PEGASUS AIRCRAFT PARTNERS II L P, 10-K405, 1999-03-31

PEGASUS AIRCRAFT PARTNERS II L P
10-K405, 1999-03-31
EQUIPMENT RENTAL & LEASING, NEC

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SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K
---------

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

For the fiscal year ended December 31, 1998
------------------------------------------------------

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from _______________________ to ______________________

Commission file number 0-18387
---------------------------------------------------------

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

Delaware 84-1111757
-------- ----------
(State of organization) (IRS employer
Identification No.)

Four Embarcadero Center, 35th Floor
San Francisco, California 94111
- --------------------------------------- ---------
(Address of principal executive offices) (Zip Code)

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. [X]

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

This document consists of 51 pages.
<PAGE>

Pegasus Aircraft Partners II, L.P.
Annual Report on Form 10-K for the
Fiscal Year Ended December 31, 1998

Table of Contents
Page
----
Part I
- ------

Item 1 Business 3
Item 2 Properties 8
Item 3 Legal Proceedings 8
Item 4 Submission of Matters to a Vote of Security Holders 8

Part II
- -------

Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters 9
Item 6 Selected Financial Data 10
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 8 Financial Statements 16
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 37

Part III
- --------

Item 10 Directors and Executive Officers of the Registrant 38
Item 11 Executive Compensation 39
Item 12 Security Ownership of Certain Beneficial Owners and Management 40
Item 13 Certain Relationships and Related Transactions 41

Part IV
- -------

Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 42

2
<PAGE>
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 Paine Webber 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 had the right, subject
to certain conditions, to reinvest the proceeds from sales of aircraft occurring
prior to August 21, 1998. The net proceeds of any future sales of aircraft will
be retained for general working capital purposes with the remainder distributed
to all partners.

Outlook for the Airline and Aircraft Leasing Industries

The US airline industry had a profitable year in 1998 that continued
the industry's profitability trend. A major expense item for operators of
aircraft is the cost of fuel and it was very low in 1998. The industry's results
have in the past been highly correlated to general economic activity, however,
the industry did experience weakened results in the fourth quarter, a period of
relatively strong economic activity.

As to the supply and demand for aircraft, the industry took on and
continues to take on a record number of new aircraft that will likely put
pressure on profitability and will lead to further retirements of older
aircraft, such as those owned by the Partnership. The full implementation of
Stage III noise standards by year end 1999 will also likely lead to additional
older Stage II aircraft being retired.

Trans World Airlines, Inc. which accounted for 21% of the Partnership's
revenues in 1998 announced its tenth consecutive unprofitable year. While TWA is
replacing older aircraft with newer, more fuel efficient aircraft, its inability
to achieve sustained profitability is of concern.

The General Partners believe that installing hushkits to achieve Stage
III noise compliance and the conversion of two Boeing 727-200 aircraft to
freighters will enhance the Partnership's portfolio. Passenger aircraft and
freighter aircraft leasing continues to be a highly competitive business and the
Partnership's lessees also continue to face significant challenges.

Recent Partnership Developments

Immediately below is a table which shows the December 31, 1998
appraised value of the Partnership's aircraft to be approximately $67.8 million,
or approximately 44% of the original acquisition cost (excluding acquisition-
related fees) plus related capital expenditures. Based in part on these
appraised values, the Partnership's net asset value at December 31, 1998 was
equal to $7.21 per Unit. It should be noted that these are only estimates of
values 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 values that may be realized upon the disposition of a Unit.

3
<PAGE>
The following table describes the Partnership's aircraft portfolio at
December 31, 1998:

Dec. Current Cumu- Cumu-
Owner- Acqui- 1998 Lease Original Noise lative lative
Current Aircraft ship sition Appraised Expiration Delivery Abatement Flight Flight
Lessee Type Interest Costs(1) Value(2) Date (3) Date Compliance Hours(4) Cycles(4)
------ ---- -------- -------- -------- -------- ---- ---------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(in millions)
Aerovias de
Mexico, S.A. McDonnell
de C.V. Douglas DC-9-31 100% $ 8.9 $ 2.8 11/6/99 1970 Stage II 64,040 60,560

Aerovias de
Mexico, S.A. McDonnell
de C.V. Douglas DC-9-31 100 8.9 2.9 2/25/00 1971 Stage II 69,808 66,190

Continental Boeing 727-200
Airlines, Inc. Advanced 100 4.5 3.0 5/1/99 1973 Stage II 74,475 51,589

TNT Transport Boeing 727-200
Intl. B.V. Advanced (6) 100 8.4 7.3 6/22/02 1973 Stage III 72,082 50,824

Continental McDonnell
Micronesia Inc. Douglas DC10-10 100 18.3 7.8 9/15/99 (8) 1973 Stage III 82,029 29,865

(7) Airbus Industrie
A300-B4-103 100 27.9 7.1 (7) 1979 Stage III 46,226 19,527

Falcon Air Boeing 727-200
Express Inc. Non-Advanced 100 11.5 5.6 3/1/02 1970 Stage III 75,665 55,586

Capital Cargo Boeing 727-200
International Advanced (9) 100 16.8 9.8 3/1/05 1973 Stage III 59,925 31,433
Airlines Inc.

Trans World McDonnell
Airlines. Douglas MD-82 100 21.0 14.4 10/31/04 1983 Stage III 48,146 24,585

(10) Lockheed
L-1011 100 17.7 1.7 (10) 1974 Stage III 61,209 22,907

US Airways McDonnell
Group, Inc. Douglas MD-81 50(5) 10.0 5.4 6/01/01 1982 Stage III 46,627 40,995
------ -----
$153.9 $67.8
====== =====
</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, net of retirements, incurred during
1998, 1997, 1996, 1995, 1994 and 1993 of $6.0 million, $5.2
million, $2.5 million, $26,000, $.3 million and $2.2 million,
respectively. This amount is net of the application of maintenance
reserves to restore aircraft of approximately $2.2 million.

(2) The December 1998 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. A discount rate of 10% was utilized and
inflation was assumed to be 2.5%. The appraised value of the
McDonnell Douglas DC10-10 aircraft does not include a $9.0 million
freighter conversion scheduled for the fourth quarter of 1999 (as
discussed in Note 5 of the Financial Statements).

(3) Lease expiration dates do not include renewal options unless
already exercised.

(4) The number of cumulative flight cycles and cumulative flight hours
shown are as of December 31, 1998, with the exception of the
McDonnell Douglas MD-81 leased to US Airways Group, Inc., which is
as of January 25, 1999.

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

4
<PAGE>
(6) This aircraft was converted to a cargo configuration, hushkitted
and delivered to TNT Transport International B.V. ("TNT") in June
1998.

(7) Aircraft off lease at December 31, 1998. The CF6-50C2 engines from
this aircraft, are on a short-term lease to Viacao Aerea Sao Paulo
S.A. The appraised value shown represents the appraised CMV of the
aircraft, exclusive of rents received from the rental of the
engines.

(8) Upon the expiration of the extended lease with Continental, the
Partnership will convert the McDonnell Douglas DC-10-10 aircraft
to a freighter pursuant to an aircraft modification agreement for
delivery to Emery Worldwide Airlines, Inc. ("Emery").

(9) Aircraft was hushkitted in December 1998.

(10) Lease terminated and aircraft returned in 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
appraised aircraft value is based upon a purchase offer received
in the fourth quarter of 1998, however there can be no certainty a
sale will occur.

A description of the principal financial terms of the leases is
described in Item 8, which is incorporated herein by reference.

Significant Lessees

The Partnership leased its aircraft to eight different airlines (and
leased engines separately to another) during 1998. Revenue from each of the
airlines which accounted for greater than 10% of the total rental revenue of the
Partnership during 1998 are as follows:

Percentage of
Total
Airline Rental Revenue
------- --------------

Continental Airlines, Inc.(2) 25%(1)
Trans World Airlines, Inc. 21%(1)
Aerovias de Mexico S.A. de C.V 14%

(1) Includes the periodic recognition of amounts that were prepaid in
connection with certain lease settlements.

(2) Includes rental revenue from Continental Micronesia, Inc., a
subsidiary of Continental Airlines, Inc.

5
<PAGE>
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.

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 II 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, 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.

6
<PAGE>
Aircraft Flight Flight Estimated
Aircraft Age Cycle Hour AD
Type Threshold Threshold Threshold Costs
-------- --------- --------- --------- ---------
(Years)

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

* 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 5.

The FAA has recently issued an AD relating to certain Boeing 727
freighter conversions that requires strengthening of certain floor beams and the
installation of restraint systems in the cargo area. The General Partners
estimate the cost of compliance will not exceed $100,000 per aircraft. For
discussion of the cost of compliance see TNT Transport International B.V., and
Capital Cargo International Airlines, Inc. in Footnote 5 to the Financial
Statements.

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, and the two McDonnell Douglas DC-9-31 aircraft on lease to
Aeromexico. 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 current 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 mitigating 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 II
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 III airplane fleet to 50 percent by
December 31, 1996; to 75 percent by December 31, 1998, and to 100 percent by
December 31, 1999.

