<PAGE>   1

                                    FORM 10-K

                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549
                                   (Mark One)

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

For the fiscal year ended     December 31, 1997
                          ------------------------------------------------------

                                       OR

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

For the transition period from                         to
                               -----------------------    ----------------------

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

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


           Delaware                                        84-1111757
           --------                                        ----------
      (State of organization)                          (I.R.S. Employer
                                                       Identification No.)


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

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

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

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

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

      State the aggregate market value of the voting stock held by
non-affiliates of the Registrant: Not applicable.
<PAGE>   2

                       Pegasus Aircraft Partners II, L.P.
                       Annual Report on Form 10-K for the
                       Fiscal Year Ended December 31, 1997

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

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


Part II
-------

Item 5      Market for Registrant's Common Equity
              and Related Stockholder Matters.............................  16
Item 6      Selected Financial Data.......................................  17
Item 7      Management's Discussion and
            Analysis of Financial Condition
              and Results of Operations...................................  18
Item 8      Financial Statements..........................................  F-1
Item 9      Changes in and Disagreements with
              Accountants on Accounting and
              Financial Disclosure........................................  25


Part III
--------

Item 10     Directors and Executive Officers
              of the Registrant...........................................  26
Item 11     Executive Compensation........................................  28
Item 12     Security Ownership of Certain
              Beneficial Owners and Management............................  28
Item 13     Certain Relationships and
              Related Transactions........................................  30

Part IV
-------

Item 14     Exhibits, Financial Statement Schedules
              and Reports on Form 8-K.....................................  31
</TABLE>
<PAGE>   3

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

Impact of the Year 2000 Issue
-----------------------------

      The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. This could result in
a system failure or miscalculations in the year 2000 causing disruptions of
operations of the Partnership, its lessees, or general partners.


                                       1
<PAGE>   4

      The Partnership has already reviewed and identified its computer systems
that are subject to Year 2000 risk. Accordingly, the Partnership has commenced
the remediation of all systems not Year 2000 compliant. Remediation and testing
of such systems will be completed in advance of Year 2000. The costs of such
remediation is expensed as incurred and will not be material to the
Partnership's financial position or results of operations.

      The Partnership has also initiated communication with lessees and vendors
to determine the extent to which the Partnership is vulnerable to those third
parties' failures to remediate their own Year 2000 issues. The Partnership has
not yet completed its communication with its lessees and vendors. As a result,
the Partnership can not determine at this time the extent, if any, to which the
Partnership may be exposed to financial risk from the inability of the
Partnership's lessees and vendors to remediate their own Year 2000 issues.

Outlook for the Airline and Aircraft Leasing Industries
-------------------------------------------------------

The US airline industry had a profitable year in 1997, which continued the
industry's profitability trend. The demand for used aircraft was reflected in,
for the most part, stable lease rates for such aircraft. 1997 also continued a
recent upward trend in aircraft production. Continental Airlines, Inc.
("Continental") continued to report positive financial results in 1997 and
USAirways Group Inc., (formerly USAir, Inc.) ("US Air") continued to show
financial improvements. Trans World Airlines Inc. significantly narrowed its
loss in 1997, increased its liquidity and continued its fleet rationalization
program. Although analysts foresee a profitable 1998, TWA has yet to achieve
sustained profitability. Aeromexico enjoyed both increased profits and cashflow
in 1997. Aircraft leasing continues to be a highly competitive business and the
Partnership's lessees continue to face significant competitive challenges.

New Accounting Pronouncements, Issued But Not Yet Effective
-----------------------------------------------------------

      In June 1997, the FASB issued 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 nonowner sources. The Partnership does not expect
this pronouncement to materially impact the reporting of the Partnership's
results of operations.

Recent Partnership Developments
-------------------------------

      Immediately below is a table which shows the December 31, 1997 appraised
value of the Partnership's aircraft to be approximately $62.0 million, or
approximately 42% of the original acquisition cost (excluding acquisition-
related fees) plus related capital expenditures. Based upon these appraised
values, adjusted for the effect of the Continental, Emery and TNT deals
discussed in Item 8, Footnote 5, "Aircraft," Footnote 13, "Commitments" and
Footnote 14, "Subsequent Events", as if these events had occurred as of December
31, 1997 and which aggregate $1.50, the Partnership's net asset value at
December 31, 1997 was equal to $8.14 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.


                                       2
<PAGE>   5

      The following table describes the Partnership's aircraft portfolio at
December 31, 1997:

<TABLE>
<CAPTION>
                                                          December    Current
                                                            1997       Lease       Original      Noise     Cumulative     Cumulative
 Current           Aircraft       Ownership  Acquisition  Appraised  Expiration    Delivery    Abatement      Flight        Flight
  Lessee             Type          Interest   Costs (1)    Value (2)   Date (3)       Date     Compliance    Hours (4)    Cycles (4)
---------        ------------     ---------  -----------  ----------  ---------    ----------  ----------   ----------   -----------
                                            (in millions)(in millions)
<S>              <C>               <C>         <C>          <C>        <C>            <C>        <C>           <C>         <C>
Aerovias de
Mexico, S.A.     McDonnell
de C.V.          Douglas DC-9-31     100%      $  8.9       $  3.4     10/31/99       1970       Stage 2       62,104       58,796

Aerovias de
Mexico, S.A.     McDonnell
de C.V.          Douglas DC-9-31     100          8.9          3.5     2/25/00        1971       Stage 2       67,430       64,144

Continental      Boeing 727-200
Airlines, Inc.   Advanced            100          4.5(8)       2.9     5/31/99        1973       Stage 2       71,597       50,360

Continental      Boeing 727-200
Airlines, Inc.   Advanced            100          4.1(8)       2.3     1/31/98(12)    1973       Stage 2       71,596       50,364

Continental      McDonnell
Micronesia Inc.  Douglas DC-10-10    100         18.3          7.7     6/30/98        1973       Stage 3       79,586       29,145

(7)              Airbus Industrie
                 A300-B4-103         100         28.1          5.2       (7)          1979       Stage 3       46,226       19,527

Falcon Air       Boeing 727-200
Express Inc.     Non-Advanced(9)     100         11.9          5.4       4/02         1970       Stage 3       73,964       54,386

Capital Cargo    Boeing 727-200
International    Advanced(10)        100         14.5          8.3       7/05         1973       Stage 2       58,460       30,441
Airlines Inc.

Trans World      McDonnell
Airlines.        Douglas MD-82       100         21.0         15.4     11/01/04       1983       Stage 3       44,984       23,053

(11)             Lockheed
                 L-1011              100         17.7          1.7       (11)         1974       Stage 3       61,209       22,907

US Airways       McDonnell
Group, Inc.      Douglas MD-81        50 (5)     10.0          6.2    6/01/01(6)      1982       Stage 3       43,528       39,104
                                               ------        -----
                                               $147.9        $62.0
                                               ======        =====
</TABLE>

Notes: (1)  Acquisition costs do not include related acquisition fees of $3.0
            million paid to the General Partners. The cost amounts shown include
            capital expenditures incurred during 1997, 1996, 1995, 1994 and 1993
            of $5.2 million, $2.5 million, $26,000, $.3 million and $2.2
            million, respectively. Such amounts include two Boeing 727-200
            Advanced aircraft received in connection with the A-300 settlement.
            The 1997 amount is net of the application of maintenance reserves to
            restore aircraft of approximately $2.2 million.

      (2)   The December 1997 appraised values were determined by an independent
            aircraft appraisal firm. Appraised values include the present value
            of rents due under leases in place plus the present value of an
            estimated residual value for the aircraft at the end of the lease.
            It should be noted that appraisals are only estimates of value and
            should not be relied on as measures of realizable value.

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

      (4)   The number of cumulative flight cycles and cumulative flight hours
            shown are as of December 31, 1997, except they are as of February 6,
            1998 with respect to the Boeing 727-200 aircraft formerly leased to
            Continental which was returned to the Partnership upon the
            expiration of the lease on January 31, 1998, January 3, 1998
            with respect to the McDonnell Douglas MD-81 leased to US Airways
            Group Inc. and November 30, 1997 with respect to the Boeing 727-200
            aircraft leased to Falcon Air Express, Inc.

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

      (6)   During 1997, US Air exercised its three year renewal, extending the
            lease to June 2001.

      (7)   Aircraft off lease at December 31, 1997. The value shown represents
            the appraised value of the engines and a purchase offer for the
            airframe.

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


                                       3
<PAGE>   6
      (9)   This aircraft was delivered to Falcon Air Express, Inc. ("Falcon")
            in March 1997.

      (10)  Aircraft was converted to cargo configuration in early 1997.

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

      (12)  The aircraft was returned upon the expiration of the lease and
            committed it to TNT Transport International B.V. for a term of
            approximately four years. The Partner also committed to finance the
            cargo conversion and hushkit of engines at a budgeted cost of
            approximately 4.5 million.

