PEGASUS AIRCRAFT PARTNERS II L P, 10-K, 1997-03-31

PEGASUS AIRCRAFT PARTNERS II L P
10-K, 1997-03-31
EQUIPMENT RENTAL & LEASING, NEC

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<PAGE> 1
March 28, 1996

Securities and Exchange Commission
Judiciary Plaza
450 Fifth Street, N.W.
Washington, D.C. 20549

Attention: 1934 Act Filing Department

Re: Pegasus Aircraft Partners II, L.P. (the "Registrant")
Commission File Number 0-18387

Ladies and Gentlemen:

On behalf of the Registrant, we are delivering herewith for filing
pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as
amended, and the Rules and Regulations promulgated thereunder, the following:

(1) One (1) complete copy which has been manually executed, of the
Registrant's Annual report on Form 10-K for 1995 (the "Form
10-K");

(2) Two (2) conformed copies of the complete Form 10-K; and

(3) Five (5) conformed copies of the Form 10-K, excluding
exhibits.

<PAGE> 2
Please acknowledge receipt of this letter and the enclosures on the
attached copy of this letter and return it to us in the enclosed, self-addressed
envelope.

Very truly yours,

Joseph P. Ciavarella, Vice President
Air Transport Leasing, Inc.

JPC/mm

Enclosures

cc: Laura Banchini
Lorna G. Bell / Moody's
Gregory Harding-Brown
Carol L. Chase, Esq.
Hugh Connelly (Corestates)
Paul J. Derenthal, Esq.
Richard W. Doust
Stephen R. Dyer
Gerald F. Goertz, Jr.
Spencer Jefferies
Anthony Anderson (Coopers and Lybrand)
Clifford B. Wattley
Meta Herzog (Finova)
Richard S. Wiley

<PAGE> 3
FORM 10-K

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549
(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]

For the fiscal year ended December 31, 1996

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

For the transition period from_______________________to ________________________

Commission file number 0-18387

Pegasus Aircraft Partners II, L.P.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)

Delaware 84-1111757
-------- ----------
(State of organization) (I.R.S. Employer
Identification No.)
Four Embarcadero Center
35th Floor
San Francisco, California 94111
------------------------- ----------
(Address of principal (Zip Code)
executive offices)

Registrant's telephone number, including area code (415) 434-3900
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:

Units of Limited Partnership Interest
-------------------------------------
(Title of Class)

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 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. [ ]

State the aggregate market value of the voting stock held by
non-affiliates of the Registrant: Not applicable.

<PAGE> 4
Pegasus Aircraft Partners II, L.P.
Annual Report on Form 10-K for the
Fiscal Year Ended December 31, 1996

Table of Contents
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
Part I

Item 1 Business........................................................ 1
Item 2 Properties...................................................... 13
Item 3 Legal Proceedings............................................... 14
Item 4 Submission of Matters to a Vote
of Security Holders......................................... 16

Part II

Item 5 Market for Registrant's Common Equity
and Related Stockholder Matters............................. 16
Item 6 Selected Financial Data......................................... 17
Item 7 Management's Discussion and
Analysis of Financial Condition
and Results of Operations................................... 18
Item 8 Financial Statements............................................ F-1
Item 9 Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure........................................ 24

Part III

Item 10 Directors and Executive Officers
of the Registrant........................................... 24
Item 11 Executive Compensation.......................................... 27
Item 12 Security Ownership of Certain
Beneficial Owners and Management............................ 27
Item 13 Certain Relationships and
Related Transactions........................................ 28

Part IV

Item 14 Exhibits, Financial Statement Schedules
and Reports on Form 8-K..................................... 30
</TABLE>

<PAGE> 5
PART I

Item 1. Business

General

Pegasus Aircraft Partners II, L.P. (the "Partnership" or the
"Registrant") is a limited partnership organized under the laws of the State of
Delaware on April 26, 1989. The general partners of the Partnership are Pegasus
Aircraft Management Corporation, the Managing General Partner, a California
corporation that is a wholly owned subsidiary of Pegasus Capital Corporation,
and Air Transport Leasing, Inc., the Administrative General Partner, a Delaware
corporation that is a wholly owned subsidiary of PaineWebber Group Inc.
(collectively, the "General Partners").

On August 15, 1989, the Partnership commenced an offering of units of
limited partnership interest ("Units"). The offering of the Units was terminated
during the third quarter of 1990, when the total capitalization of the
Partnership reached $145.1 million. The Partnership incurred $16,295,000 of
commissions and other expenses in connection with the sale of these Units.

Although the Partnership was organized on April 26, 1989, the
Partnership conducted no activities and recognized no revenues, profits or
losses prior to September 20, 1989 at which time the Partnership commenced
operations. During the period between September 21, 1989 and August 22, 1990,
the Partnership acquired its portfolio of used commercial aircraft which are
principally subject to triple net operating leases with domestic and foreign
commercial air carriers.

The Partnership is required to dissolve and distribute all of its
assets no later than December 31, 2007. The Partnership may reinvest the
proceeds from sales of aircraft occurring prior to August 21, 1998, provided
that the aggregate amount of sales proceeds so reinvested will in no event
exceed $60,000,000, and provided further that prior to any such reinvestment the
Partnership distributes to the Limited Partners cash in an amount sufficient to
pay any federal and state income taxes to be incurred by Limited Partners as a
result of the aircraft sale. Thereafter, the net proceeds of any sales of
aircraft will be distributed to the partners.

At a meeting of the Board of Directors of Air Transport Leasing, Inc.
("Board"), the Board adopted the Policy Regarding Requests for Partner Lists
attached as Exhibit 11.

Outlook for the Airline and Aircraft Leasing Industries

The US airline industry had a profitable year in 1996 with net earnings
estimated at $6 billion, which continued the industry's profitability trend.
However, the year was marred by the ValueJet and TWA crashes which raised
questions about aircraft maintenance and aging aircraft. With new aircraft
orders increasing, it was a robust year in aircraft production. The demand for
used aircraft was reflected in, for the most part, stable lease rates for such
aircraft. Continental Airlines Inc. ("Continental") continued to report positive
financial results in 1996 and USAirways Group Inc., (formerly USAir, Inc.)
("USAir") continued to show financial improvements. TWA was hurt by the incident
discussed above and continued to report losses while announcing a reduction in
European service and its fleet of 747 widebody aircraft. Kiwi

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<PAGE> 6
International Air Lines Inc. ("Kiwi") continued to have significant liquidity
concerns and in September 1996 filed for protection from its creditors under
Chapter 11 of the US Bankruptcy Code. The Partnership recovered the aircraft and
committed to lease the aircraft to two start-up carriers. Aircraft leasing
continues to be a highly competitive business and the Partnership's lessees
continue to face significant competitive challenges. Air traffic has been and
continued to be correlated to overall economic activity.

Recent Partnership Developments

Immediately below is a table which shows the December 31, 1996 appraised value
of the Partnership's aircraft to be approximately $69.7 million, or
approximately 49% of the original acquisition cost plus related capital
expenditures (excluding acquisition-related fees). Based upon these appraised
values, the Partnership's net asset value at December 31, 1996 was equal to
$8.20 per Unit. It should be noted that these are only estimates of value as of
that date, and not necessarily representative of the values that will ultimately
be realized when these aircraft are disposed of nor does this represent the
value that may be realized upon the disposition of a Unit.

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<PAGE> 7
Aircraft Portfolio

The following table describes the Partnership's aircraft portfolio at
December 31, 1996:

<TABLE>
<CAPTION>
December Current
1996 Lease Original Noise Cumulative Cumulative
Current Aircraft Ownership Acquisition Appraised Expiration Delivery Abatement Flight Flight
Lessee Type Interest Costs(1) Value(2) Date(3) Date Compliance Hours(4) Cycles(4)
------ -------- --------- ----------- ---------- ---------- -------- ---------- ----------- ----------
(in millions) (in millions)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Aerovias de
Mexico, S.A. McDonnell
de C.V. Douglas DC-9-31 100% $8.9 $ 3.3 7/06/97 1970 Stage 2 59,285 56,507

Aerovias de
Mexico, S.A. McDonnell
de C.V. Douglas DC-9-31 100 8.9 3.3 7/23/97 1971 Stage 2 64,757 61,918

Continental Boeing 727-200
Airlines, Inc. Advanced 100 4.5(8) 3.7 5/31/99 1973 Stage 2 68,646 49,088

Continental Boeing 727-200
Airlines, Inc. Advanced 100 4.1(8) 3.6 1/31/98 1973 Stage 2 68,906 49,184

Continental McDonnell
Micronesia Inc. Douglas
DC-10-10 100 18.3 8.7 6/30/98 1973 Stage 3 76,411 27,930

(7) Airbus Industrie
A300-B4-103 100 28.1 8.0 (7) 1979 Stage 3 46,107 19,527

(9) Boeing 727-200
Non-Advanced 100 9.5 6.0 (9) 1970 Stage 3 72,952 53,632

(10) Boeing 727-200
Advanced 100 11.7 8.8 (10) 1973 Stage 2 57,736 30,892

Trans World McDonnell
Airlines. Douglas MD-82 100 21.0 16.0 11/01/04 1983 Stage 3 42,343 21,790

(11) Lockheed
L-1011 100 17.7 2.8 (11) 1974 Stage 3 61,207 22,906

US Airways McDonnell
Group, Inc. Douglas MD-81 50(5) 10.0 5.5 6/01/98(6) 1982 Stage 3 40,871 37,116
------ -----
$142.7 $69.7
====== =====
</TABLE>

Notes: (1) Acquisition costs do not include related acquisition fees of
$3.0 million paid to the General Partners. The cost amounts shown
include capital expenditures incurred during 1996, 1995, 1994 and
1993 of $2.5 million, $26,000, $.3 million and $2.2 million,
respectively. Such amounts include two Boeing 727-200 Advanced
aircraft received in connection with the A-300 settlement.

(2) The December 1996 appraised values were determined by an
independent aircraft appraisal firm. Appraised values include the
present value of rents due under leases in place plus the present
value of an estimated residual value for the aircraft at the end
of the lease. It should be noted that appraisals are only
estimates of value and should not be relied on as measures of
realizable value.

(3) Lease expiration dates do not include renewal options except in
the case of US Air.

(4) The number of cumulative flight cycles and cumulative flight hours
shown are as of December 31, 1996, except they are as of March 6,
1997 with respect to the TWA MD-82.

(5) The remaining one-half beneficial interest is owned by Pegasus
Aircraft Partners, L.P., an affiliated partnership.

(6) If US Air does not renew the lease for an initial three-year
renewal period to June 2001, the partnership is entitled to a
lease termination payment.

(7) Aircraft off lease at December 31, 1996. Appraised value
represents the approximate current market value unencumbered by
lease.

(8) Represents aircraft received in connection with the A-300
settlement.

(9) Substantially all of the $2.5 million in capital expenditures in
1996 relate to this aircraft and represent hushkit ($1.9 million)
purchased as well as a portion of the last phase of maintenance
check aircraft completed as of December 31, 1996 ($.6 million).
An additional amount of approximately $.7 million was incurred
in 1997 with respect to this maintenance check prior to delivery
to Falcon Air Express, Inc. subject to a 60 month lease
commencing March 1997. This lease is reflected in the appraised
value.

3
<PAGE> 8
(10) Aircraft was committed to cargo conversion which was in the
process of being completed in early 1997. The aircraft is
scheduled to be delivered to Capital Cargo International Airlines
Inc. for a term of approximately 96 months. The hushkit
(approximately $3 million), cargo conversion ($1.6 million) and
replacement engines ($2 million) are reflected in the appraised
value.

(11) Lease terminated and aircraft returned on October 1996. TWA
prepaid the lease, on a discounted basis and paid the Partnership
$3,000,000 in lieu of meeting certain lease return conditions. The
aircraft is valued based upon its current condition.

The following is a description of the principal financial terms of the
leases listed in the table.

a. Continental Airlines Leases During September 1989, the Partnership
acquired a McDonnell Douglas DC-10-10 aircraft for a total purchase price of
$18,301,000, subject to an operating lease with Continental, originally
scheduled to expire on May 31, 1997, with rents of $252,000 per month.
Continental also had three two-year renewal options, with rent payable during
the first two such renewal periods at the lesser of the then fair market rental
value or the rental rate during the initial term, and during the third such
renewal period at the then fair market rental rate. In addition, the lessee has
a right of first refusal to purchase or re-lease the aircraft after the last
renewal period on the same terms as those included in any bona fide offer made
to the Partnership by a third party. This lease was modified in 1995 as
discussed below.

During September 1989, the Partnership acquired a Boeing 727-200
non-advanced aircraft for a total purchase price of $6,116,000, subject to an
operating lease with Continental. This aircraft was returned during
Continental's bankruptcy and subsequently leased to Kiwi (see discussion of Kiwi
below).

During August 1990, the Partnership acquired an Airbus Industrie Model
A-300-B4-103 ("A-300") aircraft for a total purchase price of $28,070,000,
subject to an operating lease with Continental, originally scheduled to expire
on December 29, 2000 and with monthly, in advance, rentals of $312,000.

Continental did not make the monthly rental payments due under the
three leases with the Partnership on December 1, 1990 and filed for Chapter 11
bankruptcy protection on December 3, 1990. The Partnership entered into various
lease modifications and financing arrangements with Continental as a result of
the bankruptcy. At December 31, 1996, the Partnership had aircraft modification
advances outstanding from Continental totaling $93,000, which are being repaid
monthly with interest.

In January 1995, Continental announced that it was grounding its fleet
of Airbus Industrie A-300 aircraft, including the A-300 aircraft leased to it by
the Partnership, and notified the Partnership of its intention to return the
aircraft to the Partnership. Continental paid $150,000 of the $312,000 monthly
rental payment due in February through May 1995. The Partnership did not accrue
as rental revenue the difference between the amount due and the amount paid by
Continental for such months. Continental took the A-300 out of service in May
1995, and the Partnership prepared the aircraft for delivery in June 1995 to a
new lessee, Akdeniz Air Mediterranean, Inc. ("Akdeniz") based in Turkey.

4
<PAGE> 9
On June 1995, the Partnership executed a lease of the A-300 aircraft to
Akdeniz for a scheduled term of four years, under which Akdeniz subsequently
defaulted. The Partnership recovered the A-300 aircraft, returned it to FAA
registry, and is currently remarketing it. The Partnership estimates that it
will spend approximately $2.5 million for a scheduled heavy maintenance check
and other modifications that will be required prior to delivery of the aircraft
to a new lessee. The Partnership received $557,000 from Continental pursuant to
the A-300 Settlement discussed below which will be applied towards such
maintenance.

On November 15, 1995, the Partnership reached an agreement with
Continental regarding the settlement of its lease obligations under the A-300
lease ("A-300 Lease Settlement"), which also included a restructuring of the
DC-10-10 aircraft lease ("DC-10 Restructuring").

Under the terms of the A-300 Lease Settlement, the Partnership received
a cash payment of approximately $3,721,000, including approximately $325,000 as
reimbursement for certain integration and transaction expenses, and (i) title to
a Boeing 727-200 advanced aircraft subject to lease with Continental for a term
of approximately 26 months at a lease rate of $85,000 per month and (ii) title
to a second Boeing 727-200 advanced aircraft subject to a lease with Continental
for a term of approximately 42 months at a lease rate of $85,000 per month.
Additionally, the Partnership received approximately $557,000 as an economic
settlement in lieu of Continental performing certain maintenance work and the
aircraft meeting certain return conditions required by the lease.

Under the DC-10 Restructuring, the Partnership received approximately
$3,100,000, the lease expiration date was changed from May 31, 1997 to October
31, 1996 and the monthly lease payments were reduced from $252,000 to $135,000
effective September 15, 1995. All other terms and conditions of the DC-10-10
lease remain unchanged. During 1996, Continental and the Partnership reached
agreement to extend the lease to June 30, 1998 at a lease rate of $150,000 per
month.

b. Trans World Airlines Leases During December 1989, the Partnership
acquired a McDonnell Douglas MD-82 aircraft for a total purchase price of
$20,763,000, subject to an operating lease with TWA, which was originally
scheduled to expire on April 13, 1993, but was amended and extended until
November 1, 1998 with monthly, in advance, rental payments of $185,000. As
described below, this lease was further extended to November 2004 during TWA's
prepackaged bankruptcy in 1995.

Upon execution of the lease amendment, the Partnership reimbursed TWA
for $225,000 of capital improvements which were made to the aircraft and
advanced $750,000 to TWA to finance certain major maintenance procedures, which
is being repaid over the remaining lease term, in monthly installments with
interest at a fixed rate of 9.70%. At December 31, 1996, the balance of the
receivable was $295,000. All 1997 repayments of advances have been made by TWA.

5
<PAGE> 10
During January 1990, the Partnership acquired a Lockheed L-1011
aircraft for a total purchase price of $17,555,000, subject to an operating
lease with TWA, originally scheduled to expire on June 30, 1993. The lease was
amended and extended to October 1,1998 with rental payments payable monthly, in
advance, at the rate of $130,000.

Upon execution of the lease amendment, the Partnership reimbursed TWA
for $225,000 of capital improvements which were made to the aircraft and
advanced $550,000 to TWA to finance certain major maintenance procedures, which
is being repaid over the remaining lease term in monthly installments with
interest at 9.68%. At December 31, 1996, the balance of the receivable was
$210,000. All 1997 repayments of advances have been made by TWA as scheduled.

In mid-October 1994, because of operating and financial problems, TWA
announced that it would seek a global restructuring of its capital by offering
common stock for its debt securities, preferred stock obligations and lease
deferrals negotiated with aircraft lessors such as the Partnership ("Exchange
Offer") with the objective of an orderly financial reorganization through a
prepackaged bankruptcy filing. In conjunction with this restructuring, TWA and
the Partnership agreed ("TWA Agreement") to a deferral of 50% of the rent
scheduled for November 1994, and 75% of the rent scheduled from December 1994 to
April 1995 for the MD-82 aircraft (50% of the December 1994 through April 1995
rent with respect to the L-1011 aircraft) followed by a return to the original
payment schedule. Under the terms of the TWA Agreement all rents deferred during
the November 1994 to April 1995 period were repaid with interest at 12% from the
date of deferral over an 18-month period which commenced May 1, 1995.
Additionally, TWA and the Partnership agreed to extend the lease of the MD-82
aircraft six years beyond the scheduled expiration date (to November 2004) at
the current lease rate of $185,000 per month. On June 30, 1995, TWA filed its
prepackaged reorganization plan under Chapter 11 of the U.S. Bankruptcy Code. On
August 23, 1995 the reorganization plan which included the foregoing lease
modification was confirmed by the Bankruptcy Court and TWA emerged from
bankruptcy. TWA has made all rental payments, advance repayments and payments of
deferred rent when due. However, there can be no assurance that it will be able
to meet its obligations in the future.

In mid-1996, as part of its fleet restructuring, TWA offered to return
the L-1011 aircraft it leases from the Partnership. The lease, which provided
for monthly rental of $130,000, was originally scheduled to expire in September
1998. TWA agreed to pay the Partnership $2,846,000, which represents rents due
under the remaining term of the lease, discounted at 5% plus $3,000,000 as an
economic settlement for noncompliance with certain lease return conditions
("L-1011 Lease Settlement"). The lease was terminated, the aircraft was returned
and the amounts aggregating $5,846,000 were received on October 16, 1996. The
Partnership is reviewing alternatives for the use of the proceeds received,
including the use of the economic settlement to purchase an additional aircraft
or engines. It is possible that the Partnership will lease the engines that were
a part of the L-1011 separately and sell the airframe for parts.

