<PAGE>

=============================================================================

                UNITED STATES SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

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

                                   FORM 10-Q/A

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

                  FOR QUARTERLY PERIOD ENDED FEBRUARY 28, 1999

                                       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: 0-25880

                            ILM II LEASE CORPORATION
             (Exact name of registrant as specified in its charter)

         VIRGINIA                                   04-3248639
-------------------------------                 -------------------
(State or other jurisdiction of                  (I.R.S. Employer
incorporation or organization)                   Identification No.)

8180 GREENSBORO DRIVE, SUITE 850, MCLEAN, VA           22102
---------------------------------------------  -----------------------
  (Address of principal executive office)            (Zip Code)

Registrant's telephone number, including area code:  (888) 257-3550
                                                     --------------

      Securities registered pursuant to Section 12(b) of the Act:

                                         Name of each exchange on
TITLE OF EACH CLASS                          which registered
-------------------                      -------------------------
     None                                          None

    Securities registered pursuant to Section 12(g) of the Act:

                SHARES OF COMMON STOCK $.01 PAR VALUE
                          (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 ___No _X__

Shares of common stock outstanding as of February 28, 1999:  5,180,952.

=============================================================================

                            Page 1 of 20

<PAGE>

                      ILM II LEASE CORPORATION

                               INDEX
<TABLE>
<CAPTION>

Part I.  Financial Information                                                                              PAGE

         <S>      <C>                                                                                         <C>
         Item 1.  Financial Statements

                  Balance Sheets
                  February 28, 1999 (Unaudited) and August 31, 1998............................................4

                  Statements of Income
                  For the six  months and three months ended February 28, 1999 and 1998 (Unaudited)............5

                  Statements of Changes in Shareholders' Equity
                  For the six months ended February 28, 1999 and 1998 (Unaudited)..............................6

                  Statements of Cash Flows
                  For the six months ended February 28, 1999 and 1998 (Unaudited)..............................7

                  Notes to Financial Statements (Unaudited).................................................8-12

         Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations....13-17

Part II.  Other Information...................................................................................18

         Item 6.  Exhibits and Reports on Form 8-K............................................................18

Signatures....................................................................................................19
</TABLE>


                                       -2-

<PAGE>

                              ILM II LEASE CORPORATION

<TABLE>
<CAPTION>

PART I.  FINANCIAL INFORMATION
         <S>      <C>
         Item I.  Financial Statements
                  (See next page)

</TABLE>



                                       -3-

<PAGE>

                          ILM II LEASE CORPORATION

                               BALANCE SHEETS
             February 28, 1999 (Unaudited) and August 31, 1998
               (Dollars in thousands, except per share data)

                             ASSETS

<TABLE>
<CAPTION>
                                                                  FEBRUARY 28, 1999           AUGUST 31, 1998
                                                                  -----------------           ---------------
<S>                                                                     <C>                         <C>
Cash and cash equivalents                                               $  1,167                    $1,497
Accounts receivable, net                                                     145                        89
Accounts receivable - related party                                          102                       102
Prepaid expenses and other assets                                             48                        50
Tax refund receivable                                                         27                       158
                                                                          -------                   -------
      Total current assets                                                 1,489                     1,896

Furniture, fixtures and equipment                                            939                       783
      Less:  accumulated depreciation                                       (344)                     (225)
                                                                          -------                   ------
                                                                             595                       558

Deposits                                                                       9                         9
Deferred tax asset, net                                                       88                       270
                                                                          ------                    ------
                                                                          $2,181                    $2,733
                                                                          ======                    ======


                                      LIABILITIES AND SHAREHOLDERS' EQUITY

Accounts payable and accrued expenses                                    $   678                   $   789
Termination fee payable                                                        -                       650
Real estate taxes payable                                                    103                       209
Accounts payable - related party                                             332                       287
Security deposits                                                             36                        25
                                                                          ------                    ------
      Total current liabilities                                            1,149                     1,960

Deferred rent payable                                                         62                        76
                                                                          ------                    ------
      Total liabilities                                                    1,211                     2,036

Shareholders' equity:
       Common stock, $0.01 par value, 20,000,000 shares
           authorized 5,180,952 issued and outstanding                        52                        52
       Additional paid-in capital                                            448                       448
       Retained earnings                                                     470                       197
                                                                          ------                    ------
              Total shareholders' equity                                     970                       697
                                                                          ------                    ------
                                                                          $2,181                    $2,733
                                                                          ======                    ======
</TABLE>


                            See accompanying notes.


                                       -4-

<PAGE>

                            ILM II LEASE CORPORATION

                             STATEMENTS OF INCOME
For the six months and three months ended February 28, 1999 and 1998 (Unaudited)
               (Dollars in thousands, except per share data)


<TABLE>
<CAPTION>
                                                                Six Months Ended            Three Months Ended
                                                                  February 28,                 February 28,
                                                                  ------------                 ------------
                                                                  1999            1998          1999           1998
                                                                  ----            ----          ----           ----

<S>                                                              <C>            <C>           <C>            <C>
REVENUES:
   Rental and other income                                       $8,122         $7,600        $4,085         $3,868
   Interest income                                                    7             12             4              7
                                                               --------         ------      --------       --------
                                                                  8,129          7,612         4,089          3,875
EXPENSES:

   Facilities lease  rent expense                                 2,644          2,446         1,333          1,254
   Dietary salaries, wages and food service expenses              1,366          1,320           675            657
   Administrative salaries, wages and expenses                      597            570           315            287
   Marketing salaries, wages and expenses                           323            332           153            165
   Utilities                                                        527            522           254            253
   Repairs and maintenance                                          286            251           156            131
   Real estate taxes                                                262            308           128            125
   Property management fees                                         547            444           323            239
   Other property operating expenses                                708            694           349            349
   General and administrative expenses                              118            106            60             57
   Directors compensation                                            27             34            13             18
   Professional fees                                                151            316           (20)           194
   Depreciation expense                                             118             44            72             21
                                                                 ------          -----         -----          -----
                                                                  7,674          7,387         3,811          3,750
                                                                  -----          -----         -----          -----