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

      a. Continental Airlines Leases During September 1989, the Partnership
acquired a McDonnell Douglas DC-10-10 aircraft for a total purchase price of
$18,301,000, subject to an operating lease with Continental. This lease was
modified in 1995 and 1996 as discussed below and at December 31, 1997, the
aircraft was subject to a lease scheduled to expire on June 30, 1998 which
provided for rentals of $150,000 per month.

      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 to the Partnership. Continental paid $150,000 of the $312,000 monthly
rental payment due in February through May 1995. The Partnership did not accrue
as rental revenue the difference between the amount due and the amount paid by
Continental for such months. Continental took the A-300 out of service in May
1995, and the 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 defaulted. The
Partnership recovered the A-300 aircraft and is currently remarketing it. The
Partnership estimates 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 will be applied towards such maintenance. However, subsequent to
December 31, 1997 the Partnership determined that the cost of market conditions
for this type of aircraft the recovery of its investment plus any incremental
investment would be problematic and the Partnership began entertaining purchase
offers. At December 31, 1997 the Partnership provided a writedown of $1.1
million to reflect a current informal purchase offer for the airframe plus the
appraised value of the engines.


                                       4
<PAGE>   7

      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 are currently discussing each
party's compliance with the return condition of the aircraft and the related
liability as well as Continental's compliance with the lease. The Partnership
entered into an agreement in principle to lease the aircraft for a term of four
years to TNT Transport International B.V. ("TNT") a foreign cargo carrier and
has begun to convert the aircraft to cargo configuration at a budgeted cost of
approximately $4,500,000, including a low gross weight hushkit.

      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 aircraft to June 30, 1998
at a lease rate of $150,000 per month. In late 1997 the Partnership and
Continental entered into discussions to extend the lease of the DC-10 aircraft
for a term of approximately 15 months beyond the scheduled expiration date at
the same lease rate. (See Item 7, Management's Discussion of and Analysis of
Financial Condition and Results of Operations and Item 8 Financial Statements,
Footnote 13, Commitments for further discussion of the Partnership's plans for
this aircraft.)

      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.

      b. 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 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


                                       5
<PAGE>   8

TWA to finance certain major maintenance procedures, which being repaid in
monthly installments through November 1998 with interest at a fixed rate of
9.70%. At December 31, 1997, the balance of the receivable was $140,000. All
1998 payments to date have been made by TWA.

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

      Upon execution of the lease amendment, the Partnership reimbursed TWA for
$225,000 of capital improvements which were made to the aircraft and advanced
$550,000 to TWA to finance certain major maintenance procedures, which is being
repaid 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 have been made by TWA.

      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. TWA has
narrowed its losses and improved its liquidity although it has yet to achieve
sustained profitability. 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. While the Partnership's L-1011 has been advertised for lease and the
Managing General partner has made inquiries of potential lessees, there has been
little interest in the aircraft on the part of potential lessees.


                                       6
<PAGE>   9

Given the number of L-1011s that are currently available for lease or purchase
and the fact that the Partnership's L-1011 requires a significant maintenance
check, the General Partners believe it is likely that the Partnership will seek
to sell the aircraft and engines. The Partnership is reviewing alternatives for
the use of the proceeds received, including the use of the economic settlement
to purchase an additional aircraft or engines.

      At December 31,1997 the L-1011 aircraft had an economic value of
approximately $1.7 million (net book value of $5.8 million adjusted for the $3
million economic settlement accounted for on the cost recovery basis and the
unearned portion of the L-1011 Lease Prepayment reflected as deferred income at
December 31, 1997 and a writedown of $300,000 to reflect current market value of
the aircraft).

      c. 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 October 31, 1999 (with
Aeromexico given the right, subject to notice to extend to February 2000) and
one of which was extended to February 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.

      d. USAirways Group Inc. ("USAIR") 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 exercise 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.

      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


                                       7
<PAGE>   10

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 in 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, 1997.

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

      e. Kiwi International Air Lines, Inc. - Bankruptcy In 1993, the
Partnership leased its two Boeing 727-200 aircraft to Kiwi. The aircraft were
originally purchased in 1989 (Non-advanced) and 1990 (Advanced) for purchase
prices of $6,261,000 and $10,748,000, respectively (including related fees). The
leases 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 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


                                       8
<PAGE>   11

third parties, the Partnership originally recorded the securities at a value of
$600,000. The securities were valued at approximately $1,000 at September 30,
1997 and December 31, 1996 (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 cash
reserves previously generated.

      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 incident, 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 (excluding the cost of the heavy maintenance check being completed prior to
delivery to Falcon Air Express Inc. discussed below). 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 late 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 assets
of Kiwi. Based upon the approved purchase price, it is likely that the
Partnership will have little or no recovery of its bankruptcy claims.


                                       9
<PAGE>   12
 f. 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.

      g. Capital Cargo International Airlines, Inc. Lease In January 1997, the
Partnership entered into an agreement in principle with Capital Cargo
International Airlines, Inc. ("Capital"), a start-up freight carrier, with
respect to the 727-200 advanced aircraft formerly leased to Kiwi. The
Partnership agreed to 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 $3 million) at which time
the lease rate increases to $139,000 per month. The Capital Lease requires
Capital to fund maintenance reserves monthly at a rate of $377 per flight hour.
Capital provided a security deposit of $50,000 and is obligated to add $17,000
per month to the security deposit during the lease term until the deposit totals
$220,000. The lease was executed and aircraft was delivered to Capital in July
1997.

      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.

      The Partnership continues to actively remarket the A-300 and search for
alternatives relating to the L-1011 aircraft, both of which are currently off
lease. The Partnership utilized the reserves collected from Kiwi to partially
offset these expenditures.


                                       10
<PAGE>   13

Significant Lessees
-------------------

      The Partnership leased its aircraft to six different airlines (and leased
engines separately to a two others) during 1997. Revenue from each of three
airlines which accounted for greater than 10% of the total rental revenue of the
Partnership during 1997 are as follows:

<TABLE>
<CAPTION>
                    Airline                Percentage of Total Rental Revenue
      -------------------------------      ----------------------------------
<S>                                                     <C>
      Continental Airlines, Inc.*                       33%(1)
      Trans World Airlines, Inc.                        30%(1)
      Aerovias de Mexico S.A. de C.V.                   15%
</TABLE>

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

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

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


                                       11
<PAGE>   14

      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.

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

      * Substantially cycle limited

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


                                       12
<PAGE>   15

      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 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 2
aircraft will be phased out from operation within United States airspace by
December 31, 1999.

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

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

      Stage 3 hushkitting and re-engineering for the Boeing 727-200 and the
McDonnell Douglas DC-9-30 aircraft have been approved by the FAA.

      Certain airlines have determined that it is economically feasible to
hushkit certain Stage 2 aircraft to achieve Stage 3 noise standards. The
Partnership continues to monitor the marketplace based upon the availability of
aircraft, pricing for Stage 2 and Stage 3 aircraft and the timetable for
implementation of Stage 3, to best position the Partnership's aircraft for
continued and future deployment.

Competition
-----------

      The aircraft leasing industry is highly competitive. The Partnership
competes with aircraft manufacturers, distributors, airlines and other
operators, equipment managers, leasing


                                       13
<PAGE>   16

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

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

      The amended complaint in the New York Limited Partnership Actions alleged,
among other things, that, in connection with the sale of interests in Pegasus
Aircraft Partners II, L.P., PaineWebber and the Administrative General Partners
(1) failed to provide adequate disclosure of the risks involved with each
partnership; (2) made false and misleading representations about the safety of
the investments and the partnerships' anticipated performance; and (3) marketed
the partnership to investors for whom such investments were not suitable. The
plaintiffs also alleged that following the sale of the partnership investments
PaineWebber and the Administrative General Partner misrepresented financial
information about the partnership's value and performance. The amended complaint
alleged that PaineWebber and the Administrative General Partner violated the
Racketeer Influenced and Corrupt Organizations Act ("RICO") and the


                                       14



<PAGE>   17

federal securities laws. The plaintiffs sought unspecified damages, including
reimbursement for all sums invested by them in the partnerships, as well as
disgorgement of all fees and income derived by PaineWebber from the limited
partnerships. In addition, the plaintiffs also sought treble damages under RICO.

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

      In January 1996, PaineWebber signed a memorandum of understanding with the
plaintiffs in the class action outlining the terms under which the parties
agreed to settle the case. A definitive settlement was agreed in July 1996 and
in March 1997, the District Court approved the settlement as fair and
reasonable. Under the terms of the settlement PaineWebber agreed to pay $125
million and additional consideration to class members. The investors who had
objected to the settlement have appealed the District Court's approval to the
United States Court of Appeals for the Second Circuit. In July 1997, the U.S.
Court of Appeals for the Second Circuit affirmed the District Court's approval
of the settlement. The District Court must still determine the extent of
attorneys fees to be awarded to plaintiffs' counsel which will be paid from the
settlement fund, so that the remainder of the monies can be distributed to class
members.

