UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



FORM
10-K

|           |                                                                               
|---------- | ------------------------------------------------------------------------------
|(Mark One) |                                                                               
|þ          | ANNUAL
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|           | For the
fiscal year ended December 31, 2010                                   
| ̈          | TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT               
|           | For the
transition period from __________ to
__________                       



Commission file number 333-131542



AdCare Health Systems, Inc.

(Exact name of small business issuer in its charter)



|                                                               |                                     
|-------------------------------------------------------------- | ------------------------------------
|Ohio                                                           | 31-1332119                          
|(State or other jurisdiction of
incorporation or organization) | (I.R.S. Employer Identification No.)
|5057 Troy Rd, Springfield, OH                                  | 45502-9032                          
|(Address of principal executive offices)                       | (Zip Code)                          



Issuers telephone number (937) 964-8974



Securities registered under Section 12(b) of the Exchange
Act:



|                           |                                          
|-------------------------- | -----------------------------------------
|Title of each class        | Name of each exchange on which registered
|Common Stock, no par value | NYSE Amex                                



Securities registered under Section 12(g) of the Exchange Act:
 None



Indicate by check
mark if the registrant is a well-known seasoned issuer, as defined in Rule 405
of the Securities Act.

Yes ̈ Noþ



Indicate by check
mark if the registrant is not required to file reports pursuant to Section 13 or
15(d) of the Exchange Act.  Yes ̈ Noþ



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 þ No ̈



Indicate by check
mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted
and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)
during the preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files).Yes  ̈ No ̈



Indicate by check
mark if disclosure of delinquent filers in response to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of
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.  þ









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Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company.
 See definition of large accelerated filer, accelerated filer and
smaller reporting company in Rule 12b-2 of the Exchange Act.  (Check
one):



|                          |                     |                                               |                            
|------------------------- | ------------------- | --------------------------------------------- | ---------------------------
|Large
accelerated filer  ̈ | Accelerated
filer  ̈ | Non-accelerated
filer  ̈                       | Smaller
reporting company þ
|                          |                     | (Do not
check if a smaller reporting company) |                            



Indicate by check
mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes ̈ Noþ



The
aggregate market value of AdCare Health Systems, Inc., Common Stock held by
non-affiliates of AdCare Health Systems, Inc., as of June 30, 2010, the last
business day of our most recently completed second fiscal quarter, was
$13,460,575.  The number of shares of AdCare Health Systems, Inc., Common
Stock, no par value, outstanding as of December 31, 2010 was 8,349,197.



|                                                                                              |                                                                    
|--------------------------------------------------------------------------------------------- | -------------------------------------------------------------------
|Documents of Which Portions
Are Incorporated by Reference                                     | Parts of Form 10-K into Which Portion of
Documents Are Incorporated
|Proxy Statement for AdCare Health Systems, Inc.s June 3,
2011 Annual Meeting of Shareholders | III                                                                













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AdCare Health
Systems, Inc.

Form 10-K

Table of Contents



|           |                                                                        |                                                                                                 |            
|---------- | ---------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------- | -----------
|           |                                                                        |                                                                                                 | Page Number
|Part I     |                                                                        |                                                                                                
|           | Item 1.                                                                | Business                                                                                        | 2          
|           | Item 1A.                                                               | Risk Factors                                                                                    | 3          
|           | Item 1B.                                                               | Unresolved Staff Comments                                                                       | 9          
|           | Item 2.                                                                | Properties                                                                                      | 9          
|           | Item 3.                                                                | Legal Proceedings                                                                               | 9          
|Part II.   |                                                                       
|           | Item 5.                                                                | Market for Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities | 10         
|           | Item 6.                                                                | Selected Financial Data                                                                         | 12         
|           | Item 7.                                                                | Managements Discussion and Analysis of Financial
Condition and Results of Operations           | 12         
|           | Item 7A.                                                               | Quantitative and Qualitative Disclosures About
Market Risk                                      | 24         
|           | Item 8.                                                                | Financial Statements and Supplementary Data                                                     | 25         
|           | Item 9.                                                                | Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure            | 62         
|           | Item 9A.                                                               | Controls and Procedures                                                                         | 62         
|           | Item 9B.                                                               | Other Information                                                                               | 63         
|Part III   |                                                                       
|           | Item 10.                                                               | Directors, Executive Officers and Corporate
Governance                                          | 63         
|           | Item 11.                                                               | Executive Compensation                                                                          | 63         
|           | Item 12.                                                               | Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters. | 63         
|           | Item 13.                                                               | Certain Relationships and Related Transactions and
Director Independence                        | 63         
|           | Item 14.                                                               | Principal Accountant Fees and Services                                                          | 64         
|Part IV    |                                                                        |                                                                                                
|           | Item 15.                                                               | Exhibits and Financial Statement Schedules                                                      | 64         
|Signatures |                                                                        |                                                                                                
|EX-23.1    | Consent of
Battelle & Battelle LLP                                     |                                                                                                
|EX-31.1    | Certification
of CEO pursuant to Section 302 of the Sarbanes-Oxley Act |                                                                                                
|EX-31.2    | Certification
of CFO pursuant to Section 302 of the Sarbanes-Oxley Act |                                                                                                
|EX-32.1    | Certification
of CEO pursuant to Section 906 of the Sarbanes-Oxley Act |                                                                                                
|EX-32.2    | Certification
of CFO pursuant to Section 906 of the Sarbanes-Oxley Act |                                                                                                
|           |                                                                        |                                                                                                