Income before taxes                                                 455            225           278            125

Income tax expense:

   Current                                                            -            235             -             50
   Deferred                                                         182          (145)           111              -
                                                                    ---          -----           ---          -----
                                                                    182            90            111             50
                                                                    ---          -----           ---          -----

NET INCOME                                                       $  273         $  135        $  167          $  75
                                                                 ======         ======        ======          =====
Basic earnings per share of common stock                         $ 0.05         $ 0.03        $ 0.03          $0.01
                                                                 ======         ======        ======          =====
</TABLE>

The above earnings per share of common stock is based upon the 5,180,952 shares
outstanding for each period.

                      See accompanying notes.

                                       -5-

<PAGE>

                          ILM II LEASE CORPORATION

                 STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
        For the six months ended February 28, 1999 and 1998 Unaudited)
               (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                       Common Stock             Additional
                                      $.01 PAR VALUE              Paid-In         Retained
                                    Shares             Amount     Capital         Earnings               Total
<S>                               <C>                   <C>            <C>               <C>             <C>
Balance at August 31, 1997        5,180,952             $ 52             $448            $219            $ 719

Net Income                                -                -                -             135              135
                                  ---------            -----           ------            ----            -----
Balance at February 28, 1998      5,180,952             $ 52             $448            $354            $ 854
                                  =========            =====           ======            ====            =====
Balance at August 31, 1998        5,180,952             $ 52             $448            $197            $ 697

Net Income                                -                -                -             273              273
                                  ---------            -----           ------            ----            -----

Balance at February 28, 1999      5,180,952             $ 52             $448            $470            $ 970
                                  =========            =====           ======            ====            =====
</TABLE>



                             See accompanying notes.

                                       -6-

<PAGE>

                            ILM II LEASE CORPORATION

                            STATEMENTS OF CASH FLOWS
      For the six months ended February 28, 1999 and 1998 (Unaudited)
                            (Dollars In thousands)

<TABLE>
<CAPTION>
                                                                             SIX MONTHS ENDED
                                                                               FEBRUARY 28,

                                                                                  1999           1998
                                                                                  ----           ----

<S>                                                                             <C>              <C>
Cash flows from operating activities:
   Net income                                                                   $ 273            $ 135
   Adjustments to reconcile net income to net cash (used in) provided by
       operating activities:
          Depreciation expense                                                    118               44
          Deferred tax expense (benefit)                                          182             (145)
          Changes in assets and liabilities:
            Accounts receivable, net                                              (56)              54
            Accounts receivable - related party                                     -              (64)
            Prepaid expenses and other assets                                       2              241
            Tax refund receivable                                                 131                -
            Accounts payable and accrued expenses                                (111)              44
            Accounts payable - related party                                       45              429
            Termination fee payable                                              (650)               -
            Real estate taxes payable                                            (106)             (96)
            Income taxes payable                                                    -              101
            Deferred rent payable                                                 (14)               -
            Security deposits, net                                                 11               (7)
                                                                                  ---              ---
               Net cash (used in) provided by operating activities               (175)             736

Cash flows from investing activities:
       Additions to furniture, fixtures and equipment                            (157)             (68)
                                                                                 ----             ----
            Net cash used in investing activities                                (157)             (68)

Net (decrease) increase in cash and cash equivalents                             (330)             668

Cash and cash equivalents, beginning of period                                  1,497            1,156
                                                                                -----            -----

Cash and cash equivalents, end of period                                       $1,167           $1,824
                                                                               ======           ======
SUPPLEMENTAL DISCLOSURE:

Cash paid during the period for state income taxes                             $    3           $    -
                                                                               ======           ======
</TABLE>


                                              See accompanying notes.

                                       -7-

<PAGE>

                            ILM II LEASE CORPORATION
                  Notes to Financial Statements (Unaudited)

1.    GENERAL

         The accompanying financial statements, footnotes and discussions should
     be read in conjunction with the financial statements and footnotes
     contained in ILM II Lease Corporation's (the "Company") Annual Report on
     Form 10-K for the year ended August 31, 1998. In the opinion of management,
     the accompanying interim financial statements, which have not been audited,
     reflect all adjustments necessary to present fairly the results for the
     interim periods. All of the accounting adjustments reflected in the
     accompanying interim financial statements are of a normal recurring nature.

         The accompanying financial statements have been prepared on the accrual
     basis of accounting in accordance with U.S. generally accepted accounting
     principles for interim financial information, which requires management to
     make estimates and assumptions that affect the reported amounts of assets
     and liabilities and disclosures of contingent assets and liabilities as of
     February 28, 1999, and revenues and expenses for each of the six- and
     three-month periods ended February 28, 1999 and 1998. Actual results may
     differ from the estimates and assumptions used. Certain numbers in the
     prior period's financial statements have been reclassified to conform to
     the current period's presentation. The results of operations for the six-
     and three-month periods ended February 28, 1999, are not necessarily
     indicative of the results to be expected for the year ended August 31,
     1999.