6
<PAGE> 11
The L-1011 aircraft was originally purchased in 1990 for $ 18,205,000
(including related fees) and had a net book value of approximately $6.1 million
(unadjusted for the $3,000,000 economic settlement accounted for as a lease
settlement reserve) at December 31, 1996.

c. Aeromexico Leases During July 1992, the Partnership released two
McDonnell Douglas DC-9-31 aircraft previously leased to Midway Airlines Inc. to
Aerovias de Mexico, S.A. de C.V. ("Aeromexico"). The leases are operating leases
that originally required quarterly rental payments, in advance, in the amount of
$234,000 per aircraft. The terms of the leases expire on July 6, 1997 and July
23, 1997. Aeromexico has the right to renew the leases for up to five
consecutive one-year renewal periods for the then fair market rental value.

The DC-9-31 aircraft had originally been acquired in April and March
1990 for purchase prices aggregating $14,295,000. At the time the Partnership
repossessed these two aircraft from Midway, the aircraft were in need of
substantial maintenance work. As a precondition to accepting the aircraft for
lease, Aeromexico required the Partnership to complete the needed maintenance
procedures and also to make certain capital improvements to the aircraft. The
Partnership incurred approximately $5.5 million in completing these maintenance
procedures and capital improvements.

In October 1994, Aeromexico failed to make the quarterly in advance
rental payments for both aircraft. Aeromexico announced it was having financial
and operating problems and, in response, made significant management changes and
began to develop a revised business plan. Aeromexico agreed to and paid monthly
rental payments equal to the monthly equivalent rent ($78,000 per aircraft)
beginning November 1994 in return for a four-month standstill agreement
("Standstill Agreement") from lessors and lenders, including the Partnership,
not to pursue their rights and remedies with respect to Aeromexico's failure to
pay rent and other debt due in October 1994. The Standstill Agreement was
extended an additional three months to allow Aeromexico to complete a financial
restructuring. Aeromexico repaid the October 1994 rent with interest and has
continued to pay the monthly rental equivalent for each aircraft.

The Partnership has entered into negotiations with Aeromexico to extend
each of the two leases to January 2000 at a slightly lower lease rate. Such
extensions are subject to final documentation.

d. USAir Lease During September 1989, the Partnership acquired one-half
of the beneficial interest in a trust ("Trust") which is the owner/lessor of a
McDonnell Douglas MD-81 aircraft for a total purchase price of $10,041,000. The
remaining one-half interest in the Trust is owned by Pegasus Aircraft Partners,
L.P., an affiliated partnership. The aircraft is subject to an operating lease
with USAir, the term of which ends on June 1, 1998. The lease may be terminated
after August 1993 subject to the lessee's guarantee that the Partnership will
receive contractually defined minimum termination values upon remarketing of the
aircraft. Rental payments are payable quarterly, in arrears, at the rate of
$304,000 (for the Partnership's one-half interest in the aircraft). The lease
provides for one three-year renewal option, at the same quarterly rental rate.
If the lease is not renewed for this first renewal period, the lessee must make
a termination payment of $1,113,000 to the Partnership. The lessee also has
three additional one-year renewal options at the then fair market rental rates.
The lessee may elect to

7
<PAGE> 12
purchase the aircraft at its then fair market value at the end of any renewal
term.

The McDonnell Douglas MD-81 aircraft under lease to USAir was purchased
subject to a tax benefit transfer lease ("TBT lease") which provided for the
transfer of the investment tax credits and depreciation deductions with respect
to the aircraft to a tax lessor. Under the TBT lease, the Trust, as the owner of
the aircraft and the tax lessee under the TBT lease, has agreed to indemnify the
tax lessor if certain anticipated tax benefits are lost by the tax lessor as a
result of, among other things, acts or omissions by the Trust, breach of
covenants by the Trust under the TBT lease, loss or damage to the aircraft or
use of the aircraft outside the United States. The TBT lease requires that a
letter of credit be posted to collateralize this obligation. The Partnership
shares in the annual cost of the letter of credit and is obligated for one-half
of any calls on the letter of credit.

The letter of credit has a current face amount of approximately $1.7
million. The letter of credit agreement originally obligated the Partnership to
deposit $35,000 per quarter (beginning on June 1, 1992) as cash collateral to
collateralize the Partnership's obligation under the letter of credit agreement.
In July 1995, the Partnership consummated an agreement with the issuer of the
letter of credit under which the issuer released its interest in the cash in the
cash collateral account.

Under the operating lease, the lessee, USAir, has assumed all
liabilities, indemnities and obligations of the Trust to the tax lessor under
the TBT lease and has agreed to indemnify the Trust for any liability, indemnity
or obligation to the tax lessor under the TBT lease except for liability
resulting from breaches by the Trust of covenants under the operating lease.
USAir has not posted a letter of credit to secure this obligation. As a result
of the foregoing, if the tax lessor draws on the letter of credit as a result of
action by the lessee, the Partnership and Pegasus Aircraft Partners, L.P.
through the trust will be responsible for the loss to the tax lessor until and
if the lessee performs under its indemnification. To date there have been no
calls on the letter of credit.

The tax lessor is entitled to call on the letter of credit whether its
loss of tax benefits is caused by Pegasus Aircraft Partners, L.P. or the
Partnership. Pegasus Aircraft Partners, L.P. and the Partnership have agreed to
indemnify each other for any loss occasioned by the acts of the other.

e. Kiwi International Air Lines Leases The Partnership leased its two
Boeing 727-200 aircraft, to Kiwi International Air Lines, Inc. ("Kiwi"). The
aircraft were originally purchased in 1989 (Non-advanced) and 1990 (Advanced)
for purchase prices of $6,261,000 and $10,748,000 respectively (including
related fees). The leases were operating leases which required monthly rental
payments, in advance, in the amounts of $60,000 (Non-advanced) and $115,000
(Advanced). The terms of the leases were originally scheduled to expire on April
15, 1998 and June 30, 1998, respectively. In 1995, the leases were amended and
extended to December 31, 1999. Kiwi was also obligated to make monthly payments
of $250 per flight hour for maintenance reserve funds administered by the
Partnership. An affiliated partnership and affiliates of the Managing General
Partner also own aircraft leased to Kiwi.

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<PAGE> 13
In connection with the delivery of the aircraft the Partnership
expended $2,228,000 with respect to the 727 Advanced aircraft, of which $971,000
was capitalized and $1,257,000 represented maintenance expense which were paid
out of funds received in a maintenance settlement with the prior lessee.
Capitalized improvements of $743,000 were made with respect to the non-advanced
aircraft.

The Partnership also received Kiwi stock and rights to warrants in
connection with these leasing transactions. The Partnership is subject to
significant restrictions on its ability to dispose of these securities. Based
upon the price at which Kiwi sold similar securities to unrelated third parties,
the Partnership originally recorded the securities at a value of $600,000. The
securities were valued at approximately $156,000 at December 31, 1995 and were
written down to $1,000 at December 31, 1996.

During 1994, the Partnership funded approximately $633,000 of costs
related to maintenance of the Kiwi aircraft, including compliance with certain
FAA airworthiness directives, $308,000 of which was scheduled to be repaid by
Kiwi over a one-year period. In March 1996, Kiwi signed a promissory note
("Bellyskin Note") scheduling the repayment of the latter amount, with interest
from February 1996 at 12% per annum, over eighteen months, commencing June 1,
1996.

In August 1996, the Partnership paid $1.9 million to hushkit the
non-advanced 727 aircraft. The purchase price was funded out of cash reserves
previously generated.

In June 1996, Kiwi agreed with the FAA to ground 25% of its fleet due
to certain pilot training handbook deficiencies. In August 1996, Kiwi and the
FAA resolved the deficiencies and Kiwi returned to full capacity. In addition to
the FAA grounding, Kiwi was also negatively impacted by the market reaction to
the ValuJet incident. During 1996, Kiwi did not meet its financial goals. In
July 1996, an institutional investor contributed $4,000,000 in return for a
convertible note due in March 1997, for up to 32% of Kiwi's common stock and two
seats on Kiwi's Board of Directors. The investor had options to invest an
additional $6,000,000 in convertible preferred stock which expires in March
1997. Existing shareholders (including directors and employees) were given the
opportunity to make additional investments.

Kiwi requested and was granted by the Partnership a deferral of its
August 1996 rental and July 1996 maintenance payments for the advanced aircraft
and the July rental and June maintenance reserves with respect to the
non-advanced aircraft. Kiwi was also unable to make its September rental and
August maintenance payments for each aircraft and was placed in default by the
Partnership.

In late September, Kiwi proposed a restructuring of its obligations
with certain creditors, including the Partnership. On September 30, 1996, Kiwi
filed a voluntary petition for reorganization under Chapter 11 of the Federal
Bankruptcy Code ("Bankruptcy Code") and did not make any subsequent payments.
The Kiwi leases accounted for approximately 11% of the Partnership's rental
revenue in 1996 and the aircraft had net book values aggregating approximately
$8,100,000 (including the hushkit), net of the provision for decline in market
value of aircraft of $100,000 at December 31, 1996 excluding the cost of the
heavy maintenance check being completed as of December 31, 1996 prior to a new
lease discussion below. Additionally, the unpaid balance of the Bellyskin Note,
plus

9
<PAGE> 14
interest (which went to non-accrual status at September 30, 1996) was $290,000
at December 31, 1996. The Partnership currently holds maintenance deposits
aggregating approximately $2.2 million, which the Partnership believes will not
be sufficient to complete work required on the aircraft and the related engines
to meet lease return conditions. On October 15, 1996, Kiwi ceased scheduled
flight operations while still exploring financial alternatives. The court
approved Kiwi's motion to reject both leases as of November 15, 1996. The
Partnership provided an allowance for bad debts in the amount of $640,000 in
respect of amounts due at December 31, 1996. The Partnership recovered the
aircraft in late 1996.

In December 1996, the Partnership entered into a lease agreement with
Falcon Air Express, Inc. ("Falcon") a charter airline with respect to the
727-200 non-advanced aircraft formerly leased to Kiwi. The lease is for a term
of 60 months and provides for a monthly rental of $95,000. Falcon provided a
security deposit of $95,000. The lease also requires Falcon to fund, on a
monthly basis, maintenance reserves of $317 per flight hour. In connection with
the delivery of the aircraft, the Partnership completed a heavy maintenance
check on the aircraft, of which $583,000 had been expended as of December 31,
1996 and approximately $700,000 was paid or payable prior to delivery. The
Partnership also purchased an engine at cost of $760,000 prior to delivery of
the aircraft. The aircraft was delivered to Falcon in March 1997.

Significant Lessees

The Partnership leased its aircraft to five different airlines during
1996. Revenue from four airlines which accounted for greater than 10% of the
total rental revenue of the Partnership during 1996 are as follows:

<TABLE>
<CAPTION>
Airline Percentage of Total Rental Revenue
------- ----------------------------------
<S> <C>
Continental Airlines, Inc.* 44.4%
Trans World Airlines, Inc. 24.7%
Aerovias de Mexico S.A. de C.V. 12.3%
Kiwi International Air Lines, Inc.(1) 10.6%
</TABLE>

* Includes rental revenue from Continental Micronesia, Inc., a
subsidiary of Continental Airlines, Inc.

(1) Includes rentals totaling $350,000 with regard to Kiwi for
which an allowance for bad debts was provided.

Safety Requirements and Aircraft Aging

In addition to registration, the FAA imposes strict requirements
governing aircraft inspection and certification, maintenance, equipment
requirements, general operating and flight rules (including limits on arrivals
and departures), noise levels, certification of personnel and recordkeeping in
connection with aircraft maintenance. FAA regulations establish standards for
repairs, periodic overhauls and alterations, and require that the owner or
operator of an aircraft establish an airworthiness inspection program to be
carried out by certified mechanics. No aircraft of the Partnership may be
operated without a current airworthiness certificate.

10
<PAGE> 15
The FAA periodically reviews Service Bulletins which are issued by the
aircraft manufacturers. These bulletins focus on safety problems that have
developed during the aircraft's operation. The FAA may incorporate these Service
Bulletins in Airworthiness Directives ("ADs"), which are mandates requiring the
airline to perform specific maintenance within a specified period of time.

Aircraft aging is a significant issue in aircraft safety regulation. In
the past, certain aviation incidents and accidents raised concerns over the
structural integrity of older aircraft. In 1989, in its "Report to Congress on
the Status of the U.S. Stage 2 Commercial Aircraft Fleet", the FAA stated that
"no correlation has been established between the chronological age of an
aircraft and its structural airworthiness. A more accurate assessment of the
physical "age" of an aircraft is the total number of flight cycles and flight
hours flown." A flight cycle is defined as one takeoff and one landing. A flight
cycle is important because of the added stress on the airframe, landing gear and
other components from repeated takeoffs, landings and pressurizations. As
different types of aircraft have different missions and carriers fly a variety
of routes, flight cycles can vary widely among aircraft of the same
chronological age. In general, narrow-body aircraft which are used for
short-haul service will have greater cycles per year than wide-body aircraft
used for longer routes. Other factors which contribute to the aging of an
aircraft are the number of hours actually flown, the predominant environment in
which an aircraft has flown, and its actual age in years.

The FAA has adopted certain ADs for Boeing and McDonnell Douglas
aircraft models, including Boeing 727s, 737s and 747s and McDonnell Douglas
DC-9s, MD-80s and DC-10s. These ADs make mandatory the periodic replacement or
modification of structural materials, fittings and skin at certain times in the
life of an aircraft, typically when the aircraft reaches a certain number of
flight cycles or age threshold. Previously, these aircraft were subject only to
periodic inspection, and the replacement and modification of materials and parts
was done where deemed necessary. Similar ADs for Lockheed and Airbus
manufactured aircraft are expected to be proposed and adopted by the FAA. In
addition, it is widely expected that foreign civil aviation authorities,
especially in Europe and Japan, will adopt similar measures to protect the
structural integrity of older aircraft.

These aging aircraft ADs will initially impact only a limited number of
older aircraft, but additional aircraft will be covered as they accumulate
time-and-service and reach the thresholds for the required modifications.
Significantly, in the case of each aircraft type, a significant majority of
replacements or modifications are mandated when a plane reaches a certain number
of flight cycles and relatively few required replacements are triggered when a
plane reaches a certain chronological age or number of flight hours.

The following table summarizes the age, flight cycle, and flight hour
thresholds for each major aircraft type under the ADs. In general, these
thresholds are based on the "economic design goal" of an aircraft, which is
typically considered to be the period of service after which an increase in
maintenance costs is expected to take place in order to assure continued
operational safety. In addition, the table provides an estimate by the FAA of
the costs of complying with all of the mandated replacements and modifications
of the ADs. It is important to note that since most of the proposed work under
the ADs is based on flight cycle thresholds,

11
<PAGE> 16
those lower-cycle aircraft which reach the aircraft age or flight hour
thresholds should incur significantly lower AD compliance cost than the total
amounts estimated below.

<TABLE>
<CAPTION>
Aircraft Flight Flight Estimated
Aircraft Age Cycle Hour AD
Type Threshold Threshold Threshold Costs
-------- --------- --------- --------- ---------
(Years)
<S> <C> <C> <C> <C>
Boeing 727 20 60,000 N/A $1,100,000
Boeing 737 20 75,000 N/A $ 934,000
Boeing 747 20 20,000* N/A $3,400,000
McDonnell Douglas DC-9 20 100,000 75,000 $ 79,000
McDonnell Douglas MD-80 20 75,000 75,000 $ 4,000
McDonnell Douglas DC-10 None 42,000 60,000 $ 187,000
</TABLE>

* Substantially cycle limited

Flight cycle and flight hour information with respect to the
Partnership's aircraft are included in the aircraft portfolio table included
earlier on Page 3.

The Partnership's leases generally require the lessees to bear the
costs of compliance with ADs which require action during the lease terms. The
only exceptions relate to the McDonnell Douglas DC-10 aircraft on lease to
Continental, the two McDonnell Douglas DC-9-31 aircraft on lease to Aeromexico
and the two Boeing 727-200 aircraft previously on lease to Kiwi. Under certain
circumstances, for these leases the Partnership is obligated to share in the
costs of complying with certain ADs. All of the Partnership's Boeing 727
aircraft have had the major calendar modifications performed as required. It is
anticipated that the 60,000-cycle aging modifications will not be due to be
performed until approximately the end of or beyond the end of, each of the
leases.

Overall, the General Partners believe that the increased maintenance
costs mandated for older aircraft may have some negative impact on re-lease and
resale values for these planes, but counterbalancing this, compliance with the
ADs should also serve to prolong the revenue lives of the affected aircraft.

Aircraft Noise Regulations

On November 5, 1990, Congress enacted into law the Airport Noise and
Capacity Act of 1990 (the "Act"). On September 24, 1991, the FAA issued the
final rules of implementation for the Act. The Act provides that Stage 2
aircraft will be phased out from operation within United States airspace by
December 31, 1999.

Implementing regulations proposed by the FAA required or require each
United States operator to increase its Stage 3 airplane fleet to 50 percent by
December 31, 1996; to 75 percent by December 31, 1998, and to 100 percent by
December 31, 1999.

12
<PAGE> 17
However, the Act further provides, that if by July 1, 1999, at least
85% of an air carrier's fleet complies with Stage 3 noise levels, the carrier
may apply for a waiver of the operational ban for the remaining aircraft in the
operator's fleet until December 31, 2003. The application for such a waiver must
be submitted to the Secretary of the Department of Transportation no later than
January 1, 1999 and must include a plan with firm orders for making all aircraft
operated by the air carrier comply with Stage 3 noise levels by December 31,
2003.

Stage 3 hushkitting and re-engineering for the Boeing 727-200 and the
McDonnell Douglas DC-9-30 aircraft have been approved by the FAA. Certain
airlines have determined that it is economically feasible to hushkit certain
Stage 2 aircraft to achieve Stage 3 noise standards. The Partnership continues
to monitor the marketplace based upon the availability of aircraft, pricing for
Stage 2 and Stage 3 aircraft and the timetable for implementation of Stage 3, to
best position the Partnership's aircraft for continued and future deployment.

Competition

The aircraft leasing industry is highly competitive, depending, in
part, upon the type of leased aircraft and prospective lessees. The Partnership
competes with aircraft manufacturers, distributors, airlines and other
operators, equipment managers, leasing companies, financial institutions and
other parties engaged in leasing, managing or remarketing aircraft, many of
which have significantly greater financial resources and greater experience than
the Partnership. Such competitors may lease aircraft at lower rates than the
Partnership and provide benefits, such as direct maintenance, crews, support
services and trade-in privileges, which the Partnership does not intend to
provide. Competitors may include certain affiliates of the General Partners.

Employees

The Partnership has no employees. The officers, directors and employees
of the General Partners and their affiliates perform services on behalf of the
Partnership. The General Partners are entitled to certain fees and
reimbursements of certain out-of-pocket expenses incurred in connection with the
performance of these management services. See Item 10 of this Report, "Directors
and Executive Officers of the Registrant", and Item 13 of this Report, "Certain
Relationships and Related Transactions", which are incorporated herein by
reference.

Item 2. Properties

The Partnership does not own or lease any physical properties other
than the aircraft which are discussed in Item 1 of this Report, "Business",
which is incorporated herein by reference.