Special Note Regarding Forward Looking Statements



Certain statements in this report constitute forward-looking
statements.  These forward-looking statements involve known or unknown
risks, uncertainties and other factors that may cause the actual results,
performance, or achievements of AdCare to be materially different from any
future results, performance or achievements expressed or implied by the
forward-looking statements.  Specifically, the actions of competitors and
customers and our ability to execute our business plan, and our ability to
increase revenues is dependent upon our ability to continue to expand our
current business and to expand into new markets, general economic conditions,
and other factors.  You can identify forward-looking statements by
terminology such as may, will, should, expects, intends, plans,
anticipates, believes, estimates, predicts, potential, continues, or
the negative of these terms or other comparable terminology.  Although we
believe that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance
or achievements.  We undertake no obligation to publicly update or review
any forward-looking statements, whether as a result of new information, future
developments or otherwise.



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PART I

Item 1.
 Business



Business
Development



We
are a Springfield, Ohio based developer, owner and manager of retirement
communities, assisted living facilities, nursing homes, and provide home health
care services.  We currently manage twenty-nine facilities, comprised of
twenty skilled nursing centers, eight assisted living residences and one
independent living/senior housing facility, totaling over 2,400 units.  Our
communities are located in Ohio, Georgia and Alabama.



We
are a holding company with wholly owned subsidiaries owning, leasing and
operating skilled nursing facilities, assisted living facilities and providing
home health care services.  Through our subsidiaries, we provide a full
complement of administrative services as well as consultative services that
permit our local facility leadership teams to better focus on the delivery of
healthcare services.  We also provide these services to unaffiliated third
party long term care operators and/or owners with whom we enter into
contracts.  We currently provide these services to four unaffiliated
facility owners.



We
have an ownership interest in ten of the facilities we manage, comprised of 100%
ownership of four of the skilled nursing centers and six assisted living
facilities.  We have lease agreements on eleven skilled nursing facilities.
 The assisted living facilities that we own operate under the name Hearth
& Home, with the tag line Home is where the hearth is  We also
maintain a development/consulting initiative which provides potential management
opportunities to our core long-term care business.  AdCare Health Systems,
Inc. and Hearth & Home are registered trademarks.



We
were organized in 1989 by Gary Wade and J. Michael Williams.  Mr. Wade
remains active in the management of the business, as Co-CEO and President.
 Mr. Wade plans to retire on June 30, 2011, but remain an active member of
Board of Directors.  Passport Retirement, founded by David A. Tenwick, our
Chairman, acquired AdCare Health Systems in 1995.  We have a seasoned
senior management team with substantial senior living, healthcare and real
estate industry experience. Our senior management team is incentivized to
continue to grow our business through their combined ownership of approximately
25.6% of our common stock.



Description of Business

Our
business operates in four segments: skilled nursing facilities (SNF), assisted
living facilities (ALF), home health and management and development. As
of December 31, 2010, our company operated facilities in Ohio, Georgia, and
Alabama.  On January 1, 2011, the Company began operations at a newly
acquired facility in North Carolina.  In our skilled nursing and assisted
living segments, we operate, have ownership interests in or lease twenty-one
facilities for which we collect fees from the residents of those facilities.
Profits/losses are generated to the extent that the monthly patient fees exceed
the costs associated with operating those facilities. In our home health segment
profits/losses are generated to the extent that the monthly patient fees exceed
the costs associated with providing services to patients in their homes.
 In our management and development segment, we manage an aggregate of eight
assisted living facilities, nursing homes and an independent living campus all
of which are owned by third parties. With respect to these facilities, we
receive a management fee based on the revenue generated by the facilities.
Within our management and development segment, we provide development,
consulting and accounting services to third parties. In these instances, we
receive a fee for providing those services. These fees vary from project to
project, with the development fee in most cases being based on a percentage of
the total cost to develop the project.