However, the Act further provides, that if by July 1, 1999, at least
85% of an air carrier's fleet complies with Stage III 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 III noise levels by December 31,
2003.

Stage III hushkitting and re-engineering for the Boeing 727-200 and the
McDonnell Douglas DC-9-30 aircraft have been approved by the FAA.

The Partnership continues to monitor the marketplace based upon the
availability of aircraft, pricing for Stage II and Stage III aircraft and the
timetable for implementation of Stage III, to best position the Partnership's
aircraft for continued and future deployment.

7
<PAGE>
The European Commission has promulgated rules relating to aircraft
noise that would ban aircraft that are modified ("hushkitted") to achieve Stage
III noise compliance from European airspace after the year 2002. Such aircraft
cannot be added to European fleets after April of 1999. It is unclear in what
manner and if such rules will achieve full implementation.

Competition

The aircraft leasing industry is highly competitive. 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.

ITEM 3. LEGAL PROCEEDINGS

The Partnership has filed a claim in the Bankruptcy Court for unpaid
rents and other damages related to the rejection by Kiwi International Airlines,
Inc. ("Kiwi") of the leases. Given the sale of Kiwi's operating assets as
approved by the Court, it is remote that the Partnership will obtain any
recovery. Based on a petition by creditors, the case has been converted to a
Chapter 7 liquidation and a Trustee has been appointed by the court.

On March 10, 1999, the Trustee appointed in Kiwi's bankruptcy
proceedings made a demand for the return of payments approximating $1,276,000 to
an affiliate of the Managing General Partner, the Partnership and an affiliated
Partnership (see discussion herein under "Kiwi International Airlines, Inc. -
Bankruptcy") on the basis that these payments were made by Kiwi in the ninety
days prior to Kiwi's filing of its voluntary bankruptcy petition and were
therefore preferential. The payments relate to seven aircraft, only two of which
are owned by the Partnership. Management has notified the Trustee of the
existence of a Stipulation and Consent Order, dated April 22, 1997, which
provides for waiver and relinquishment by Kiwi of any potential preference
claims it might have against the Partnership.

The General Partners, on the advice of counsel, believe that the claim
will be withdrawn.

The parties in the Mallia lawsuit (as set forth in the Partnership's
September 30, 1998 quarterly report on Form 10-Q incorporated by reference
herein) have settled. Although Paine Webber could seek indemnification from the
Partnership, the General Partners believe this possibility is remote.

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, 1998.

8
<PAGE>
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, 1999, the number of Limited Partners of record was
approximately 7,869.

The Partnership declared the following distributions to its Limited
Partners out of cash flow received from operations during 1998 and 1997:

Amount of
Distribution
Period Per Unit Record Date Payment Date
------ ------------ ----------- ------------

1st Quarter 1998 $.40 March 31, 1998 April 25, 1998
2nd Quarter 1998 .40 June 30, 1998 July 23, 1998
3rd Quarter 1998 .40 September 30, 1998 October 28, 1998
4th Quarter 1998 .40 December 31, 1998 January 27, 1999
1st Quarter 1997 .40 March 31, 1997 April 25, 1997
2nd Quarter 1997 .40 June 30, 1997 July 25, 1997
3rd Quarter 1997 .40 September 30, 1997 October 24, 1997
4th Quarter 1997 .40 December 31, 1997 January 23, 1998

Total distributions to all partners for 1998 and 1997 were made as
follows (in thousands):

1998 1997
---- ----

Limited Partners $11,608 $11,608
General Partners 117 117
------- -------
$11,725 $11,725
------- -------

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 84%, 89% and 75%,
respectively, of the cash distributions paid to the partners for the years ended
December 31, 1998, 1997 and 1996 constituted a return of capital. Also, based on
the amount of cumulative net income reported by the Partnership for accounting
purposes, approximately 83% of the cash distributions paid to the partners from
the inception of the Partnership through December 31, 1998 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.

9
<PAGE>

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 Notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included in Items 8 and 7,
respectively, of this Report.

As of December 31,
or Year Ended December 31,
--------------------------
1998 1997 1996 1995 1994
(in thousands, except per unit amounts)

Rental Revenue $12,424 $12,183 $15,231 $14,026 $15,537
Net Income 1,855 1,255 2,898 2,019 1,413
Net Income per Limited
Partnership Unit 0.22 0.17 0.40 0.28 0.19
Distributions per Limited
Partnership Unit (1) 1.60 1.60 1.60 1.60 1.60
Total Assets 51,423 58,273 72,039 80,799 86,350
Notes Payable 10,000 4,751 4,751 6,638 7,382
Partners' Equity 34,200 44,070 54,540 63,367 73,073

(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.

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

The following discussion should be read in conjunction with the
"Selected Financial Data" and the Consolidated Financial Statements of the
Partnership and the Notes thereto. This report may contain, in addition to
historical information, forward-looking statements that include risks and other
uncertainties. The Partnership's actual results may differ materially from those
anticipated in these forward-looking statements. Factors that might cause such a
difference include those discussed below, as well as general economic and
business conditions, competition and other factors discussed elsewhere in this
report. The Partnership undertakes no obligation to release publicly any
revisions to the forward-looking statements, if any, to reflect events or
circumstances after the date hereof or to reflect the occurrence of anticipated
or unanticipated events.

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 1998,
1997 and 1996, respectively. Net cash provided by operating activities was $11.7
million in 1998, $8.9 million in 1997 and $13.5 million in 1996. In the
aggregate, for this three-year period net cash provided by operating activities
totaled $34.1 million and cash distributions declared by the Partnership totaled
$35.1 million. In 1996, the Partnership received $3,000,000 as part of the lease
settlement and return of the L-1011 by Trans World Airlines, Inc. ("TWA") in
lieu of TWA complying with certain lease return conditions. Such amount was
accounted for on the cost recovery basis and thus was not included in cash from
operating activities.

Partnership equity declined by approximately $9,870,000 from December
31, 1997 to December 31, 1998 as a result of the declaration and payment of cash
distributions to the partners in excess of the Partnership's net income. This

10
<PAGE>
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.

The Partnership invests working capital and cash flow from operations
prior to its distribution to the partners in short-term, highly liquid
investments or a fund that invests in such instruments. At December 31, 1998,
the Partnership's unrestricted cash and cash equivalents of $2,863,000 was held
in an interest bearing money market account. This amount was $2,842,000 less
than the Partnership's unrestricted cash and cash equivalents at December 31,
1997 of $5,705,000. This decrease in unrestricted cash was attributable to the
amount by which cash distributions to partners and capitalized aircraft
improvements exceeded cash generated by operating activities, collection of
advances to lessees, proceeds from notes payable and the unapplied maintenance
reserves during 1998.

Rent and other receivables increased by $47,000 from $444,000 at
December 31, 1997 to $491,000 at December 31, 1998. This increase is primarily
the result of rentals due from Falcon Air Express, Inc. ("Falcon") and Viacao
Aerea Sao Paulo S.A. ("VASP") during 1998, partially offset by the repayment of
the advances to TWA.

TWA was current on its lease payments in 1998 and made final repayment
of the funds advanced by the Partnership however, TWA reported its 10th
consecutive annual loss in 1998. Although TWA had a cash position of $314
million at September 30, 1998, given TWA's historical financial difficulties,
the ongoing losses increase the possibility of a default or deferral of lease
payments by TWA, which accounted for 21% of the Partnership's lease revenue in
1998.

Due to its failure to pay rents in the fourth quarter of 1998, Falcon
was placed on non-accrual status beginning October 1, 1998. At December 31,
1998, Falcon was four months in arrears to the Partnership, with respect to
scheduled rent payments, for a total of $380,000 and $179,000 in arrears with
respect to maintenance reserve payments. Falcon has made all scheduled rent and
maintenance reserve payments in 1999, and has paid $100,000 of the maintenance
arrearages. The Partnership has recorded a receivable for $95,000 of past due
rent and is also holding a $95,000 security deposit from Falcon.

The Partnership is in discussions with Falcon regarding the
establishment of an interest bearing note in favor of the Partnership for the
remaining arrearages. Falcon has become significantly leveraged and there can be
no assurance that Falcon will meet its future obligations. If Falcon were to
fall in arrears in the future, the Partnership may need to repossess the
aircraft and if the Partnership remarkets the aircraft, there can be no
assurance as to the ability to do so, the time it would take and the lease rate
that might be achieved.

At December 31, 1998, VASP, discussed below, was in arrears with
respect to scheduled rent payments, for a total of $273,000, which is reflected
in rent and other receivables and $129,000 in arrears with respect to
maintenance reserve payments. As of December 31, 1998 the Partnership was also
holding security deposits from VASP of $400,000. If VASP is unable to bring
their payments current, the Partnership would evaluate all of its rights
including repossession and remarketing of the engines, which may include
re-installing them on and remarketing the A-300 aircraft. If the Partnership
remarkets the engines or the aircraft, there can be no assurance as to the
ability to do so, the time it would take and the lease rate or sale price that
might be achieved.