      In April 1995, two investors in the Pegasus limited partnerships filed a
purported class action in the Circuit Court of the State of Illinois for Cook
County entitled Robert M. Jacobson, et al. v. PaineWebber, Inc. et al., making
allegations substantially similar to those in the New York Limited Partnership
Actions, but limited in subject matter to the sale of the Pegasus partnerships,
and without a RICO claim. The Illinois case has been dismissed.

      Three actions were filed in the District Court for Brazoria County, Texas,
relating to the sale and sponsorship of interests in the Partnership and an
affiliated partnership. The complaints made state law claims, specifically,
common law fraud, conspiracy, violations of section 27.01 of the Texas Business
and Commerce Code, fraud in the inducement, negligent misrepresentation,
negligence, breach of fiduciary duty, violations of the Texas Securities Act,
and violations of the Texas Deceptive Trade Practices Act. The plaintiffs sought
unspecified damages, including attorneys' fees, reimbursement for all sums
invested by them in the partnerships, exemplary damages, and treble damages
under the Texas Deceptive Trade Practices Act. All three actions were removed to
federal court and two were transferred to the United States District Court for
the Southern District of New York and consolidated under the title, Mallia vs.
PaineWebber, Inc. The third action was dismissed with the consent of the parties
on the grounds that it was duplicative of the two actions that were before the
federal court in New York.

      In February 1996, approximately 230 plaintiffs filed an action entitled
Abbate v. PaineWebber Inc. in Sacramento, California Superior Court against
PaineWebber Incorporated and various affiliated entities concerning the
plaintiff's purchase of various limited partnership interests. The complaint
alleged, among other things, that PaineWebber and its related entities committed
fraud and misrepresentation and breached fiduciary duties allegedly owed to the
plaintiffs by selling or promoting limited partnership investments that were
unsuitable for the plaintiffs and by overstating the benefits, understating the
risks and failing to state material facts


                                       15
<PAGE>   18

concerning the investments. The complaint sought compensatory damages of $15
million plus punitive damages. In September 1996, the California Superior Court
dismissed many of the plaintiff's claims as barred by the applicable statutes of
limitation.

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

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

      On September 30, 1996, Kiwi filed a voluntary petition for reorganization
under Chapter 11 of the Federal Bankruptcy Code and the Partnership recovered
the aircraft. See Item 8, Note 5 Aircraft Under Operating Lessees for a
discussion of the related litigation.

      The Partnership was also involved in litigation with the company that
acted as Kiwi's engine manager regarding each party's compliance with a
settlement agreement to facilitate the recovery of the aircraft and engines. The
parties achieved a negotiated settlement in May 1997 with the payment by the
Partnership of amounts due and the receipt by the Partnership of certain
equipment.

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, 1997.

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, 1998, the number of Limited Partners of record was
approximately 8,133.


                                       16
<PAGE>   19

The Partnership declared the following distributions to its Limited Partners out
of cash flow received from operations during 1997 and 1996:

<TABLE>
<CAPTION>
                           Amount Of
                         Distribution
           Period          Per Unit    Record Date          Payment Date
           ------          --------    -----------          ------------
<S>                          <C>       <C>                  <C>
      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

      1st Quarter 1996        .40      March 31, 1996       April 25, 1996

      2nd Quarter 1996        .40      June 30, 1996        July 25, 1996

      3rd Quarter 1996        .40      September 30, 1996   October 25, 1996

      4th Quarter 1996        .40      December 31, 1996    January 24, 1997
</TABLE>

      Total distributions to all partners for 1997 and 1996 were made as follows
(in thousands):

<TABLE>
<CAPTION>
                                          1997           1996
                                         -------       -------
<S>                                      <C>           <C>
      Limited Partners                   $11,608       $11,608
      General Partners                       117           117
                                         -------       -------
                                         $11,725       $11,725
                                         -------       -------
</TABLE>

      Distributions may be characterized for tax, accounting and economic
purposes as a return of capital, a return on capital, or both. The portion of
each cash distribution by a partnership which exceeds its net income may be
deemed a return of capital. Based on the amount of net income reported by the
Partnership for accounting purposes, approximately 89%, 75% and 83%,
respectively, of the cash distributions paid to the partners for the years ended
December 31, 1997, 1996 and 1995 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, 1997 constituted a return
of capital. However, the total actual return on capital over the Partnership's
life can be determined only at the termination of the Partnership after all cash
flows, including proceeds from the sale of the aircraft, have been realized.

Item 6.     Selected Financial Data
            -----------------------

      The following selected financial data of the Partnership was derived from
the audited financial statements for the indicated periods. The information set
forth below should be read in conjunction with the Partnership's Financial
Statements and 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.


                                       17
<PAGE>   20

<TABLE>
<CAPTION>
                                                         As of December 31,
                                                     or Year Ended December 31,
                                           -----------------------------------------------
                                             1997      1996      1995      1994      1993
                                           -------   -------   -------   -------   -------
                                               (in thousands, except per unit amounts)
<S>                                        <C>       <C>       <C>       <C>       <C>
Rental Revenue                             $12,183   $15,231   $14,026   $15,537   $14,985
Net Income                                   1,255     2,898     2,019     1,413     1,549
Net Income per Limited
  Partnership Unit                             .17       .40       .28       .19       .21
  Distributions per Partnership Unit (1)      1.60      1.60      1.60      1.60      1.60

Total Assets                                58,273    72,039    80,799    86,350    95,842
Notes Payable                                4,751     4,751     6,638     7,382     7,735
Partners' Equity                            44,070    54,540    63,367    73,073    83,385
</TABLE>

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


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

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 contains, 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 these forward-looking statements 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 1997, 1996 and
1995, respectively. Net cash provided by operating activities was $8.9 million
in 1997, $13.5 million in 1996 and $17.6 million in 1995. In the aggregate, for
this three-year period net cash provided by operating activities totaled $40.0
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 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. Additionally,
in 1995, the Partnership received the A-300 Lease Settlement proceeds, a portion
of which was accounted for under the cost recovery method and thus, was not
included in cash from operating activities.


                                       18
<PAGE>   21

      Partnership equity declined by approximately $10,518,000 from December 31,
1996 to December 31, 1997 as a result of the declaration and payment of cash
distributions to the partners in excess of the Partnership's net income. This
resulted primarily from the fact that, unlike net income, cash flow generated
from operations, which is the source of the cash utilized to make the
distributions, is not reduced by depreciation expense and provisions for decline
in market value of aircraft attributable to the Partnership's aircraft.

      At December 31, 1997, the Partnership had $2,771,000 of unrestricted cash
and cash equivalents in excess of declared, but unpaid, distributions to the
partners. This represents a decrease of $7,071,000 from a similarly computed
amount at December 31, 1996 of $9,842,000, this is attributable primarily to the
capital improvement made in 1997 net of maintenance reserves applied as well as
the fact that because the cash distribution right exceeded cash generated from
operations, adjusted for collection of advances, certain of the cash reserves
generated in prior periods from various settlements were utilized to fund
distributions to partners.

      Rent and other receivables decreased by $187,000 from $758,000 at December
31, 1996 to $571,000 at December 31, 1997. This decrease is primarily the result
of the continued repayment of deferred rentals and advances by Continental and
TWA during 1997.

      The payable to affiliates decreased by $297,000 from $636,000 at December
31, 1996 to $339,000 at December 31, 1997 principally due to the payment of
amounts previously deferred on a voluntary basis by the Administrative General
Partner. Such amounts were assigned by an affiliate to an escrow account for the
benefit of the class action members of the Administrative General Partner in
connection with the class action settlement. (See Item 8, Note 10, "Litigation"
for a complete description).

      Deferred income and deposits decreased by $1,195,000 from $3,779,000 at
December 31, 1996 to $2,584,000 at December 31, 1997. This decrease was
attributable to the amortization of amounts recognized in connection with the
A-300 Lease Settlement and the L-1011 Lease Settlement received in 1996 offset
by the collection of security deposits totalling $556,000 during 1997.

      During 1997, the Partnership invested $7.6 million in capitalized aircraft
improvements and maintenance checks, of which $2.3 million was funded by the
application of maintenance reserves collected from Kiwi in prior periods. During
1997, the Partnership delivered one 727-200 aircraft to Falcon and a second to
Capital Cargo. The L-1011 aircraft and the A-300 remained off lease during 1997.
In early 1998, the Partnership received informal offers to purchase these
aircraft. Based upon the offers received, the Partnership recognized a provision
for decline in market value of approximately $1.4 million to recognize the
decrease in value of these aircraft. There can be no assurance that either offer
will result in the consummation of a sale. However, if the aircraft are sold,
the Partnership may utilize such proceeds, to the extent permitted under the
Partnership Agreement, to invest (along with the $3,000,000 L-1011 return
condition settlement received in 1996) in additional used aircraft subject to
lease or may distribute such amounts to partners.


