third quarter.
<PAGE>

As of December 31, 1998, the settlement agreement entered into by the
Partnership, Centocor and Centocor Development Corporation III to settle the
class action brought by R&D Partners II, is subject to court approval and
remains pending before the court.

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 $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 $3,579 per $10,000 investment
in R&D Partners II.

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 and
Cerezyme replacement enzymes for the treatment of Gaucher disease. It also
develops and markets surgical and diagnostic services and pharmaceuticals.

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 hyaluronic acid ("HA").
The products are designed to reduce the incidence and severity of adhesions, a
serious post-operative complication.

In May, Genzyme raised $250 million through a private placement of 2.25 percent
convertible notes due in 2005 to boost its drug development pipeline,
particularly in the area of cardiovascular gene therapy, and its surgical
product business. Genzyme has made several deals over the last few years,
including one with Deknatel Snowden Pencer (DSP) in July 1996, for which Genzyme
paid $250 million in cash. The acquisition added $50 million in revenues to
Genzyme, and was described as a move to help boost the introduction of Genzyme's
post-operative anti-adhesion devices to marketplace. The acquisition of DSP
formed the basis of Genzyme's surgical product unit.
<PAGE>

In the third quarter, Genzyme met with the FDA regarding its clinical trial of
Seprafilm II in pediatric cardiac surgery, which is expected to begin in the
first quarter 1999. Because Genzyme expects to use this trial and one in
colorectal surgery, rather than a pre-market approval application supplement to
gain approval for Seprafilm II, it expensed $1.0 million after taxes of
previously capitalized process development and qualification costs for Seprafilm
II.

Warrant
R&D Partners II distributed the Genzyme warrant in June 1992. Per $10,000
investment, investors received a warrant to purchase 22 shares of Genzyme common
stock 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 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.

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

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</TABLE>