13
<PAGE> 18
Item 3. Legal Proceedings

In November 1994, a series of purported class actions (the "New York
Limited Partnership Actions") were filed in the United States District Court for
the Southern District of New York ("District Court") concerning PaineWebber
Incorporated sale and sponsorship of various limited partnership investments,
including those offered by the Partnership. The lawsuits were brought against
PaineWebber Incorporated and Paine Webber Group, Inc. (together, "PaineWebber"),
among others, by allegedly dissatisfied partnership investors. In March 1995,
after the actions were consolidated under the title In re: PaineWebber Limited
Partnerships Litigation, the plaintiffs amended their complaint to assert claims
against a variety of other defendants, including Air Transport Leasing, Inc., an
affiliate of PaineWebber and the Administrative General Partner in the
Partnership ("Administrative General Partner").

The amended complaint in the New York Limited Partnership Actions
alleged, among other things, that, in connection with the sale of interests in
Pegasus Aircraft Partners II, L.P., PaineWebber and the Administrative General
Partners (1) failed to provide adequate disclosure of the risks involved with
each partnership; (2) made false and misleading representations about the safety
of the investments and the partnership's anticipated performance; and (3)
marketed the partnership to investors for whom such investments were not
suitable. The plaintiffs also alleged that following the sale of the partnership
investments PaineWebber and the Administrative General Partner misrepresented
financial information about the partnership's value and performance. The amended
complaint alleged that PaineWebber and the Administrative General Partner
violated the Racketeer Influenced and Corrupt Organizations Act ("RICO") and the
federal securities laws. The plaintiffs sought unspecified damages, including
reimbursement for all sums invested by them in the partnerships, as well as
disgorgement of all fees and other income derived by PaineWebber from the
limited partnerships. In addition, the plaintiffs also sought treble damages
under RICO.

On May 30, 1995, the District Court certified class action treatment of
the plaintiffs' claims in the New York Limited Partnership Actions.

In January 1996, PaineWebber signed a memorandum of understanding with
the plaintiffs in the class action outlining the terms under which the parties
agreed to settle the case. A definitive settlement was signed in July 1996 and
in March 1997, the District Court approved the settlement as fair and
reasonable. Under the terms of the settlement, PaineWebber agreed to pay $125
million and additional consideration to class members.

In April 1995, two investors in the Pegasus limited partnerships filed
a purported class action in the Circuit Court of the State of Illinois for Cook
County entitled Robert M. Jacobson, et al. v. PaineWebber, Inc., et al., making
allegations substantially similar to those in the New York Limited Partnership
Actions, but limited in subject matter to the sale of the Pegasus partnerships,
and without a RICO claim. The plaintiffs in the Jacobson case simultaneously
remained as participants in the New York Limited Partnership Actions, and
challenged the proposed settlement of these cases. Their objections were
overruled when the District Court approved the class action settlement with
respect to the New York Limited Partnership Actions. The Illinois case has been
dismissed.

14
<PAGE> 19
Three actions were filed in the District Court for Brazoria County,
Texas, relating to the sale and sponsorship of interests in the Partnership and
an affiliated partnership. The complaints make state law claims, specifically,
common law fraud, conspiracy, violations of section 27.01 of the Texas Business
and Commerce Code, fraud in the inducement, negligent misrepresentation,
negligence, breach of fiduciary duty, violations of the Texas Securities Act,
and violations of the Texas Deceptive Trade Practices Act.

The plaintiffs seek unspecified damages, including attorneys' fees,
reimbursement for all sums invested by them in the partnerships, exemplary
damages, and treble damages under the Texas Deceptive Trade Practices Act. All
three actions have been removed to federal court and two have been transferred
to the District Court and consolidated under the title, Mallia vs. PaineWebber,
Inc. The third action has been dismissed with the consent of the parties on the
grounds that it is duplicative of the two actions now before the federal court
in New York.

In February 1996, approximately 230 plaintiffs filed an action entitled
Abbate v. PaineWebber Inc. in Sacramento, California Superior Court against
PaineWebber Incorporated and various affiliated entities concerning the
plaintiff's purchases of various limited partnership interests. The complaint
alleges, among other things, that PaineWebber 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 seeks compensatory damages of $15 million plus punitive damages. In
September 1996, the California Superior Court dismissed many of the plaintiffs'
claims as barred by the applicable statutes of limitation.

In June 1996, counsel for the Abbate plaintiffs instituted two
additional actions containing allegations nearly identical to those set forth in
Abbate. Bandrowski v. PaineWebber Incorporated. et al. was filed in California
Superior Court and Barstad v. Paine Webber Incorporated. et al. was filed in
Arizona Superior Court. Collectively, the two additional actions are brought by
approximately 50 plaintiffs and seek compensatory damages of approximately $4
million plus punitive damages. In March 1997, all of these actions were settled.

Under certain limited circumstances, pursuant to the Partnership
Agreement and other contractual obligations, PaineWebber and its affiliates,
including the Administrative General Partner were entitled to indemnification
from the Partnership for expenses and liabilities in connection with the above
actions. PaineWebber and its affiliates have agreed to not seek any
indemnification from the Partnership for any amounts prepared in connection with
the New York Partnership Actions. The General Partners do not believe that the
settlement of the Abbate, Bandrowski and Barstad actions will have a material
effect on the Partnership's financial statements taken as a whole.

15
<PAGE> 20
discussions with a hearing date scheduled for June 1997. The Partnership
estimates that the cost to meet return condition would be approximately
$4,100,000. The Partnership is also involved in a litigation with the company
that acted as Kiwi's manager regarding each party's compliance with a settlement
agreement into facilitate the recovery of the aircraft.

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

No matters were submitted to a vote of the Limited Partners of the
Partnership, through the solicitation of proxies or otherwise, during the fourth
quarter of the fiscal year ended December 31, 1996.

PART II

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

There is no organized trading market for the purchase and sale of the
Units and certain measures have been adopted and implemented to assure that no
organized trading market will develop.

As of March 1, 1997, the number of Limited Partners of record was
approximately 8,300.

The Partnership declared the following distributions to its Limited Partners out
of cash flow received from operations during 1996 and 1995:

<TABLE>
<CAPTION>
Amount Of
Distribution
Period Per Unit Record Date Payment Date
------ ------------ ----------- ------------
<S> <C> <C> <C>
1st Quarter 1996 $.40 March 31, 1996 April 29, 1996

2nd Quarter 1996 .40 June 30, 1996 July 29, 1996

3rd Quarter 1996 .40 September 30, 1996 October 21, 1996

4th Quarter 1996 .40 December 31, 1996 January 24, 1997

1st Quarter 1995 .40 March 31, 1995 April 29, 1995

2nd Quarter 1995 .40 June 30, 1995 July 29, 1995

3rd Quarter 1995 .40 September 30, 1995 October 29, 1995

4th Quarter 1995 .40 December 31, 1995 January 28, 1996
</TABLE>

16
<PAGE> 21
Total distributions to all partners for 1996 and 1995 were declared as
follows (in thousands):

<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Limited Partners $11,608 $11,608
General Partners 117 117
------- -------
$11,725 $11,725
======= =======
</TABLE>

Distributions may be characterized for tax, accounting and economic
purposes as a return of capital, a return on capital, or both. The portion of
each cash distribution by a partnership which exceeds its net income may be
deemed a return of capital. Based on the amount of net income reported by the
Partnership for accounting purposes, approximately 75%, 83%, and 88%
respectively, of the cash distributions paid to the partners for the years ended
December 31, 1996, 1995 and 1994 constituted a return of capital. Also, based on
the amount of cumulative net income reported by the Partnership for accounting
purposes, approximately 82% of the cash distributions paid to the partners from
the inception of the Partnership through December 31, 1996 constituted a return
of capital. However, the total actual return on capital over the Partnership's
life can be determined only at the termination of the Partnership after all cash
flows, including proceeds from the sale of the aircraft, have been realized.

Item 6. Selected Financial Data

The following selected financial data of the Partnership was derived
from the audited financial statements for the indicated periods. The information
set forth below should be read in conjunction with the Partnership's Financial
Statements and Supplementary Data thereto and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in Items 8
and 7, respectively, of this Report.

<TABLE>
<CAPTION>
As of December 31, 31,
or Year Ended December

1996 1995 1994 1993 1992
------------------------------------------------------------------
(in thousands, except per unit amounts)
<S> <C> <C> <C> <C> <C>
Rental Revenue $15,231 $14,026 $15,537 $14,985 $14,556
Net Income 2,898 2,019 1,413 1,549 1,949
Net Income per Limited
Partnership Unit .40 .28 .19 .21 .27
Distributions per Partnership
Unit(1) 1.60 1.60 1.60 1.60 1.90

Total Assets 72,039 80,799 86,350 95,842 101,690
Notes Payable 4,751 6,638 7,382 7,735 4,000
Partners' Equity 54,540 63,367 73,073 83,385 93,561
</TABLE>

- ------------
(1) Distribution amounts are reflected during the period in which the cash
for the distribution was generated. A portion of the actual cash
distributions are paid subsequent to such period.

(See Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations".) As has historically been the case, the
amount of future cash distributions will be determined on a quarterly basis
after an evaluation of the Partnership's operating results and its current and
expected financial position.

17
<PAGE> 22
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

Liquidity and Capital Resources

The Partnership owns and manages a diversified portfolio of leased
commercial aircraft and makes quarterly distributions to the partners of net
cash flow generated by operations. In certain situations, the Partnership may
retain cash flow from operations to finance authorized capital expenditures.

Cash distributions declared and cash distributions paid by the
Partnership were approximately $11.7 million ($1.60 per Unit) in each of 1996,
1995 and 1994, respectively. Net cash provided by operating activities was $13.5
million in 1996, $17.6 million in 1995 and $14.2 million in 1994. In the
aggregate, for this three-year period net cash provided by operating activities
totaled $45.3 million and cash distributions declared by the Partnership totaled
$35.17 million. In 1996, the Partnership received $3,000,000 as part of the
lease settlement and return of the L-1011 by TWA in lieu of TWA complying with
certain lease return conditions. Such amount was included as a lease settlement
reserve and thus was not included in cash from operating activities.
Additionally, in 1995, the Partnership received the A-300 Lease Settlement
proceeds, a portion of which was accounted for under the cost recovery method
and thus, was not included in cash from operating activities.

Partnership equity declined by approximately $8,827,000 from December
31, 1995 to December 31, 1996 as a result of the declaration and payment of cash
distributions to the partners in excess of the Partnership's net income. This
resulted primarily from the fact that, unlike net income, cash flow generated
from operations, which is the source of the cash utilized to make the
distributions, is not reduced by depreciation expense and provisions for decline
in market value of aircraft attributable to the Partnership's aircraft.

Distributions may be characterized for tax, accounting and economic
purposes as a return of capital, a return on capital, or both. The portion of
each cash distribution by a partnership which exceeds its net income may be
deemed a return of capital. Based on the amount of net income reported by the
Partnership for accounting purposes, approximately 75%, 83%, and 88%
respectively, of the cash distributions paid to the partners for the years ended
December 31, 1996, 1995, and 1994 constituted a return of capital. Also, based
on the amount of cumulative net income reported by the Partnership for
accounting purposes, approximately 82% of the cash distributions paid to the
partners from the inception of the Partnership through December 31, 1996
constituted a return of capital. However, the total actual return on capital
over the Partnership's life can be determined only at the termination of the
Partnership after all cash flows, including proceeds from the sale of the
aircraft, have been realized.

The primary reason for the net increase in liquidity was the L-1011
Settlement. In mid-1996, as part of its fleet restructuring, TWA offered to
return the L-l011 aircraft it leases from the Partnership. The lease, which
provided for monthly rental of $130,000, was originally scheduled to expire in
September 1998. TWA agreed to pay the Partnership $2,846,000, which represents
rents due under the remaining term of the lease, discounted at 5% plus
$3,000,000 as

18
<PAGE> 23
an economic settlement for noncompliance with certain lease return conditions.
The lease was terminated, the aircraft was returned and the amounts aggregating
$5,846,000 were received on October 16, 1996. The Partnership is reviewing
alternatives for the use of the proceeds received, including the use of the
economic settlement to purchase an additional aircraft or engines. It is likely
that the Partnership will lease the engines that were a part of the L-1011
separately and sell the airframe for parts.

At December 31, 1996, the Partnership had $9,842,000 of unrestricted
cash and cash equivalents in excess of declared, but unpaid, distributions to
the partners. This represents a slight increase from a similarly computed amount
at December 31, 1995 of $9,024,000.

Rent and other receivables decreased $1,799,000 from $2,557,000 at
December 31, 1995 to $758,000 at December 31, 1996. This primarily decrease is
primarily the result of the continued repayment of deferred rentals and advances
by Continental and TWA during 1996. Additionally, the Partnership provided an
allowance for bad debts of $640,000 with respect to amounts outstanding with
respect to Kiwi at December 31, 1996.

The payable to affiliates decreased $257,000 from $893,000 at December
31, 1995 to $636,000 at December 31, 1996 principally due to the payment of
amounts previously deferred on a voluntary basis by the Administrative General
Partner.

Deferred income decreased by $893,000 from $4,672,000 at December 31,
1995 to $3,779,000 at December 31, 1996. This decrease was attributable to the
amortization of amounts recognized in connection with the A-300 Lease Settlement
and the DC-10 Lease Restructuring and the removal of deferred income associated
with the Kiwi stock held by the Partnership offset by the proceeds relating to
the lease prepayment derived from the L-1011 Lease received in 1996.

The Partnership's liquidity increased in 1996, principally because of
the proceeds received with respect to the L-1011 Lease Settlement which
aggregated $5,846,000 partially offset by capital improvements made principally
to the non-advanced 727-200 aircraft formerly leased to Kiwi in the amount of
$2,500,000 and the impact of the Kiwi bankruptcy which reduced cash flow.
Additionally, since December 31, 1996, the Partnership committed or expended an
additional $700,000 for the 727-200 Non-advanced aircraft with respect to the
C-10 check prior to its delivery to Falcon Air Express, purchased a replacement
engine at a cost of $760,000 and committed $1,600,000 towards a cargo conversion
of the 727-200 advanced aircraft (with a further commitment to hushkit the
aircraft prior to December 31, 1999 at a cost of approximately $3,000,000). The
Partnership will also be required to replace or overhaul certain engines that
were installed on the former Kiwi aircraft. It is anticipated that the A-300
aircraft will require a heavy maintenance check in connection with its
remarketing which, along with estimated modifications and FAA mandated
maintenance is expected to cost approximately $2,500,000, of which $557,000
was provided and set aside as reserve for maintenance as part of the A-300 Lease
Settlement. In order to finance these obligations, in December 1996, the
Partnership established a new $10,000,000 loan facility with an unaffiliated
third party lender. The loan commitment is for a period of 36 months,
terminating December 31, 1999, at which time outstanding principal is due. The
loan provides for interest at a rate of 1% over the lender's prime rate of
interest which is payable monthly. The Partnership must maintain a minimum

19
<PAGE> 24

balance outstanding of $4,000,000 during the loan commitment period. The loan is
collateralized by the Partnership's interest in the MD-82 aircraft leased to TWA
and the two 727-200 advanced aircraft leased to Continental. The Partnership
utilized $4,751,000 of this loan to pay off its prior two loan facilities.

The Partnership entered into an agreement to lease the 727-200 non-advanced
aircraft to a start-up charter carrier for a term of five years and entered into
an agreement to lease the 727-200 advanced aircraft to a start-up cargo carrier
for a term of eight years. Further, the Partnership began discussions with a
foreign airline with respect to the lease of the A-300 aircraft and has had
discussions with Aeromexico regarding the extension of the leases of the
aircraft scheduled to expire in July 1997. The L-1011 aircraft will require a C
check shortly and it is possible that the Partnership will lease the engines and
sell the airframe for parts. Finally, Continental extended the lease of the
DC-10-10 aircraft to June 30, 1998 at a lease rate of $150,000 per month.
Additionally the Partnership may utilize the portion of the settlement received
with respect to lease return conditions from the L-1011 Lease Settlement ($3
million) to purchase an additional aircraft. The Partnership currently holds
$2.2 million of maintenance reserves collected from Kiwi which are subject to
the Kiwi bankruptcy proceedings and which are not sufficient to meet the lease
return conditions. However, even with the remarketed leases of the two ex-Kiwi
aircraft described above, the Partnership's expected cash flow for 1997 from its
leases will be less than its previous level of cash distributions to partners.
It is anticipated that the Partnership will utilize cash reserves to fund its
distribution requirements.

Litigation

See Item 3, "Legal Proceedings", for a discussion of certain class action
lawsuits.

Results of Operations

Substantially all of the Partnership's revenue was generated from the
leasing of the Partnership's aircraft to commercial air carriers under operating
leases.

Under the terms of the triple net leases, substantially all of the
expenses related to the operation and maintenance of the aircraft during 1996,
were paid for by the lessees or funded out of maintenance reserves collected.
The direct lease expenses incurred by the Partnership represent the costs of
providing insurance coverage for the Partnership's aircraft in excess of the
amounts required to be carried by the lessees, trustee fees related to the
ownership of the aircraft, the cost of the letter of credit required under the
terms of the TBT lease on the McDonnell Douglas MD-81 leased to USAir, the
amortization of costs incurred in connection with the Aeromexico leases, the
costs of storing the A-300 aircraft and the costs relating to the recovery of
the Kiwi aircraft.

The Partnership also records depreciation expense pertaining to the
aircraft and incurs interest expense and management fee and certain general and
administrative expenses in connection with the operations of the Partnership.
General and administrative expenses consist primarily of investor reporting
expenses, transfer agent and audit fees, and the cost of accounting services.

20
<PAGE> 25

1996 as compared to 1995

The increase in the Partnership's net income for the year ended
December 31, 1996 ("1996 Period") as compared to the year ended December 31,
1995 ("1995 Period") was attributable to the rental income recognized with
respect to the two 727-200 aircraft received in the A-300 Lease Settlement,
partially offset by the effect of the Kiwi bankruptcy (the Partnership did not
record any rental revenue with respect to Kiwi beyond the bankruptcy date), the
provision for bad debts and loss in value of stock. Further, net income was
positively impacted because interest income increased due primarily to an
increase in cash available for investment, interest expense decreased due to the
continued repayment of outstanding indebtedness and the necessity for provisions
for decline in market valued decreased. However, net income was reduced in the
1996 Period as compared to the 1995 Period due to aircraft direct lease costs
relating to insurance, storage of the A-300 and the recovery of the Kiwi
aircraft increasing substantially.

Rental income increased by $1,205,000, or 9% in the 1996 Period, as
compared to the 1995 Period reflecting the difference between the income
recognized with respect to the A-300 Lease Settlement (including the rent
associated with the two 727 aircraft received in the Lease settlement) and DC-10
Restructuring in the 1996 Period and the rents recognized in the 1995 Period,
which included the DC-10-10 rentals at the original lease rate ($252,000) and
the rents recognized under the A-300 Lease under which rentals of $312,000 were
recognized in January 1995 and reduced rents ($150,000 per month) were
recognized in February through May 1995. This increase was partially offset by
the impact of the Kiwi bankruptcy filing. The Partnership did not recognize any
rental revenue after the bankruptcy filing and recovered the aircraft in late
1996 after Kiwi rejected the leases (see Item 8, Financial Statements, Note 5,
"Kiwi-Bankruptcy" for a further discussion).

Interest income increased $135,000, or 22%, for the 1996 Period, in
comparison to the 1995 Period. This increase was primarily attributable to the
interest income earned with respect to the cash reserves held by the Partnership
during the 1996 Period (substantially provided by the A-300 Lease Settlement and
DC 10-10 Restructuring discussed above).