                                       19
<PAGE>   22

      In the fourth quarter of 1997, the Partnership entered into discussions
with lessee regarding the DC 10-10 aircraft, the lease of which is scheduled to
expire on June 30, 1998. Continental Micronesia agreed in principle to extend
the lease for an additional fifteen months (through September 30, 1999) at the
current lease rate ($150,000 per month). Upon the expiration of the extended
lease, the Partnership would 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 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 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 of $109,000 at December 31, 1997.

      The workscope under the aircraft modification agreement requires the
investment of approximately $8.0 million by the Partnership. Additionally, the
Partnership is committed to fund in 1999 the hushkit for the 727 leased to
Capital, which is expected to cost approximately $3 million. In early 1998,
Continental returned one 727-200 ADV aircraft the lease of which expired January
31, 1998. The Partnership and Continental are discussing each party's compliance
with return conditions required by the lease. Continental's position is that the
airframe exceeded return condition requirements and that the engines net the
aggregate return condition requirements; the Partnership believes that the
engines failed to meet return conditions and agree generally regarding the
airframe. The ultimate resolution is unknown at this time. The Partnership
entered into an agreement in principle to deliver this aircraft to TNT Transport
International B.V. for a term of approximately four years. In conjunction with
the agreement in principle, the Partnership agreed to convert the aircraft to
cargo configuration and hushkit the engines at a budgeted cost of approximately
$4.5 million. In all the Partnership has capital commitments of $15.5 million.
The Partnership currently has $5.2 million available under its $10 million
borrowing facility. The Partnership is permitted to borrow up to 35% of the
original offering proceeds ($50,785,000). The Partnership has commenced
discussions with the lender to increase the amount available under the borrowing
facility. However, there can be no assurance that the Partnership will be able
to obtain additional borrowings. The Partnership may have to utilize cash from
operations to finance such cost, thus potentially reducing distribution to
partners.

Litigation
----------

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

Results of Operations
---------------------

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

      Under the terms of the triple net leases, substantially all of the
expenses related to the operation and maintenance of the aircraft during 1997,
were paid for by the lessees or funded out of maintenance reserves collected.
The direct lease expenses incurred by the Partnership represent the costs of
providing insurance coverage for the Partnership's aircraft in excess of the


                                       20
<PAGE>   23

amounts required to be carried by the lessees, trustee fees related to the
ownership of the aircraft, the cost of the letter of credit required under the
terms of the TBT lease on the McDonnell Douglas MD-81 leased to USAir, the
amortization of costs incurred in connection with the Aeromexico leases, the
costs of storing the A-300 aircraft and the costs relating to the recovery of
the Kiwi aircraft.

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

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 writedowns 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 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.

      The Partnership provided writedowns aggregating $1,400,000 to reflect
the loss in value of the A-300 aircraft and the L-1011 aircraft at December 31,
1997; writedowns 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.


                                       21
<PAGE>   24

      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, "Kiwi Bankruptcy"). 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, "Kiwi Bankruptcy").

1996 as compared to 1995

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

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


                                       22
<PAGE>   25

1996 after Kiwi rejected the leases (see Item 8, Financial Statements, Note 5,
"Kiwi- Bankruptcy") for a further discussion.

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

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

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

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

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

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

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

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


                                       23
<PAGE>   26

Inflation and Changing Prices
-----------------------------

      Inflation has had no material impact on the operations or financial
condition of the Partnership from inception through December 31, 1997. However,
market and worldwide economic conditions and changes in federal regulations have
in the past, and may in the future, affect the airline industry and thus lease
rates and aircraft values. Additionally, inflation and changing prices, may
affect subsequent lease rates and the eventual selling prices of the aircraft.


                                       24
<PAGE>   27

Item 8.     Financial Statements
            --------------------

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------


List of Financial Statements
----------------------------
                                                                            Page
                                                                            ----

Report of Independent Accountants                                            F-2

Balance Sheets -- December 31, 1997 and 1996                                 F-3

Statements of Income for the years ended
      December 31, 1997, 1996 and 1995                                       F-4

Statements of Partners' Equity for the years ended
      December 31, 1997, 1996 and 1995                                       F-5

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

Notes to Financial Statements                                                F-8


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


                                      F-1
<PAGE>   28
                      REPORT OF INDEPENDENT ACCOUNTANTS
                      ---------------------------------


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


      We have audited the accompanying financial statements as listed in the
index on Page F-1 herein. These financial statements are the responsibility of
the Partnership's management. Our responsibility is to express an opinion on
these financial statements based on our audits.

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

      In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Pegasus Aircraft Partners
II, L.P. as of December 31, 1997 and 1996, and the results of its operations and
its cash flows for the years ended December 31, 1997, 1996 and 1995, in
conformity with generally accepted accounting principles.


                                                      Coopers & Lybrand L.L.P.

New York, New York
March 23, 1998


                                      F-2
<PAGE>   29


                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                 BALANCE SHEETS - DECEMBER 31, 1997 AND 1996
                 -------------------------------------------

<TABLE>
<CAPTION>
                                    ASSETS
                                    ------

                                                               1997           1996
                                                             --------       --------
                                                        (in thousands, except unit data)
<S>                                                          <C>            <C>
Cash and cash equivalents (Note 4)                           $  5,705       $ 12,831
Restricted cash (Notes 1 and 5)                                    --          2,248
Rent and other receivables, net (Note 5)                          444            758
Aircraft, net (Notes 5, 9, 12, 13 and 14)                      52,098         56,177
Other assets                                                       26             25
                                                             --------       --------
   Total Assets                                              $ 58,273       $ 72,039
                                                             ========       ========


                       LIABILITIES AND PARTNERS' EQUITY
                       --------------------------------

LIABILITIES:

   Lease settlement reserve (Note 5)                         $  3,000       $  3,000
   Accounts payable and accrued expenses                          123             96
   Payable to affiliates (Note 7)                                 211            636
   Maintenance reserves collected (Notes 1 and 5)                 591          2,248
   Notes payable (Note 6)                                       4,751          4,751
     Deferred income and deposits (Note 5)                      2,584          3,779
     Distributions payable to partners                          2,943          2,989
                                                             --------       --------
     Total Liabilities                                         14,203         17,499
                                                             --------       --------

CONTINGENCIES (Notes 5, 6, 10, 12, 13 and 14)

PARTNERS' EQUITY:

   General Partners                                            (1,008)          (904)
   Limited Partners (7,255,000 units outstanding
     in 1997 and 1996)                                         45,078         55,444
                                                             --------       --------
     Total Partners' Equity                                    44,070         54,540
                                                             --------       --------
      Total Liabilities and Partners' Equity                 $ 58,273       $ 72,039
                                                             ========       ========
</TABLE>

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



                                      F-3
<PAGE>   30

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                             STATEMENTS OF INCOME
                             --------------------

             FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 and 1995
             ----------------------------------------------------

<TABLE>
<CAPTION>
                                               1997        1996          1995
                                            ----------   ----------   ----------
                                              (in thousands, except unit data
                                                    and per unit amounts)
<S>                                         <C>          <C>          <C>
REVENUE:
   Rentals from operating leases            $   12,183   $   15,231   $   14,026
   Interest                                        467          736          601
                                            ----------   ----------   ----------
                                                12,650       15,967       14,627
                                            ----------   ----------   ----------


EXPENSES:
   Depreciation and amortization                 7,863        9,701        9,662
   Writedowns (Note 5)                           1,400          100          450
   Management and re-lease fees (Note 7)           977        1,069        1,162
   Interest                                        455          674          839
   General and administrative (Note 7)             316          334          298
   Direct lease (Note 7)                           384          396          197
   Loss in value of securities (Note 5)             --          155           --
   Provisions for bad debts                         --          640           --
                                            ----------   ----------   ----------
                                                11,395       13,069       12,608
                                            ----------   ----------   ----------


NET INCOME                                  $    1,255   $    2,898   $    2,019
                                            ==========   ==========   ==========

NET INCOME ALLOCATED:
   To the General Partners                          13           29           20
   To the Limited Partners                       1,242        2,869        1,999
                                            ----------   ----------   ----------
                                            $    1,255   $    2,898   $    2,019
                                            ==========   ==========   ==========

NET INCOME PER LIMITED
   PARTNERSHIP UNIT                         $      .17   $      .40   $      .28
                                            ==========   ==========   ==========

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

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


                                      F-4
<PAGE>   31

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                        STATEMENTS OF PARTNERS' EQUITY
                        ------------------------------

             FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 and 1995
             ----------------------------------------------------

<TABLE>
<CAPTION>
                                              General     Limited
                                             Partners     Partners       Total
                                             --------     --------     --------
                                                      (in thousands)
<S>                                          <C>          <C>          <C>
Balance, December 31, 1994                   $   (719)    $ 73,792     $ 73,073

   Net income                                      20        1,999        2,019

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

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

   Net income                                      29        2,869        2,898

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

Balance, December 31, 1996                       (904)      55,444       54,540

   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
                                             ========     ========     ========
</TABLE>