During the first quarter of 1999, one of the engines on lease to VASP
failed. The engine is currently being overhauled in a maintenance facility by
Air France at VASP's expense.

The payable to affiliates increased by $381,000 from $211,000 at
December 31, 1997 to $592,000 at December 31, 1998 principally due to an
increase in unpaid management fees due to the General Partners.

Deferred rental income and deposits decreased by $686,000 from
$2,584,000 at December 31, 1997 to $1,898,000 at December 31, 1998. This
decrease was primarily attributable to the amortization of amounts previously
received in connection with the A-300 Lease Settlement and the L-1011 Lease
prepayment. Also contributing to the decrease, was the reclassification of the
unearned portion of the L-1011 lease prepayment, to additional impairment on the
L-1011 aircraft, in the third quarter of 1998. This decrease was partially
offset by the collection of $583,000 of additional security deposits in 1998.

During 1998, the Partnership invested $9.0 million in capitalized
aircraft improvements and maintenance checks, none of which was funded by the
application of maintenance reserves. During 1998, the Partnership delivered one
727-200 aircraft to TNT Transport International B.V. ("TNT"). The L-1011

11
<PAGE>
aircraft and the A-300 remained off lease during 1998, however the General
Electric CF6-50C2 engines from the A-300 were on short-term (minimum of 6
months) leases to VASP at December 31, 1998. The Partnership continues to
remarket the A-300 and L-1011 aircraft for lease or sale. If the aircraft are
sold, the Partnership may utilize such proceeds, for working capital or
distributions to partners.

In the fourth quarter of 1997, the Partnership entered into discussions
with the lessee regarding the DC 10-10 aircraft, the lease of which was
scheduled to expire on June 30, 1998. Continental Micronesia agreed to extend
the lease for an additional fifteen months (through September 30, 1999) at a
lease rate ($138,500 per month) equal to 92% of the previous rate. Upon the
expiration of the extended lease, the Partnership will convert the aircraft to a
freighter pursuant to an aircraft modification agreement for delivery to Emery
Worldwide Airlines Inc. ("Emery"). The Partnership and Emery have signed an
agreement which provides for a lease of 84 months with rent of $218,000 per
month. The lease also provides a two year renewal at a monthly lease rate of
$200,000, followed by three additional two year renewal options at the then fair
market rental. Emery provided a security deposit totaling $218,000. The
Partnership has $790,000 on deposit with a freighter conversion facility.

The workscope under the aircraft modification agreement requires the
investment of approximately $8.0 million by the Partnership. The Partnership
also estimates expending another $1.0 million to meet lease delivery conditions.

In early 1998, Continental Airlines, Inc. ("Continental") returned one
727-200 ADV aircraft the lease of which expired January 31, 1998. The
Partnership and Continental continue discussing each party's obligation with
respect to the return condition of the aircraft under the lease. This aircraft
is currently on lease to TNT.

In 1998, the Partnership entered into discussions with Kitty Hawk
Aircargo, Inc. ("Kitty Hawk") for the lease of the Boeing 727-200 aircraft, upon
the expiration of the current lease with Continental, which expires in May,
1999. The lease would require the Partnership to hushkit and convert the
aircraft to a freighter at an estimated cost of $4.2 million. The lease
agreement would provide for 84 months rent at $112,700 per month. Kitty Hawk
provided a security deposit totaling $56,000 during 1998.

In February 1999, the Partnership consummated an agreement to increase
the committed amount of the loan facility from $10 million to $12.5 million and
the interest rate from 1% to 1.25% over prime. The Partnership has pledged all
of its aircraft as collateral in connection with the loan commitment. The
Partnership will utilize the additional borrowings to replenish working capital,
which was drawn down to pay for the hushkit for the aircraft on lease to Capital
Cargo International Airlines, Inc. ("Capital Cargo"). This loan is due in
December, 1999. If the Partnership is unable to renegotiate or refinance it will
be forced to reduce or suspend distributions.

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 1998,
were paid for by the lessees directly 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 US Airways,
Inc. ("USAir") and the costs of storing the Airbus A-300 and Lockheed L-1011
aircraft.

The Partnership also records depreciation expense pertaining to the
aircraft on lease and incurs interest expense and management fees 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.

1998 as compared to 1997

The Partnership's net income was $1,855,000 for the year ended December
31, 1998 ("1998 Period") as compared to $1,255,000 for the year ended December
31, 1997 ("1997 Period").

12
<PAGE>
The increase in the Partnership's net income for the 1998 Period was
principally due to the increase in rental income in the 1998 Period as compared
to the 1997 Period, the gain recognized on the sale of an engine in 1998 and the
write-downs required in the 1997 Period, partially offset by an increase in
interest expense in the 1998 Period.

Rental income increased by $241,000 or 2% in the 1998 Period as
compared to the 1997 Period. The increase was substantially attributable to the
income recognized during the 1998 Period with respect to the VASP and Capital
Cargo leases.

Interest income decreased $280,000 or 60% for the 1998 Period. This
decrease was primarily attributable to the utilization during 1998 of a
significant portion of the cash reserves held by the Partnership, for cash
distributions and improvements in aircraft, as well as the repayment of advances
by lessees, on which interest had been earned.

During the 1998 Period, the Partnership recognized other income of
$124,000, primarily due to the realization of a gain of $116,000, representing
the difference between the amount realized and the book value of the
Partnership's claim from the 1991 Continental bankruptcy. There was no other
income recognized in 1997.

Depreciation and amortization expense increased $410,000 or 5% for the
1998 Period in comparison to the 1997 Period. The increase was attributable to
the increase in depreciation relating to the engines from the A-300 aircraft on
lease to VASP and the capital improvements made to the aircraft on lease to
Falcon and Capital Cargo.

The Partnership provided write-downs aggregating $537,000 to reflect
the loss in value of the L-1011 aircraft and various engines and interiors at
December 31, 1998, compared to write-downs of $1,400,000 in the 1997 period.

Management and re-lease fees for the 1998 Period, increased by $40,000
or 4% in comparison to the 1997 Period primarily because of the increase in
rental income which serves as the basis upon which certain management and
re-lease fees are calculated.

Interest expense for the 1998 Period increased by $303,000 or 67% in
comparison to the 1997 Period, primarily due to the 1998 increase in the amount
of debt outstanding and the related interest rate.

Direct lease expenses decreased by $147,000 or 38% in the 1998 Period
as compared to the 1997 period, due to a reduction in the cost of maintenance
work performed on aircraft borne by the Partnership.

1997 as compared to 1996

The Partnership's net income was $1,255,000 for the year ended December
31, 1997 ("1997 Period") as compared to $2,898,000 for the year ended December
31, 1996 ("1996 Period").

The decrease in the Partnership's net income for the 1997 Period was
principally due to the decrease in rental income in the 1997 Period as compared
to the 1996 Period and the write-downs required in the 1997 Period partially
offset by a decrease in depreciation.

Rental income decreased by $3,048,000 or 20% in the 1997 Period as
compared to the 1996 Period. The decrease was substantially attributable to the
income recognized during the 1996 Period with respect to the DC-10 Restructuring
as well as the fact that the two 727 non-advanced aircraft formerly leased to
Kiwi International Airlines, Inc. ("Kiwi") were off lease for part of the 1997
Period prior to delivery to Falcon and Capital.

Interest income decreased $269,000 or 37% for the 1997 Period. This
decrease was primarily attributable to the utilization during 1997 of a
significant portion of the cash reserves held by the Partnership for
improvements in aircraft as well as the reduction (due to repayment) of advances
to lessees, on which interest is earned.

Depreciation and amortization expense decreased $1,838,000 or 19% for
the 1997 Period in comparison to the 1996 Period. The decrease was attributable
to the decrease in depreciation relating to the DC 10-10 aircraft as well as the
reduction in depreciation expense with respect to the L-1011 aircraft both of
which were off lease during the 1997 Period (thus no depreciation was
recognized). The A-300 aircraft was off lease in each period.

13
<PAGE>
The Partnership provided write-downs aggregating $1,400,000 to reflect
the loss in value of the A-300 aircraft and the L-1011 aircraft at December 31,
1997; write-downs of $100,000 were provided in the 1996 period.

Management and re-lease fees for the 1997 Period, decreased by $92,000
or 9% in comparison to the 1996 Period primarily because of the decrease in
rental income which serves as the basis upon which certain management and
re-lease fees are calculated.

Interest expense for the 1997 Period decreased by $219,000 or 32% in
comparison to the 1996 Period, primarily because of the December 1996
refinancing which lowered the average amount of debt outstanding and reduced the
interest rate.

General and administrative expenses decreased by $18,000 or 5% in the
1997 Period as compared to the 1996 Period which was consistent with the
Partnership's level of operations.

Direct lease expenses decreased by $12,000 or 3% in the 1997 Period as
compared to the 1996 period, due primarily to storage costs and technical
consulting costs related to the ex-Kiwi aircraft which were off lease during a
portion of the 1997 Period.

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 Footnote 5). No such amounts were
provided in the 1997 Period.