Depreciation and amortization expense increased $39,000, or less than
1%, for the 1996 Period in comparison to the 1995 Period. The increase was
attributable to the increase in depreciation relating to the DC 10-10 aircraft
(based upon a change in estimate of the aircraft's end of lease residual value)
as well as the depreciation relating to the two 727 aircraft received in the
A-300 Lease Settlement, which were not in place in the 1995 Period, offset by a
reduction in depreciation expense with respect to the A-300 which was off lease
during the 1996 Period (thus no depreciation was recognized) and the L-1011
aircraft and the Kiwi aircraft which were taken out of service during the fourth
quarter of 1996.

Management and re-lease fees for the 1996 Period, decreased by $93,000
or 8%, in comparison to the 1995 Period primarily because certain of the amounts
received in the A-300 Settlement and DC 10-10 Restructuring in 1995 were
accounted for under the cost recovery method (making the base upon which certain
fees are deemed different), partially offset by an increase in rental revenue
recognized and net income (adjusted for depreciation) in 1996, which

21
<PAGE> 26
serve as bases upon which such fees are derived.

Interest expense for the 1996 Period, decreased by $165,000 or 20% in
comparison to the 1995 Period, primarily because of the continued repayment of
the notes resulting in a reduction in the principal outstanding.

General and administrative expenses increased by $36,000 or 12% during
the 1996 Period, as compared to the 1995 Period primarily due to legal fees
incurred in connection with the Kiwi bankruptcy.

Direct lease expenses increased by $199,000 in the 1996 Period, or 101%
as compared to the 1995 Period, due primarily to an increase in insurance
premiums and certain storage costs and technical consulting costs related to the
A-300 aircraft which was off lease during the 1996 Period, and certain costs
relating to the recovery of the Kiwi aircraft in late 1996.

At December 31, 1996 the Partnership provided an allowance for bad
debts in the amount of $640,000 which represented rents, advances (Bellyskin
Note) and related interest due from Kiwi (See Item 8, Financial Statements, Note
5, "Aircraft, Kiwi - Bankruptcy").

Additionally, as of December 31, 1996, the Partnership recognized a
loss of $155,000 with respect to Kiwi securities received in prior transactions.
The securities will be carried at a nominal value (See Item 8, Financial
Statements, Note 5, "Aircraft, Kiwi - Bankruptcy").

1995 Compared to 1994

The Partnership's net income for the year ended 1995 Period was
$2,019,000 as compared to $1,413,000 for the year ended December 31, 1994 ("1994
Period").

The increase in the Partnership's net income in the 1995 Period as
compared to the 1994 Period was due primarily to the fact that the Partnership
provided for a decline in market value of aircraft of $450,000 in the 1995
Period as compared to $2,600,000 in the 1994 Period offset by a reduction in
rental revenue principally due to the reduction in lease payments, and return of
the aircraft to off lease status as the result of the A-300 Lease Settlement and
subsequent default by Akdeniz.

Rental revenue decreased by approximately 10% or $1,511,000 for the
1995 Period, as compared to the 1994 Period, principally due to the recognition
of reduced rental income in the 1995 Period with respect to the A-300 Aircraft
discussed above.

Interest income increased by 47% or $193,000 for the 1995 Period in
comparison to the 1994 Period. This increase was primarily attributable to the
interest income earned on the balances of the deferred of rentals by TWA, Kiwi
and Aeromexico, which were not outstanding during the 1994 Period as well as the
cash received pursuant to the A-300 Lease Settlement and DC-10-10 Lease
Restructuring partially offset by continued repayments of advances and
deferrals.

22
<PAGE> 27
Depreciation and amortization decreased 1% or $54,000 in the 1995
Period as compared to the 1994 Period. The decrease was the result of the
reserve for decline in market value of certain aircraft which the Partnership
recorded at December 31, 1994, which reduced the depreciable basis of the
related aircraft. This was offset by a change (reduction) to the estimated
residual value of the DC-10-10, which resulted in an increase in related
depreciation expense in the 1995 period.

Provision for decline in market value in aircraft was $450,000 in the
1995 Period as compared to $2,600,000 in the 1994 Period and reflected
management's estimate of the recoverability of the value of the leased aircraft
at the end of the respective periods based upon third party cash flows, third
party appraisals and market conditions.

Management and re-lease fees for the 1995 Period increased by 2% or
$22,000 in comparison to the 1994 Period. This increase was attributable
primarily to the fees recognized with respect to the A-300 Lease Settlement (a
portion of which was recognized under the cost recovery method) and the DC-10-10
Lease Restructuring, which was partially offset by a reduction in rental income
recognized during 1995.

Interest expense for the 1995 Period increased by $85,000 or 11% in
comparison to the 1994 Period primarily because of the increase in interest
rates which increased the rate on the variable rate note payable, which was
slightly offset by the continued repayment of the fixed rate loan.

General and administrative expenses increased by $61,000 or 26% in the
1995 Period as compared to the 1994 Period due to an increase in the level of
certain administrative expenses, including transfer agent fees and legal
expenses.

Direct lease expenses increased by 11% or $19,000 in the 1995 Period as
compared to the 1994 Period. The increase of the 1995 Period as compared to the
1994 Period was due principally to expenses incurred in the first quarter in the
1995 Period associated with the Aeromexico transaction offset by a reduction in
the letter of credit fee.

Inflation and Changing Prices

Inflation has had no material impact on the operations or financial
condition of the Partnership from inception through December 31, 1996. However,
market and worldwide economic conditions and changes in federal regulations have
in the past, and may in the future, affect the airline industry and thus lease
rates and aircraft values. Additionally, inflation and changing prices, may
affect subsequent lease rates and the eventual selling price of the aircraft.

23
<PAGE> 28
Item 8. Financial Statements

PEGASUS AIRCRAFT PARTNERS II, L.P.

List of Financial Statements

<TABLE>
<CAPTION>
Page
----

<S> <C>
Report of Independent Accountants F-2

Balance Sheets -- December 31, 1996 and 1995 F-3

Statements of Income for the years ended
December 31, 1996, 1995 and 1994 F-4

Statements of Partners' Equity for the years ended
December 31, 1996, 1995 and 1994 F-5

Statements of Cash Flows for the years ended
December 31, 1996, 1995 and 1994 F-6

Notes to Financial Statements F-8
</TABLE>

All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission have been omitted since
(1) the information required is disclosed in the financial statements and notes
thereto; (2) schedules are not required under the related instructions; or (3)
the schedules are inapplicable.

F-1
<PAGE> 29
REPORT OF INDEPENDENT ACCOUNTANTS

To the Limited Partners of
Pegasus Aircraft Partners II, L.P.

We have audited the accompanying financial statements as listed in the
index on Page F-1 herein. 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 Pegasus Aircraft
Partners II, L.P. as of December 31, 1996 and 1995, and the results of its
operations and its cash flows for the years ended December 31, 1996, 1995 and
1994, in conformity with generally accepted accounting principles.

New York, New York
March 7, 1997

F-2
<PAGE> 30
PEGASUS AIRCRAFT PARTNERS II, L.P.

BALANCE SHEETS - DECEMBER 31, 1996 AND 1995

ASSETS

<TABLE>
<CAPTION>
1996 1995
-------- --------
(in thousands, except unit data)
<S> <C> <C>
Cash and cash equivalents (Note 4) $ 12,831 $ 11,955
Restricted cash (Notes 1 and 5) 2,248 2,104
Rent and other receivables, net (Note 5) 758 2,557
Aircraft, net (Notes 5, 9 and 12) 56,177 63,482
Other assets 25 701
-------- --------
Total Assets $ 72,039 $ 80,799
======== ========

LIABILITIES AND PARTNERS' EQUITY

LIABILITIES:

Lease settlement reserve (Note 5) $ 3,000 $ -
Accounts payable and accrued expenses 95 148
Payable to affiliates (Note 7) 636 893
Maintenance reserves payable (Notes 1 and 5) 2,248 2,104
Notes payable (Note 6) 4,751 6,638
Deferred income (Note 5) 3,779 4,672
Distributions payable to partners 2,989 2,931
Interest payable 1 46
-------- --------
Total Liabilities 17,499 17,432
-------- --------

CONTINGENCIES (Notes 5, 6, 10 and 12)

PARTNERS' EQUITY:

General Partners (904) (816)
Limited Partners (7,255,000 units outstanding
in 1996 and 1995) 55,444 64,183
-------- --------
Total Partners' Equity 54,540 63,367
-------- --------
Total Liabilities and Partners' Equity $ 72,039 $ 80,799
======== ========
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-3
<PAGE> 31
PEGASUS AIRCRAFT PARTNERS II, L.P.

STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994

<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
(in thousands, except unit data
and per unit amounts)
<S> <C> <C> <C>
REVENUE:
Rentals from operating leases $ 15,231 $ 14,026 $ 15,537
Interest 736 601 408
Other (Note 5) - - 81
---------- ---------- ----------
15,967 14,627 16,026
---------- ---------- ----------

EXPENSES:
Depreciation and amortization 9,701 9,662 9,716
Provision for decline in market
value of aircraft (Note 5) 100 450 2,600
Loss in value of securities (Note 5) 155 - -
Provisions for bad debts 640 - -
Management and re-lease fees (Note 7) 1,069 1,162 1,140
Interest 674 839 754
General and administrative (Note 7) 334 298 237
Direct lease (Note 7) 396 197 166
---------- ---------- ----------
13,069 12,608 14,613
---------- ---------- ----------

NET INCOME $ 2,898 $ 2,019 $ 1,413
========== ========== ==========

NET INCOME ALLOCATED:
To the General Partners 29 20 $ 14
To the Limited Partners 2,869 1,999 1,399
---------- ---------- ----------
$ 2,898 $ 2,019 $ 1,413
========== ========== ==========

NET INCOME PER LIMITED
PARTNERSHIP UNIT $ .40 $ .28 $ .19
========== ========== ==========

WEIGHTED AVERAGE NUMBER OF
LIMITED PARTNERSHIP
UNITS OUTSTANDING 7,255,000 7,255,000 7,255,000
========== ========== ==========
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-4
<PAGE> 32
PEGASUS AIRCRAFT PARTNERS II, L.P.

STATEMENTS OF PARTNERS' EQUITY

FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994

<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNERS PARTNERS TOTAL
-------- -------- ---------
(in thousands)
<S> <C> <C> <C>
Balance, December 31, 1993 $(616) $ 84,001 $ 83,385

Net income 14 1,399 1,413

Distribution to partners declared (117) (11,608) (11,725)
----- -------- --------

Balance, December 31, 1994 (719) 73,792 73,073

Net income 20 1,999 2,019

Distributions to partners declared (117) (11,608) (11,725)
----- -------- --------

Balance, December 31, 1995 (816) 64,183 63,367

Net income 29 2,869 2,898

Distributions to partners declared (117) (11,608) (11,725)
----- -------- --------

Balance, December 31, 1996 $(904) $ 55,444 $ 54,540
===== ======== ========
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-5
<PAGE> 33
PEGASUS AIRCRAFT PARTNERS II, L.P.

STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994

<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,898 $ 2,019 $ 1,413
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 9,701 9,662 9,716
Provision for maintenance costs and decline
in market value of aircraft 100 450 2,600
Provision for bad debts 640
Maintenance funds received from lessee 557
Loss (income) from securities received in
leasing transaction 155 (81)
Change in assets and liabilities:
Rent and other receivables 711 590 34
Other assets 77 56 76
Accounts payable and accrued expenses (53) 58 35
Deferred income (449) 3,733 70
Payable to affiliates (257) 442 355
Interest payable (45) (2) 6
-------- -------- --------
Net cash provided by operating activities 13,478 17,565 14,224
-------- -------- --------

CASH FLOWS FROM INVESTING ACTIVITIES:
Capitalized aircraft costs (2,496) (26) (325)
Lease settlement reserve 3,000
Lease settlement proceeds accounted for under the cost
recovery method 1,565
Advances to lessees (537)
Repayment of advances by lessees 448 422 426
-------- -------- --------
Net cash provided by (used in) investing
activities 952 1,961 (436)
-------- -------- --------
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-6
<PAGE> 34
PEGASUS AIRCRAFT PARTNERS II, L.P.

STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (continued)

<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Proceeds from notes payable $ 4,751 $ - $ -
Repayment of notes payable (6,638) (744) (353)
Transfers from (to) restricted cash 385 (140)
Cash distributions paid to partners (11,667) (11,725) (11,725)
-------- -------- --------
Net cash used in financing activities (13,554) (12,084) (12,218)
-------- -------- --------

NET INCREASE IN CASH AND CASH
EQUIVALENTS 876 7,442 1,570

CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 11,955 4,513 2,943
-------- -------- --------

CASH AND CASH EQUIVALENTS AT END OF
YEAR $ 12,831 $ 11,955 $ 4,513
======== ======== ========

Supplemental schedule of cash flow information:
Interest paid $ 719 $ 841 $ 748
======== ======== ========
Restricted maintenance reserves collected, net of
maintenance drawdowns $ 144 $ 668 $ 788
======== ======== ========

NONCASH TRANSACTIONS
Leased aircraft received in lease settlement
accounted for under the cost recovery method $ - $ 8,550 $ -

Distributions to partners declared but unpaid $ 2,989 $ 2,931 $ 2,931

Other assets and deferred income removed from
the books related to Kiwi bankruptcy $ 444 $ - $ -
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-7
<PAGE> 35
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

1. SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation Pegasus Aircraft Partners II, L.P. (the
"Partnership"), a Delaware limited partnership, maintains its accounting records
and prepares financial statements on the accrual basis of accounting. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the dates of the financial statements and
the reported amounts of revenues and expenses during the reporting periods. The
most significant assumptions and estimates relate to useful life and
recoverability of the aircraft and tax indemnity provisions described below.
Actual results could differ from those estimates.

Cash and Cash Equivalents The Partnership invests funds not immediately
required for operations or distributions in temporary investments until such
time as the funds are required to meet its obligations. The short term, highly
liquid investments are recorded at cost which approximates fair market value.
For purposes of the balance sheets and the statements of cash flows, the
Partnership considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents.

Restricted Cash Restricted cash represents maintenance reserves (also
described below) collected from Kiwi International Air Lines, Inc. ("Kiwi") with
respect to the two aircraft formerly leased to Kiwi. (See also Note 5, "Aircraft
- - Kiwi Bankruptcy").

Aircraft and Depreciation The aircraft are recorded at cost, which
includes acquisition costs and the acquisition fee and the financial management
advisory fee paid to the General Partners. Depreciation to an estimated salvage
value (in general, 10%) is computed using the straight-line method over an
estimated economic life of twelve years. Improvements to aircraft are
capitalized when incurred and depreciated over the useful life of the
improvement. Depreciation is not recorded for aircraft that are off lease. The
Partnership evaluates these costs based upon changes in market conditions in
accordance with generally accepted accounting principles and accordingly,
records a provision for decline in market value of aircraft to recognize loss in
the value of an aircraft when the General Partners believe that the
recoverability of the Partnership's investment in an aircraft has been impaired.
Proceeds received in lease settlements are accounted for under the cost recovery
method when based upon third party appraisals and market conditions, there has
been a diminution to the carrying value of the aircraft.

Tax Benefit Transfer Lease The McDonnell Douglas MD-81 aircraft under
lease to USAirways Group, Inc. ("US Air"), was purchased subject to a tax
benefit transfer lease which provided for the transfer of the investment tax
credits and depreciation deductions with respect to

F-8
<PAGE> 36
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

the aircraft to a tax lessor. The transfer was accomplished by the sale, for
income tax purposes only, of the aircraft to the tax lessor for cash and a note
and a leaseback of the aircraft for rental payments which match the payments on
the note. Under the terms of the tax benefit transfer lease, the Partnership's
required rental payments are contingent upon and may, by agreement, be offset by
the lessor's required note payments. Accordingly, no asset or liability for the
tax benefit transfer lease has been recorded.

Maintenance Reserve Funds Two of the Partnership's former leases
required the lessee to make monthly payments to maintenance reserve funds
administered by the Partnership. These funds are included in restricted cash on
the balance sheets.

Operating Leases The aircraft leases, which are structured principally
as triple net leases, are accounted for as operating leases. Lease revenues are
recognized in equal installments over the terms of the related leases.

Deferred Income Some of the Partnership's operating leases require
rental payments to be paid monthly, or quarterly, in advance. Lease revenues not
yet earned are deferred and recognized as income when earned.

The Partnership received stock and rights to warrants of the lessee in
connection with two of its leases. The Partnership recorded the securities at
their estimated value and previously recognized a portion of such associated
income ratably over the respective lease terms. The Partnership stopped
recognizing such income in the fourth quarter of 1994 (See Note 5, "Aircraft -
Kiwi Bankruptcy").

Lease settlement payments received in connection with the termination
or modification of a lease of an aircraft, the carrying value of which has not
been impaired, are recognized ratably over the original lease term in the case
of a lease termination and over the modified lease term in connection with a
lease modification.

Income Taxes No provision for income taxes has been made in the
financial statements since such taxes are the responsibility of the individual
partners rather than the Partnership.

Net Income Per Limited Partnership Unit The net income per limited
partnership unit is computed by dividing the net income allocated to the Limited
Partners by the weighted average number of Units outstanding during the year.

Reclassifications Certain reclassifications have been made to the 1995
financial statements to conform to the classifications used in 1996.

F-9
<PAGE> 37
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

2. ORGANIZATION OF THE PARTNERSHIP

The Partnership was formed on April 26, 1989 for the purpose of
acquiring, leasing and ultimately selling used commercial aircraft. The Managing
General Partner of the Partnership is Pegasus Aircraft Management Corporation, a
wholly owned subsidiary of Pegasus Capital Corporation, and the Administrative
General Partner is Air Transport Leasing, Inc., a wholly owned subsidiary of
PaineWebber Group Inc. (collectively, the "General Partners"). The Partnership
is required to dissolve and distribute all of its assets no later than December
31, 2007. The Partnership may reinvest the proceeds from sales of aircraft
occurring prior to August 21, 1998, provided that the aggregate amount of sales
proceeds so reinvested will in no event exceed $60,000,000, and provided further
that, prior to any such reinvestment the Partnership distributes to Limited
Partners cash in an amount sufficient to pay any federal and state income taxes
to be incurred by the Limited Partners as a result of the aircraft sale.
Thereafter, the net proceeds of any sales of aircraft will be distributed to the
partner.

Upon formation of the Partnership, the General Partners each
contributed $500 to the capital of the Partnership. An additional 7,255,000
units of limited partnership interest ("Units") were then sold at a price of $20
per Unit with the Partnership receiving gross offering proceeds of $145,100,000.

Title to the aircraft owned by the Partnership is held by
non-affiliated trustees of trusts of which the Partnership is the beneficiary or
one of two beneficiaries. The purpose of this method of holding title is to
satisfy certain registration requirements of the Federal Aviation
Administration. The Partnership's share of the assets of the trusts are
recorded herein on a proportional consolidation basis.

3.PARTNERSHIP ALLOCATIONS

The Partnership Agreement provides that cash flow from operations be
distributed on a quarterly basis at the General Partners' discretion, 99% to the
Limited Partners and 1% to the General Partners. Cash flow is defined in the
Partnership Agreement as including cash receipts from operations and interest
income earned, less expenses incurred and paid in connection with the ownership
and operation of the aircraft. Depreciation and amortization expenses are not
deducted from cash receipts in determining cash flow. Distributable proceeds
from sales of aircraft upon liquidation of the Partnership will be distributed
in accordance with the partners' capital accounts after all allocations of
income and losses.

F-10
<PAGE> 38
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

Income and losses generally will be allocated 99% to the Limited
Partners and 1% to the General Partners. Upon the sale of aircraft, gain
generally will be allocated, first, to the General Partners in an amount equal
to the difference between their capital contributions and 1.01% of the aggregate
capital contributions of the Limited Partners, and, then, 99% to the Limited
Partners, and 1% to the General Partners.