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



                                      F-5
<PAGE>   32

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                           STATEMENTS OF CASH FLOWS
                           ------------------------

             FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 and 1995
             ----------------------------------------------------

<TABLE>
<CAPTION>
                                                    1997        1996        1995
                                                  --------    --------    --------
                                                         (in thousands)
<S>                                               <C>         <C>         <C>
 CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income                                     $  1,255    $  2,898    $  2,019
   Adjustments to reconcile net income to net
   cash
     provided by operating activities:
       Depreciation and amortization                 7,863       9,701       9,662
       Writedowns                                    1,400         100         450
       Provision for bad debts                          --         640          --
       Maintenance funds received from lessee
         in lease settlement                            --          --         557
       Loss from securities received in leasing
         transaction                                    --         155          --
       Change in assets and liabilities:
         Rent and other receivables                     53         711         590
         Other                                         (47)         77          56
         Accounts payable and accrued expenses          27         (98)         56
         Deferred income                            (1,751)       (449)      3,733
         Payable to affiliates                        (425)       (257)        442
         Unrestricted maintenance reserves
         collected                                     591          --          --
                                                  --------    --------    --------
            Net cash provided by operating
            activities                               8,966      13,478      17,565
                                                  --------    --------    --------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Capitalized aircraft costs                       (5,240)     (2,496)        (26)
   Lease settlement reserve                             --       3,000          --
   Lease settlement proceeds accounted for
   under the cost
     recovery method                                    --          --       1,565
   Repayment of advances by lessees                    363         448         422
                                                  --------    --------    --------
            Net cash (used in) provided by
            investing
                activities                          (4,877)        952       1,961
                                                  --------    --------    --------
</TABLE>

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


                                      F-6
<PAGE>   33

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                           STATEMENTS OF CASH FLOWS
                           ------------------------

       FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 and 1995 (continued)
       ----------------------------------------------------------------

<TABLE>
<CAPTION>
                                                    1997        1996        1995
                                                  --------    --------    --------
                                                        (in thousands)
 CASH FLOWS FROM FINANCING ACTIVITIES:
<S>                                               <C>         <C>         <C>
   Security deposits                              $    556          --          --
   Proceeds from notes payable                          --    $  4,751    $     --
   Repayment of notes payable                                   (6,638)       (744)
   Cash distributions paid to partners             (11,771)    (11,667)    (11,725)
   Other                                                --          --         385
                                                  --------    --------    --------
            Net cash used in financing
            activities                             (11,215)    (13,554)    (12,084)
                                                  --------    --------    --------

NET (DECREASE) INCREASE IN CASH AND
   CASH EQUIVALENTS                                 (7,126)        876       7,442

CASH AND CASH EQUIVALENTS AT
   BEGINNING OF YEAR                                12,831      11,955       4,513
                                                  --------    --------    --------

CASH AND CASH EQUIVALENTS AT END OF
   YEAR                                           $  5,705    $ 12,831    $ 11,955
                                                  ========    ========    ========

Supplemental schedule of cash flow information:

   Interest paid                                  $    456    $    719    $    841
                                                  ========    ========    ========
   Restricted maintenance reserves
   collected, net
     of maintenance drawdowns                     $     --    $    144    $    668
                                                  ========    ========    ========

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

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

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

Transfers from restricted cash utilized to
   restore aircraft                               $  2,248    $      --   $     --
</TABLE>

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


                                      F-7
<PAGE>   34

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                        NOTES TO FINANCIAL STATEMENTS
                        -----------------------------

                              DECEMBER 31, 1997
                              -----------------

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.

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

      Aircraft and Depreciation The aircraft are recorded at cost, which
includes acquisition costs and the acquisition fee and the financial management
advisory fee paid to the General Partners. Depreciation to an estimated salvage
value (in general, 10%) is computed using the straight-line method over an
estimated economic life of twelve years. Major improvements to aircraft are
capitalized when incurred and depreciated over the useful life of the
improvement. The Partnership evaluates these costs based upon changes in market
conditions in accordance with generally accepted accounting principles and
accordingly, records a writedown to recognize loss in the value of an aircraft
when the General Partners believe that the recoverability of the Partnership's
investment in an aircraft has been impaired. Proceeds received in lease
settlements are accounted for under the cost recovery method when based upon
third party appraisals and market conditions, there has been a diminution to the
carrying value of the aircraft.

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


                                      F-8
<PAGE>   35

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


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

      Maintenance Reserve Funds Two of the Partnership's former leases required
the lessee to make monthly payments to maintenance reserve funds administered by
the Partnership. These funds are included in restricted cash on the balance
sheets through December 31, 1996. Additionally the partnership entered into two
leases in 1997 which require the lessees to make maintenance reserve deposits
which can be drawn on a basis similar to the one described above.

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

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

      The Partnership received stock and rights to warrants of the lessee in
connection with two of its leases. The Partnership recorded the securities at
their estimated value and previously recognized a portion of such associated
income ratably over the respective lease terms. The Partnership stopped
recognizing such income in the fourth quarter of 1994 and wrote down the
securities to nominal value in 1996. (See Note 5, "Aircraft - Kiwi Bankruptcy").

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

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

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


                                      F-9
<PAGE>   36

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                     ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


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

      Statement 128

      FASB 128 had no impact on the Partnership's computation of per unit
values in any year presented.

      New Accounting Pronouncements, Issued But Not Yet Effective In June 1997,
the FASB issued 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 nonowner sources. The Partnership does not expect this pronouncement to
materially impact the reporting of the Partnership's results of operations.

2.    ORGANIZATION OF THE PARTNERSHIP
      -------------------------------

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

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

      Title to the aircraft owned by the Partnership is held by non-affiliated
trustees of trusts of which the Partnership is the beneficiary or one of two
beneficiaries. The purpose of this method of holding title is to satisfy certain
registration requirements of the Federal Aviation Administration.



                                      F-10
<PAGE>   37

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


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.

      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, 1997, the Partnership held short-term commercial paper
with various maturities as follows:

<TABLE>
<CAPTION>
                                                    Purchase
         Issuer               Purchase Date           Price         Par value
         ------               -------------           -----         ---------
                                                  (in thousands)  (in thousands)
<S>                         <C>                    <C>            <C>
 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
                                                   =============  =============
</TABLE>



                                      F-11
<PAGE>   38

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


 5.    AIRCRAFT
       --------

                          Net Investment in Aircraft
                          --------------------------

      The Partnership's net investment in aircraft as of December 31, 1997 and
1996 consisted of the following (in thousands):
<TABLE>
<CAPTION>
                                                            1997         1996
                                                         ---------    ---------
<S>                                                      <C>          <C>
 Aircraft on operating leases                            $ 103,990    $  77,189
 Less: Accumulated depreciation                            (55,513)     (39,518)
        Writedowns                                          (8,143)      (3,339)
                                                         ---------    ---------
                                                         $  40,334    $  34,332
                                                         ---------    ---------

 Aircraft held for lease or sale                         $  46,934    $  68,495
 Less: Accumulated depreciation                            (18,839)     (26,971)
        Writedowns                                          (5,659)      (9,007)
        Amounts received, including value of
          aircraft, in Lease Settlement accounted
          for under the cost recovery method               (10,115)     (10,115)
        Reserves for maintenance                              (557)        (557)
                                                         ---------    ---------
                                                            11,764       21,845
                                                         ---------    ---------
                                                         $  52,098    $  56,177
                                                         =========    =========
</TABLE>

                           Rent and Other Receivables
                           --------------------------

      Rents and other receivables composed the following at December 31, 1997
and 1996 (in thousands):

<TABLE>
<CAPTION>
                                                            1997         1996
                                                         ---------    ---------
<S>                                                      <C>          <C>
Rent receivables                                         $     494    $     440
Advances to lessees                                            516          879
Accrued interest and other                                      74           79
                                                         ---------    ---------
                                                             1,084        1,398
Allowance for bad debts                                       (640)        (640)
                                                         ---------    ---------

Rent and other receivables                               $     444    $     758
                                                         =========    =========
</TABLE>


                                      F-12
<PAGE>   39

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


                          Financial Terms of Leases
                          -------------------------

      a. Continental Airlines Leases During September 1989, the Partnership
acquired a McDonnell Douglas DC-10-10 aircraft for a total purchase price of
$18,301,000, subject to an operating lease with Continental. This lease was
modified in 1995 and 1996 as discussed below and at December 31, 1997, the
aircraft was subject to a lease scheduled to expire on June 30, 1998 which
provided for rentals of $150,000 per month.