         The Company was incorporated on September 12, 1994 under the laws of
     the State of Virginia by ILM II Senior Living, Inc., a Virginia finite-life
     corporation ("ILM II"), formerly PaineWebber Independent Living Mortgage
     Inc. II, to operate six rental housing projects that provide
     independent-living and assisted-living services for independent senior
     citizens ("the Senior Housing Facilities") under a facilities lease
     agreement dated September 1, 1995 (the "Facilities Lease Agreement"),
     between the Company, as lessee, and ILM II Holding, Inc. ("ILM II
     Holding"), as lessor, and a direct subsidiary of the ILM II. The Company's
     sole business is the operation of the Senior Housing Facilities. ILM II
     made mortgage loans to Angeles Housing Concepts, Inc. ("AHC") secured by
     the Senior Housing Facilities between July 1990 and July 1992. In March
     1993, AHC defaulted under the terms of such mortgage loans and in
     connection with the settlement of such default, title to the Senior Housing
     Facilities was transferred, effective April 1, 1994, to certain indirect
     subsidiaries of ILM II, subject to the mortgage loans. Subsequently, these
     property-owning subsidiaries were merged into ILM II Holding. As part of
     the fiscal 1994 settlement agreement with AHC, AHC was retained as the
     property manager for all of the Senior Housing Facilities pursuant to the
     terms of a management agreement, which was assigned to the Company as of
     September 1, 1995 and subsequently terminated in July 1996. ILM II is a
     public company subject to the reporting obligations of the Securities and
     Exchange Commission.

         In July 1996, following termination of the property management
     agreement with AHC, the Company entered into a property management
     agreement (the "Management Agreement") with Capital Senior Management 2,
     Inc. ("Capital") to handle the day-to-day operations of the Senior Housing
     Facilities. Lawrence A. Cohen, who served through July 28, 1998 as a
     Director of the Company and President, Chief Executive Officer and Director
     of ILM II, has also served as Vice Chairman and Chief Financial Officer of
     Capital Senior Living Corporation, an affiliate of Capital, since November
     1996. As a result, the Management Agreement with Capital was considered a
     related party transaction (see Note 3) through July 28, 1998.

                                       -8-

<PAGE>

                         ILM II LEASE CORPORATION
               Notes to Financial Statements (Unaudited)
                               (continued)

2.   THE FACILITIES LEASE AGREEMENT

         ILM II Holding (the "Lessor") leases the Senior Housing Facilities to
     the Company (the "Lessee") pursuant to the Facilities Lease Agreement. Such
     lease is scheduled to expire on December 31, 2000 (December 31, 1999 with
     respect to the Santa Barbara Facility), unless terminated earlier at the
     election of the Lessor in connection with the sale by the Lessor of the
     Senior Housing Facilities to a non-affiliated third party, upon 30 days'
     notice to the Company. As noted below in Recent Developments, ILM II has
     entered into an agreement and plan of merger with Capital Senior Living
     Corporation and certain affiliates of Capital, and has agreed to cause ILM
     II Holding to cancel and terminate the Facilities Lease Agreement
     immediately prior to the effective time of the merger. Consummation of the
     merger is presently anticipated in October 1999. The lease is accounted for
     as an operating lease in the Company's financial statements.

         Descriptions of the properties covered by the Facilities Lease
     Agreement between the Company and ILM II Holding are summarized as follows:

<TABLE>
<CAPTION>
                                                                     Year
                                                                   Facility         Rentable           Resident
Property Name and Location               Type Of Property           Built           Units (2)         Capacities (2)
---------------------------              ----------------           -----           ---------        --------------
<S>                                  <C>                             <C>                  <C>                <C>
The Palms
Fort Myers, FL                       Senior Housing Facility         1988                 205                255

Crown Villa
Omaha, NE                            Senior Housing Facility         1992                  73                 73

Overland Park Place
Overland Park, KS                    Senior Housing Facility         1994                 141                153

Rio Las Palmas
Stockton, CA                         Senior Housing Facility         1988                 164                190

The Villa at Riverwood
St. Louis County, MO                 Senior Housing Facility         1986                 120                140

Villa Santa Barbara (1)
Santa Barbara, CA                    Senior Housing Facility         1979                 125                125

</TABLE>

   (1) The Company operates Villa Santa Barbara under a co-tenancy
       arrangement with an affiliated company, ILM I Lease Corporation ("Lease
       I"). The Company has entered into an agreement with Lease I regarding
       such joint tenancy. Lease I was formed for similar purposes as the
       Company by an affiliated company, ILM Senior Living, Inc. ("ILM I"), a
       subsidiary of which owns 25% of the Villa Santa Barbara property. The
       portion of the Senior Housing Facility leased by the Company represents
       75% of the total project. Villa Santa Barbara is 25% owned by ILM Holding
       Inc. and 75% by ILM II Holding, Inc., a direct subsidiary of ILM II, as
       tenants in common. Upon the sale of ILM I or ILM II, arrangements would
       be made to transfer the Santa Barbara facility to the non-selling joint
       tenant (or one of its subsidiaries). The property was extensively
       renovated in 1995.

   (2) Rentable units represent the number of apartment units and is a
       measure commonly used in the real estate industry. Resident capacity
       equals the number of bedrooms contained within the apartment units and
       corresponds to measures commonly used in the healthcare industry.


                                       -9-

<PAGE>

                         ILM II LEASE CORPORATION
                 Notes to Financial Statements (Unaudited)
                               (continued)

2.   THE FACILITIES LEASE AGREEMENT (CONTINUED)

          Pursuant to the Facilities Lease Agreement, the Company pays annual
     base rent for the use of the Senior Housing Facilities in the aggregate
     amount of $4,035,600. The facilities lease is a "triple-net" lease whereby
     the Lessee pays all operating expenses, governmental taxes and assessments,
     utility charges and insurance premiums, as well as the costs of all
     required maintenance, personal property and non-structural repairs in
     connection with the operation of the Senior Housing Facilities. ILM II
     Holding, as Lessor, is responsible for all major capital improvements and
     structural repairs to the Senior Housing Facilities. Also, any fixed assets
     of the Company at a Senior Housing Facility would remain with the Senior
     Housing Facility at the termination of the lease. The Company also pays
     variable rent, on a quarterly basis, for each facility in an amount equal
     to 40% of the excess of aggregate total revenues for the Senior Housing
     Facilities, on an annualized basis, over $13,021,000. Variable rent was
     $642,000 and $332,000 for the six- and three-month periods ended February
     28, 1999, respectively, compared to $436,000 and $245,000 for the six- and
     three-month periods ended February 28, 1998, respectively.