Additionally, in the 1996 Period, the Partnership recognized a loss of
$155,000 with respect to Kiwi securities received in prior transactions. The
securities are carried at a nominal value (See Footnote 5).

Inflation and Changing Prices

Inflation has had no material impact on the operations or financial
condition of the Partnership from inception through December 31, 1998. However,
market and worldwide economic conditions and changes in federal and foreign
aircraft 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
prices of the aircraft.

New Accounting Pronouncements

In March 1998 the Partnership adopted SFAS No. 130, "Reporting
Comprehensive Income", which establishes standards for the reporting and display
of comprehensive income and its components in a full set of general purpose
financial statements. Comprehensive income is defined as the change in equity of
a business enterprise during a period from transactions and other events and
circumstances arising from non-owner sources. The adoption of this pronouncement
did not impact the reporting of the Partnership's results of operations.

In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (FAS 133). FAS 133 is effective for all
fiscal quarters of all fiscal years beginning after June 15, 1999 (January 1,
2000 for the Partnership). FAS 133 requires that all derivative instruments be
recorded on the balance sheet at their fair value. Changes in the fair value of
derivatives are recorded each period in current earnings or other comprehensive
income, depending on whether a derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction. The adoption of this
pronouncement is not expected to impact the Partnership's earnings or statement
of financial position.

Impact of the Year 2000 Issue

The Year 2000 issue is the result of computer programs being written
using two digits rather than four digits to define the applicable year. This
could result in a failure of the information technology systems (IT systems) and
other equipment containing imbedded technology (non-IT systems) in the Year
2000, causing disruption of operation of the Partnership, its lessees or
vendors.

14
<PAGE>
The Partnership does not own its own software, but is reliant upon
software owned by the General Partners or third party vendors. The General
Partners and third party vendors are either currently Year 2000 compliant or
have instituted plans to be so.

The plan for addressing third party critical dependencies includes:
identification of third party critical dependencies including lessees, vendors
and financial institutions; circulation to all applicable third parties of a
written request for their plans and progress in addressing the Year 2000 issue;
evaluation of responses; and development of contingency plans to address risks
of non-compliance by third parties. The Partnership has completed the
identification of critical dependencies and the circulation for requests for
Year 2000 compliance status.

The costs associated with addressing the Year 2000 issue, including
developing and implementing the above stated plan will be nominal and will be
expensed as incurred.

While the Partnership expects to have no interruption of operations as
a result of internal IT and non-IT systems, uncertainties remain about the
affect of third party critical dependencies who are not Year 2000 compliant.

The Partnership is not aware of any significant Year 2000 systems
issues with respect to the airworthiness of aircraft, however, should such an
issue result in Airworthiness Directives or other manufacturer recommended
maintenance, the implementation and the majority of the cost of such
implementation would be the responsibility of the aircraft lessee. Any resulting
costs to the Partnership cannot be estimated at this time.

Non-compliance on the part of a lessee could result in lost revenue for
the lessee and an inability to make lease payments to the Partnership.
Non-compliance by the lessee's financial institution could also affect the
ability to process lease payments. The Partnership has attempted to mitigate
such risks by inquiring of each lessee about its Year 2000 plans, including
whether they have addressed the issue with their financial institution.

The Partnership's lessees face the potential risk of non-compliance by
the air traffic control systems throughout the world. A disruption in the
operations of some or all of the air traffic control systems may cause
disruption to the operations of the Partnership's lessees, which may adversely
affect their ability to generate revenue.

A possible scenario would be that lessees are unable to operate and
generate revenues and as a result be unable to make lease payments. The
Partnership is unable to estimate the likelihood or the magnitude of the
resulting lost revenue at this time. Should this occur, the Partnership would
attempt to repossess aircraft from non-compliant lessees and place the aircraft
with compliant lessees. No assurances can be given that the Partnership would be
able to re-lease such aircraft at favorable terms or at all. If a significant
number of aircraft could not be re-leased at favorable terms or at all, or their
re-lease is delayed, the Partnership's business, financial condition and results
of operations would be adversely affected.

15
<PAGE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

PEGASUS AIRCRAFT PARTNERS II, L.P.

List of Financial Statements Page
----

Report of Independent Accountants .......................................... 17

Balance Sheets -- December 31, 1998 and 1997................................ 18

Statements of Income for the years ended
December 31, 1998, 1997 and 1996....................................... 19

Statements of Partners' Equity for the years ended
December 31, 1998, 1997 and 1996....................................... 20

Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996....................................... 21

Notes to Financial Statements............................................... 23

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.

16
<PAGE>

REPORT OF INDEPENDENT ACCOUNTANTS

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

In our opinion, the accompanying balance sheets and the related
statements of income and partners' equity and of cash flows present fairly, in
all material respects, the financial position of Pegasus Aircraft Partners II,
L.P. (the "Partnership") as of December 31, 1998 and 1997, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the
Partnership's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.

PricewaterhouseCoopers LLP

New York, New York
March 17, 1999

17
<PAGE>

PEGASUS AIRCRAFT PARTNERS II, L.P.

BALANCE SHEETS

DECEMBER 31, 1998 AND 1997

ASSETS

1998 1997
---- ----
(in thousands,
except unit data)

Cash and cash equivalents (Note 4) $ 2,863 $ 5,705
Rent and other receivables, net (Note 5) 491 444
Aircraft, net (Notes 5, 6, 11 and 12) 47,258 52,098
Other assets 811 26
-------- --------
Total Assets $ 51,423 $ 58,273
======== ========

LIABILITIES AND PARTNERS' EQUITY

LIABILITIES:

Lease settlement reserve (Note 5) $ -- $ 3,000
Accounts payable and accrued expenses 106 123
Payable to affiliates (Note 7) 592 211
Maintenance reserves collected (Notes 1 and 5) 1,696 591
Notes payable (Note 6) 10,000 4,751
Deferred income and deposits (Note 5) 1,898 2,584
Distributions payable to partners 2,931 2,943
-------- --------
Total Liabilities 17,223 14,203
-------- --------

COMMITMENTS AND CONTINGENCIES (Notes 5, 6, 9, 11, and 12)

PARTNERS' EQUITY:

General Partners (868) (1,008)
Limited Partners (7,255,000 units outstanding in
1998 and 1997) 35,068 45,078
-------- --------
Total Partners' Equity 34,200 44,070
-------- --------
Total Liabilities and Partners' Equity $ 51,423 $ 58,273
======== ========

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

18
<PAGE>

PEGASUS AIRCRAFT PARTNERS II, L.P.

STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 and 1996

1998 1997 1996
---- ---- ----
(in thousands, except unit data
and per unit amounts)

REVENUE:
Rentals from operating leases $ 12,424 $ 12,183 $ 15,231
Interest 187 467 736
Other income 124 -- --
Gain on sale of engine and equipment 254 -- --
---------- ---------- ----------
12,989 12,650 15,967
---------- ---------- ----------

EXPENSES:
Depreciation and amortization 8,273 7,863 9,701
Write-downs (Note 5) 537 1,400 100
Management and re-lease fees (Note 7) 1,017 977 1,069
Interest 758 455 674
General and administrative (Note 7) 312 316 334
Direct lease (Note 7) 237 384 396
Loss in value of securities (Note 5) -- -- 155
Provisions for bad debts -- -- 640
---------- ---------- ----------
11,134 11,395 13,069
---------- ---------- ----------

NET INCOME $ 1,855 $ 1,255 $ 2,898
========== ========== ==========

NET INCOME ALLOCATED:
To the General Partners 257 13 29
To the Limited Partners 1,598 1,242 2,869
---------- ---------- ----------
$ 1,855 $ 1,255 $ 2,898
---------- ---------- ----------

NET INCOME PER LIMITED PARTNERSHIP UNIT $ 0.22 $ 0.17 $ 0.40
========== ========== ==========

WEIGHTED AVERAGE NUMBER OF LIMITED
PARTNERSHIP UNITS OUTSTANDING 7,255,000 7,255,000 7,255,000
========== ========== ==========

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

19
<PAGE>

PEGASUS AIRCRAFT PARTNERS II, L.P.

STATEMENTS OF PARTNERS' EQUITY

FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 and 1996

General Limited
Partners Partners Total
-------- -------- -----
(in thousands)

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

Net income 13 1,242 1,255

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

Balance, December 31, 1997 (1,008) 45,078 44,070

Net income 257 1,598 1,855

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

Balance, December 31, 1998 $ (868) $ 35,068 $ 34,200
======== ======== ========

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

20
<PAGE>

PEGASUS AIRCRAFT PARTNERS II, L.P.

STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 and 1996

1998 1997 1996
---- ---- ----
(in thousands)

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,855 $ 1,255 $ 2,898
Adjustments to reconcile net income to net
cash provided by operating activities:
Gain on sale of engine and equipment (254) -- --
Depreciation and amortization 8,273 7,863 9,701
Write-downs 537 1,400 100
Provision for bad debts -- -- 640
Loss from securities received in leasing
transaction -- -- 155
Change in assets and liabilities:
Rent and other receivables (289) 53 711
Other 5 (47) 77
Accounts payable and accrued expenses (17) 27 (98)
Deferred income 57 (1,751) (449)
Payable to affiliates 381 (425) (257)
Maintenance reserves collected 1,105 591 --
-------- -------- --------

Net cash provided by operating
activities 11,653 8,966 13,478
-------- -------- --------

CASH FLOWS FROM INVESTING ACTIVITIES:
Deposit for aircraft modifications (790) -- --
Capitalized aircraft costs (9,012) (5,240) (2,496)
Lease settlement reserve -- -- 3,000
Proceeds from the sale of equipment 1,553 -- --
Repayment of advances by lessees 242 363 448
-------- -------- --------

Net cash (used in) provided by
investing activities (8,007) (4,877) 952
-------- -------- --------

CASH FLOWS FROM FINANCING ACTIVITIES:
Security deposits $ -- $ 556 $ --
Proceeds from notes payable 5,249 -- 4,751
Repayment of notes payable -- -- (6,638)
Cash distributions paid to partners (11,737) (11,771) (11,667)
-------- -------- --------
Net cash used in financing
activities (6,488) (11,215) (13,554)
-------- -------- --------

NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (2,842) (7,126) 876

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 5,705 12,831 11,955
-------- -------- --------

CASH AND CASH EQUIVALENTS AT END OF YEAR $ 2,863 $ 5,705 $ 12,831
======== ======== ========

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

21
<PAGE>

PEGASUS AIRCRAFT PARTNERS II, L.P.

STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 and 1996 (continued)

1998 1997 1996
---- ---- ----
(in thousands)

SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:

Interest paid $ 750 $ 456 $ 719
======== ======== ========

Restricted maintenance reserves collected,
net of maintenance draw-downs $ -- $ -- $ 144
======== ======== ========

NONCASH TRANSACTIONS:
Distributions to partners declared but unpaid $ 2,931 $ 2,943 $ 2,989

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

Transfers from restricted cash utilized to
restore aircraft $ -- $ 2,248 $ --

Deferred income transferred to write-down $ 743 $ -- $ --

Lease settlement reserve transferred to
write-down $ 3,000 $ -- $ --

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

22
<PAGE>
PEGASUS AIRCRAFT PARTNERS II, L.P.
NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1998

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 and other indemnity provisions described
below. Actual results could differ from such 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.

Aircraft and Depreciation. The aircraft are recorded at cost, which
includes acquisition costs and the acquisition fee and the financial management
advisory fee paid upon acquisition 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. Major improvements to
aircraft are capitalized when incurred and depreciated over the useful life of
the improvement. The Partnership evaluates the carrying value of the aircraft
based upon changes in market and other physical and economic conditions and will
record write-downs to recognize a loss in the value of the aircraft when
management believes that, based on expected future cash flows, the
recoverability of the Partnership's investment 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. ("USAir"), 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 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. The Partnership has four leases where the
lessee is required to make monthly payments to maintenance reserve funds
administered by the Partnership. The Partnership may be obligated to reimburse
the lessee for specified maintenance costs out of the reserve funds, upon
submission of appropriate evidence documenting the maintenance costs incurred by
the lessee. Excess costs over the reserve are the lessees' responsibility.

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 wrote-down the
securities to nominal value in 1996. (See Note 5, "Aircraft - Kiwi International
Air Lines, Inc. - Bankruptcy").

23
<PAGE>
Lease settlement payments received in connection with the early
termination or modification of a lease of an aircraft, the carrying value of
which has not been impaired, have been recognized ratably over the remaining
original lease term in the case of a lease termination and over the modified
lease term in connection with a lease modification. In certain cases, where
management believes there has been an impairment in value, the payment has been
recorded under the cost recovery method.

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.

New Accounting Pronouncements

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
Paine Webber 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 had the right, subject to certain
conditions, to reinvest the proceeds from sales of aircraft occurring prior to
August 21, 1998. The net proceeds of any future sales of aircraft will be
retained for working capital purposes with the remainder distributed to all
partners.

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.

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.

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<PAGE>
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

At December 31, 1998, all cash was held in an interest bearing money market
account. At December 31, 1997, the Partnership held short-term commercial paper
with various maturities as follows:

Purchase
Issuer Purchase Date Price Par value
------ ------------- -------- ---------
(in thousands) (in thousands)

Prudential December 19, 1997 $ 2,540 $ 2,550
Ford Motor Company Inc. December 23, 1997 572 575
American Express Inc. December 31, 1997 499 500
------- -------
$ 3,611 $ 3,625
======= =======

5. Aircraft
Net Investment in Aircraft

The Partnership's net investment in aircraft as of December 31, 1998
and 1997 consisted of the following (in thousands):

1998 1997
---- ----

Aircraft on operating leases, at cost $ 110,149 $ 103,990
Less: Accumulated depreciation (62,050) (55,513)
Write-downs (8,058) (8,143)
--------- ---------
$ 40,041 $ 40,334
========= =========

Aircraft held for lease or sale, at cost $ 46,744 $ 46,934
Less: Accumulated depreciation (19,093) (18,839)
Write-downs (10,319) (6,216)
Lease settlement accounted for under the cost
recovery method (10,115) (10,115)
--------- ---------
7,217 11,764
--------- ---------
Aircraft, net $ 47,258 $ 52,098
========= =========

Rent and Other Receivables

Rents and other receivables composed the following at December 31, 1998
and 1997 (in thousands):

1998 1997
---- ----

Rent receivables $ 491 $ 494
Advances to lessees -- 516
Accrued interest and other -- 74
--------- ---------
491 1,084
Allowance for bad debts -- (640)
--------- ---------
Rent and other receivables, net $ 491 $ 444
========= =========

25
<PAGE>
Financial Terms of Leases

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. This lease was
modified as discussed below. The aircraft is subject to an extended lease
scheduled to expire on September 15, 1999 which provides for rentals of $138,500
per month.

Upon the expiration of the extended lease with Continental, the
Partnership will convert the McDonnell Douglas DC-10-10 aircraft to a freighter
pursuant to an aircraft modification agreement for delivery to Emery Worldwide
Airlines, Inc. ("Emery"). The Partnership and Emery have signed a lease which
provides for 84 months rent at $218,000 per month. The lease also provides a
two-year renewal option at $200,000 per month, and three additional two-year
renewal options at the then fair market rental. Emery has provided a security
deposit aggregating $218,000 at December 31, 1998. The Partnership provided a
deposit of $790,000 to the third party modification center which will perform
the conversion. This deposit is included in other assets on the balance sheet as
of December 31, 1998. The current workscope under the aircraft modification
agreement requires the investment of approximately $8.0 million, subject to
escalation, by the Partnership. The Partnership also estimates expending another
$1.0 million to meet the lease delivery conditions.

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 to the Partnership
during Continental's bankruptcy, remarketed to Kiwi (and recovered from Kiwi,
after Kiwi filed for bankruptcy in late 1996) and was delivered in March 1997 to
Falcon Air Express Inc. (see discussion below).

During August 1990, the Partnership acquired an Airbus Industrie Model
A300-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 rentals, in advance, of $312,000.

In January 1995, Continental announced that it was grounding its fleet
of Airbus 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. Continental took the A-300 out of service in May 1995, and the
aircraft was prepared for delivery in June 1995 to a new lessee, Akdeniz Air
Mediterranean, Inc. ("Akdeniz") based in Turkey.

In 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. The Partnership
estimated that it would cost approximately $2.5 million for a scheduled heavy
maintenance check, modifications and FAA mandated work 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
was applied towards such maintenance. At December 31, 1997 the Partnership
provided a write-down of $1.1 million to reflect a current informal purchase
offer for the airframe plus the appraised value of the engines.

On November 15, 1995, the Partnership reached an agreement with
Continental regarding the settlement for the 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 for the Akdeniz
remarket, 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. ("Continental 727 No. 1") (ii) title to a second Boeing
727-200 advanced aircraft subject to a lease with Continental for a term of 42
months at a lease rate of $85,000 per month ("Continental 727 No.2").
Additionally, the Partnership received approximately $557,000 as an economic
settlement in lieu of Continental performing certain maintenance work and
meeting the return conditions required by the A-300 lease. The lease of the
Continental 727 No. 1 expired January 31, 1998 and the aircraft was returned to
the Partnership. The Partnership and Continental continue discussing each
party's obligation with respect to the return condition of the aircraft under
the lease. The Partnership entered into a lease of the aircraft for a term of
four years to TNT Transport International B.V. ("TNT") a foreign cargo carrier

26
<PAGE>
and has converted the aircraft to cargo configuration, including a low gross
weight hushkit. (See TNT discussion below). See also Note 11, herein with
respect to the disposition of Continental 727 No. 2.

Under the DC-10 Restructuring the Partnership received approximately
$3,100,000 in cash, 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 remained unchanged. During 1996, Continental and the Partnership
reached an agreement to extend the lease of the DC-10-10 aircraft to June 30,
1998 at a lease rate of $150,000 per month. In late 1997 the Partnership and
Continental signed a lease amendment which extended the lease of the DC-10-10
aircraft from July 1, 1998 through September 15, 1999 at a monthly lease rate of
$138,500.