      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 to the Partnership. Continental paid $150,000 of the $312,000 monthly
rental payment due in February through May 1995. The Partnership did not accrue
as rental revenue the difference between the amount due and the amount paid by
Continental for such months. Continental took the A-300 out of service in May
1995, and the 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 defaulted. The
Partnership recovered the A-300 aircraft and is currently remarketing it. The
Partnership estimates 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 will be applied towards such maintenance. However, subsequent to
December 31, 1997 the Partnership determined that the cost of market conditions
for this type of aircraft the recovery of its investment plus any incremental
investment would be problematic and the Partnership began entertaining purchase
offers. The Partnership provided a writedown of $1.1 million to reflect a
current purchase offer for the


                                      F-13
<PAGE>   40

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


airframe plus the appraisal value for 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 are currently discussing each
party's compliance with the return condition of the aircraft and the related
liability as well as Continental's compliance with the lease. The Partnership
entered into an agreement in principle to lease the aircraft for a term of four
years to TNT Transport International B.V. ("TNT") a foreign cargo carrier and
has begun to convert the aircraft to cargo configuration at a budgeted cost of
approximately $4,500,000, including a low gross weight hushkit.

      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 aircraft to June 30, 1998
at a lease rate of $150,000 per month. In late 1997 the Partnership and
Continental entered into discussions to extend the lease of the DC-10 aircraft
for a term of approximately 15 months at the same lease rate. (See Item 7,
"Management's Discussion of and Analysis of Financial Condition and Results of
Operations" and Item 8 Financial Statements, Footnote 13, "Commitments" for
further discussion of the Partnership's plans for this aircraft.)

      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.


                                      F-14
<PAGE>   41

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


      b. 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 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
being repaid in monthly installments through November 1998 with interest at a
fixed rate of 9.70%. At December 31, 1997, the balance of the receivable was
$140,000. All 1998 payments to date have been made by TWA.

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

      Upon execution of the lease amendment, the Partnership reimbursed TWA for
$225,000 of capital improvements which were made to the aircraft and advanced
$550,000 to TWA to finance certain major maintenance procedures, which is being
repaid 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 have been made by TWA.

      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


                                      F-15
<PAGE>   42

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


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. TWA has narrowed its losses and improved its liquidity although
it has yet to achieve substantial profitability. 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. While the Partnership's L-1011 has been advertised for lease and the
Managing General partner has made inquiries of potential lessees, there has been
little interest in the aircraft on the part of potential lessees. Given the
number of L-1011s that are currently available for lease or purchase and the
fact that the Partnership's L-1011 requires a significant maintenance check, the
General Partners believe it is likely that the Partnership will seek to sell the
aircraft and engines. The Partnership is reviewing alternatives for the use of
the proceeds received, including the use of the economic settlement to purchase
an additional aircraft or engines.

      At December 31, 1997 the L-1011 aircraft had economic value of
approximately $1.7 million (net book value of $5.8 million adjusted for the $3
million economic settlement accounted for on the cost recovery basis on the
balance sheets and the unearned portion of the L-1011 Lease Prepayment reflected
as deferred income at December 31, 1997, and a writedown of aircraft of $300,000
to reflect current market value of the aircraft).

      c. 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 October 31, 1999 (with
Aeromexico given the right subject to notice to extend to February 2000) and one
of which was extended to February 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


                                      F-16
<PAGE>   43

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


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.

      d. USAirways ("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 US Air which is scheduled to expire 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). USAir also has three additional one-year
renewal options at fair market rental rates. USAir may elect to purchase the
aircraft at its fair market value at the end of any renewal term.

      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, amount other things, acts or
omissions by the Trust, breach of covenants by the Trust under the TBT lease,
loss or damage to the aircraft or use of the aircraft outside the United States.
The TBT lease requires that a letter of credit be posted to collateralize this
obligation. The Partnership is obligated for one-half the annual cost of the
letter of credit as well as any calls on the letter of credit.

      The letter of credit has a current face amount of approximately $1.2
million. The letter of credit agreement obligated the Partnership to deposit
$35,000 per quarter (beginning on June 1, 1992) as cash collateral to
collateralize the Partnership's obligation under the letter of credit agreement.
In July 1995, the Partnership consummated an agreement with the issuer of the
letter of credit under which the issuer released its interest in substantially
all of the cash in the cash collateral account and eliminated the requirement
for future deposits to such account.

      Under the operating lease, the lessee, USAir, Inc., has assumed all
liabilities, indemnities and obligations of the Trust to the tax lessor under
the TBT lease and has agreed to indemnify the Trust for any liability, indemnity
or obligation to the tax lessor under the TBT lease except for liability
resulting from breaches by the Trust of covenants under the operating lease. US
Air has not posted a letter of credit to collateralize this obligation. As a
result of the foregoing, if the tax


                                      F-17
<PAGE>   44

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


lessor draws on the letter of credit as a result of an action by the lessee, the
Partnership and Pegasus Aircraft Partners, L.P., through the Trust, will be
responsible for the loss to the tax lessor until and if the lessee performs
under its indemnification. There have been no calls against the letter of credit
through December 31, 1997.

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

      e. Kiwi International Air Lines, Inc. - Bankruptcy In 1993, the
Partnership leased its two Boeing 727-200 aircraft to Kiwi. The aircraft were
originally purchased in 1989 (Non-advanced) and 1990 (Advanced) for purchase
prices of $6,261,000 and $10,748,000, respectively (including related fees). The
leases 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 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. The Partnership was subject to
significant restrictions on its ability to dispose of these securities. Based
upon the price at which Kiwi sold similar securities to unrelated third parties,
the Partnership originally recorded the securities at a value of $600,000. The
securities were valued at approximately $1,000 at December 31, 1997 and December
31, 1996 (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


                                      F-18
<PAGE>   45

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------

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 cash
reserves previously generated.

      During 1996, inpart because of the grounding of certain aircraft by the
FAA as the result of pilot handbook deficiencies and the market reaction to the
ValuJet incident, 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 (excluding the cost of the heavy maintenance check being completed prior to
delivery to Falcon Air Express Inc. discussed below). 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 late 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 assets
of Kiwi. Based upon the approved purchase price, it is likely that the
Partnership will have little or no recovery of its bankruptcy claims.

      f. 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


                                      F-19
<PAGE>   46

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------

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.

      g. Capital Cargo International Airlines, Inc. Lease In January 1997, the
Partnership entered into an agreement in principle with Capital Cargo
International Airlines, Inc. ("Capital"), a start-up freight carrier, with
respect to the 727-200 advanced aircraft formerly leased to Kiwi. The
Partnership agreed to 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 $3 million) at which time
the lease rate increases to $139,000 per month. The Capital Lease requires
Capital to fund maintenance reserves monthly at a rate of $377 per flight hour.
Capital provided a security deposit of $50,000 and is obligated to add $17,000
per month to the security deposit during the lease term until the deposit totals
$220,000. The lease was executed and aircraft was delivered to Capital in July
1997.

      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.


                                      F-20
<PAGE>   47

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


Significant Lessees
-------------------

      The Partnership leased its aircraft to six different airlines during 1997.
Revenues from each of airlines which accounted for greater than 10% of the
Partnership's total rental revenue during 1997, 1996 and 1995 are as follows:

<TABLE>
<CAPTION>
      Airlines                            Percentage of Rental Revenue(2)
      --------                            -------------------------------
                                          1997        1996(1)       1995
                                          ----        -------       ----
<S>                                        <C>          <C>          <C>
      Continental Airlines, Inc.*          33%         44%           33%
      Trans World Airlines, Inc.           30           25           27
      Aerovias de Mexico S.A. de C.V.      15           12           13
      Kiwi International Air Lines, Inc.    -           11           15
</TABLE>

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

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

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

      Revenues include rentals from aircraft leased to foreign airlines or
carriers of $1,851,000 $1,872,000 and $2,376,000 in 1997, 1996 and 1995
respectively.

                         Future Minimum Rental Income
                         ----------------------------

      The following is a schedule by year of future minimum rental income under
the leases as of December 31, 1997 (in thousands):

<TABLE>
<CAPTION>
                          Year                Amount
                          ----                ------
<S>                                           <C>
                          1998                $9,639
                          1999                 7,909
                          2000                 6,332
                          2001                 5,534
                          2002                 4,208
                          Thereafter           8,490
                                             -------
                          Total              $42,112
                                             =======
</TABLE>


      The above schedule of future minimum rental income does not include rental
income which would result from the renewal of existing leases or the re-leasing
of the aircraft, unless the renewal has been exercised.


                                      F-21
<PAGE>   48

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


      The Partnership operates in one industry, the leasing of used aircraft to
commercial 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 outstanding principal is
due. The loan provides for interest at a rate of 1% over the lender's prime rate
of interest (9.50% at December 31, 1997) and is payable monthly. The Partnership
must maintain a minimum balance outstanding of $4,000,000 during the loan
commitment period. The loan is collateralized by the Partnership's interest in
the MD-82 aircraft leased to TWA and the two 727-200 advanced aircraft leased to
Continental. The Partnership utilized $4,751,000 to pay off its prior two
facilities.