         The Company's use of the properties is limited to use as Senior Housing
     Facilities. The Company has responsibility to obtain and maintain all
     licenses, certificates and consents needed to use and operate each Senior
     Housing Facility, and to use and maintain each Senior Housing Facility in
     compliance with all local board of health and other applicable governmental
     and insurance regulations. The Senior Housing Facilities located in
     California, Florida and Kansas are licensed by such states to provide
     assisted living services. In addition, various health and safety
     regulations and standards, which are enforced by state and local
     authorities, apply to the operation of all the Senior Housing Facilities.
     Violations of such health and safety standards could result in fines,
     penalties, closure of a Senior Housing Facility, or other sanctions.

     RECENT DEVELOPMENTS

         On February 7, 1999, ILM II entered into an agreement and plan of
     merger with Capital Senior Living Corporation, the corporate parent of
     Capital, and certain affiliates of Capital. Consummation of the merger is
     presently anticipated in October 1999. In connection with the merger, ILM
     II has agreed to cause ILM II Holding to cancel and terminate the
     Facilities Lease Agreement immediately prior to the effective time of the
     merger. As noted above, the Facilities Lease Agreement, which is scheduled
     to expire on December 31, 2000, may be terminated earlier at the election
     of the Lessor in connection with the sale by the Lessor of the Senior
     Housing Facilities to a non-affiliated third party, upon 30 days' notice to
     the Company. Although there can be no assurance as to whether the merger
     will be consummated or, if consummated, as to the timing thereof, the
     Company's operations would not be expected to continue beyond the effective
     time of the merger.

3.   RELATED PARTY TRANSACTIONS

         Subject to the supervision of the Company's Board of Directors,
     assistance in managing the business of the Company was provided by
     PaineWebber. As previously discussed in the Company's Annual Report on Form
     10-K for the year ended August 31, 1998, PaineWebber resigned effective as
     of June 18, 1997.

         The Company has retained Capital to be the property manager of the
     Senior Housing Facilities pursuant to the Management Agreement, which
     commenced on July 29, 1996. Lawrence A. Cohen, who served through July 28,
     1998 as a Director of the Company as well as President, Chief Executive
     Officer and Director of ILM II, has also served as Vice Chairman and Chief
     Financial Officer of Capital Senior Living Corporation, an affiliate of
     Capital, since November 1996. The Management Agreement is co-terminous with
     the Facilities Lease Agreement. If, for any reason, the Facilities Lease
     Agreement is extended beyond December 31, 2000, the scheduled expiration
     date of the Management Agreement would be extended as well, but not beyond
     July 29, 2001. There is no present intention to extend the term of the
     Facilities Lease Agreement or the term of the Management Agreement and it
     is likely they will be terminated before the end of the term of the
     Facilities Lease Agreement (see "Recent Developments" in Note 2). Under the
     terms of the Management Agreement, Capital earns a base management fee
     equal to 4% of the gross operating revenues of the Senior Housing
     Facilities, as defined. Capital also earns an incentive management fee
     equal to 25% of the amount by which the

                                       -10-
<PAGE>

                           ILM II LEASE CORPORATION
                    Notes to Financial Statements (Unaudited)
                                (continued)

3.   RELATED PARTY TRANSACTIONS (CONTINUED)

     "net cash flow" of the Senior Housing Facilities, as defined, exceeds a
     specified base amount. Each August 31, the base amount is increased based
     on the percentage increase in the Consumer Price Index as well as 15% of
     Senior Housing Facility expansion costs. ILM II has guaranteed the payment
     of all fees due to Capital under the terms of the Management Agreement. For
     the six- and three-month periods ended February 28, 1999, Capital earned
     property management fees from the Company of $547,000 and $323,000,
     respectively, compared to $444,000 and $239,000, for the six- and
     three-month periods ended February 28, 1998, respectively.

                  On September 18, 1997, the Company entered into an agreement
     with Capital Senior Development, Inc., an affiliate of Capital, to manage
     the development process for the potential expansions of several of the
     Senior Housing Facilities. Capital Senior Development, Inc. would receive a
     fee equal to 7% of the total development costs of these potential
     expansions if they are pursued. ILM II Holding would also reimburse the
     Company for all costs related to these potential expansions including fees
     to Capital Senior Development, Inc. For the six- and three-month periods
     ended February 28, 1999, Capital Senior Development, Inc. earned no fees
     from the Company compared to fees of $99,000 and $59,000 earned for the
     six- and three-month periods ended February 28, 1998, respectively, for
     managing pre-construction development activities for potential expansions
     of the Senior Housing Facilities.

         Jeffry R. Dwyer, Secretary and Director of the Company, is a
     shareholder of Greenberg Traurig, Counsel to the Company and its affiliates
     since 1997. For the six- and three-month periods ended February 28, 1999,
     Greenburg Traurig earned fees from the Company of $22,000 and $20,000,
     respectively. For the six- and three-month periods ended February 28, 1998,
     Greenberg Traurig earned fees from the Company of $69,000 and $33,000,
     respectively.