In addition to improving our existing operations, our management
team believes that there are significant opportunities to continue the growth of
our business.  Our nursing homes, assisted living facilities and
independent living facilities operate in the senior living facilities market.
 Our management believes that this market is one of the most dynamic and
rapidly growing sectors within the healthcare space. We believe the trends are
encouraging as a result of two key industry drivers: positive demographics, due
to the aging of America, coupled with the limited supply of senior living
facilities. Our strategy is to be opportunistic by exploiting these trends and
growing both internally and through strategic acquisitions.

Our principal executive offices are located at 5057 Troy Road,
Springfield, Ohio 45502, and our telephone number is (937) 964-8974.  We
maintain a website at www.adcarehealth.com.



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Employees

As of December 31, 2010, we had approximately 2,210 total
employees of which 1,652 were full time employees.

Item 1A.
 Risk Factors



The following are certain risk factors that could affect our
business, operations and financial condition.  These risk factors should be
considered in connection with evaluating the forward-looking statements
contained in this Annual Report of Form 10-K because these factors could cause
the actual results and conditions to differ materially from those projected in
forward-looking statements.  This section does not describe all risks
applicable to our business, and we intend it only as a summary of certain
material factors.  If any of the following risks actually occur, our
business, financial condition or results of operations could be negatively
affected.  In that case, the trading price of our stock could
decline.

We
intend to expand our business into new areas of operation.

Our business model calls for seeking to acquire existing cash
flowing operations and to expand our operations by pursuing an acquisition
merger and acquisition growth strategy to acquire and lease long term care
facilities, primarily nursing homes.  Our success will largely depend on
our ability to finance the new acquisitions and implement and integrate the new
acquisitions into our management systems.  As a result, we expect to
experience all of the risks that generally occur with rapid expansion such
as:

·

adapting our management systems and personnel into the new
acquisition;

·

integrating the new acquisition and businesses into our
structure;

·

acquisition and operation of new acquisitions and businesses in
the Southeastern United States, a geographic region in which we have not
historically operated;

·

obtaining adequate financing under acceptable terms;

·

retention of key personnel, customers and vendors of the acquired
business and the hiring of new personnel;

·

impairments of goodwill and other intangible assets; and

·

contingent and latent risks associated with the past operations
of, and other unanticipated costs and problems arising in, an acquired
business.

If we are unable to successfully integrate the operations of an
acquired property or business into our operations, we could be required to
undertake unanticipated changes.  These changes could have a material
adverse effect on our business.  Since we went public in November, 2006, we
have not expanded into new areas of business.

We may need additional financing to complete our long-term
acquisition and expansion plans, and we do not have commitments for additional
financing.

To achieve our growth objectives, we will need to obtain
sufficient financial resources to fund our expansion, development and
acquisition activities.  We believe we may need to secure debt financing in
order to help us leverage our equity resources and make further acquisitions. As
of December 31, 2010 we had an accumulated deficit of $12,548,870 and working
capital of approximately $708,000.  Our cumulative losses have, in the
past, made it difficult for us to borrow adequate funds on what management
believed to be commercially reasonable terms.  There can be no assurance
that adequate financing will be available on terms that are acceptable to us, if
at all.  In addition, our Board of Directors may elect to use our stock as
"currency" in acquiring additional businesses.  If so, our stockholders may
experience dilution.

We currently have lines of credit in place which may be
insufficient to satisfy short-term cash needs.