7.    TRANSACTIONS WITH AFFILIATES
      ----------------------------

      Management Fees The General Partners are entitled to a quarterly
subordinated base management fee in an amount generally equal to 1.5% of gross
aircraft rentals, net of re-lease fees paid. Of this amount, 1.0% is payable to
the Managing General Partner and 0.5% is payable to the Administrative General
Partner. During the years ended December 31, 1997, 1996 and 1995, the General
Partners earned base management fees of $179,000, $219,000 and $230,000,
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, 1997, 1996 and 1995, the General Partners
earned incentive management fees of $495,000, $598,000 and $645,000,
respectively.

      Re-lease Fee The General Partners are entitled to a quarterly subordinated
fee for re-leasing aircraft or renewing a lease in an amount equal to 3.5% of
the gross rentals from such re-lease or renewal for each quarter for which such
payment is received. Of this amount, 2.5% is payable to the Managing General
Partner and 1.0% is payable to the Administrative General Partner. During the
years ended December 31, 1997, 1996 and 1995, the General Partners earned
re-lease fees of $303,000, $252,000 and $287,000, respectively.


                                      F-22
<PAGE>   49

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                             DECEMBER 31, 1997
                              -----------------


      Beginning July 1, 1995, the Administrative General Partner deferred the
receipt of fees it was otherwise entitled to. As part of the Class action
settlement (discussed in Note 10, "Litigation"), these fees as well as 1996 and
all future fees and distributions earned by the Administrative General Partner
have been assigned by an affiliate to an escrow account for the benefit of the
class action members.

      Accountable Expenses The General Partners are entitled to reimbursement of
certain expenses paid on behalf of the Partnership which are incurred in
connection with the administration and management of the Partnership. Such
reimbursable expenses amounted to $75,000 in each of the years ended December
31, 1997, 1996 and 1995, all of which was paid to the Administrative General
Partner.

      Other During 1997 and 1996, the Partnership paid $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 1997 and 1996 the
Partnership paid $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. In 1995, the Partnership purchased certain equipment and parts
relating to the integration of the A-300 aircraft to Akdeniz (see Footnote 9).
Such amount was recovered from Continental and Akdeniz.



                                      F-23
<PAGE>   50

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


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):

<TABLE>
<CAPTION>
                                                          1997        1996        1995
                                                        --------    --------    --------
<S>                                                     <C>         <C>         <C>
Net income per financial statements                     $  1,255    $  2,898    $  2,019
Increase (decrease) resulting from:
   Depreciation                                           (4,547)     (3,381)     (3,286)
   TBT interest income less
    TBT rental expense                                      (932)       (742)       (590)
   Reserves for maintenance costs, net of maintenance
    expense and writedowns of aircraft                     1,400         244       1,810
   Maintenance reserve payable                               590       3,000          --
   Deferred rental income                                 (1,686)       (449)      3,733
   Provisions for bad debts                                   --         640          --
   Loss on value of stock                                                155          --
   Lease settlement payment, including lease aircraft
    received accounted for under the cost
    recovery method                                           --          --      10,115
   Other                                                     123        (161)        187
                                                        --------    --------    --------
Taxable (loss) income per federal income tax return     $ (3,797)   $  2,204    $ 13,988
                                                        ========    ========    ========
</TABLE>


                                      F-24
<PAGE>   51


                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------

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

<TABLE>
<CAPTION>
                                                       1997        1996       1995
                                                    --------    --------    --------
<S>                                                 <C>         <C>         <C>
Total Partnership equity per financial statements   $ 44,070    $ 54,540    $ 63,367
Increase (decrease) resulting from:
  Commission and expenses paid
   in connection with the sale of limited
   partnership units                                  16,295      16,295      16,295
  Distributions payable to partners                    2,943       2,989       2,931
  Reserves for maintenance costs and
   writedowns                                         20,276      18,286      15,042
  Deferred income                                      2,028       3,733       4,672
  Accumulated depreciation                           (38,712)    (34,165)    (30,784)
  TBT interest income less TBT rental expense        ( 3,881)     (2,949)     (2,207)
  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                                                  354         254         368
                                                     --------    --------    --------
Tax bases of net assets                              $54,727    $ 70,337    $ 79,799
                                                     --------    --------    --------
</TABLE>

9.    LESSEE DEFAULT
      --------------

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


                                      F-25
<PAGE>   52


                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


collection efforts, which were applied against rents receivable. Akdeniz has
ceased operations. The Partnership applied the security deposit against the
remaining unpaid 1995 rents as well as certain integration costs, repossession
costs and legal expenses.

 10.   LITIGATION (See Also Note 5)

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

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

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

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


                                      F-26
<PAGE>   53

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


$125 million and additional consideration to class members. The investors who
had objected to the settlement have appealed the District Court's approval to
the United States Court of Appeals for the Second Circuit. In July 1997, the
U.S. Court of Appeals for the Second Circuit affirmed the District Court's
approval of the settlement. The District Court must still determine the extent
of attorneys fees to be awarded to plaintiffs' counsel which will be paid from
the settlement fund, so that the remainder of the monies can be distributed to
class members.

      In April 1995, two investors in the Pegasus limited partnerships filed a
purported class action in the Circuit Court of the State of Illinois for Cook
County entitled Robert M. Jacobson, et al. v. PaineWebber, Inc. et al., making
allegations substantially similar to those in the New York Limited Partnership
Actions, but limited in subject matter to the sale of the Pegasus partnerships,
and without a RICO claim.

      Three actions were filed in the District Court for Brazoria County, Texas,
relating to the sale and sponsorship of interests in the Partnership and an
affiliated partnership. The complaints made state law claims, specifically,
common law fraud, conspiracy, violations of section 27.01 of the Texas Business
and Commerce Code, fraud in the inducement, negligent misrepresentation,
negligence, breach of fiduciary duty, violations of the Texas Securities Act,
and violations of the Texas Deceptive Trade Practices Act. The plaintiffs sought
unspecified damages, including attorneys' fees, reimbursement for all sums
invested by them in the partnerships, exemplary damages, and treble damages
under the Texas Deceptive Trade Practices Act. All three actions were removed to
federal court and two were transferred to the United States District Court for
the Southern District of New York and consolidated under the title, Mallia vs.
PaineWebber, Inc. The third action was dismissed with the consent of the parties
on the grounds that it was duplicative of the two actions that were before the
federal court in New York.

      In February 1996, approximately 230 plaintiffs filed an action entitled
Abbate v. PaineWebber Inc. in Sacramento, California Superior Court against
PaineWebber Incorporated and various affiliated entities concerning the
plaintiff's purchase of various limited partnership interests. The complaint
alleged, among other things, that PaineWebber and its related entities committed
fraud and misrepresentation and breached fiduciary duties allegedly owed to the
plaintiffs by selling or promoting limited partnership investments that were
unsuitable for the plaintiffs and by overstating the benefits, understanding the
risks and failing to state material facts concerning the investments. The
complaint sought compensatory damages of $15 million plus punitive damages. In
September 1996, the California Superior Court dismissed many of the plaintiff's
claims as barred by the applicable statutes of limitation.


                                      F-27
<PAGE>   54


                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


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

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

      The Partnership was also involved in litigation with the company that
acted as Kiwi's engine manager regarding each party's compliance with a
settlement agreement to facilitate the recovery of the aircraft and engines. The
parties achieved a negotiated settlement in May 1997 with the payment by the
Partnership of amounts due and the receipt by the Partnership of certain
equipment.

11.   FAIR VALUE OF FINANCIAL INSTRUMENTS
      -----------------------------------

      SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires disclosure of fair value of certain financial instruments, whether or
not reported in the balance sheet. Where quoted market prices are 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 case flows. In addition,
because SFAS No. 107 excludes certain assets such as leased aircraft owned by
the Partnership, the aggregate fair value amounts discussed below do not purport
to represent and should not be considered representative of the underlying
market value of the Partnership.

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

      Cash equivalents rents and other receivables. For these balances, carrying
value approximates fair value due to their short-term nature.


                                      F-28
<PAGE>   55

                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


      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.

12.   CONTINGENCY
      -----------

      Impact of the Year 2000 issue. The Year 2000 issue is the result of
computer programs being written during two digits rather than four to define the
applicable year. This could result in a system failure or miscalculations in the
year 2000 causing disruptions of operations of the Partnership, its lessees, or
general partners.

      The Partnership has already reviewed and identified its computer software
that are subject to Year 2000 risk. Accordingly, the Partnership has commenced
the remediation of all software not Year 2000 compliant. Remediation and testing
of such systems will be completed in advance of Year 2000. The costs of such
remediation is expensed as incurred and will not be material to the
Partnership's financial position or results of operations.

      The Partnership has also initiated communication with lessees and vendors
to determine the extent to which the Partnership is vulnerable to those third
parties' failure to remediate their own Year 2000 issues. The Partnership has
not yet completed its communication with its lessees and vendors. As a result,
the Partnership can not determine at this time the extent, if any, the
Partnership may be exposed to financial risk from the inability of the Company's
lessees and vendors to remediate their own Year 2000 issues.