4. CASH EQUIVALENTS

The Partnership invests funds not immediately required for operations
or distributions in short-term highly liquid investments. The investments are
primarily commercial paper issued by large domestic corporations. At December
31, 1996, the Partnership held short-term commercial paper with various
maturities as follows:

<TABLE>
<CAPTION>
Issuer Purchase Date Purchase Price Par value
------ ------------- -------------- ---------
(in thousands) (in thousands)
<S> <C> <C> <C>
Fleet Funding Inc. December 5, 1996 $ 1,986 $ 2,000
Ford Motor Credit Inc. Various 4,900 4,925
United Parcel Services, Inc. December 31, 1996 5,930 5,950
------- -------

$12,816 $12,875
======= =======
</TABLE>

F-11
<PAGE> 39
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

5. AIRCRAFT

Rents and other receivables were composed as follows at December 31,
1996 and 1995 (in thousands):

<TABLE>
<CAPTION>
1996 1995
------- ------
<S> <C> <C>
Rent receivables $ 440 $1,144
Advances to lessees 879 1,327
Accrued interest and other 79 86
------- ------
1,398 2,557
Allowance for bad debts (640) --
------- ------

Rent and other receivables $ 758 $2,557
======= ======
</TABLE>

Net Investment in Aircraft

The Partnership's net investment in aircraft as of December 31, 1996
and 1995 consisted of the following (in thousands):

<TABLE>
<CAPTION>
1996 1995
-------- ---------

<S> <C> <C>
Aircraft on operating leases $ 77,189 $ 114,460
Less: Accumulated depreciation (39,518) (45,775)
Reserve for decline in market
value of aircraft (3,339) (12,246)
-------- ---------
$ 34,332 $ 56,439
-------- ---------

Aircraft held for lease $ 68,495 $ 28,728
Less: Accumulated depreciation (26,971) (11,013)
Reserve for decline in market value
of aircraft (9,007) --
Amounts received, including value of
aircraft, in Lease Settlement accounted
for under the cost recovery method (10,115) (10,115)
Reserves for maintenance (557) (557)
-------- ---------
21,845 7,043
-------- ---------
$ 56,177 $ 63,482
======== =========
</TABLE>

F-12
<PAGE> 40
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

Financial Terms of Leases

a. Continental Airlines Leases During September 1989, the Partnership
acquired a McDonnell Douglas DC-10-10 aircraft for a total purchase price of
$18,301,000, subject to an operating lease with Continental, originally
scheduled to expire on May 31, 1997, with rents of $252,000 per month.
Continental also had three two-year renewal options, with rent payable during
the first two such renewal periods at the lesser of the then fair market rental
value or the rental rate during the initial term, and during the third such
renewal period at the then fair market rental rate. In addition, the lessee has
a right of first refusal to purchase or release the aircraft after the last
renewal period on the same terms as those included in any bona fide offer made
to the Partnership by a third party. This lease was modified in 1995 as
discussed below.

Continental did not make the monthly rental payments due under the
three leases with the Partnership on December 1, 1990 and filed for Chapter 11
bankruptcy protection on December 3, 1990. The Partnership entered into various
lease modifications and financing arrangements with Continental as a result of
the bankruptcy. At December 31, 1996, the Partnership had an aircraft
modification advance outstanding from Continental totaling $93,000, which is
being repaid monthly with interest.

F-13
<PAGE> 41
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

June 1995, the Partnership executed a lease of the A-300 aircraft to
Akdeniz for a scheduled term of four years, under which Akdeniz subsequently
defaulted. The Partnership recovered the A-300 aircraft, returned it to FAA
registry, and is currently remarketing it. The Partnership estimates that it
will spend approximately $2.5 million for a scheduled heavy maintenance check
that will be required prior to delivery of the aircraft to a new lessee. The
Partnership received $557,000 from Continental pursuant to the A-300 Settlement
discussed below which will be applied towards such maintenance.

Under the DC-10 Restructuring, the Partnership received approximately
$3,100,000, the lease expiration date was changed from May 31, 1997 to October
31, 1996 and the monthly lease payments were reduced from $252,000 to $135,000
effective September 15, 1995. All other terms and conditions of the DC-10-10
lease remain unchanged. During 1996, Continental and the Partnership reached an
agreement to extend the lease to June 30, 1998 at a lease rate of $150,000 per
month.

F-14
<PAGE> 42
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

term, in monthly installments with interest at a fixed rate of 9.70%. At
December 31, 1996, the balance of the receivable was $295,000. All 1997
repayments of advances have been made by TWA.

During January 1990, the Partnership acquired a Lockheed L-1011
aircraft for a total purchase price of $17,555,000, subject to an operating
lease with TWA, originally scheduled to expire on June 30, 1993. The lease was
amended and extended to October 1,1998 with rental payments payable monthly, in
advance, at the rate of $130,000.

Upon execution of the lease amendment, the Partnership reimbursed TWA
for $225,000 of capital improvements which were made to the aircraft and
advanced $550,000 to TWA to finance certain major maintenance procedures, which
is being repaid over the remaining lease term in monthly installments with
interest at 9.68%. At December 31,1996, the balance of the receivable was
$210,000. All 1997 repayments of advances have been made by TWA.

F-15
<PAGE> 43
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

In mid-1996, as part of its fleet restructuring, TWA offered to return
the L-1011 aircraft it leases from the Partnership. The lease, which provided
for monthly rentals of $130,000, was originally scheduled to expire in September
1998. TWA agreed to pay the Partnership $2,846,000, which represents rents due
under the remaining term of the lease, discounted at 5% plus $3,000,000 as
an economic settlement for noncompliance with certain lease return conditions.
The lease was terminated, the aircraft was returned and the amounts aggregating
$5,846,000 were received on October 16, 1996. The Partnership is reviewing
alternatives for the use of the proceeds received, including the use of the
economic settlement to purchase an additional aircraft or engines. It is likely
that the Partnership will lease the engines that were a part of the L-1011
separately and sell the airframe for parts.

The L-1011 aircraft was originally purchased in 1990 for $ 18,205,000
(including related fees) and had a net book value of approximately $6.1 million
unadjusted for the $3,000,000 economic settlement accounted for as a Lease
settlement reserve on the balance sheet at December 31, 1996. Additionally, the
prepayment for the rents due under the lease ($2,846,000) was accounted for as
deferred income and will be recognized ratably over the original lease term.

F-16
<PAGE> 44
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

rights and remedies with respect to Aeromexico's failure to pay rent and other
debt due in October 1994. The Standstill Agreement was extended an additional
three months to allow Aeromexico to complete a financial restructuring.
Aeromexico made all of its monthly rental payments due, repaid the October 1994
rent with interest and has continued to pay the monthly rent equivalent for each
aircraft.

The Partnership has entered into negotiations with Aeromexico to extend
each of the two leases to January 2000 at a slightly lower lease rate. Such
extensions are subject to final documentation.

d. USAir Lease During September 1989, the Partnership acquired one-half
of the beneficial interest in a trust ("Trust") which is the owner/lessor of a
McDonnell Douglas MD-81 aircraft for a total purchase price of $10,041,000. The
remaining one-half interest in the Trust is owned by Pegasus Aircraft Partners,
L.P., an affiliated partnership. Such interest is included herein on a
proportional consolidated basis. The aircraft is subject to an operating lease
with USAir, the term of which ends on June 1, 1998. The lease may be terminated
after August 1993 subject to the lessee's guarantee that the Partnership will
receive contractually defined minimum termination values upon remarketing of the
aircraft. Rental payments are payable quarterly, in arrears, at the rate of
$304,000 (for the Partnership's one-half interest in the aircraft). The lease
provides for one three-year renewal option, at the same quarterly rental rate.
If the lease is not renewed for this first renewal period, the lessee must make
a termination payment of $1,113,000 to the Partnership. The lessee also has
three additional one-year renewal options at fair market rental rates. The
lessee may elect to purchase the aircraft at its fair market value at the end of
any renewal term.

The McDonnell Douglas MD-81 aircraft under lease to USAir was purchased
subject to a tax benefit transfer lease ("TBT lease") which provided for the
transfer of the investment tax credits and depreciation deductions with respect
to the aircraft to a tax lessor. Under the TBT lease, the Trust, as the owner of
the aircraft and the tax lessee under the TBT lease, has agreed to indemnify the
tax lessor if certain anticipated tax benefits are lost by the tax lessor as a
result of, amount other things, acts or omissions by the Trust, breach of
covenants by the Trust under the TBT lease, loss or damage to the aircraft or
use of the aircraft outside the United States. The TBT lease requires that a
letter of credit be posted to collateralize this obligation. The Partnership is
obligated for one-half the annual cost of the letter of credit as well as any
calls on the letter of credit.

The letter of credit has a current face amount of approximately $1.7
million. The letter of credit agreement obligated the Partnership to deposit
$35,000 per quarter (beginning on June 1, 1992) as cash collateral to
collateralize the Partnership's obligation under the letter of credit agreement.
In July 1995, the Partnership consummated an agreement with the issuer of the
letter

F-17
<PAGE> 45
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

of credit under which the issuer released its interest in substantially of the
cash in the cash collateral account.

Under the operating lease, the lessee, USAir, Inc., has assumed all
liabilities, indemnities and obligations of the Trust to the tax lessor under
the TBT lease and has agreed to indemnify the Trust for any liability, indemnity
or obligation to the tax lessor under the TBT lease except for liability
resulting from breaches by the Trust of covenants under the operating lease. It
has not posted a letter of credit to collateralize this obligation. As a result
of the foregoing, if the tax lessor draws on the letter of credit as a result of
an action by the lessee, the Partnership and Pegasus Aircraft Partners, L.P.,
through the Trust, will be responsible for the loss to the tax lessor until and
if the lessee performs under its indemnification. To date there have been no
calls against the letter of credit.

The tax lessor is entitled to call on the letter of credit whether its
loss of tax benefits is caused by Pegasus Aircraft Partners, L.P. or the
Partnership, and Pegasus Aircraft Partners, L.P. and the Partnerships have
agreed to indemnify each other for any loss occasioned by the acts of the other.

e. Kiwi - Bankruptcy In 1993, the Partnership leased its two Boeing
727-200 aircraft, to Kiwi. The aircraft were originally purchased in 1989
(Non-advanced) and 1990 (Advanced) for purchase prices of $6,261,000 and
$10,748,000 respectively (including related fees). The leases are operating
leases which require monthly rental payments, in advance, in the amounts of
$60,000 (Non-advanced) and $115,000 (Advanced). The terms of the leases were
originally scheduled to expire on April 15, 1998 and June 30, 1998,
respectively. In 1995, the leases were amended and extended to December 31,
1999. Kiwi is also obligated to make monthly payments of $250 per flight hour
for maintenance reserve funds administered by the Partnership. An affiliated
partnership and affiliates of the Managing General Partner also own aircraft
leased to Kiwi.

In connection with the delivery of the aircraft the Partnership
expended $2,228,000 with respect to the 727 Advanced aircraft, of which $971,000
was capitalized and $1,257,000 represented maintenance costs which were paid out
of funds received in a maintenance settlement with the prior lessee. Capitalized
improvements of $743,000 were made with respect to the non-advanced aircraft.

F-18
<PAGE> 46
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

During 1994, the Partnership funded approximately $633,000 of costs
related to maintenance of the Kiwi aircraft, including compliance with certain
FAA airworthiness directives, $308,000 of which was scheduled to be repaid by
Kiwi over a one-year period. In March 1996, Kiwi signed a promissory note
("Bellyskin Note") scheduling the repayment of this amount, with interest from
February 1996 at 12% per annum, over eighteen months which began June 1, 1996.

In August 1996, the Partnership paid $1.9 million to hushkit the
non-advanced 727 aircraft. The purchase price was funded out of cash reserves
previously generated.

In June 1996, Kiwi agreed with the FAA to ground 25% of its fleet due
to certain pilot training handbook deficiencies. In August 1996, Kiwi and the
FAA resolved the deficiencies and Kiwi returned to full capacity. In addition to
the FAA grounding, Kiwi was also negatively impacted by the market reaction to
the ValuJet incident and as a result, did not meet its financial goals. In July
1996, an institutional investor contributed $4,000,000 in return for a
convertible note due in March 1997, for up to 32% of Kiwi's common stock and two
seats on Kiwi's Board of Directors. The investor had options to invest an
additional $6,000,000 in convertible preferred stock which expires in March
1997. Existing shareholders (including directors and employees) were given the
opportunity to make additional investments.

In late September, Kiwi proposed a restructuring of its obligations
with certain creditors, including the Partnership. On September 30, 1996, Kiwi
filed a voluntary petition for reorganization under Chapter 11 of the Federal
Bankruptcy Code ("Bankruptcy Code") and did not made any subsequent payments.
The Kiwi leases accounted for approximately 11% of the Partnership's rental
revenue in 1996 and the aircraft had net book values aggregating approximately
$8,100,000 (including the hushkit), net of allowance for decline in market value
of aircraft of $100,000 at December 31, 1996 (excluding the cost of the heavy
maintenance check being completed at December 31, 1996 prior to delivery to a
new lessee discussed below). Additionally the unpaid balance of the Bellyskin

F-19
<PAGE> 47
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

Note, plus interest was $290,000 at December 31, 1996. The Partnership currently
holds maintenance deposits aggregating approximately $2.2 million, which the
Partnership believes will not be sufficient to complete work required on the
aircraft and the related engines to meet lease return conditions. On October 15,
1996, Kiwi ceased scheduled flight operations while still exploring financial
alternatives. Kiwi filed a motion to reject both leases as of on November 15,
1996. The Partnership provided an allowance for bad debts in the amount of
$640,000 in respect of amounts due at December 31, 1996. The Partnership
recovered the aircraft in late 1996.

f. Falcon Air Express, Inc. In December 1996, the Partnership entered
into a lease agreement with Falcon Air Express, Inc. ("Falcon") a charter
airline with respect to the 727-200 non-advanced aircraft formerly leased to
Kiwi. The lease is for a term of 60 months and provides for a monthly rental of
$95,000. Falcon provided a security deposit of $95,000. The lease also requires
Falcon to fund, on a monthly basis, maintenance reserves of $317 per flight
hour. In connection with the delivery of the aircraft, the Partnership completed
a heavy maintenance check on the aircraft, of which $583,000 had been expended
as of December 31, 1996 and $700,000 was paid or payable prior to delivery. The
Partnership also purchased an engine at a cost of $760,000 prior to delivery of
the aircraft. The aircraft was delivered to Falcon in March 1997.

Significant Lessees

The Partnership leased its aircraft to five different airlines during
1996. Revenues from airlines which accounted for greater than 10% of the
Partnership's total rental revenue during 1996, 1995 and 1994 are as follows:

<TABLE>
<CAPTION>
Airlines Percentage of Rental Revenue
-----------------------------
1996(1) 1995 1994
<S> <C> <C> <C>
Continental Airlines, Inc.* 44.4% 32.8% 43.6%
Trans World Airlines, Inc. 24.7 27.0 24.3
Aerovias de Mexico S.A. de C.V 12.3 13.3 12.0
Kiwi International Air Lines, Inc. 10.6 14.6 12.3
</TABLE>

* Includes rental revenue from Continental Micronesia, Inc., a
subsidiary of Continental Airlines, Inc.

(1) Such percentage includes amounts earned from Kiwi leases for
which an allowance for bad debt was provided.

Revenues include rentals from aircraft leased to foreign airlines or
carriers of $1,872,000, $2,376,000 and $1,872,000 in 1996, 1995 and 1994
respectively.

F-20
<PAGE> 48
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

Future Minimum Rental Income

The following is a schedule by year of future minimum rental income
under the leases as of December 31, 1996 (in thousands):

<TABLE>
<CAPTION>
Year Amount
---- ------
<S> <C>
1997 $ 9,770
1998 6,609
1999 3,859
2000 3,434
2001 2,828
Thereafter 6,290
-------
Total $32,790
=======
</TABLE>

The above schedule of future minimum rental income does not include
rental income which would result from the renewal of existing leases or the
re-leasing of the aircraft, except for the initial three-year renewal period for
the McDonnell Douglas MD-81 aircraft under lease to US Air. This renewal
representing $3,644,000 is included since USAir must make a significant
termination payment if the renewal is not exercised. Additionally, the above
schedule does not include the rent associated with the lease of the 727-200
Non-advanced aircraft which was delivered in March 1997 and which will generate
annual rents of $1.1 million for five years. Finally, the schedule does not
include the lease of the 727 Advanced aircraft which is undergoing a cargo
conversion and which was scheduled for delivery in the second quarter of 1997
and which is scheduled to generate annual rents (subject to increase upon
completion of hushkitting) of $1.26 million for eight years.

The Partnership operates in one industry, the leasing of used aircraft
to commercial airlines.

6. NOTES PAYABLE

At December 31, 1995, the Partnership had outstanding borrowings of
$6,638,000 under two separate loan facilities. The Partnership's first loan
facility had outstanding borrowings of $6,109,000 collateralized by three of the
Partnership's aircraft and the Partnership's second loan facility had
outstanding borrowings of $529,000 at December 31, 1995 collateralized by two of
the Partnership's aircraft.

In December 1996, the Partnership established a new $10,000,000 loan
facility with an unaffiliated third party lender. The loan commitment is for a
period of 36 months, terminating December 31, 1999, at which time outstanding
principal is due. The loan provides for interest at

F-21
<PAGE> 49
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

a rate of 1% over the lender's prime rate of interest (9.25% at December 31,
1996) and is payable monthly. The Partnership must maintain a minimum balance
outstanding of $4,000,000 during the loan commitment period. The loan is
collateralized by the Partnership's interest in the MD-82 aircraft leased to TWA
and the two 727-200 Advanced aircraft leased to Continental. The Partnership
utilized $4,751,000 to pay off the prior two facilities.

7. TRANSACTIONS WITH AFFILIATES

Management Fees The General Partners are entitled to a quarterly
subordinated base management fee in an amount generally equal to 1.5% of gross
aircraft rentals, net of re-lease fees paid. Of this amount, 1.0% is payable to
the Managing General Partner and 0.5% is payable to the Administrative General
Partner. During the years ended December 31, 1996, 1995 and 1994, the General
Partners earned base management fees of $219,000, $230,000 and $229,000,
respectively.

The General Partners also are entitled to a quarterly subordinated
incentive management fee, in an amount equal to 4.5% of quarterly cash flow and
sales proceeds (net of resale fees), of which 2.5% is payable to the Managing
General Partner and 2.0% is payable to the Administrative General Partner.
During the years ended December 31, 1996, 1995 and 1994, the General Partners
earned incentive management fees of $598,000, $645,000 and $647,000,
respectively.

Re-lease Fee The General Partners are entitled to a quarterly
subordinated fee for re-leasing aircraft or renewing a lease in an amount equal
to 3.5% of the gross rentals from such re-lease or renewal for each quarter for
which such payment is received. Of this amount, 2.5% is payable to the Managing
General Partner and 1.0% is payable to the Administrative General Partner.
During the years ended December 31, 1996, 1995 and 1994, the General Partners
earned re-lease fees of $252,000, $287,000 and $264,000, respectively.

Beginning January 1, 1995 and for the year ended December 31, 1995, the
Administrative General Partner deferred the receipt of management fees and
re-lease fees which aggregated $445,000. As part of the Class action settlement
(discussed in Note 10, "Litigation"), these fees as well as 1996 and all future
fees and distributions earned by the Administrative General Partner have been
assigned by an affiliate to an escrow account for the benefit of the class
action members.