Continental 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 all of which had
been repaid as of January 1998.

During June 1998, the Partnership entered into an Engine Exchange
Agreement and Bill of Sale with an affiliate of the Managing General Partner.
Pursuant to this agreement, the Partnership received cash in the amount of
$190,000 and a General Electric CF6-50C2 engine in exchange for a General
Electric CF6-50C2 engine from the Airbus A-300 aircraft. The $190,000 boot
received was deducted from the net book value of the aircraft, but no gain or
loss resulted from the transaction. The amount of the payment was determined
through a third party appraisal of the engines, which were $2.53 million and
$2.72 million, respectively.

In December 1997, the Partnership leased, on a short-term (six month
minimum) basis, one of the CF6-50C2 engines from the Airbus A-300 aircraft to
Viacao Aerea Sao Paulo S.A. ("VASP"), a Brazilian carrier, for rents of $2,200
per day, plus maintenance reserves of $225 per engine hour or cycle, whichever
is greater. The Partnership and VASP extended the lease to December 1998. In
December 1998, the Partnership and VASP entered into an agreement for the lease
of the second engine from the A-300 aircraft, the terms of which are the same as
the first engine lease. Both engine leases are scheduled to expire in June 1999.
The Partnership continues to re-market this aircraft for lease or sale.

At December 31, 1998, VASP was in arrears with respect to scheduled
rent payments, for a total of $273,000, which is reflected in rent and other
receivables and $129,000 in arrears with respect to maintenance reserve
payments. As of December 31, 1998 the Partnership was also holding security
deposits from VASP of $400,000. If VASP is unable to bring their payments
current, the Partnership would evaluate all of its rights including repossession
and remarketing of the engines, which may include re-installing them on and
remarketing the A-300 aircraft. If the Partnership remarkets the engines or the
aircraft, there can be no assurance as to the ability to do so, the time it
would take and the lease rate or sale price that might be achieved.

During the first quarter of 1999, one of the engines on lease to VASP
failed. The engine is currently being overhauled in a maintenance facility by
Air France at VASP's expense.

Trans World Airlines, Inc. Lease. 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 Trans World Airlines, Inc.
("TWA"), which was originally scheduled to expire on April 13, 1993, but was
amended and extended until November 1, 1998 with monthly rental payments, in
advance, 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 1993 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
was fully repaid in monthly installments through November 1998 with interest at
a fixed rate of 9.70%.

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
was fully repaid in monthly installments through October 1998 with interest at
9.68%. At December 31, 1997, the balance of the receivable was $94,000. All 1998
repayments of advances were made by TWA.

27
<PAGE>
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. 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 US 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. There can
be no assurance that it will be able to meet its obligations in the future.

In mid-1996, as part of the fleet restructuring, TWA returned the
L-1011 aircraft it leased from the Partnership. The lease, which provided for
monthly rentals of $130,000, was originally scheduled to expire in September
1998. In connection with the return of the L-1011 aircraft TWA paid the
Partnership $2,846,000, which represented rents due under the remaining term of
the lease, discounted at 5% ("L-1011 Lease Prepayment") plus $3,000,000 as an
economic settlement for noncompliance with certain lease return conditions. The
lease was terminated, the aircraft was returned and $5,846,000 was received on
October 16, 1996.

At December 31, 1998 the L-1011 aircraft had a book value of
approximately $1.7 million. During the third quarter of 1998, the Partnership
reclassified the $3,000,000 return condition settlement and the $743,000
unearned portion of the L-1011 lease prepayment, as an additional write-down on
the L-1011 aircraft. No additional impairment expense was recognized. In
addition, a write-down of $420,000 was taken to reflect the estimated market
value of the aircraft. The Partnership is currently remarketing the Lockheed
L-1011 aircraft.

Aeromexico Leases. During July 1992, the Partnership re-leased two
McDonnell Douglas DC-9-31 aircraft previously leased to and repossessed from
Midway Airlines Inc. ("Midway") to Aerovias de Mexico, S.A. de C.V.
("Aeromexico") for terms of approximately five years. The leases, which
originally provided for quarterly rentals in advance of $234,000, were scheduled
to expire in July 1997; one lease was extended to November 6, 1999 (with
Aeromexico given the right, subject to notice to extend to February 2000) and
one of which was extended to February 25, 2000, each at a rate of $75,000 per
month.

The DC-9-31 aircraft had originally been acquired in March and April
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 prior to delivery of the aircraft to
Aeromexico.

USAirways Group Inc. ("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, which is scheduled to
expire to June 1, 2001 pursuant to the renewal option exercised by USAir in
1997. Rental payments are payable quarterly, in arrears, at the rate of $304,000
(for the Partnership's one-half interest in the aircraft). 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 then fair market value at the
end of any renewal term.

28
<PAGE>
The aircraft 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 one-half of 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 $1.2
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 on the cash in the
cash collateral account and eliminated the requirement for future deposits to
such 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 collateralize 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. There have been no calls
on the letter of credit through December 31, 1998.

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.

Kiwi International Air Lines, Inc. - Bankruptcy. In 1993, the
Partnership leased two Boeing 727-200 aircraft to Kiwi International Airlines,
Inc. ("Kiwi") one of which was previously leased to Continental and the other to
Dan-Air Services Limited. 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) (collectively, the "Kiwi
Leases"). The Kiwi Leases were originally scheduled to expire on April 15, 1998
and June 30, 1998, respectively. In 1996, the Kiwi 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 and held by
the Partnership. An affiliated partnership and affiliates of the Managing
General Partner also own aircraft which were leased to Kiwi.

In connection with the delivery of the aircraft to Kiwi the Partnership
expended $2,228,000 with respect to the Boeing 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.

The Partnership also received Kiwi stock and rights to warrants in
connection with these leasing transactions. 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 $-0- at December 31, 1998 and $1,000 at December 31, 1997 (see
Kiwi bankruptcy discussion below).

During 1994, the Partnership funded approximately $633,000 of costs
primarily related to 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 over eighteen months which began June 1, 1996, with
interest from February 1997 at 12% per annum.

In August 1996, the Partnership paid $1.9 million to hushkit the
non-advanced 727 aircraft for which Kiwi was to pay an increased lease rate over
an extended lease term. The hushkit purchase price was funded out of operating
cash previously generated.

29
<PAGE>
During 1996, in part because of the grounding of certain aircraft by
the FAA as the result of pilot handbook deficiencies and the market reaction to
the ValuJet crash, Kiwi did not meet its financial goals. 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.

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), at December 31, 1996. Additionally, the unpaid balance of the
Bellyskin Note, plus interest, was $290,000 at that time. On October 15, 1996,
Kiwi ceased scheduled flight operations and rejected both leases as of November
15, 1996. The Partnership provided an allowance for bad debts in the amount of
$640,000 with respect of amounts due at September 30, 1996 and did not record
any revenue beyond that date. The Partnership recovered the aircraft in 1996 and
prepared them for delivery to new lessees, Falcon Air Express, Inc. and Capital
Cargo International Airlines, Inc. as discussed below. The Partnership filed
claims in Kiwi's bankruptcy for all unpaid items and rejection damages. In April
1997, the Partnership won a summary judgment in Bankruptcy Court permitting the
use of the previously collected maintenance reserve ($2.3 million). The
Partnership reclassified the collected reserves from restricted cash to cash and
cash equivalents and utilized thereof a portion against expenditures to make the
aircraft leasable. In July 1997, the Bankruptcy Court approved a proposal
submitted by a group that includes certain of the parties that had provided
debtor-in-possession financing to purchase the operating assets of Kiwi from the
bankrupt estate. Based upon the approved purchase price and the remaining
assets, it is likely that the Partnership will have little or no recovery of its
bankruptcy claims. Based on a petition by creditors, the case has been converted
to a Chapter 7 liquidation and a Trustee has been appointed by the court.

Falcon Air Express, Inc. Lease. 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, including certain
modifications at a cost of approximately $2,700,000, $600,000 of which was
expended in 1996. The Partnership also purchased an engine at a cost of $760,000
prior to delivery of the aircraft and spent approximately $700,000 with respect
to maintenance work on one engine returned by Kiwi. The aircraft was delivered
to Falcon in March 1997. Maintenance reserves previously collected from Kiwi of
approximately $1,104,000 were applied to such costs to restore the aircraft.

In September 1998, the Partnership received cash proceeds of $300,000
and realized a gain of $241,000 on the sale of an engine that had been
dismantled and stored since the return of this aircraft by Kiwi in 1996.