13.   COMMITMENTS
      -----------

      In the fourth quarter of 1997, the Partnership entered into discussions
regarding the lease of the DC 10-10 aircraft, the lease of which is scheduled to
expire on June 30, 1998. Continental Micronesia agreed in principle to extend
the lease for an additional fifteen months (through September 30, 1999) at the
current lease rate ($150,000 per month). Upon the expiration of the extended
lease, the Partnership would 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 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, the three additional two
year renewal options at the then fair market rental. Emery provided a security
deposit of $109,000 at December 31, 1997.


                                      F-29
<PAGE>   56


                      PEGASUS AIRCRAFT PARTNERS II, L.P.
                      ----------------------------------

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                   -----------------------------------------

                              DECEMBER 31, 1997
                              -----------------


      The workscope under the aircraft modification agreement requires the
investment of approximately $8.0 million. Additionally, the Partnership is
committed in 1999, to fund the hushkit for the 727 leased to Capital, which is
expected to cost approximately $3 million. The Partnership currently has $5.2
million available under its borrowing facility (see Note 14 "Subsequent Event").

14.   SUBSEQUENT EVENT
      ----------------

       In early 1998, Continental returned one 727-200 ADV aircraft the lease of
which expired January 31, 1998. The Partnership and Continental continue to
discuss Continental's compliance with return conditions required by the lease.
Continental believes that the airframe exceeded return conditions and that the
engines net the aggregate return condition requirements; the Partnership
believes that the engines failed to meet return conditions and agree generally
regarding the airframe. The ultimate resolution is unknown at this time. The
Partnership entered into an agreement in principle to deliver this aircraft to
TNT Transport International B.V. for a term of approximately four years and
agreed to convert the aircraft to cargo configuration and hushkit the engineers
at a budgeted cost of approximately $4.5 million. In all, the Partnership has
capital commitments of $15.5 million and has commenced discussions with its
lender to increase the amounts available under the existing borrowing facility.

      To the extent that the Partnership is unable to increase its loan
facilities or aircraft addition borrowings, the Partnership may have to utilize
cash from operation to finance these obligations, potentially reducing
distributions to partners.


                                      F-30
<PAGE>   57

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 1997, 1996 and
1995.


                                       25
<PAGE>   58

                                   PART III
                                   --------


Item 10.    Directors and Executive Officers of the Registrant
            --------------------------------------------------

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

                   Pegasus Aircraft Management Corporation
                   ---------------------------------------
<TABLE>
<CAPTION>
      Name                    Positions Held
      ----                    --------------
<S>                           <C>
      Richard S. Wiley        President and Chairman of the Board
      Carol L. Chase          Senior Vice President, General Counsel and Secretary
      Robert M. Brown         Senior Vice President
      Richard L. Funk         Senior Vice President, Technical
</TABLE>

      Richard S. Wiley, age 44, is President and Chairman of the Board of the
Managing General Partner and Pegasus Capital Corporation, which was formed in
1988. Prior to forming Pegasus Capital Corporation, Mr. Wiley was a Vice
President of CIS Corporation ("CIS"), a wholly owned subsidiary of Continental
Information Systems Corporation ("Continental") for the period 1986 to 1988. Mr.
Wiley originated aircraft transactions throughout the world and sold aircraft to
third-party investors. From 1985 to 1986, Mr. Wiley worked as Treasurer of
Caterpillar Capital Company in San Diego, California. From 1983 to 1985, he
served as Managing General Partner and President of RAM Financial Corporation in
Houston, Texas, an equipment leasing venture capital company. Prior to joining
RAM, he worked for GATX Leasing Corporation as a District Manager from 1980 to
1983. Mr. Wiley received a B.S. degree from the Indiana University School of
Business and an M.B.A. from the University of California, Los Angeles.

      Carol L. Chase, Esq., age 45, 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.


                                       26
<PAGE>   59

      Robert M. Brown, 39, 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, 60, 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.

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

      Gerald F. Goertz, Jr., age 40, 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 48, 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.


                                       27
<PAGE>   60

      Stephen R. Dyer, age 38, is a Vice President, Assistant Secretary and a
Director of the Administrative General Partner. He joined PaineWebber
Incorporated in June 1988 as a Divisional Vice President and is currently a
Corporate Vice President and Director of Private Investments. Prior to joining
PaineWebber Incorporated, Mr. Dyer had been employed, since June 1987, as an
Assistant Vice President in the Retail National Products Group of L.F.
Rothschild & Co. Incorporated. Prior to joining L.F. Rothschild he was employed,
beginning in January 1985, as an Associate in the Real Estate Department of
Thomson McKinnon Securities Inc. From July 1981 to August 1983, Mr. Dyer was on
the audit staff of the accounting firm of Arthur Young & Co. He received his
Bachelor of Science degree in Accounting in 1981 from Boston College and a
Masters of Business Administration from Indiana University in December 1984. Mr.
Dyer is a Certified Public Accountant.

      Joseph P. Ciavarella, age 42, is a Vice President, Secretary, Treasurer
and Chief Financial and Accounting Officer of the Administrative General
Partner. He joined PaineWebber Incorporated in May 1994 as a Corporate Vice
President. Prior to joining PaineWebber Incorporated, he was affiliated with
Aviation Capital Group in the area of aircraft finance. He was associated with
Integrated Resources, Inc. from 1983 to 1993 as a first vice president as well
as a divisional senior vice-president and chief financial officer of the
equipment leasing, aircraft finance and venture capital areas. He has a Bachelor
of Business Administration degree in Accounting from Hofstra University and is a
Certified Public Accountant.


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 1997.


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.


                                       28
<PAGE>   61


      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, 1998.

<TABLE>
<CAPTION>
                                              Amount and Nature
                                                Of Beneficial        Percent
                             Name                 Ownership         of Class
                    ----------------------    -----------------     --------
<S>                                           <C>                   <C>
                    Pegasus Aircraft
                    Management Corporation
                    ----------------------


                        Richard S. Wiley            29,501              *

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

                    Air Transport Leasing, Inc.
                    ---------------------------

                        None

</TABLE>

                    *Less than 1% of class.

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


                                       29
<PAGE>   62

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 1997.

      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 1997, the General Partners earned base management fees of
$179,000.

      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 $495,000
during 1997.

      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 $303,000 during 1997.

      Accountable Expenses The General Partners are entitled to reimbursement of
certain expenses paid on behalf of the Partnership which are incurred in
connection with the administration and management of the Partnership. Such
reimbursable expenses amounted to $75,000 during 1997, all of which was paid or
accrued to the Administrative General Partner.

      Other In 1997, 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 $2,308,000. During 1997, the Partnership paid $1,694,000 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 1997. In addition, $38,000 of the Partnership's net taxable (loss) for
1997 was allocated to the General Partners.


                                       30
<PAGE>   63

                                   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, 1997, the Partnership filed a
            report on Form 8-K dated November 24, 1997 reporting the resignation
            of two officers and directors of the Managing General Partner and
            the election of two senior officers, by the Managing General
            Partner.

      (c)   Exhibits required to be filed.

      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.*


                                       31
<PAGE>   64

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

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

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

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

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

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

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

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


                                       32
<PAGE>   65

      (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.*


                                       33
<PAGE>   66

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

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

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

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

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


                                       34
<PAGE>   67

      (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).*


                                       35
<PAGE>   68

      (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.*


                                       36
<PAGE>   69

      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.*


                                       37
<PAGE>   70

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

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

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

      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.*


                                       38
<PAGE>   71

      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 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,

                                       39
<PAGE>   72

                  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 10.8(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.*


                                       40
<PAGE>   73

      (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.*

      (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.*


                                       41
<PAGE>   74

      (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


                                       42
<PAGE>   75


                  Utah, National Association and Pegasus Aircraft Partners II,
                  L.P., as Mortgagor, and Greyhound Financial Corporation, as
                  Mortgagee. Filed as Exhibit 10.1(g) to the Registrant's
                  Quarterly Report on Form 10-Q for the quarter ended September
                  30, 1992.*

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

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

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

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

      (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 N357KP.*

      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.


                                       43
<PAGE>   76

      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.



                                       44
<PAGE>   77

                                  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 ___, 1998

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

                     By:  Air Transport Leasing, Inc.
                          Administrative General Partner

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

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

                     By:  Pegasus Aircraft Management Corporation
                          Managing General Partner

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



                                       45
<PAGE>   78

      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 ___, 1997.


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

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


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

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

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



                                       46
<PAGE>   79

                             PARTNERSHIP INFORMATION
                             -----------------------


Pegasus Aircraft Partners II, L.P.
2424 South 130th Circle
Omaha, Nebraska  68144-2596
(800) 234-7342


General Partners
Pegasus Aircraft Management Corporation
Air Transport Leasing, Inc.


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


Legal Counsel
Derenthal & Dannhauser
San Francisco, California


Transfer Agent
Service Data Corporation
Omaha, Nebraska


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


                                       49