         Accounts receivable - related party at February 28, 1999 and August 31,
     1998 includes an insurance refund due to the Company from Lease I in the
     amount of $102,140. Accounts payable - related party at February 28, 1999
     and August 31, 1998 includes $332,000 and $287,000, respectively, for
     variable rent due to ILM II Holding.

4.   LEGAL PROCEEDINGS AND CONTINGENCIES

         A property management agreement between ILM II Holding and AHC, which
     covered the management of all six Senior Housing Facilities, was assigned
     to the Company effective September 1, 1995. On July 29, 1996, the Company
     and ILM II Holding ("the Companies") terminated the property management
     agreement with AHC for "cause" pursuant to the terms of the contract.
     Simultaneously with the termination of the management agreement, the
     Companies, together with certain affiliated entities, filed suit against
     AHC in the United States District Court for the Eastern District of
     Virginia for breach of contract, breach of fiduciary duty and fraud. The
     Company and ILM II Holding alleged, among other things, that AHC willfully
     performed actions specifically in violation of the management agreement and
     that such actions caused damages to the Companies.

         Due to the termination of the agreement for cause, no termination fee
     was paid to AHC. Subsequent to the termination of the agreement, AHC filed
     for protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic
     State of California. The Companies challenged the filing, and the
     Bankruptcy Court dismissed AHC's case effective October 15, 1996. In
     November 1996, AHC filed with the Virginia District Court an answer in
     response to the litigation initiated by the Companies and a counterclaim
     against ILM II Holding. The counterclaim alleged that the management
     agreement was wrongfully terminated for cause and requested damages, which
     included the payment of a termination fee in the amount of $750,000,
     payment of management fees pursuant to the contract from August 1, 1996
     through October 15, 1996, which is the earliest date the management
     agreement could have been terminated without cause, and recovery of
     attorney's fees and expenses. The aggregate amount of damages against all
     parties as requested in AHC's counterclaim exceeded $2,000,000. On June 13,
     1997 and July 8, 1997, the court issued orders to enter judgment against
     ILM II and ILM I in the aggregate amount of $1,000,000. The orders did not
     contain any findings of fact or conclusions of law. On July 10, 1997, the
     Company, ILM I, ILM II, and Lease I filed a notice of appeal to the United
     States Court of Appeals for the Fourth Circuit from the orders.

                                       -11-

<PAGE>

                            ILM II LEASE CORPORATION
                    Notes to Financial Statements (Unaudited)
                                (continued)

4.   LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED)

         On February 4, 1997, AHC filed a complaint in the Superior Court of the
     State of California against Capital, Lawrence Cohen, who, through July 28,
     1998 was a Director of the Company and President, Chief Executive Officer
     and Director of ILM II, and others alleging that the defendants
     intentionally interfered with AHC's property management agreement (the
     "California litigation"). The complaint sought damages of at least
     $2,000,000. On March 4, 1997, the defendants removed the case to Federal
     District Court in the Central District of California. At a meeting on
     February 26, 1997, the Company's Board of Directors concluded that since
     all of Mr. Cohen's actions relating to the California litigation were taken
     either on behalf of the Company under the direction of the Board or as a
     PaineWebber employee, the Company or its affiliates should indemnify Mr.
     Cohen with respect to any expenses arising from the California litigation,
     subject to any insurance financial recoveries for those expenses. Legal
     fees paid by the Company and Lease I on behalf of Mr. Cohen totaled
     $239,000 as of February 28, 1999. The Company's Board also concluded that,
     subject to certain conditions, legal fees and expenses incurred by Capital
     and its affiliates in the California litigation. Subsequently, the Boards
     of Directors of the Company and Lease I voted to increase the maximum
     amount of the advance to $100,000. By the end of November 1997, Capital had
     incurred $100,000 of legal expenses in the California litigation. On
     February 2, 1998, the amount to be advanced to Capital was increased to
     include 75% of the California litigation legal fees and costs incurred by
     Capital for December 1997 and January 1998, plus 75% of such legal fees and
     costs incurred by Capital thereafter, not to exceed $500,000. By February
     28, 1999, $209,000 of legal fees had been either advanced or accrued in the
     Company's financial statements and $313,000 of legal fees have been either
     advanced or accrued in Lease I's financial statements for Capital's
     California litigation costs.

         On August 18, 1998, the Company and its affiliates along with Capital
     and its affiliates entered into a settlement agreement with AHC. The
     Company and Lease I agreed to pay $1,625,000 and Capital and its affiliates
     agreed to pay $625,000 to AHC in settlement of all claims, including those
     related to the Virginia litigation and the California litigation. The
     Company and its affiliates also entered into an agreement with Capital
     and its affiliates to mutually release each other from all claims that
     any such parties may have against each other, other than any claims
     under the property management agreements. The Company's Board of
     Directors believed that settling the AHC litigation was a prudent course
     of action because the settlement amount represented a small percentage
     of the increases in cash flow and value achieved for the Company and its
     affiliates over the past two years.

         On September 4, 1998, the full settlement amounts were paid to AHC and
     its affiliates with the Company paying $650,000 and Lease I paying $975,000
     to AHC and its affiliates.

5.    CONSTRUCTION LOAN FINANCING

         The Company has finalized negotiations with a major bank to provide a
     construction loan facility that will provide ILM II with up to $8.8 million
     to fund the capital costs of these potential expansion programs. The
     construction loan facility will be secured by a first mortgage of ILM II's
     properties and collateral assignment of the Company's leases of such
     properties. The loan will have a three-year term with interest accruing at
     a rate equal to LIBOR plus 1.10% or Prime plus 0.5%. The loan term could be
     extended for an additional two years beyond its maturity date with monthly
     payments of principal and interest on a 25-year amortization schedule.