In March of 2010, we increased our available line of credit with
Huntington National Bank to $200,000 in order to assist with cash flow.  As
of December 31, 2010, approximately $187,000 was used in operation of the
Company.  We have also



- 3
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established a $191,000 line of credit using funds from our
non-qualified deferred compensation plan.  Members of this plan, which is
only available to senior management, authorized the transfer of funds to
establish the line of credit with interest accruing at 8%.  The funds are
presently used in the operation of the Company.  Additionally, on October
29, 2010, AdCare subsidiaries ADK Powder Springs Operator, LLC, ADK Lumber City
Operator, LLC, ADK Jeffersonville Operator, LLC, ADK LaGrange Operator, LLC, and
ADK Thomasville Operator, LLC (collectively, the Borrowers) entered into a
Credit Agreement with lender, Gemino Healthcare Finance, LLC (the Lender), to
provide a credit facility in the maximum amount of $5,000,000. The initial term
of the Credit Facility will expire on October 29, 2013.  Borrowing under
the Credit Facility is not limited to use by the Borrowers and may be used for
various business purposes. Conditions of the Credit Agreement require the
Borrowers to pay interest on a minimum balance of $1,000,000.
 Subsequently, on February 25, 2011, we joined five additional AdCare
subsidiaries:  ADK Thunderbolt Operator, LLC, ADK Savannah Beach Operator,
LLC, ADK Oceanside Operator, LLC, Attalla Nursing ADK, LLC, and Coosa Nursing
ADK, LLC as additional borrowers in the Credit Agreement.  The additional
borrowers increased the amount of credit available to us and the maximum amount
of the credit facility increased to $7,500,000.  As of December 31, 2010,
approximately $1,763,000 of the credit facility was used in the operations of
the business.

Businesses typically use lines of credit to finance short-term and
unexpected cash needs.  There can be no assurances that these lines of
credit will be sufficient in the event of an acute cash deficit.
 Therefore, we intend to secure additional lines of credit or increases in
our existing lines but we can provide no assurance that it will be available on
acceptable terms, if at all, or that the amount of any line of credit obtained
will be sufficient to handle future cash needs as they arise.

Our business depends on reimbursement under federal and state
programs, and legislation or regulatory action may reduce or otherwise adversely
affect the amount of reimbursements.



Our revenues are heavily dependent on payments administered under
the Medicare and Medicaid programs. The economic downturn has caused many states
to institute freezes on or reductions in Medicaid reimbursements to address
state budget concerns.  Moreover, for the 2010 federal fiscal year,
CMS effectively reduced our Medicare reimbursement rates; for the 2011 federal
fiscal year, CMS has implemented changes to the Resource Utilization Group
classification system, which may impact our Medicare revenues adversely.

In addition to these reductions, there have been numerous
initiatives on the federal and state levels for comprehensive reforms affecting
the payment for and availability of healthcare services. Aspects of certain of
these initiatives, such as further reductions in funding of the Medicare and
Medicaid programs, additional changes in reimbursement regulations by CMS,
enhanced pressure to contain healthcare costs by Medicare, Medicaid and other
payers, and additional operational requirements, could adversely affect us.

We have a history of operating losses and may incur losses in
the future as we expand.

For the year ended December 31, 2010, for amounts attributable to
the Company, we had a net loss of $2,743,621 compared to a net income of
$440,283 for the year ended December 31, 2009.  There can be no
assurance that we will be able to operate profitably as we expand.  As of
December 31, 2010, we have working capital of approximately $708,000.

Management's plans with the objective of improving liquidity and
profitability in future years encompass the following:

·

refinancing debt where possible to obtain more favorable terms.

·

increase facility occupancy, improve the occupancy mix by
increasing Medicare patients.

·

add additional management contracts.

·

Acquire additional long term care facilities with existing cash
flowing operations to expand our operations.

Management believes that the actions that will be taken by the
Company provide the opportunity for the Company to improve liquidity and achieve
profitability.  However, there can be no assurance that such events will
occur.



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Assisted living and skilled nursing facility financial
stability could be negatively impacted by the current economic
conditions.

Approximately 8% of our skilled nursing occupants and nearly all
the occupants of our assisted living facilities rely on their personal
investments and wealth to pay for their stay in our facilities.  Recent
declines in market values of investments could limit their ability to pay for
services or shorten the period of time for which they can pay privately for
their stay.  The declining market for the sale of homes could limit their
ability to sell their personal assets further reducing their ability to remain
in our facilities.  Furthermore, adult children who have recently become
unemployed may decide to care for their parent at home so that their parent's
income may help offset some of their own financial burdens.  During 2010,
we have experienced lower occupancy in our assisted living facilities and
believe it may be due in part to our potential customers response to the
current economic conditions.  We do not believe lower occupancy in our
assisted living facilities represents a trend.