Capital Cargo International Airlines, Inc. Lease. 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
Boeing 727-200 advanced aircraft formerly leased to Kiwi. The Partnership agreed
to finance the conversion of the aircraft to a freighter and complete a C-check
(totaling approximately $2.4 million). The Capital Cargo Lease ("Capital Cargo
Lease") is for a term of approximately eight years and provides for an initial
monthly lease rate of $105,000 per month. The Capital Cargo Lease requires the
Partnership to hushkit the aircraft on or before its 1999 C-check visit at its
own expense (approximately $2.5 million) at which time the lease rate increases
to $139,000 per month. Pursuant to the lease agreement, the aircraft underwent a
"C" check and received a hushkit in December 1998. The Partnership had incurred

30
<PAGE>
costs of approximately $2,000,000 related to the hushkit, as of December 31,
1998.

The Capital Lease requires Capital to fund maintenance reserves monthly
at a rate of $377 per flight hour. Capital provided an initial security deposit
of $50,000 and added $17,000 per month to the security deposit during the lease
term until the deposit totaled $220,000. The lease was executed and aircraft was
delivered to Capital in July 1997.

Shortly after delivery of the aircraft to Capital in 1997, one of the
engines failed. In August 1998, the Partnership reached an agreement with
Capital, in which the Partnership shared in the cost to overhaul the engine on
this aircraft. The Partnership's share of the overhaul was $266,000.

In July 1997, in connection with the delivery of the aircraft to
Capital, the Partnership purchased two JT8D-15 engines from an unaffiliated
third party for cash of $1,550,000 plus two JT8D-15 engine cores returned with
the aircraft by Kiwi. Maintenance reserves previously collected from Kiwi of
approximately $1,144,000 were applied to such costs to restore the aircraft.

TNT Transport International B.V. Lease. In June 1998 the Partnership
delivered a Boeing 727-200 advanced aircraft formerly leased to Continental to a
European freight carrier, TNT Transport International B.V. ("TNT") for a lease
term of four years. The lease provides for monthly rentals of $123,500 (subject
to a reduction of approximately 10% after two years if TNT exercises, during the
lease term, an option to extend the lease for an additional two years beyond the
original expiration date) and airframe and landing gear reserves aggregating $85
per flight hour. TNT has contracted with a third party service provider for
maintenance of the engines. TNT has provided a $150,000 security deposit. TNT
also has the right to extend the lease for an additional two years at the end of
the initial lease term (if the above option is not exercised) at $95,000 per
month.

The Partnership has invested approximately $7.8 million for a low gross
weight hushkit and cargo conversion of the aircraft, and the purchase of three
JT8D-7B engines. The Partnership received cash proceeds of $1,050,000 for the
sale of the JT8D-15 engines from this aircraft, which resulted in a $60,000
loss. In the third quarter of 1998, due to the conversion of this aircraft to a
freighter, the Partnership wrote-off the remaining net book value of the
interior, determined through a third party appraisal, which resulted in an
impairment expense of $57,000. The work was performed and certain of the
aircraft parts were provided by companies affiliated with the Managing General
Partner or its President and Director. See Note 7 ("Transactions with Affiliates
- - Other").

TNT is responsible for the first $50,000 of cost in complying with the
newly issued freighter conversion AD. Costs in excess of this amount are
initially paid for by TNT. At the end of the lease, TNT will be reimbursed by
the Partnership for a portion of the AD compliance cost based on a formula set
forth in the Partnership agreement, not to exceed $250,000. The reimbursed cost
will be assumed to be amortized over 10 years on a straight line basis. The
amortization will begin at the time of conversion.

The European Commission has promulgated rules relating to aircraft
noise that would ban aircraft that are modified ("hushkitted") to achieve Stage
III noise compliance from European airspace after the year 2002. Such aircraft
cannot be added to European fleets after April of 1999. It is unclear in what
manner and if such rules will achieve full implementation

Significant Lessees

The Partnership leased its aircraft to seven different airlines during
1998. Revenues from each of the airlines which accounted for greater than 10% of
the Partnership's total rental revenue during 1998, 1997 and 1996 are as
follows:

Airlines Percentage of Rental Revenue(2)
1998 1997 1996(1)
---- ---- -------

Continental Airlines, Inc. (3) 25% 33% 44%
Trans World Airlines, Inc. 21 30 25
Aerovias de Mexico S.A. de C.V 14 15 12
Kiwi International Air Lines, Inc. (4) (4) 11

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

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<PAGE>
(2) Such percentages include the periodic recognition of amounts that were
prepaid in connection with certain lease settlements.

(3) Includes rental revenue from Continental Micronesia, Inc., a subsidiary
of Continental Airlines, Inc.

(4) Represents less than 10%.

Revenues include rentals from aircraft leased to foreign airlines or
carriers of $3,429,000, $1,851,000 and $1,872,000 in 1998, 1997 and 1996
respectively.

Future Minimum Rental Income

The following is a schedule by year of future minimum rental income
under the leases as of December 31, 1998 (in thousands):

Year Amount
---- ------

1999 $10,490
2000 7,455
2001 6,616
2002 4,394
2003 3,480
Thereafter 3,383
-------
Total $35,818
=======

The above schedule of future minimum rental income, includes a total of
$3,618 of rents from those lessees on non-accrual status, but does not include
rental income which would result from the renewal of existing leases or the
re-leasing of the aircraft, unless the renewal has been exercised.

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

6. Notes Payable

In December 1996, the Partnership established a $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 the
outstanding principal is due. The loan provides for interest at a rate of 1%
over the lender's prime rate of interest and is payable monthly. At December 31,
1998 the interest rate was 8.75%. 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 and TNT. The
Partnership utilized $4,751,000 to pay off its prior two facilities. In
February, 1999, the lender agreed to increase the borrowing commitment from
$10,000,000 to $12,500,000. (See Note 12, "Subsequent Event").

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, 1998, 1997 and 1996, the General
Partners earned base management fees of $177,000, $179,000 and $219,000,
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, 1998, 1997 and 1996, the General Partners
earned incentive management fees of $505,000, $495,000 and $598,000,
respectively.

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<PAGE>
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, 1998, 1997 and 1996, the General Partners
earned re-lease fees of $335,000, $303,000 and $252,000, respectively.

Beginning July 1, 1995, as part of the 1996 and 1997 class action
settlement, the Administrative General Partner remits to an affiliate, all
management fees as well as all 1997 and future fees and distributions received
by the Administrative General Partner, for deposit into 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 $19,000, $75,000 and $75,000
in each of the years ended December 31, 1998, 1997 and 1996, of which $38,000
was payable to the Administrative General Partner at December 31, 1998. The
decline in accountable expenses is due to the subcontracting of certain
accounting services, and their cost is included in general and administrative
expenses.

Other. During 1998, 1997 and 1996, the Partnership paid $1,313,000,
$1,694,000 and $554,000 to a licensed maintenance facility affiliated with the
Managing General Partner for work performed on certain aircraft. Additionally
during 1998, 1997 and 1996 the Partnership paid $1,887,000, $2,308,000 and
$134,000 respectively to a company owned by the President and Director and two
former officers and directors of the Managing General Partner, for the purchase
of parts in connection with certain capital projects.

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<PAGE>
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 (loss) income reported for
federal income tax purposes (in thousands):

1998 1997 1996
---- ---- ----

Net income per financial statements $ 1,855 $ 1,255 $ 2,898
Increase (decrease) resulting from:
Depreciation (4,523) (4,547) (3,381)
TBT interest income, less
TBT rental expense (1,174) (932) (742)
Gain on sale of engines 524 -- --
Reserves for maintenance costs,
net of maintenance expense and
write-downs of aircraft 459 1,400 244
Maintenance reserve payable 1,184 590 3,000
Deferred rental income (526) (1,686) (449)
Rental income 285 -- --
Provisions for bad debts (1,678) -- 640
Loss on value of stock -- -- 155
Management fees (26) -- --
Other (18) 123 (161)
-------- -------- --------
Taxable (loss) income per federal
income tax return $ (3,638) $ (3,797) $ 2,204
======== ======== ========

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):

1998 1997 1996
---- ---- ----

Total Partnership equity per
financial statements $ 34,200 $ 44,070 $ 54,540
Increase (decrease) resulting from:
Commission and expenses paid
in connection with the sale of limited
partnership units 16,295 16,295 16,295
Accounts receivable 285 -- --
Distributions payable to partners 2,931 2,943 2,989
Management fees payable (26) -- --
Reserves for maintenance costs and
write-downs 22,321 20,276 18,286
Deferred income 759 2,028 3,733
Accumulated depreciation (42,448) (38,712) (34,165)
TBT interest income less TBT rental expense (5,055) (3,881) (2,949)
Lease settlement payment, including lease
aircraft received accounted for under the
cost recovery method 10,115 10,115 10,115
Allowance for bad debts -- 640 640
Securities received in leasing transaction -- 599 599
Other (13) 354 254
-------- -------- --------
Tax bases of net assets $ 39,364 $ 54,727 $ 70,337
======== ======== ========

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<PAGE>
9. Litigation

The General Partners, on the advice of counsel, believe that the claim
will be withdrawn.

10. 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 unavailable
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 cash 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 rents and other receivables. For these balances,
carrying value approximates fair value due to their 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 these balances carrying value approximates fair
value due to its short-term nature.