Accountable Expenses The General Partners are entitled to
reimbursement of certain expenses paid on behalf of the Partnership which are
incurred in connection with the

F-22
<PAGE> 50
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

administration and management of the Partnership. Such reimbursable expenses
amounted to $75,000 in each of the years ended December 31, 1996, 1995 and 1994,
all of which was paid to the Administrative General Partner.

Other In 1995, the Partnership purchased certain equipment and parts
relating to the integration of the A-300 aircraft to Akdeniz (see Footnote 9)
from a company owned by the three directors of the Managing General Partner in
the amount of $89,000. Such amount was recovered from Continental and Akdeniz.
No such amounts were incurred in 1994. During 1996, the Partnership paid
$554,000 to a maintenance facility affiliated with the Managing General Partner
for work performed on certain aircraft. The Partnership also paid $134,000 for
aircraft parts to the company owned by the three directors of the Managing
General Partner. At December 31, 1996, an engine owned by the Partnership was as
part of an aircraft leased by an affiliated Partnership. Under the terms of the
lease, the Partnership is entitled to $15,000 per month plus maintenance
reserves based upon flight hours. It is anticipated that the engine will be
returned to the Partnership in early April-May 1997. At December 31, 1996, the
Partnership had established a receivable of $15,000 with respect to the engine.

8. RECONCILIATION TO INCOME TAX METHOD OF ACCOUNTING

The following is a reconciliation of the net income as shown in the
accompanying financial statements to the taxable income reported for federal
income tax purposes (in thousands):

<TABLE>
<CAPTION>
1996 1995 1994
------- -------- -------
<S> <C> <C> <C>
Net income per financial statements $ 2,898 $ 2,019 $ 1,413
Increase (decrease) resulting from:
Depreciation (3,381) (3,286) (2,820)
TBT interest income less
TBT rental expense (742) (590) (471)
Reserves for maintenance costs, net of maintenance
expense and decline in market value of aircraft 244 1,810 3,388
Maintenance reserve payable 3,000 - -
Deferred rental income (449) 3,733 (310)
Provisions for bad debts 640 - -
Loss on value of stock 155 - -
Lease settlement payment, including lease aircraft
received accounted for under the cost
recovery method - 10,115 -
Other (161) 187 53
------- -------- -------
Taxable income per federal income tax return $ 2,204 $ 13,988 $ 1,253
------- -------- -------
</TABLE>

F-23
<PAGE> 51
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

The following is a reconciliation of the amount of the Partnership's
total Partnership equity as shown in the accompanying financial statements to
the tax bases of the Partnership's net assets (in thousands):

<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Total Partnership equity per financial statements $ 54,540 $ 63,367 $ 73,073
Increase (decrease) resulting from:
Commission and expenses paid
in connection with the sale of limited
partnership units 16,295 16,295 16,295
Distributions payable to partners 2,989 2,931 2,931
Reserves for maintenance costs and decline in
market value of aircraft 18,286 15,042 13,232
Deferred income 3,733 4,672 939
Accumulated depreciation (34,165) (30,784) (27,498)
TBT interest income less TBT rental expense (2,949) (2,207) (1,617)
Lease settlement payment, including lease
aircraft received accounted for under the
cost recovery method 10,115 10,115 -
Allowance for bad debts 640 - -
Securities received in leasing transaction 599 - -
Other 254 368 181
-------- -------- --------
Tax bases of net assets $ 70,337 $ 79,799 $ 77,536
-------- -------- --------
</TABLE>

9. LESSEE DEFAULT

In June 1995, the Partnership completed the negotiation of a lease with
Akdeniz Air Mediterranean, Inc. ("Akdeniz"), a start-up foreign charter carrier
based in Turkey, regarding the lease of the A-300 aircraft previously leased to
Continental. The lease was for a scheduled term of approximately four years,
with two one-year renewal options and required rentals payable monthly in
advance, maintenance reserves based upon utilization of the aircraft and a
security deposit of $200,000. The lease rate averaged approximately $117,000 per
month over the term of the lease which was significantly less than the original
scheduled lease rate paid by Continental with respect to the lease. The aircraft
was removed from the Federal Aviation Administration ("FAA") registry and placed
on the Turkish Ministry of Transportation registry. Akdeniz did not pay the
monthly, in advance, rental payment due on September 10, 1995 and October 10,
1995 and had made a pro-rated payment for June 1995. Further, they did not fund
any maintenance reserves as required under the lease which aggregated $510,000.
The Partnership placed Akdeniz in default and after a series of negotiations
obtained a judgment in the Turkish Courts, moved to de-register the aircraft in
Turkey and re-register the A-300 with the FAA, and repossessed the aircraft. The
Partnership collected $175,000 through subsequent collection efforts, which were
applied against rents receivable. Akdeniz has ceased operations.

F-24
<PAGE> 52
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

The Partnership applied the security deposit against the remaining unpaid 1995
rents as well as certain integration costs, repossession costs and legal
expenses.

10. LITIGATION

In November 1994, a series of purported class actions (the "New York
Limited Partnership Actions") were filed in the United States District Court for
the Southern District of New York ("District Court") concerning PaineWebber
Incorporated sale and sponsorship of various limited partnership investments,
including those offered by the Partnership. The lawsuits were brought against
PainneWebber Incorporated and Paine Webber Group, Inc. (together,
"PainneWebber"), among others, by allegedly dissatisfied partnership investors.
In March 1995, after the actions were consolidated under the title In re:
PainneWebber Limited Partnerships Litigation, the plaintiffs amended their
complaint to assert claims against a variety of other defendents, including Air
Transport Leasing, Inc., an affiliate of PainneWebber and the Administrative
General Partner in the Partnership ("Administrative General Partner").

The amended complaint in the New York Limited Partnership Actions
alleged, among other things, that, in connection with the sale of interests in
Pegasus Aircraft Partners II, L.P., PaineWebber and the Administrative General
Partners (I) failed to provide adequate disclosure of the risks involved with
each partnership; (2) made false and misleading representations about the safety
of the investments and the partnership's anticipated performance; and (3)
marketed the partnership to investors for whom such investments were not
suitable. The plaintiffs also alleged that following the sale of the partnership
investments PaineWebber and the Administrative General Partner misrepresented
financial information about the partnership's value and performance. The amended
complaint alleged that PaineWebber and the Administrative General Partner
violated the Racketeer Influenced and Corrupt Organizations Act ("RICO") and the
federal securities laws. The plaintiffs sought unspecified damages, including
reimbursement for all sums invested by them in the partnerships, as well as
disgorgement of all fees and other income derived by PaineWebber from the
limited partnerships. In addition, the plaintiffs also sought treble damages
under RICO.

On May 30, 1995, the District Court certified class action treatment of
the plaintiffs' claims in the New York Limited Partnership Actions.

F-25
<PAGE> 53
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

In January 1996, PaineWebber signed a memorandum of understanding with
the plaintiffs in the class action outlining the terms under which the parties
agreed to settle the case. A definitive settlement was agreed in July 1996 and
in March 1997, the District Court approved the settlement as fair and
reasonable. Under the terms of the settlement PaineWebber agreed to pay $125
million and additional consideration to class members.

Three actions were filed in the District Court for Brazoria County,
Texas, relating to the sale and sponsorship of interests in the Partnership and
an affiliated partnership. The complaints make state law claims, specifically,
common law fraud, conspiracy, violations of section 27.01 of the Texas Business
and Commerce Code, fraud in the inducement, negligent misrepresentation,
negligence, breach of fiduciary duty, violations of the Texas Securities Act,
and violations of the Texas Deceptive Trade Practices Act.

The plaintiffs seek unspecified damages, including attorneys' fees,
reimbursement for all sums invested by them in the partnerships, exemplary
damages, and treble damages under the Texas Deceptive Trade Practices Act. All
three actions have been removed to federal court and two have been transferred
to the United States District Court for the Southern District of New York and
consolidated under the title, Mallia vs. PaineWebber, Inc. The third action has
been dismissed with the consent of the parties on the grounds that it is
duplicative of the two actions now before the federal court in New York.

F-26
<PAGE> 54
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

In February 1996, approximately 230 plaintiffs filed an action entitled Abbate
v. PaineWebber Inc. in Sacramento, California Superior Court against PaineWebber
Incorporated and various affiliated entities concerning the plaintiff's
purchases of various limited partnership interests. The complaint alleges, among
other things, that PaineWebber 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 seeks
compensatory damages of $15 million plus punitive damages. In September 1996,
the California Superior Court dismissed many of the plaintiffs' claims as barred
by the applicable statutes of limitation.

Under certain limited circumstances, pursuant to the Partnership
Agreement and other contractual obligations, PaineWebber and its affiliates,
including the Administrative General Partner were entitled to
indemnification from the Partnership for expenses and liabilities in connection
with the above actions. PaineWebber and its affiliates have agreed to not seek
any indemnification from the Partnership for any amounts payables in connection
with the New York Limited Partnership Actions. The General Partners do not
believe that the settlement of the Abbate, Bandrowski and Barstad actions will
have a material effect on the Partnership's financial statements, taken as a
whole.

On September 30, 1996, Kiwi filed a voluntary petition for
reorganization under Chapter 11 of the Federal Bankruptcy Code and the
Partnership recovered the aircraft. The Partnership has a claim against Kiwi for
all unpaid items under the leases as well as rejection damages. The Partnership
filed an adversarial complaint seeking the Bankruptcy Court's authority to use
certain maintenance reserves ($2.2 million) collected from Kiwi. The parties are
in settlement discussions with a hearing date scheduled for June 1997. The
Partnership is also involved in a litigation with the Kiwi bankruptcy with the
company that acted as Kiwi's manager regarding each party's compliance with a
settlement agreement into facilitate the recovery of the aircraft.

F-27
<PAGE> 55
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

11. FAIR VALUE OF FINANCIAL INSTRUMENTS

SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires disclosure of fair value of certain financial instruments, whether or
not reported in the balance sheet. Where quoted market prices are available the
values are based on estimates using present value or other valuation techniques.
The results are significantly affected by the assumptions used including the
discount rate and estimates of future case flows. In addition, because SFAS No.
107 excludes certain assets such as leased aircraft owned by the Partnership,
the aggregate fair value amounts discussed below do not purport to represent and
should not be considered representative of the underlying market value of the
Partnership.

The methods and assumptions used to estimate the fair value of each
class of the financial instruments are described below.

Cash equivalents. For cash equivalents, carrying value approximates
fair value due to its short-term nature.

Rents and other receivables. For rents and other receivables, carrying
value approximates fair value due to its short-term nature.

Notes payable. For notes payable, carrying value approximates fair
value based upon current rates offered for note of the same remaining
maturities.

Accounts payable and accrued expenses, payable to affiliates, and
accrued interest payable. For accounts payable, accrued expenses, payable to
affiliates and accrued interest payable, carrying value approximates fair value
due to its short-term nature.

12. SUBSEQUENT EVENT

In January 1997, the Partnership entered into a lease agreement with
Capital Cargo International Airlines, Inc. ("Capital"), a start-up freight
carrier, with respect to the 727-200 advanced aircraft formerly leased to Kiwi.
The Partnership agreed to convert the aircraft to a freighter at its own
expense, which is estimated to cost $1.5 million. The lease is for a term of
approximately eight years and provides for an initial monthly lease rate of
$105,000 per month. The lease requires the Partnership to hushkit the aircraft
during its 1999 C check visit at its own expense (approximately $3 million) at
which time the lease rate increases to $139,000 per month. The lease requires
Capital to fund maintenance reserves monthly at a rate of $377 per flight hour.
Capital provided a security deposit of $50,000 and is obligated to add $17,000
per month to the security deposit during the lease term until the deposit totals
$220,000.

F-28
<PAGE> 56
PEGASUS AIRCRAFT PARTNERS II, L.P.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1996

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

There were no changes or disagreements with accountants with respect to
accounting or financial disclosure issues during 1996, 1995 and 1994.

PART III

Item 10. Directors and Executive Officers of the Registrant

The Partnership has no officers and directors. The General Partners
jointly manage and control the affairs of the Partnership and have general
responsibility and authority in all matters affecting its business. Information
concerning the directors and executive officers of the General Partners is as
follows:

Pegasus Aircraft Management Corporation

<TABLE>
<CAPTION>
Name Positions Held
---- --------------
<S> <C>
Richard S. Wiley President and Chairman of the Board
Richard W. Doust Executive Vice President, Assistant Secretary and
Director
Gregory Harding-Brown Executive Vice President, Assistant Secretary,
Treasurer and Director
Carol L. Chase Senior Vice President, General Counsel and Secretary
</TABLE>

Richard S. Wiley, age 43, is President and Chairman of the Board of the
Managing General Partner and Pegasus Capital Corporation, which was formed in
1988. Prior to forming Pegasus Capital Corporation, Mr. Wiley was a Vice
President of CIS Corporation ("CIS"), a wholly owned subsidiary of Continental
Information Systems Corporation ("Continental") for the period 1986 to 1988. Mr.
Wiley originated aircraft transactions throughout the world and sold aircraft to
third-party investors. From 1985 to 1986, Mr. Wiley worked as Treasurer of
Caterpillar Capital Company in San Diego, California. From 1983 to 1985, he
served as Managing General Partner and President of RAM Financial Corporation in
Houston, Texas, an equipment leasing venture capital company. Prior to joining
RAM, he worked for GATX Leasing Corporation as a District Manager from 1980 to
1983. Mr. Wiley received a B.S. degree from the Indiana University School of
Business and an M.B.A. from the University of California, Los Angeles.

Richard W. Doust, age 53, is an Executive Vice President, Assistant Secretary
and Director of the Managing General Partner and Pegasus Capital Corporation. He
is also a co-founder of Cirrus Capital Corporation of Florida ("CCCF") and
Cirrus Capital Corporation ("Cirrus"), both of which were formed in October 1989
to engage in aircraft and other financing activities. Under dual capacity as
President of Cirrus and Vice President of CCCF, Mr. Doust was responsible,

24
<PAGE> 57
along with Mr. Harding-Brown (below), for the day-to-day operations for these
companies including origination, finance and aircraft sales transactions
totaling $225,000,000 involving DC-10s, MD-80s, 737-300s, 727s and other
aircraft. Mr. Doust has 31 years of varied experience within the aviation and
finance industries dating back to 1966. Prior to forming Cirrus, Mr. Doust was
with Security Pacific Leasing Corporation from 1983 to 1989 as head of the
Aviation Division. In that position, he purchased and sold all aircraft types.
From December 1978 to 1982, Mr. Doust was director of aircraft marketing and air
agreements for World Airways. Mr. Doust holds an MBA from Golden Gate University
(1982) in International Business (finance) and a BA from the University of San
Francisco (1966). He has a Commercial Pilots License, and has been awarded the
Air Medal with Bronze Star and Distinguished Flying Cross by the U.S.
Government. He also holds both Series 7 and Series 24 licenses as a registered
principal with Pegasus Securities Corporation, an NASD member firm.

Gregory Harding-Brown, age 41, is an Executive Vice President,
Assistant Secretary, Treasurer and Director of the Managing General Partner and
Pegasus Capital Corporation. He is a co-founder of Cirrus Capital Corporation of
Florida ("CCCF") and Cirrus Capital Corporation ("Cirrus"), both of which were
formed in October 1989 to engage in aircraft and other financing activities.
Under dual capacity as Executive Vice President of Cirrus and Vice President of
CCCF, Mr. Harding-Brown was responsible, along with Mr. Doust (above), for the
day-to-day operations for these companies including origination, finance, equity
sales and lease analysis transactions totaling $225,000,000. Prior to forming
Cirrus, Mr. Harding-Brown was with Security Pacific Leasing Corporation from
1983 to 1989. He was responsible for more than $450 million in financing on all
types of aircraft and transportation equipment. From 1980 to 1983, he held
various positions with financial service companies. Mr. Harding-Brown holds a BA
from the University of California at Berkeley in Political Economy of Industrial
Societies (International Economics). He also holds both Series 7 and Series 24
licenses as a registered principal with Pegasus Securities Corporation, an NASD
member firm.

Carol L. Chase, Esq., age 44, is a Senior Vice President, General
Counsel and Secretary of the Managing General Partner and Pegasus Capital
Corporation. She is responsible for providing legal counsel for all aspects of
capital equipment leasing, financing and placement. Prior to joining Pegasus,
from 1987 to 1988, Ms. Chase was Senior Corporate Counsel at CIS where she
provided legal counsel for transactions involving aircraft and related
equipment. From 1981 to 1987, Ms. Chase was legal counsel at Transamerica
Airlines where she was responsible for the legal negotiation and documentation
for the purchase, sale, lease and finance of aircraft and aircraft-related
equipment. Ms. Chase received a B.A. degree from California State University,
Hayward and a J.D. degree from the University of California, Davis. She is a
member of the State Bar of California, the American Bar Association, and the
American Corporate Counsel Association.

25
<PAGE> 58
Air Transport Leasing, Inc.

<TABLE>
<CAPTION>
Name Positions Held
---- --------------
<S> <C>
Gerald F. Goertz, Jr. Chairman of the Board
Clifford B. Wattley President and Director
Stephen R. Dyer Vice President, Assistant Secretary and Director
Joseph P. Ciavarella Vice President, Secretary, Treasurer and
Chief Financial and Accounting Officer
</TABLE>

Gerald F. Goertz, Jr., age 39, is Chairman of the Board of Directors of
the Administrative General Partner. Mr. Goertz joined PaineWebber Incorporated
in December 1990 and holds the position of Senior Vice President and Director of
Specialized Investment Services. Prior to joining PaineWebber Incorporated, Mr.
Goertz was associated with CG Realty Advisors and The Freeman Company. He
received his Bachelor of Arts degree in Business Administration in 1979 from
Vanderbilt University and his Juris Doctorate and Masters of Business
Administration from Memphis State University in 1982.

Clifford B. Wattley, age 47, is President and a Director of the
Administrative General Partner. Mr. Wattley is a Corporate Vice President with
PaineWebber Incorporated, having joined the firm in 1986. He also was employed
previously by Paine, Webber, Jackson & Curtis from 1979 to 1980. From 1986 to
1992, Mr. Wattley participated in PaineWebber's Principal Transactions Group.
Since 1992, Mr. Wattley has been a member of the Private Investment Department.
He holds a Bachelor of Science degree in engineering from Columbia University
and a Masters in Business Administration from Harvard University.

Stephen R. Dyer, age 37, is a Vice President, Assistant Secretary and a
Director of the Administrative General Partner. He joined PaineWebber
Incorporated in June 1988 as a Divisional Vice President and is currently a
Corporate Vice President and Director of Private Investments. Prior to joining
PaineWebber Incorporated, Mr. Dyer had been employed, since June 1987, as an
Assistant Vice President in the Retail National Products Group of L.F.
Rothschild & Co. Incorporated. Prior to joining L.F. Rothschild he was employed,
beginning in January 1985, as an Associate in the Real Estate Department of
Thomson McKinnon Securities Inc. From July 1981 to August 1983, Mr. Dyer was on
the audit staff of the accounting firm of Arthur Young & Co. He received his
Bachelor of Science degree in Accounting in 1981 from Boston College and a
Masters of Business Administration from Indiana University in December 1984. Mr.
Dyer is a Certified Public Accountant.

Joseph P. Ciavarella, age 41, is a Vice President, Secretary, Treasurer
and Chief Financial and Accounting Officer of the Administrative General
Partner. He joined PaineWebber Incorporated in May 1994 as a Corporate Vice
President. Prior to joining PaineWebber Incorporated, he was affiliated with
Aviation Capital Group in the area of aircraft finance. He was associated with
Integrated Resources, Inc. from 1983 to 1993 as a first vice president as well
as a divisional senior vice-president and chief financial officer of the
equipment leasing, aircraft finance and venture capital areas. He has a Bachelor
of Business Administration degree in Accounting from Hofstra University and is a
Certified Public Accountant.