We are engaged in an evolving and highly-regulated industry,
which increases the cost of doing business and may require us to change the way
our business is conducted.

Health care is an area of extensive and frequent regulatory
change.  Changes in the laws or new interpretations of existing laws can
have a significant effect on methods of doing business, cost of doing business,
and amounts of reimbursements from the government and other payers.  Our
assisted living residences and nursing homes are subject to regulation and
licensing by state and local health and social service agencies and other
regulatory authorities.  We are and will continue to be subject to varying
degrees of regulation and licensing by health or social service agencies.
 A failure to comply with applicable requirements could cause us to be
fined or could cause the cessation of our business, which would have a material
adverse effect on our company.

The manner and the extent to which assisted living is regulated at
the federal and state level is evolving.  Changes in the laws or new
interpretations of existing laws may have a significant effect on our methods
and costs of doing business.  Our success will depend partially on our
ability to satisfy the applicable regulations and requirements and to procure
and maintain required licenses.  Our operations could also be adversely
affected by, among other things, regulatory developments such as mandatory
increases in the scope and quality of care given to the residents and revisions
in licensing and certification standards.  We believe that our operations
do not presently violate any existing federal or state laws.  But there can
be no assurance that federal, state, or local laws or regulatory procedures
which might adversely affect our business, financial condition, and results of
operations for prospects will not be expanded or imposed.

State and federal regulatory changes also affect our
business.

Because of the nature of our business, changes to both state and
federal regulations may impact the pricing for our services and the methods of
reimbursement.  Changes which reduce the amount which we can charge for our
services or delay or reduce the amount of our reimbursement could have a
material adverse effect upon our business.

An expanded Federal program is underway to recover Medicare
overpayments.

The Medicare Modernization Act of 2003 established a three year
demonstration project to recover overpayments and identify underpayments on
Medicare claims from hospitals, skilled nursing facilities and home health
agencies through a review of claims previously paid by Medicare beginning in
October, 2007.  Medicare contracted nationwide with third parties known as
Recovery Audit Contractors (RAC) to conduct these reviews commonly referred to
as RAC Audits.  Due to the success of the program, the Tax Relief and
Healthcare Act of 2006 made the program permanent and mandated its expansion to
all 50 states in 2010.  As of December 31, 2010, we have not received
notification that any of our claims are subject to RAC Audits however, we can
make no assurances that our claims will not be selected for RAC Audits in the
future and if they are the extent to which these audits may reduce our revenue
or otherwise hinder cash flow.

State Certificate of Need laws and other regulations could
negatively impact our ability to grow our nursing home business.

Many states in which we could expand, have adopted Certificate of
Need or similar laws that generally require that a state agency approve certain
nursing home acquisitions and determine the need for certain nursing home bed
additions, new services, capital expenditures, or other changes prior to the
acquisition or addition of beds or services, the implementation of other
changes, or expenditure of capital.  State approvals are generally issued
for specified maximum expenditures and require implementation of the proposal
within a specified period of time.  Failure to obtain the necessary state
approval can result in the inability to provide the service, to operate the
centers, to complete the acquisition, addition, or other change, and can also
result



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in sanctions or adverse action on the center's license and adverse
reimbursement action.  There can be no assurance that we will be able to
obtain Certificate of Need approval for all future projects requiring the
approval, or that approvals will be timely.

Due to the high-risk circumstances in which we conduct
business, we may encounter liability claims in excess of insurance
coverage.

The provision of health care services entails an inherent risk of
liability.  In recent years, participants in the long-term care industry
have become subject to an increasing number of lawsuits alleging malpractice or
related legal theories, many of which involve large claims and significant
defense costs.  We currently maintain $1,000,000 in liability insurance for
any one exposure.  This insurance is intended to cover malpractice and
other lawsuits.  Although we believe that it is in keeping with industry
standards, there can be no assurance that claims in excess of our limits will
not arise.  Any such successful claims could have a material adverse effect
upon our financial condition and results of operations.  Claims against us,
regardless of their merit or eventual outcome, may also have a material adverse
effect upon our ability to attract and retain business.  In addition, our
insurance policies must be renewed annually and there can be no assurance that
we will be able to retain coverage in the future or, if coverage is available,
that it will be available on acceptable terms.

We encounter intense competition from competitors, many of whom
have greater resources than AdCare.