11. Commitments

Upon the expiration of the extended lease for the DC-10-10 aircraft
with Continental Micronesia, the Partnership will convert the aircraft to a
freighter pursuant to an aircraft modification agreement for delivery to Emery
Worldwide Airlines Inc. ("Emery"). The workscope under the aircraft modification
agreement requires the investment of approximately $8.0 million, subject to
price escalation. The Partnership estimates expending an additional $1.0 million
to meet the delivery conditions under the lease with Emery. The Partnership and
Emery have signed an agreement in principle which provides for a lease of 84
months with rent of $218,000 per month. The lease also provides a two year
renewal of $200,000 per month, followed by three additional two year renewal
options at the then fair market rental. Emery provided a security deposit of
$218,000.

In 1998, the Partnership entered into discussions with Kitty Hawk for
the lease of the Boeing 727-200 aircraft, upon the expiration of the current
lease of that aircraft, with Continental, which expires in May, 1999. The lease

35
<PAGE>
would require the Partnership to hushkit and convert the aircraft to a freighter
at an estimated cost of $4.2 million. The lease agreement would provide for a
lease of 84 months with rent of $112,700 per month. Kitty Hawk has provided a
security deposit of $56,000.

In all, the Partnership has estimated commitments of $13.7 million. The
Partnership has drawn all available funds under its $10 million borrowing
facility and the principal balance at December 31, 1998 is $10 million. In
February, 1999, the lender increased the borrowing commitment from $10 million
to $12.5 million. (See Note 12, "Subsequent Event"). The Limited Partnership
Agreement permits the Partnership to borrow up to 35% (or $50,785,000) of the
original offering proceeds. It is the intent of the General Partners to obtain
financing utilizing the Kitty Hawk and Emery leases to fund the conversions of
such assets. If unable to secure additional borrowing capacity to fund the
commitments, the Partnership may need to forgo the lease with Kitty Hawk, as
well as possibly sell equipment. Further, the Partnership may have to utilize
cash from operations to finance such commitments, thus potentially reducing
distributions to partners.

12. Subsequent Event

In February 1999, the Partnership consummated an agreement to increase
the committed amount of the loan facility from $10 million to $12.5 million and
the interest rate from 1% to 1.25% over prime. The Partnership has pledged all
of its aircraft as collateral in connection with the increased loan commitment.
The Partnership will utilize the additional borrowings to replenish working
capital, which was drawn down to pay for the hushkit for the aircraft on lease
to Capital Cargo International Airlines, Inc. ("Capital Cargo"). This loan is
due in December, 1999. If the Partnership is unable to renegotiate or refinance
the loan it will be forced to reduce or suspend distributions.

36
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

There were no changes in accountants or disagreements with accountants
with respect to accounting or financial disclosure issues during 1998, 1997 and
1996.

37
<PAGE>
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

Name Positions Held
- ---- --------------

Richard S. Wiley President and Chairman of the Board
Carol L. Chase Senior Vice President, General Counsel and Secretary
Robert M. Brown Senior Vice President
Richard L. Funk Senior Vice President, Technical

Richard S. Wiley, age 45, is President and Chairman of the Board of the
Managing General Partner and Pegasus Capital Corporation ("PCC"), 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.

Carol L. Chase, Esq., age 46, 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.

Robert M. Brown, 40, joined PCC in 1988 and is involved in aircraft
acquisitions, finance and leasing. His primary responsibility is the structuring
of debt transactions which accommodate the PCC trading and long-term investing
activities. Previously, he served as Vice President, Aircraft Sales, and as
Regional Marketing Director during the offerings of the Partnership and an
affiliated partnership. Prior to joining PCC, Mr. Brown was District Manager
with the Chrysler Corporation. He holds a BA degree from Dartmouth College and
an MBA from the University of Washington.

Richard L. Funk, 61, joined PCC in 1992 and is responsible for the
technical aspects of aircraft marketing, including delivery and redelivery of
aircraft to airlines world wide. From 1990 to 1992, he served as technical
marketing consultant to the aviation industry and from 1987 to 1990 he was
President of Avtek Industries, Inc., an aircraft, missile, and electronic
components manufacturer which he founded. From 1984 to 1986 he was President and
Chief Operating Officer of Standard Aero Western, Inc., a commercial airline
maintenance facility. From 1979 to 1982, he was Senior Vice President of
Engineering and Maintenance at World Airways, Inc. From 1963 to 1979 he held
various positions with United Air Lines, Inc., including Manager of Airframe
Maintenance for a period of six years.

38
<PAGE>
Air Transport Leasing, Inc.

Name Positions Held
- ---- --------------

Gerald F. Goertz, Jr. Chairman of the Board
Clifford B. Wattley President and Director
Stephen R. Dyer Vice President, Assistant Secretary and Director
Carmine Fusco Vice President, Secretary, Treasurer and
Chief Financial and Accounting Officer

Gerald F. Goertz, Jr., age 41, 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 49, 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 39, is 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
Senior 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.

Carmine Fusco, age 30, is Vice President, Secretary, Treasurer and
Chief Financial and Accounting Officer of the Administrative General Partner, he
also serves as an Assistant Vice President within the Private Investments
Department of PaineWebber Incorporated. Mr. Fusco had previously been employed
as a Financial Valuation Consultant in the Business Valuation Group of Deloitte
& Touche, LLP from January 1997 to August 1998. He was employed as a Commodity
Fund Analyst in the Managed Futures Department of Dean Witter Reynolds
Incorporated, from October 1994 to November 1995. Prior to joining Dean Witter,
Mr. Fusco was a Mutual Fund Accountant with the Bank of New York Company
Incorporated. He received his Bachelor of Science degree in Accounting and
Finance in May 1991 from Rider University and a Master of Business
Administration from Seton Hall University in June 1996.

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 1998.

39
<PAGE>
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, 1999.

Amount and Nature
of Beneficial Percent
Name Ownership of Class
---- ----------------- --------

Richard S. Wiley 29,501 *

Carol L. Chase 1,300 *

All directors and
officers as a group
(4 persons) 30,801 *

Air Transport Leasing, Inc.
None

* 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.

40
<PAGE>
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 1998.

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 1998, the General Partners earned base management fees of
$177,000.

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 $505,000
during 1998.

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 $335,000 during 1998.

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 $19,000 during 1998, all of
which was paid or accrued to the Administrative General Partner. As discussed in
Note 7 to the Financial Statements, accountable expenses declined due to the
subcontracting of certain accounting services, and their cost is included in
general and administrative expenses.

Other. In 1998, the Partnership purchased certain equipment and parts
for two partnership aircraft from a company owned by the Director and President
and two former officers and directors of the Managing General Partner in the
amount of $1,887,000. During 1998, the Partnership paid $1,313,000 to a licensed
maintenance facility affiliated with the Managing General Partner for work
performed on certain aircraft.

Partnership Interest. The General Partners received or were entitled to
receive distributions of $117,000 as their allocable share of distributable cash
flow for 1998. In addition, $257,000 of the Partnership's net taxable income for
1998 was allocated to the General Partners.

41
<PAGE>
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, 1998, the Partnership did
not file any reports on Form 8-K.

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

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.*

(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.*

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<PAGE>
(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.*

(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.*

(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.*

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<PAGE>
(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.*

(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).*

44
<PAGE>
(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 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 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.*

45
<PAGE>
(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.*

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 to Form 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 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).*

(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

46
<PAGE>
engines. Filed as Exhibit 19.1(a) 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 10.8(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.

(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.*

47
<PAGE>
(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.*

(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.*

48
<PAGE>
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.*

10.13(a) Aircraft lease of 727-200 Advanced Aircraft 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 _______ between ___
Bank, N.A. and First Security Bank as Owner Trustee.

11 Partnership Policy for Requests for Partner Lists.

49
<PAGE>

SIGNATURES

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

Dated: March 29, 1999

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/ CARMINE FUSCO
Carmine Fusco
Vice President, Secretary,
Treasurer 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 29, 1999.

Signature Title
- --------- -----

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

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

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

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

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM REPORT ON
FORM 10-K FOR PEGASUS AIRCRAFT PARTNERS II LP.
</LEGEND>

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 2863000
<SECURITIES> 0
<RECEIVABLES> 491000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 4165000
<PP&E> 156893000
<DEPRECIATION> 109635000 <F1>
<TOTAL-ASSETS> 51423000
<CURRENT-LIABILITIES> 7223000
<BONDS> 10000000
0
0
<COMMON> 0
<OTHER-SE> 34200000
<TOTAL-LIABILITY-AND-EQUITY> 51423000
<SALES> 0
<TOTAL-REVENUES> 12989000
<CGS> 0
<TOTAL-COSTS> 10064000
<OTHER-EXPENSES> 312000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 758000
<INCOME-PRETAX> 1855000
<INCOME-TAX> 0
<INCOME-CONTINUING> 1855000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1855000
<EPS-PRIMARY> 0.22
<EPS-DILUTED> 0
<FN>
<F1>INCLUDES WRITE-DOWNS AND CERTAIN OTHER RESERVES
</FN>

</TABLE>