6.    SUBSEQUENT EVENT

         On March 9, 1999, Jeffry R. Dwyer was elected President of the
Company and Lease I.


                                       -12-

<PAGE>

                           ILM II LEASE CORPORATION

                      MANAGEMENT'S DISCUSSION AND ANALYSIS
              OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

    GENERAL

         The facilities lease is a "triple-net" lease whereby the Lessee pays
     all operating expenses, governmental taxes and assessments, utility charges
     and insurance premiums, as well as the costs of all required maintenance,
     personal property and non-structural repairs in connection with the
     operation of the Senior Housing Facilities. ILM II Holding, as Lessor, is
     responsible for all major capital improvements and structural repairs to
     the Senior Housing Facilities. If the Company and ILM II Holding decide
     that any of the Senior Housing Facilities should be expanded, the
     Facilities Lease Agreement between the Company and ILM II Holding would be
     amended to include such expansion. Pursuant to the Facilities Lease
     Agreement, the Company pays annual base rent for use of all the Senior
     Housing Facilities in the aggregate amount of $4,035,600. The Company also
     pays variable rent, on a quarterly basis, for each Senior Housing Facility
     in an amount equal to 40% of the excess, if any, of the aggregate total
     revenues for the Senior Housing Facilities, on an annualized basis, over
     $13,021,000. Variable rent was $642,000 and $332,000 for the six- and
     three-month periods ended February 28, 1999, respectively, compared to
     $436,000 and $245,000 for the six- and three-month periods ended February
     28, 1998, respectively.

         The Facilities Lease Agreement is scheduled to expire on December 31,
     2000 (December 31, 1999, with respect to Santa Barbara). Accordingly, since
     the Company does not have any current plans to operate or own any other
     facilities or engage in any other business outside of its relationship with
     ILM II, there is no assurance that the Company's operations will continue
     beyond December 2000. Moreover, the Facilities Lease Agreement is subject
     to termination at any time by ILM II Holding upon 30 days' notice to the
     Company in connection with the sale to a non-affiliated third party of the
     Senior Housing Facilities.

    RECENT DEVELOPMENTS

         On February 7, 1999, ILM II entered into an agreement and plan of
     merger with Capital Senior Living Corporation, the corporate parent of
     Capital, and certain affiliates of Capital. Consummation of the merger is
     presently anticipated in October 1999. In connection with the merger, ILM
     II has agreed to cause ILM II Holding to cancel and terminate the
     Facilities Lease Agreement immediately prior to the effective time of the
     merger. As noted above, the Facilities Lease Agreement, which is scheduled
     to expire on December 31, 2000, may be terminated earlier at the election
     of the Lessor in connection with the sale by the Lessor of the Senior
     Housing Facilities to a non-affiliated third party, upon 30 days' notice to
     the Company. Although there can be no assurance as to whether the merger
     will be consummated or, if consummated, as to the timing thereof, the
     Company's operations would not be expected to continue beyond the effective
     time of the merger.

    LIQUIDITY AND CAPITAL RESOURCES

         Occupancy levels for the six properties which the Company leases from
    ILM II Holding averaged 95% and 95% for the three months ended February 28,
    1999 and 1998, respectively. Base rent payments of $4,035,600 will remain in
    effect throughout the remaining term of the lease. As noted above, the
    Facilities Lease Agreement also provides for the payment of variable rent.
    The Senior Housing Facilities are currently generating gross revenues, which
    are in excess of the specified threshold in the variable rent calculation.
    Current annualized operating income levels are sufficient to cover the
    Company's base and variable rent obligations to ILM II Holding.

         At February 28, 1999, the Company had cash and cash equivalents of
    $1,167,000 compared to $1,497,000 at August 31, 1998. The decrease of
    $330,000 is primarily attributable to the September 4, 1998 payment of the
    AHC litigation settlement of $650,000 (see Note 4) offset by other cash
    flows provided by operating activities. Remaining amounts of cash will be
    used for the Company's working capital requirements. As noted above, under
    the terms of the facilities lease, the Lessor is responsible for major
    capital improvements and structural repairs to the Senior Housing
    Facilities. Consequently, the Company does not have any material commitments

                                       -13-

<PAGE>

                             ILM II LEASE CORPORATION

                      MANAGEMENT'S DISCUSSION AND ANALYSIS
            OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

     LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)

     for capital expenditures. Furthermore, the Company does not currently
     anticipate the need to engage in any borrowing activities. As a result,
     substantially all of the Company's cash flow will be generated from
     operating activities. The Company did not pay cash dividends in fiscal
     years 1998 and 1997 or for the first and second quarter of fiscal 1999.
     Payment of dividends, if any, will be at the discretion of the Company's
     Board of Directors and will depend upon such factors as the Company's
     financial condition, earnings, anticipated investments and other relevant
     factors. The source of future liquidity is expected to be from operating
     cash flows from the Senior Housing Facilities, net of the Facilities Lease
     Agreement payments to ILM II Holding, and interest income earned on
     invested cash reserves. Such sources of liquidity are expected to be
     adequate to meet the Company's operating requirements on both a short-term
     and long-term basis.

     YEAR 2000

         The Year 2000 issue is the result of computer programs being written
     using two digits rather than four to define the applicable year. Any of the
     Company's computer programs or hardware that have date-sensitive software
     or embedded chips may recognize the year 2000 as a date other than the year
     2000. This could result in a system failure or miscalculations causing
     disruptions of operations, including, among other things, a temporary
     inability to process transactions, send invoices or engage in similar
     normal business activities.