26
<PAGE> 59

Item 11. Executive Compensation

No compensation was paid by the Partnership to the officers and
directors of the General Partners. See Item 13 of this Report, "Certain
Relationships and Related Transactions", which is incorporated herein by
reference, for a description of the compensation and fees paid to the General
Partners and their affiliates by the Partnership during 1996.

Item 12. Security Ownership of Certain Beneficial Owners and Management

(a) As of the date hereof, no person is known by the
Partnership to be the beneficial owner of more than
5% of the Units of the Partnership. The Partnership
has no directors or officers, and neither of the
General Partners of the Partnership owns any Units.
The Assignor Limited Partner for the Partnership,
Pegasus Assignor L.P.A., Inc. (an affiliate of the
Managing General Partner), owns 5 Units.
Additionally, ATL Inc., an affiliate of the
Administrative General Partner owns approximately
112,916 Units as the result of legal settlements with
various limited partners.

The names and addresses of the General Partners are as
follows:

Managing General Partner:

Pegasus Aircraft Management Corporation
Four Embarcadero Center, 35th Floor
San Francisco, CA 94111

Administrative General Partner:

Air Transport Leasing, Inc.
1200 Harbor Boulevard, 5th Floor
Weehawken, NJ 07087

The General Partners, collectively, have a 1%
interest in each item of the Partnership's income,
gains, losses, deductions, credits and distributions.

(b) The following table sets forth the number of Units
beneficially owned by directors of the General
Partners and by all directors and officers of such
corporations as a group as of March 1, 1997.

27
<PAGE> 60

<TABLE>
<CAPTION>
Amount and Nature Percent
Name Of Beneficial Ownership of Class
---- ----------------------- --------
<S> <C> <C>
Pegasus Aircraft Management
Corporation
---------------------------
Richard S. Wiley 29,501 *
Richard W. Doust 27,874 *
Gregory Harding-Brown 16,751 *

Air Transport Leasing, Inc.
---------------------------
None

All directors and officers 75,426 1.04%
as a group (4 persons)
</TABLE>

*Less than 1% of class.

(c) The Partnership knows of no arrangements, the
operation of the terms of which may at a subsequent
date result in a change in control of the
Partnership.

Item 13. Certain Relationships and Related Transactions

The General Partners and their affiliates have received or will receive
certain types of compensation, fees, or other distributions in connection with
the operations of the Partnership. The fees and compensation were determined in
accordance with the applicable provisions of the Partnership Agreement.

Following is a summary of the amounts paid or payable to the General
Partners and their affiliates during 1996.

Base Management Fee The General Partners receive a quarterly
subordinated base management fee in an amount generally equal to 1.5% of gross
aircraft rentals, net of re-lease fees paid. Of this amount, 1.0% is payable to
the Managing General Partner and 0.5% is payable to the Administrative General
Partner. During 1996, the General Partners earned base management fees of
$219,000.

Incentive Management Fee The General Partners receive a quarterly
subordinated incentive management fee, in an amount equal to 4.5% of quarterly
cash flow and sales proceeds (net of resale fees), of which 2.5% is payable to
the Managing General Partner and 2.0% is payable to the Administrative General
Partner. The General Partners earned incentive management fees of $598,000
during 1996.

28
<PAGE> 61
Re-lease Fee The General Partners receive a quarterly subordinated fee for
re-leasing aircraft or renewing a lease in an amount equal to 3.5% of the gross
rentals from such re-lease or renewal for each quarter for which such payment is
received. Of this amount, 2.5% is payable to the Managing General Partner and
1.0% is payable to the Administrative General Partner. The General Partners
earned re-lease fees of $252,000 during 1996.

Beginning January 1, 1995 and for the year ended December 31, 1995, the
Administrative General Partner deferred the receipt of management fees and
re-lease fees which aggregated $445,000. As part of the Class action settlement
(discussed in Item 8, Financial statements, Footnote 10, "Litigation") these
fees as well as 1996 and all future fees and distributions earned by the
Administrative General Partner have been assigned by an affiliate to an escrow
account for the benefit of the class action members.

Accountable Expenses The General Partners are entitled to
reimbursement of certain expenses paid on behalf of the Partnership which are
incurred in connection with the administration and management of the
Partnership. Such reimbursable expenses amounted to $75,000 during 1996, all of
which was paid or accrued to the Administrative General Partner.

Partnership Interest The General Partners received or were entitled
to receive distributions of $117,000 as their allocable share of distributable
cash flow for 1996. In addition, $22,000 of the Partnership's net income for
1996 was allocated to the General Partners.

29
<PAGE> 62
PART IV

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

(a) The following documents are filed as part of this Report:

1. Financial Statements: (Incorporated by reference to
Item 8 of this Report, "Financial Statements and
Supplementary Data").

(b) During the quarter ended December 31, 1996, the Partnership
filed a Form 8-K dated September 30, 1996 reporting the
bankruptcy of Kiwi International Air Lines, Inc., a
significant lessee and the early lease termination and return
of the L-1011 aircraft by TWA. The Partnership also filed a
Form 8-K dated November 22, 1996 reporting the net asset value
per unit at September 30, 1996 and the Partnership's Safe
Harbor policy regarding sales of units.

3.1 (a) Amended and Restated Limited Partnership Agreement dated April
27, 1989, as amended and restated July 11, 1989. Filed as
Exhibit 3.1 to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1989.*

(b) Amendment, dated as of December 26, 1990, to the Amended and
Restated Limited Partnership Agreement dated July 11, 1989.
Filed as Exhibit 1 to the Registrant's Current Report on Form
8-K dated December 26, 1990.*

(c) Amendment, dated as of March 31, 1992, to the Amended and
Restated Limited Partnership Agreement dated July 11, 1989.
Filed as Exhibit 4 to the Registrant's Current Report on Form
8-K dated April 16, 1992.*

10.1 (a) Agreement pursuant to Selection 168(f)(8) of the Internal
Revenue Code of 1954, as amended, between Pacific Southwest
Airlines and General Mills, Inc. Filed as Exhibit 19.3(c) to
the Quarterly Report on Form 10-Q for the quarter ended March
31, 1989 for Pegasus Aircraft Partners, L.P. (Commission File
No. 33-22986).*

(b) Participation Agreement, dated September 21, 1989, among
Pegasus Aircraft Partners, L.P., a Delaware limited
partnership ("Pegasus Aircraft Partners"), First Security Bank
of Utah, National Association (the "Owner Trustee"), Concord
Asset Management, Inc., a Delaware corporation ("CAMI"), and
the Registrant. Filed as Exhibit 19.2(e) to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September
30, 1989.*

30
<PAGE> 63

(c) Amended and Restated Reimbursement Agreement, dated September
21, 1989 between Pegasus Aircraft Partners and CAMI. Filed as
Exhibit 19.2(f) to the Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1989.*

(d) Reimbursement Agreement, dated September 21, 1989, between the
Registrant and CAMI. Filed as Exhibit 19.2(g) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1989.*

(e) Amended and Restated Security Agreement, dated September 21,
1989 between Pegasus Aircraft Partners and CAMI. Filed as
Exhibit 19.2(h) to the Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1989.*

(f) Security Agreement, dated September 21, 1989, between the
Registrant and CAMI. Filed as Exhibit 19.2(i) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1989.*

(g) Security Agreement, dated September 21, 1989, between the
Registrant and Pegasus Aircraft Partners. Filed as Exhibit
19.2(j) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1989.*

(h) Security Agreement, dated September 21, 1989, between Pegasus
Aircraft Partners and the Registrant. Filed as Exhibit 19.2(k)
to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1989.*

(i) Trust Agreement 814, dated as of March 10, 1989, among Pegasus
Capital Corporation, a California corporation ("PCC") as
Beneficiary, Pegasus Aircraft Partners as Beneficiary, and the
Owner Trustee. Filed as Exhibit 19.3(i) to the Quarterly
Report on Form 10-Q for the quarter ended March 31, 1989 for
Pegasus Aircraft Partners, L.P. (Commission File No.
33-22986).*

(j) First Amendment to Trust Agreement 814, dated September 21,
1989, among Pegasus Aircraft Partners as Beneficiary, the
Registrant as Beneficiary, and the Owner Trustee. Filed as
Exhibit 19.2(m) to the Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1989.*

31
<PAGE> 64

(k) Amended and Restated Lease No. 1, dated October 14, 1988,
between PS Group, Inc. and USAir, Inc. Filed as Exhibit 10.2.9
to Form S-1 Registration Statement dated July 3, 1989
(Commission File No. 33-28359).*

(l) Assumption Agreement, dated March 22, 1989, among PCC, the
Buyer, CAMI and Pegasus Aircraft Partners. Filed as Exhibit
No. 19.3(e) to the Quarterly Report on Form 10-Q for the
quarter ended March 31, 1989 for Pegasus Aircraft Partners,
L.P. (Commission File No. 33-22986).*

(m) Letter of Credit Agreement, dated as of April 30, 1992,
between First Security Bank of Utah as Owner Trustee and
Philadelphia National Bank, Incorporated, as CoreStates Bank,
N.A. Filed as Exhibit 10.4(a) to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1992.*

(n) Assumption Agreement, dated April 30, 1992, among Pegasus
Aircraft Partners, L.P. and Pegasus Aircraft Partners II, L.P.
as Obligors and Philadelphia National Bank, Incorporated, as
CoreStates Bank, N.A. Filed as Exhibit 10.4(b) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1992.*

(o) Security Agreement and Assignment of Lease, dated as of April
30, 1992, between First Security Bank of Utah, National
Association as Owner Trustee and Philadelphia National Bank,
Incorporated, as CoreStates Bank, N.A. Filed as Exhibit
10.4(c) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1992.*

(p) Assignment of Collateral, dated as of April 30, 1992, between
Pegasus Aircraft Partners II, L.P. and Philadelphia National
Bank, Incorporated, as CoreStates Bank, N.A. Filed as Exhibit
10.4(d) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1992.*

10.2 (a) Trust Agreement 047, dated as of April 12, 1989, between PCC
as Beneficiary, and First Security Bank of Utah, National
Association as Owner Trustee. Filed as Exhibit 19.3(b) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1989.*

32
<PAGE> 65

(b) Lease Agreement 047, dated as of April 12, 1989, between Owner
Trustee and Continental Airlines, Inc. Filed as Exhibit
19.3(c) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1989.*

(c) Amendment No. 1 to Lease Agreement 047, dated September 21,
1989. Filed as Exhibit 10.3(f) to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1989.*

(d) Stipulation and Order, dated June 19, 1991, among Continental
Airlines, Inc., New York Airlines, Inc., Bay Air Lease I,
Cirrus Capital Corporation of Florida, Bay Air Lease III,
Meridian Trust Company, as Owner Trustee, IAL Aircraft
Acquisitions, Inc., Pegasus Aircraft Partners II, L.P.,
Pegasus Capital Corporation, IAL Aviation Resources, Inc.,
Aircraft Leasing, Inc., Pegasus Aircraft Partners, L.P.,
Gilman Financial Services, Inc. and First Security Bank of
Utah, as Owner Trustee concerning various aircraft and
aircraft engines. Filed as Exhibit 19.1(a) to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1991.*

(e) Agreed Order, dated July 3, 1991, in connection with approval
of Stipulation and Order, dated June 19, 1991, among
Continental Airlines, Inc., New York Airlines, Inc., Bay Air
Lease I, Cirrus Capital Corporation of Florida, Bay Air Lease
III, Meridian Trust Company, as Owner Trustee, IAL Aircraft
Acquisitions, Inc., Pegasus Aircraft Partners II, L.P.,
Pegasus Capital Corporation, IAL Aviation Resources, Inc.,
Aircraft Leasing, Inc., Pegasus Aircraft Partners, L.P.,
Gilman Financial Services, Inc. and First Security Bank of
Utah, as Owner Trustee concerning various aircraft and
aircraft engines. Filed as Exhibit 19.1(b) to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1991.*

(f) Supplemental Stipulation and Order, dated December 30, 1992,
among Continental Airlines, Inc., Bay Air Lease I, Cirrus
Capital Corporation of Florida, Bay Air Lease III, Aviation
Assets I, Aviation Assets II, Aviation Assets III, Aviation
Assets IV, IAL Aircraft Acquisitions, Inc., Pegasus Aircraft
Partners II, L.P., Pegasus Capital Corporation, IAL Aviation
Resources, Inc., Pegasus Aircraft Partners, L.P., Gilman
Financial Services, and First Security Bank of Utah, as Owner
Trustee concerning various aircraft and aircraft engines.
Filed as Exhibit 10.2(f) to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1992.*

<PAGE> 66

(g) Amendment No. 2 to Lease Agreement 047 between First Security
Bank of Utah, N.A. as Lesser and Continental Micronesia as
Lessee dated March 15, 1995.

10.3 (a) Trust Agreement 32719 between the Registrant and First
Security Bank of Utah, National Association as Owner Trustee.
Filed as Exhibit 19.4(c) to the Registrant's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1989.*

(b) Aircraft Lease Agreement, dated as of February 15, 1993,
between First Security Bank of Utah, National Association as
Owner Trustee and KIWI International Air Lines, Inc. Filed as
Exhibit 10.1(a) to the Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 1993.*

(c) Lease Supplement No. 1, dated March 5, 1993, between First
Security Bank of Utah, National Association as Owner Trustee
and KIWI International Air Lines, Inc. Filed as Exhibit
10.1(b) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1993.*

(d) Amendment No. 1 dated March 15, 1995 to the lease between
First Security Bank of Utah National Association as Trustee
(Lessor) and Kiwi International Air Lines Inc. with respect to
a certain 727 Aircraft, US Registration N32719.*

10.4 (a) Trust Agreement 909, dated as of May 25, 1989, between PCC as
Beneficiary and First Security Bank of Utah, National
Association as Owner Trustee. Filed as Exhibit 10.5(b) to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1989.*

(b) Lease Agreement, dated as of October 1, 1983, between DC-9T-II
as Lessor and Trans World Airlines, Inc. ("TWA") as Lessee.
Filed as Exhibit 10.2.8 to Form S-1 Registration Statement
dated July 3, 1989 (Commission File No. 33-28359).*

(c) Lease Supplement No. 1 dated, October 13, 1983, between TWA
and DC-9T-II. Filed with Lease Agreement as Exhibit 10.2.8 to
Form S-1 Registration Statement dated July 3, 1989 (Commission
File No. 33-28359).*

(d) Amendment No. 1, dated as of May 1, 1991, to Lease dated as of
October 1, 1983, each between First Security Bank of Utah,
National Association as Owner Trustee and Lessor and Trans
World Airlines, Inc. as Lessee. Filed as Exhibit 19.1(a) to
the

<PAGE> 67
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1991.*

(e) Provisional Amendment, dated as of March 31, 1993, between
First Security Bank of Utah, National Association as Owner
Trustee and Trans World Airlines, Inc. Filed as Exhibit
10.3(a) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1993.*

(f) Amendment No. 2, dated as of April 15, 1993, between First
Security Bank of Utah, National Association as Owner Trustee
and Trans World Airlines, Inc. Filed as Exhibit 10.3(b) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1993.*

(g) Agreed Order, dated April 14, 1993, approving lease amendments
among Trans World Airlines, Inc., Pegasus Aircraft Partners,
L.P., Registrant and Pegasus Capital Corporation relating to
leases of certain aircraft. Filed as Exhibit 10.3(c) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1993.*

(h) Amendment No. 3 dated January 16, 1995 between First Security
Trust of Utah as Lessor Owner Trustee and TWA as lessee with
respect to the lease of one Lockheed L-1011 aircraft, U.S.
Registration No. N41016.*

(i) Amendment No. 3 dated as of January 16, 1995 between Meridian
Trust Company as Lessor Owner Trustee and TWA as lessee with
respect to the lease of one McDonnell Douglas MD-82 aircraft,
U.S. Registration No. 909TW.*

10.5 (a) Lease Agreement, dated as of December 30, 1981, between First
Security Bank of Utah, National Association as Lessor and TWA
as Lessee. Filed as Exhibit 10.2.3 to Form S-1 Registration
Statement dated July 3, 1989 (Commission File No. 33-28359).*

(b) Trust Agreement, dated as of December 30, 1981, between BWL as
Owner Participant and First Security Bank of Utah, National
Association as Owner Trustee. Filed as Exhibit 10.6(h) to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1989.*

(c) Amendment No. 1, dated as of May 1, 1991, to Lease dated as of
December 30, 1981, each between First Security Bank of Utah,
National Association as Owner Trustee and Lessor and Trans

35
<PAGE> 68
World Airlines, Inc. as Lessee. Filed as Exhibit 19.1(a) to
the Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1991.*

(d) Provisional Amendment, dated as of March 31, 1993, between
First Security Bank of Utah, National Association as Owner
Trustee and Trans World Airlines, Inc. Filed as Exhibit
10.4(a) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1993.*

(e) Amendment No. 2, dated as of April 15, 1993, between First
Security Bank of Utah, National Association as Owner Trustee
and Trans World Airlines, Inc. Filed as Exhibit 10.4(b) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1993.*

(f) Agreed Order, dated April 14, 1993, approving lease amendments
among Trans World Airlines, Inc., Pegasus Aircraft Partners,
L.P., Registrant and Pegasus Capital Corporation relating to
leases of certain aircraft. Filed as Exhibit 10.4(c) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1993.*

10.6 (a) Trust Agreement 935, dated as of April 2, 1990, between
Registrant as Beneficiary and First Security Bank of Utah,
National Association, as Owner Trustee. Filed as Exhibit
19.1(b) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1990.*

(b) Aircraft Lease Agreement, dated as of June 1, 1992, between
First Security Bank of Utah, National Association as Owner
Trustee and Lessor and Aerovias de Mexico, S.A. de C.V. as
Lessee, pertaining to one McDonnell Douglas DC-9-31 aircraft,
U.S. Registration No. N935ML. Filed as Exhibit 10.1(a) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1992.*

(c) Estoppel and Acceptance Certificate, dated July 1, 1992,
executed by Aerovias de Mexico, S.A. de C.V. as Lessee under
Aircraft Lease Agreement, dated as of June 1, 1992, between
Aerovias de Mexico, S.A. de C.V. and First Security Bank of
Utah, National Association as Owner Trustee and Lessor,
pertaining to one McDonnell Douglas DC-9-31 aircraft, U.S.
Registration No. N935ML. Filed as Exhibit 10.1(b) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1992.*

36
<PAGE> 69
10.7 (a) Trust Agreement 936, dated as of May 9, 1990, between
Registrant as Beneficiary and First Security Bank of Utah,
National Association, as Owner Trustee. Filed as Exhibit
19.1(b) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1990.*

(b) Aircraft Lease Agreement, dated as of June 1, 1992, between
First Security Bank of Utah, National Association as Owner
Trustee and Lessor and Aerovias de Mexico, S.A. de C.V. as
Lessee, pertaining to one McDonnell Douglas DC-9-31 aircraft,
U.S. Registration No. N936ML. Filed as Exhibit 10.2(a) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1992.*

(c) Estoppel and Acceptance Certificate, dated July 20, 1992,
executed by Aerovias de Mexico, S.A. de C.V. as Lessee under
Aircraft Lease Agreement, dated as of June 1, 1992, between
Aerovias de Mexico, S.A. de C.V. and First Security Bank of
Utah, National Association as Owner Trustee and Lessor,
pertaining to one McDonnell Douglas DC-9-31 aircraft, U.S.
Registration No. N936ML. Filed as Exhibit 10.2(b) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1992.*