The long-term care industry is highly competitive and we believe
that it will become even more competitive in the future.  Our assisted
living facilities and nursing homes compete with numerous companies providing
similar long-term care alternatives, such as home health care agencies,
community-based service programs, retirement communities and convalescent
centers, and other assisted living providers.  We compete with national
companies such as HCR Manor Care, Alterra and Extended Care with respect to both
our nursing home and assisted living facilities.  We also compete with
locally owned entities as well as Health Care Facilities-HCF on a regional
basis.  Historically, we have found that the entry of one or more of these
competitors into one of our established markets can reduce both our occupancy
and the rates we are able to charge to our customers. In the past, we have found
national publicly traded competitors who are willing to enter into a market
already served by us.  When these competitors experienced lower than
expected occupancies, they relied on their greater financial resources to reduce
their rates in order to increase occupancy.  This resulted in our
occupancies decreasing below expected levels. Eventually, demographics improved
and rates stabilized.  However, there can be no assurance that similar
events will not occur in the future which could limit our ability to attract
residents or expand our business and that could have a negative effect on our
financial condition, results of operations, and prospects.  We can provide
no assurance that competitive pressures will not have a material adverse effect
on us.

The home health care business is also highly competitive.
 Since we first acquired Assured Health Care in 2005, its operations remain
relatively centralized in the Dayton, Ohio area.  However, in that area,
Assured faces competition from several sources including, without limitation,
Fidelity Nursing Home Systems, Kettering Network Home Care, GEM City Home Care,
Greene Memorial Hospital Home Care, and Community Springfield.

Our business is very labor intensive, we operate in smaller
markets with limited personnel resources, and our success is tied to our ability
to attract and retain qualified employees.

We
compete with other providers of home health care, nursing home care, and
assisted living with respect to attracting and retaining qualified personnel.
 We depend on the availability of Registered Nurses and Licensed Practical
Nurses to provide skilled care to our nursing home residents.  According to
the Ohio Hospital Association, the supply of nurses nationwide is predicted to
be 800,000 short of demand by 2020.  Another study conducted by Dr. David
I. Auerbach for the journal Health Affairs estimated the shortage to
increase to 340,000 by 2020.  According to the Bureau of Labor Statistics,
"employment of registered nurses is expected to grow 23 percent [or 587,000
jobs] from 2006 to 2016, much faster than the average for all occupations".
 The Bureau of Labor Statistics also reports "employment of LPNs is
expected to grow 14 percent [or 105,000 jobs] between 2006 and 2016, faster than
the average for all occupations, in response to the long-term care needs of an
increasing elderly population and the general increase in demand for health care
services".  While the experts may not agree on the size of the shortage,
they all appear to agree that there is and will continue to be a shortage.
 Because of the small markets in which we operate, shortages of nurses
and/or trained personnel may require us to enhance our wage and benefit package
in order to compete and lure qualified employees from more metropolitan areas.
 To date, we have been able to adequately staff all of our operations.
 However, we can provide no assurance that our labor costs will not
increase, or that, if they do increase, they can be matched by corresponding
increases in revenues.





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We are dependent on our management team and the loss of any of
these individuals would harm our business.



Our future success depends largely upon the management experience,
skill, and contacts of our officers and directors, in particular, David A.
Tenwick, Chairman, Christopher Brogdon, Vice-Chairman and Chief Acquisitions
Officer, Gary L. Wade, co-CEO and President, Boyd Gentry, co-CEO and President
and Scott Cunningham, Chief Financial Officer.  Mr. Tenwick, Mr. Wade and
Mr. Cunningham have each signed employment contracts that are effective through
September 2011.  Mr. Gentry has also entered an employment agreement.
 Mr. Brogdon is not currently a party to an employment contract with us.
 Loss of the services of any or all of these officers could be materially
detrimental to our operations.  In addition, due to the location of our
corporate headquarters in a smaller urban region, we may experience difficulty
attracting senior managers in the future.

We own multiple parcels of real estate and could be subject to
environmental liability for hazardous substances found on any of those parcels,
whether or not we caused the contamination.

While we are not aware of any potential problems at this time, we
own multiple parcels of real estate, each of which is subject to various
federal, state, and local environmental laws, ordinances, and regulations.
 Many of these laws and regulations provide that a current or previous
owner of real property may be held liable for the cost of removing hazardous or
toxic substances, including materials containing asbestos that would be located
on, in, or under the property.  These laws and regulations often impose
liability whether or not the owner or operator knew, or was responsible for, the
presence of the hazardous or toxic substances.  The cost of the removal is
generally not limited under the laws and regulations and could exceed the
property's value and the aggregate assets of the owner or operator.  The
presence of these substances or failure to remediate such substances properly
may also adversely affect the owner's ability to sell or rent the property or to
borrow using the property as collateral.  If any of our properties were
found to have environmental issues, we may be required to expend significant
amounts to rehabilitate the property and we may be subject to significant
liability.