         Based on ongoing assessments, the Company, through Capital, its
     property manager, has developed a program to modify or replace portions of
     its software and certain hardware, which are generally PC-based systems, so
     that those systems will properly recognize and utilize dates beyond
     December 31, 1999. While there can be no assurance, as of May 31, 1999, the
     Company believes that it substantially completed all software and hardware
     upgrades as of December 31, 1998. The Company believes that these
     modifications and replacements of existing software and certain hardware
     will mitigate the Year 2000 issue. However, if such modifications and
     replacements are not completed timely, the Year 2000 issue could have a
     material impact on the operations of the Company. The costs of Year 2000
     remediation are not expected to be material based on the Company's
     operations.

         The Company has assessed its exposure to operating equipment, and such
     exposure is not significant due to the nature of the Company's business.

         The Company is not aware of any external agent with a Year 2000 issue
     that would materially impact the Company's results of operations, liquidity
     or capital resources. However, the Company has no means of determining
     whether or ensuring those external agents will be Year 2000 ready. The
     inability of external agents to complete their Year 2000 resolution process
     in a timely fashion could impact the Company.

         Management of the Company believes it has an effective program in place
     to resolve the Year 2000 issue in a timely manner. As noted above, the
     Company has substantially completed all necessary phases of its Year 2000
     program. In addition, disruptions in the economy generally resulting from
     Year 2000 issues could also adversely affect the Company. Although the
     amount of potential liability and lost revenue cannot be reasonably
     estimated at this time, in a worst case situation, if Capital, the
     Company's most significant third party contractor, were to experience a
     year 2000 problem, it is likely that the Company would not receive rental
     income as it became due from Senior Living Facility residents. The Company
     in turn would fail to pay ILM II Holding lease payments as they arise under
     the master lease, and ILM II Holding in turn would fail to pay ILM II
     mortgage payments due it. However, the Company believes that given the
     nature of its business, such problem would be temporary and is easily
     remedied with a simple accounting.

                                       -14-

<PAGE>

                           ILM II LEASE CORPORATION

                    MANAGEMENT'S DISCUSSION AND ANALYSIS
       OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

RESULTS OF OPERATIONS

SIX MONTHS ENDED FEBRUARY 28, 1999 VERSUS Six MONTHS ENDED FEBRUARY 28, 1998

    REVENUES

         Total revenues were $8,129,000 for the six months ended February 28,
     1999 compared to $7,612,000 for the same period of the prior year,
     representing an increase of $517,000 or 6.8%. This increase is the result
     of increased rental rates at certain of the Company's Senior Housing
     Facilities located in strong markets.

    EXPENSES

           Total expenses were $7,674,000 for the six months ended February 28,
     1999 compared to $7,387,000 for the same period in the prior year,
     representing an increase of $287,000 or 3.9%. This increase was primarily
     due to increases in Facilities Lease rent expense of $198,000 or 8.1%;
     property management fees of $103,000 or 23.2%; and depreciation expense of
     $74,000 or 168.2%, offset by a $165,000 or 52.2% decrease in professional
     fees as a result of settling the AHC litigation as well as minor increases
     and decreases in certain other expenses. The increase in Facilities Lease
     rent expense is the result of increased variable rent payments due under
     the Facilities Lease Agreement. The increase in property management fees is
     attributable to higher incentive management fees earned by the property
     manager as a result of improved performance at the Senior Housing
     Facilities. The increase in depreciation expense is due to the change in
     the estimated useful lives of the Company's fixed assets as a consequence
     of the expected lease termination date of December 31, 2000, as such assets
     are not subject to repurchase by ILM II Holding.

    INCOME TAX EXPENSE

     Income tax expense increased overall by $92,000 or 102.2% as compared to
    the same period in the prior year, as a result of an increase in income
    before taxes of $230,000 or 50.5%.

    NET INCOME

     Primarily as a result of the factors noted above, net income increased
    $138,000 or 102.2%, to net income of $273,000 for the six months ended
    February 28, 1999 from net income of $135,000 for the six months ended
    February 28, 1998.

    THREE MONTHS ENDED FEBRUARY 28, 1999 VERSUS THREE MONTHS ENDED FEBRUARY
    28, 1998

    REVENUES

         Total revenues were $4,089,000 for the quarter ended February 28, 1999
     compared to $3,875,000 for the same period of the prior year, representing
     an increase of $214,000 or 5.5%. This increase is the result of increased
     rental rates at certain of the Company's Senior Housing Facilities located
     in strong markets.

    EXPENSES

         Total expenses were $3,811,000 for the quarter ended February 28, 1999
     compared to $3,750,000 for the same period in the prior year, representing
     an increase of $61,000 or 1.6%. This increase was principally comprised of
     increases in Facilities Lease rent expense of $79,000 or 6.3%; property
     management fees of $84,000 or 35.1%; and depreciation expense of $51,000 or
     242.9%, offset by significant decreases in professional fees of $214,000 or
     110.3% as a result of settling the AHC litigation as well as a $209,000 or
     98% decrease in general and administrative expense due to changes in
     estimated liabilities at August 31, 1997, that were reduced in 1998. The
     increase in Facilities Lease rent expense is the result of increased
     variable rent payments due under the Facilities Lease Agreement. The
     increase in property management fees is attributable to higher incentive
     management fees earned by the property manager as a result of improved
     performance at the Senior Housing Facilities. The increase in depreciation
     expense is due to the change in the estimated useful lives of the Company's
     fixed assets as a consequence of the expected lease termination date of
     December 31, 1999, as such assets are not subject to repurchase by ILM
     Holding.

                                       -15-

<PAGE>

                          ILM II LEASE CORPORATION

                    MANAGEMENT'S DISCUSSION AND ANALYSIS
     OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

RESULTS OF OPERATIONS (CONTINUED)

    INCOME TAX EXPENSE

         Income tax expense increased overall by $61,000 or 122%, as compared to
     the same period in the prior year, as a result of an increase in income
     before taxes of $153,000 or 122.4%.