10.7 (d) Standstill Agreement dated December 13, 1994, between Aerovias
de Mexico SA de CV and First Security Bank of Utah National
Association as Owner Trustee of two DC-9-31 Aircraft, US
Registration N936ML and N937ML.*

10.7 (e) Standstill Extension and Amendment dated as of February 28,
1995 between Aerovias de Mexico SA de CV and First Security
Bank of Utah National Association as Owner Trustee of two
DC-9-31 Aircraft, US Registration N936ML and N937ML.*

10.8 (a) Trust Agreement 16982, dated as of August 22, 1990, between
Registrant as Beneficiary and First Security Bank of Utah,
National Association as Owner Trustee. Filed as Exhibit
19.1(b) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1990.*

(b) Lease Agreement 212, dated as of December 15, 1988, between
Wilmington Trust Company as Owner Trustee and Lessor and
Continental Airlines, Inc. as Lessee. Filed as Exhibit 10.2.5
toForm S-1 Registration Statement dated July 3, 1989,
(Commission File No. 33-28359).*

(c) Amendment No. 1, dated as of May 26, 1989, to Lease Agreement
212, between Wilmington Trust Company as Owner Trustee and

37
<PAGE> 70

Lessor and Continental Airlines, Inc. as Lessee. Filed as
Exhibit 10.2.5 to Form S-1 Registration Statement dated July
3, 1989, (Commission File No. 33-28359).*

(f) Supplemental Stipulation and Order, dated December 30, 1992,
among Continental Airlines, Inc., Bay Air Lease I, Cirrus
Capital Corporation of Florida, Bay Air Lease III, Aviation
Assets I, Aviation Assets II, Aviation Assets III, Aviation
Assets IV, IAL Aircraft Acquisitions, Inc., Pegasus Aircraft
Partners II, L.P., Pegasus Capital Corporation, IAL Aviation
Resources, Inc., Pegasus Aircraft Partners, L.P., Gilman
Financial Services, and First Security Bank of Utah, as Owner
Trustee concerning various aircraft and aircraft engines.
Filed as Exhibit 10.8(f) to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1992.*

(g) Lease Termination Agreement dated November 15, 1995 between
and among Continental Airlines, Inc., First Security Bank of
Utah, N.A., Pegasus Aircraft Management, Inc. and Air
Transport Leasing, Inc.*

38
<PAGE> 71

(h) Supplement to Lease Termination Agreement between and among
Continental Airlines, Inc., First Security Bank of Utah, N.A.,
Pegasus Aircraft Management, Inc. and Air Transport Leasing,
Inc.*

10.9 Prospectus of Registrant, dated as of July 11, 1989. Filed as
Exhibit 2 of the Registrant's Form 8-K filed for the Event
occurring on September 20, 1989.*

10.10 (a) Loan Agreement, dated June 10, 1992, between Pegasus Aircraft
Partners II, L.P. and Philadelphia National Bank,
Incorporated, as CoreStates Bank, N.A. Filed as Exhibit
10.3(a) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1992.*

(b) Promissory Note, dated June 10, 1992, made by Pegasus Aircraft
Partners II, L.P. in favor of Philadelphia National Bank,
Incorporated, as CoreStates Bank, N.A. Filed as Exhibit
10.3(b) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1992.*

(c) Assignment of Collateral, dated as of June 10, 1992, between
Pegasus Aircraft Partners II, L.P. and Philadelphia National
Bank, Incorporated, as CoreStates Bank, N.A. Filed as Exhibit
10.3(c) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1992.*

(d) Security Agreement and Assignment of Lease, dated as of June
10, 1992, between First Security Bank of Utah, National
Association as Owner Trustee and Philadelphia National Bank,
Incorporated, as CoreStates Bank, N.A. Filed as Exhibit
10.3(d) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1992.*

10.11(a) Secured Loan Agreement, dated September 10, 1992, among
Greyhound Financial Corporation, as Lender and First Security
Bank of Utah, National Association as Owner Trustee under (i)
Trust Agreement 935, dated as of April 2, 1990, between First
Security Bank of Utah, National Association and Pegasus
Aircraft Partners II, L.P., (ii) Trust Agreement 936, dated as
of May 9, 1990, between First Security Bank of Utah, National
Association and Pegasus Aircraft Partners II, L.P., and (iii)
Trust Agreement 909, dated as of May 25, 1989, between First
Security Bank of Utah, National Association and Pegasus
Aircraft Partners II, L.P. as Co-Borrowers. Filed as Exhibit
10.1(a) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1992.*

39
<PAGE> 72
(b) Promissory Note, dated September 10, 1992, made by First
Security Bank of Utah, National Association as Owner Trustee
under (i) Trust Agreement 935, dated as of April 2, 1990,
between First Security Bank of Utah, National Association and
Pegasus Aircraft Partners II, L.P., (ii) Trust Agreement 936,
dated as of May 9, 1990, between First Security Bank of Utah,
National Association and Pegasus Aircraft Partners II, L.P.,
and (iii) Trust Agreement 909, dated as of May 25, 1989,
between First Security Bank of Utah, National Association and
Pegasus Aircraft Partners II, L.P. in favor of Greyhound
Financial Corporation. Filed as Exhibit 10.1(b) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1992.*

(c) Beneficial Interest Security Agreement, dated as of September
10, 1992, between Pegasus Aircraft Partners II, L.P. and
Greyhound Financial Corporation. Filed as Exhibit 10.1(c) to
the Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1992.*

(d) Continuing Guaranty and Subordination Agreement, dated
September 10, 1992, between Greyhound Financial Corporation
and First Security Bank of Utah, National Association as Owner
Trustee under (i) Trust Agreement 935, dated as of April 2,
1990, between First Security Bank of Utah, National
Association and Pegasus Aircraft Partners II, L.P., (ii) Trust
Agreement 936, dated as of May 9, 1990, between First Security
Bank of Utah, National Association and Pegasus Aircraft
Partners II, L.P., and (iii) Trust Agreement 909, dated as of
May 25, 1989, between First Security Bank of Utah, National
Association and Pegasus Aircraft Partners II, L.P. Filed as
Exhibit 10.1(d) to the Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1992.*

(e) Negative Pledge Agreement, dated as of September 10, 1992, by
and among Greyhound Financial Corporation and First Security
Bank of Utah, National Association as Owner Trustee under (i)
Trust Agreement 935, dated as of April 2, 1990, between First
Security Bank of Utah, National Association and Pegasus
Aircraft Partners II, L.P., (ii) Trust Agreement 936, dated as
of May 9, 1990, between First Security Bank of Utah, National
Association and Pegasus Aircraft Partners II, L.P., (iii)
Trust Agreement 909, dated as of May 25, 1989, between First
Security Bank of Utah, National Association and Pegasus
Aircraft Partners II, L.P., and (iv) Trust Agreement 16982
between First Security Bank of Utah, National Association and
Pegasus Aircraft Partners II, L.P. Filed as Exhibit 10.1(e) to
the Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1992.*

40
<PAGE> 73

(f) First Priority Aircraft Chattel Mortgage and Security
Agreement, dated September 10, 1992, between First Security
Bank of Utah, National Association as Owner Trustee under
Trust Agreement 935, dated as of April 2, 1990, between First
Security Bank of Utah, National Association and Pegasus
Aircraft Partners II, L.P., as Mortgagor, and Greyhound
Financial Corporation, as Mortgagee. Filed as Exhibit 10.1(f)
to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1992.*

(g) First Priority Aircraft Chattel Mortgage and Security
Agreement, dated September 10, 1992, between First Security
Bank of Utah, National Association as Owner Trustee under
Trust Agreement 936, dated as of May 9, 1990, between First
Security Bank of Utah, National Association and Pegasus
Aircraft Partners II, L.P., as Mortgagor, and Greyhound
Financial Corporation, as Mortgagee. Filed as Exhibit 10.1(g)
to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1992.*

(h) First Priority Aircraft Chattel Mortgage and Security
Agreement, dated September 10, 1992, between First Security
Bank of Utah, National Association as Owner Trustee under
Trust Agreement 909, dated as of May 25, 1989, between First
Security Bank of Utah, National Association and Pegasus
Aircraft Partners II, L.P., as Mortgagor, and Greyhound
Financial Corporation, as Mortgagee. Filed as Exhibit 10.1(h)
to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1992.*

10.12(a) Trust Agreement 357, dated as of February 15, 1993, between
Registrant and First Security Bank of Utah, National
Association as Owner Trustee. Filed as Exhibit 10.2(a) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1993.*

(b) Aircraft Lease Agreement, dated as of March 15, 1993, between
First Security Bank of Utah, National Association as Owner
Trustee and KIWI International Air Lines, Inc. Filed as
Exhibit 10.2(b) to the Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 1993.*

(c) Lease Supplement No. 1, dated May 24, 1993, between First
Security Bank of Utah, National Association as Owner Trustee
and KIWI International Air Lines, Inc. Filed as Exhibit
10.1(a) to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1993.*

41
<PAGE> 74

10.13 (a) Aircraft lease of 727-200 Advanced Airraft N16784 (formerly
N516PE) as of September 25, 1984 by Seventh HFC Leasing
Corporation as Lessor and People Express Airlines, Inc. as
Lessee.*

(b) Amendment No. 1 to lease of 727-200 Advanced Aircraft N16784
dated November 15, 1995 between Continental Airlines, Inc. as
Lessee and First Security Bank of Utah as Owner Trustee of a
trust in which Pegasus Aircraft Partners II, L.P. is the sole
beneficiary.*

10.14 (a) Aircraft lease of 727-200 advanced Aircraft N77780
(formerly N512PE) as of August 23, 1984 by Mellon Financial
Services Corporation #3 as Lessor and People Express as
Lessee.*

(b) Amendment No. 1 to lease of 727-200 Advanced Aircraft N77780
dated November 21, 1995 between Continental Airlines, Inc. as
Lessee and First Security Bank of Utah as Owner Trustee of a
trust in which Pegasus Aircraft Partners II, L.P. is the sole
beneficiary.*

10.15 (a) Promissory note issued in favor of Pegasus Aircraft Partners
II, L.P. with face amount of $307,166 dated March 16, 1996
from Kiwi International Airlines Inc.*

10.16(a) Loan and Security Agreement dated December 23, 1996 between
Provident Bank, N.A. and First Security Bank National
Association, as Owner Trustee of trusts in which Pegasus
Aircraft Partners II, L.P. is the sole beneficiary.*

11 Partnership Policy for Requests for Partner Lists.

42
<PAGE> 75

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.

Dated: March 31, 1997

Pegasus Aircraft Partners II, L.P.
(Registrant)

By: Air Transport Leasing, Inc.
Administrative General Partner

By: /s/ Clifford B. Wattley
-------------------------------
Clifford B. Wattley
President and Director

By: /s/Joseph P. Ciavarella
-------------------------------
Joseph P. Ciavarella
Vice President, Treasurer,
Secretary and Chief Financial
and Accounting Officer

By: Pegasus Aircraft Management
Corporation Managing General Partner

By: /s/ Richard S. Wiley
-------------------------------
Richard S. Wiley
President and Chairman
of the Board

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 on March ___, 1996.

Signature Title

/s/ Richard S. Wiley President and Chairman of
- ------------------------------- the Board of Pegasus Aircraft
Richard S. Wiley Management Corporation

/s/ Richard W. Doust Executive Vice President,
- ------------------------------- Assistant Secretary, Treasurer
Richard W. Doust and Director of Pegasus Aircraft
Management Corporation

43
<PAGE> 76

/s/ Gregory Harding-Brown Executive Vice President,
- ------------------------------- Assistant Secretary, Treasurer
Gregory Harding-Brown and Director of Pegasus Aircraft
Management Corporation

/s/ Gerald F. Goertz, Jr. Chairman of the Board of
- ------------------------------- Air Transport Leasing, Inc.
Gerald F. Goertz, Jr.

/s/ Clifford B. Wattley President and Director of
- ------------------------------- Air Transport Leasing, Inc.
Clifford B. Wattley

/s/ Stephen R. Dyer President, Assistant
- ------------------------------- Secretary and Director of
Stephen R. Dyer Air Transport Leasing, Inc.

44
<PAGE> 77
PARTNERSHIP INFORMATION

PEGASUS AIRCRAFT PARTNERS II, L.P.
2424 South 130th Circle
Omaha, Nebraska 68144-2596
(800) 234-7342

GENERAL PARTNERS
Pegasus Aircraft Management Corporation
Air Transport Leasing, Inc.

AUDITORS
Coopers & Lybrand L.L.P.
New York, New York

LEGAL COUNSEL
Derenthal & Dannhauser
San Francisco, California

TRANSFER AGENT
Service Data Corporation
Omaha, Nebraska

A Copy of the Annual Report on Form 10-K, as filed with the Securities and
Exchange Commission, will be furnished without charge to Limited Partners upon
request.

47
<PAGE> 78
EXHIBIT INDEX
-------------

Exhibit No. Description
----------- -----------

10.2(g) Amendment No. 2 to Lease Agreement 047 between First Security
Bank of Utah, N.A. as Lesser and Continental Micronesia as
Lessee dated March 15, 1995.

11 Partnership Policy for Requests for Partner Lists.

27 Financial Data Schedule

<PAGE> 1

AMENDMENT NO. 2 TO LEASE AGREEMENT 047

This Amendment No. 2 to Lease Agreement 047 (this "Amendment") is
dated as of November 15, 1995 by and between CONTINENTAL MICRONESIA, INC., a
Delaware corporation ("LESSEE"), and FIRST SECURITY BANK OF UTAH, NATIONAL
ASSOCIATION, a national banking association, not in its individual capacity but
solely as owner trustee for the benefit of Pegasus Aircraft Partners II, L.P.
(the "Owner Participant") under Trust Agreement 047 dated as of April 12, 1989
("LESSOR").

WITNESSETH

WHEREAS, pursuant to that certain Lease Agreement 047 dated as of
April 12, 1989, by and between LESSOR, as lessor, and Continental Airlines,
Inc. ("CAL") (predecessor-in-interest to LESSEE), as lessee (the "Lease"),
LESSEE leased one (1) McDonnell Douglas model DC-10-10 aircraft bearing
Manufacturer's Serial Number 47801 and U.S. Registration Number N68047 and
three (3) General Electric model CF6-6D engines bearing Manufacturer's Serial
Numbers 451282, 451457 and 451379 (collectively, the "Aircraft"), which Lease,
with Lease Supplement No. 1 dated May 3, 1989 attached thereto, was recorded by
the FAA on June 13, 1989, as Conveyance No. W06098, as thereafter amended by
Amendment No. 1 to Lease Agreement 047 dated September 21, 1989, recorded by
the FAA on October 2, 1989, as Conveyance No. BB14064 Capitalized terms used but
not otherwise defined herein shall have the meanings attributed thereto in the
Lease;

WHEREAS, pursuant to that certain Aircraft Lease Assignment and
Assumption Agreement dated as of April 27, 1993 (the "Assignment"), CAL
assigned all of its right, title and interest under the Lease to LESSEE, which
Assignment was recorded by the FAA on July 27, 1993, as Conveyance No. VV004051;

WHEREAS, LESSEE, as sublessor, subleased the Aircraft to CAL, as
sublessee, pursuant to that certain Sublease Agreement dated as of April 27,
1993 (the "Sublease"), which Sublease was recorded by the FAA on July 27, 1993,
as Conveyance No. VV004052;

WHEREAS, LESSOR and LESSEE desire to further amend the terms of the
Lease as hereinafter set forth.

NOW THEREFORE, for and in consideration of the premises, and other
good and valuable consideration, the receipt and sufficiency of which is hereby
acknowledged, the parties hereto agree as follows:

1. The Term of the Lease shall expire on October 31, 1996.

1
<PAGE> 2

2. The monthly rent for the Aircraft shall be decreased to $135,000,
payable monthly in advance on the first business day of each month, such
decrease to be effective, retroactively, as of September 15, 1995.

3. Consents and Approvals. Each of the parties hereto represents and
warrants that it has obtained all consents and approvals of third parties
(including governmental entities) required in connection with the execution,
delivery and performance of this Amendment.

4 Miscellaneous.

4.1 Status of Lease. This Amendment shall be construed in connection
with, and as part of, the Lease. The terms, conditions, covenants, agreements,
rights, remedies, powers and privileges set forth in the Lease as previously or
heretofore amended, or as otherwise modified hereby, are hereby confirmed in
all respects by the parties hereto and shall continue in full force and effect.

4.2 Counterparts. This Amendment may be executed in any number of
counterparts, all of which taken together shall constitute one and the same
agreement, and either of the parties hereto may enter into this Amendment by
executing such a counterpart.

4.3 Governing Law. This Amendment shall be governed by and construed
in accordance with the laws of the State of New York. Any judicial proceeding
brought with respect to this Amendment may be brought in any court of competent
jurisdiction located in the City and State of New York, and, by execution and
delivery of this Amendment, each of the parties hereto (a) accepts, generally
and unconditionally, the non-exclusive jurisdiction of such courts and any
related appellate court and irrevocably agrees to be bound by any judgment
rendered thereby, and (b) irrevocably waives any objection it may now or
hereafter have as to the venue of any such proceeding brought in such a court
or that such a court is an inconvenient forum.

[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]

2
<PAGE> 3
IN WITNESS THEREOF, the parties hereto have caused this Amendment to
be executed as of the date first above written.

FIRST SECURITY BANK OF UTAH,
NATIONAL ASSOCIATION, not in its
individual capacity but solely as
owner trustee under Trust Agreement 047
CONTINENTAL MICRONESIA, INC. dated as of April 12, 1989

By: /s/ Jennifer Vogel By: /s/ Greg A. Hawley
--------------------------------- -----------------------------------
Name: Jennifer Vogel Name: Greg A. Hawley
------------------------------ --------------------------------
Title: Secretary & Senior Vice Title: Assistant Vice President
President --------------------------------
-----------------------------

<PAGE> 1
Exhibit 11

Policy Regarding Requests for Partners Lists
--------------------------------------------

In accordance with 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 and 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
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM PEGASUS
AIRCRAFT PARTNERS II LLP FORM 10-K.
</LEGEND>

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996<F1>
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-17-1997
<CASH> 12,831,000
<SECURITIES> 0
<RECEIVABLES> 1,398,000
<ALLOWANCES> 640,000
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 145,684,000
<DEPRECIATION> (89,507,000)
<TOTAL-ASSETS> 72,039,000
<CURRENT-LIABILITIES> 3,721,000
<BONDS> 4,751,000
0
0
<COMMON> 0
<OTHER-SE> 54,540,000
<TOTAL-LIABILITY-AND-EQUITY> 72,039,000
<SALES> 0
<TOTAL-REVENUES> 15,967,000
<CGS> 0
<TOTAL-COSTS> 11,265,000
<OTHER-EXPENSES> 489,000
<LOSS-PROVISION> 640,000
<INTEREST-EXPENSE> 674,000
<INCOME-PRETAX> 2,898,000
<INCOME-TAX> 0
<INCOME-CONTINUING> 2,898,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,898,000
<EPS-PRIMARY> .40
<EPS-DILUTED> 0
<FN>
<F1>5.02(14) SUCH AMOUNT INCLUDES CERTAIN PROVISIONS FOR DECLINE IN MARKET
VALUE AND OTHER RESOURCES.
5.03(31) REFLECT THE CAPITAL ACCOUNTS OF BOTH LIMITED PARTNERS AND GENERAL
PARTNERS, ADJUSTED FOR ACCUMULATED EARNINGS, DISTRIBUTORS AND SYNDICATION COST.
</FN>

</TABLE>