The price of our securities may be subject to
fluctuation.

The
market price of our common stock and warrants will likely be highly volatile and
subject to wide fluctuations in response to various factors, many of which are
beyond our control.  These factors include:



·

variations in our operating results;

·

changes in the general economy, and more specifically the Ohio
economy or in the local economies in which we operate;

·

the financial markets; the state and length of the present bull
market and when the market may revert to a bear market;

·

the departure of any of our key executive officers and
directors;

·

the level and quality of securities analysts coverage for our
common stock;

·

announcements by us or our competition of significant
acquisitions, strategic partnerships, joint ventures or capital commitments;

·

changes in federal, state, and local health-care regulations to
which we are subject; and

·

future sales of our common stock.

For these reasons, comparing our operating results on a
period-to-period basis may not be meaningful, and you should not rely on past
results as an indication of future performance.

Our management substantially controls all major
decisions.

Our directors and officers beneficially own approximately 29.4% of
our outstanding common shares, options and warrants.  Therefore, our
directors and officers will be able to influence major corporate actions
required to be voted on by stockholders, such as the election of directors, the
amendment of our charter documents, and the approval of significant corporate
transactions such as mergers, reorganizations, sales of substantially all of our
assets, and liquidation.  Furthermore, our directors will be able



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to make decisions affecting our capital structure, including
decisions to issue additional capital stock, implement stock repurchase programs
and incur indebtedness.  This control may have the effect of deterring
hostile takeovers, delaying or preventing changes in control or changes in
management, or limiting the ability of our other stockholders to approve
transactions that they may deem to be in their best interest.

As we expand our operations, we may open or manage facilities
that are geographically near other facilities that we operate or manage.

While the facilities that we own and manage are sufficiently
well-spaced so that they do not currently compete for business, there can be no
assurance in the future, as we grow, that circumstances will not arise where
facilities which we own and/or manage will compete with each other for patients.
 If this were to occur, it may damage our relationships with facilities
that we manage that could result in the termination of our management
agreements.

The requirements of being a public company may strain our
resources and distract our management.

As a public company, we are subject to the reporting requirements
of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the
Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act.  These requirements
may place a strain on our systems and resources.  The Exchange Act requires
that we file annual, quarterly and current reports with respect to our business
and financial condition.  The Sarbanes-Oxley Act requires that we maintain
effective disclosure controls and procedures and internal controls for financial
reporting.  We are required to document and test our internal control
procedures in order to satisfy the requirements of Section 404 of the
Sarbanes-Oxley Act, which requires annual management assessments of the
effectiveness of our internal controls over financial reporting and, although
not currently required, a report by our independent registered public
accountants addressing these assessments.  During the course of our
testing, we may identify deficiencies which we may not be able to remediate in
time to meet the deadline imposed by the Sarbanes-Oxley Act for compliance with
the requirements of Section 404.  In addition, if we fail to achieve and
maintain the adequacy of our internal controls, as such standards are modified,
supplemented or amended from time to time, we may not be able to ensure that we
can conclude on an ongoing basis that we have effective internal controls over
financial reporting in accordance with Section 404 of the Sarbanes-Oxley
Act.

In order to maintain and improve the effectiveness of our
disclosure controls and procedures and internal control over financial
reporting, significant resources and management oversight is required.
 This may divert management's attention from other business concerns, which
could have a material adverse effect on our business, financial condition,
results of operations and cash flows.  In addition, we may need to hire
additional accounting and financial staff with appropriate public company
experience and technical accounting knowledge, and we cannot assure you that we
will be able to do so in a timely fashion.

Takeover defense provisions may adversely affect the market
price of our common stock.

Various provisions of Ohio corporation law and of our corporate
governance documents may inhibit changes in control not approved by our Board of
Directors and may have the effect of depriving our investors of an opportunity
to receive a premium over the prevailing market price of our common stock in the
event of an attempted hostile takeover.  In addition, the existence of
these provisions may adversely affect the market price of our common stock and
warrants.  These provisions include:

·

a requirement that special meetings of stockholders be called by
our Board of Directors, the Chairman, the President, or the holders of shares
with voting power of at least 25%;

·

staggered terms among our directors with these classes of
directors and only one class to be elected each year;

·

advance notice requirements for stockholder proposals and
nominations; and

·

availability of blank check preferred stock.