    NET INCOME

         Primarily as a result of the factors noted above, net income increased
     $92,000 or 122.7% to net income of $167,000 for the quarter ended February
     28, 1999 from net income of $75,000 for the quarter ended February 28,
     1998.







                                       -16-

<PAGE>

                           ILM II LEASE CORPORATION

                    MANAGEMENT'S DISCUSSION AND ANALYSIS
         OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

      FORWARD-LOOKING INFORMATION

         CERTAIN STATEMENTS INCLUDED IN THIS QUARTERLY REPORT ON FORM 10-Q
     ("QUARTERLY REPORT") CONSTITUTE "FORWARD-LOOKING STATEMENTS" INTENDED TO
     QUALIFY FOR THE SAFE HARBORS FROM LIABILITY ESTABLISHED BY SECTION 27A OF
     THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND SECTION
     21E OF THE SECURITIES ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). THESE
     FORWARD-LOOKING STATEMENTS GENERALLY CAN BE IDENTIFIED AS SUCH BECAUSE THE
     CONTEXT OF THE STATEMENT WILL INCLUDE WORDS SUCH AS "BELIEVES," "COULD,"
     "MAY," "SHOULD," "ENABLE," "LIKELY," "PROSPECTS," "SEEK," "PREDICTS,"
     "POSSIBLE," "FORECASTS," "PROJECTS," "ANTICIPATES," "EXPECTS" AND WORDS OF
     ANALOGOUS IMPORT AND CORRELATIVE EXPRESSIONS THEREOF, AS WELL AS STATEMENTS
     PRECEDED OR OTHERWISE QUALIFIED BY: "THERE CAN BE NO ASSURANCE" OR "NO
     ASSURANCE CAN BE GIVEN." SIMILARLY, STATEMENTS THAT DESCRIBE THE COMPANY'S
     FUTURE PLANS, OBJECTIVES, STRATEGIES OR GOALS ALSO ARE FORWARD-LOOKING
     STATEMENTS. SUCH STATEMENTS MAY ADDRESS FUTURE EVENTS AND CONDITIONS
     CONCERNING, AMONG OTHER THINGS, THE COMPANY'S CASH FLOWS, RESULTS OF
     OPERATIONS AND FINANCIAL CONDITION; THE CONSUMMATION OF ACQUISITION AND
     FINANCING TRANSACTIONS AND THE EFFECT THEREOF ON THE COMPANY'S BUSINESS,
     ANTICIPATED CAPITAL EXPENDITURES, PROPOSED OPERATING BUDGETS AND ACCOUNTING
     RESERVES; LITIGATION; PROPERTY EXPANSION AND DEVELOPMENT PROGRAMS OR PLANS;
     REGULATORY MATTERS; AND THE COMPANY'S PLANS, GOALS, STRATEGIES AND
     OBJECTIVES FOR FUTURE OPERATIONS AND PERFORMANCE. ANY SUCH FORWARD-LOOKING
     STATEMENTS ARE SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES THAT COULD CAUSE
     ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED IN SUCH
     FORWARD-LOOKING STATEMENTS. SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT TO
     A NUMBER OF ASSUMPTIONS REGARDING, AMONG OTHER THINGS, GENERAL ECONOMIC,
     COMPETITIVE AND MARKET CONDITIONS. SUCH ASSUMPTIONS NECESSARILY ARE BASED
     ON FACTS AND CONDITIONS AS THEY EXIST AT THE TIME SUCH STATEMENTS ARE MADE,
     THE PREDICTION OR ASSESSMENT OF WHICH MAY BE DIFFICULT OR IMPOSSIBLE AND,
     IN ANY CASE, BEYOND THE COMPANY'S CONTROL. FURTHER, THE COMPANY'S BUSINESS
     IS SUBJECT TO A NUMBER OF RISKS THAT MAY AFFECT ANY SUCH FORWARD-LOOKING
     STATEMENTS AND ALSO COULD CAUSE ACTUAL RESULTS OF THE COMPANY TO DIFFER
     MATERIALLY FROM THOSE PROJECTED OR IMPLIED BY SUCH FORWARD-LOOKING
     STATEMENTS. ALL FORWARD-LOOKING STATEMENTS CONTAINED IN THIS QUARTERLY
     REPORT ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE CAUTIONARY
     STATEMENTS IN THIS PARAGRAPH. MOREOVER, THE COMPANY DOES NOT INTEND TO
     UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS TO REFLECT ANY CHANGES IN
     GENERAL ECONOMIC, COMPETITIVE OR MARKET CONDITIONS AND DEVELOPMENTS BEYOND
     ITS CONTROL.

         READERS OF THIS QUARTERLY REPORT ARE CAUTIONED NOT TO PLACE UNDUE
     RELIANCE ON ANY OF THE FORWARD-LOOKING STATEMENTS SET FORTH HEREIN AND THE
     COMPANY MAKES ABSOLUTELY NO PROMISES, GUARANTEES, REPRESENTATIONS OR
     WARRANTIES AS TO THE ACCURACY THEREOF.


                                       -17-

<PAGE>

                           ILM II LEASE CORPORATION

                          PART II-OTHER INFORMATION

ITEM 1. THROUGH 5.                  NONE

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)      Exhibits:         27. Financial Data Schedule

(b)       Reports on Form 8-K:  NONE







                                       -18-

<PAGE>

                          ILM II LEASE CORPORATION

                                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.

                                            BY: ILM II LEASE CORPORATION

                                            By: /S/ JEFFRY R. DWYER
                                                ---------------------------
                                                Jeffry R. Dwyer
                                                President

Dated: NOVEMBER 12, 1999