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Provisions in our bylaws provide for indemnification of
officers and directors, which could require us to direct funds away from our
business and future products.

Our Articles of Incorporation and Code of Regulations provide for
the indemnification of our officers and directors.  We may be required to
advance costs incurred by an officer or director and to pay judgments, fines and
expenses incurred by an officer or director, including reasonable attorneys'
fees, as a result of actions or proceedings in which our officers and directors
are involved by reason of being or having been an officer or director of our
company.  Funds paid in satisfaction of judgments, fines and expenses may
be funds we need for the operation of our business and the development of our
product candidates, thereby affecting our ability to attain or maintain
profitability.

Item 1B.  Unresolved Staff Comments

None.

Item 2.  Properties

Facilities

As of December 31, 2010, we operated 29 facilities in three states
with the operational capacity to serve approximately 2,493 residents.  Of
the twenty-nine facilities that we operated, we owned ten facilities, leased
eleven pursuant to operating leases, and managed eight facilities for third
parties.

The following table provides summary information regarding the
number of operational beds at our facilities at December 31, 2010:

|                   |  |                 |  |                      |  |        |  |                           |  |      
|------------------ |  | --------------- |  | -------------------- |  | ------ |  | ------------------------- |  | -----
|                   |  |                 |  | Number of Facilities
|State              |  | Number of Units |  | Owned                |  | Leased |  | Managed for Third Parties |  | Total
|Alabama            |  | 411             |  | 2                    |  | -      |  | 1*                        |  | 3    
|Georgia            |  | 1,184           |  | -                    |  | 10     |  | -                         |  | 10   
|Ohio               |  | 898             |  | 8                    |  | 1      |  | 7                         |  | 16   
|Total              |  | 2,493           |  | 10                   |  | 11     |  | 8                         |  | 29   
|                   |  |                 |  |                      |  |        |  |                           |  |      
|Facility
Type      |  |                 |  |                      |  |        |  |                           |  |      
|Skilled
nursing    |  | 2,087           |  | 4                    |  | 11     |  | 5                         |  | 20   
|Assisted
living    |  | 323             |  | 6                    |  | -      |  | 2                         |  | 8    
|Independent
living |  | 83              |  | -                    |  | -      |  | 1                         |  | 1    
|Total              |  | 2,493           |  | 10                   |  | 11     |  | 8                         |  | 29   



* Although the Company does not own this location, it is a managed
related party affiliate that is consolidated by the Company as a variable
interest entity.

Corporate Office

Our corporate office is located in Springfield, Ohio.  We own
the office building, which contains approximately 7,200 square feet of office
space.  In the event we need additional office space in the future,
suitable office space is available in the Springfield area.  We own
additional land on which we could expand our office facilities.

Item 3.  Legal Proceedings

We are not currently involved in any material litigation.  We
may from time to time become a party to various legal proceedings arising in the
ordinary course of our business.



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PART II

Item 5.  Market for Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity
Securities.

Our units began trading on the American Stock Exchange on November
10, 2006, under the symbol ADK.U.  Each unit consisted of two shares of
common stock and two five year warrants for two shares of common stock.
 The units stopped trading and the common stock and the warrants began to
trade separately on December 21, 2006, with the common stock under the symbol
ADK and the warrants under the symbol ADK.WS.

In October 2008, NYSE Euronext acquired the American Stock
Exchange.  Consequently, our stock is now traded on the NYSE Amex exchange.
 The high, low and closing prices of our stock and dividends declared and
paid during 2010 and 2009 were as follows:

|         |                |       |       |                |      | 
|-------- | -------------- | ----- | ----- | -------------- | ---- | 
|ADK    | High           | Low   | Close | Cash Dividends
|2010     | First Quarter  | $5.99 | $3.90 | $5.75          | None
|         | Second Quarter | $5.84 | $3.10 | $3.10          | None
|         | Third Quarter  | $3.62 | $3.01 | $3.45          | None
|         | Fourth Quarter | $4.43 | $3.40 | $3.90          | None
|         |                |       |       |               
|ADK.WS | High           | Low   | Close | Cash Dividends
|2010     | First Quarter  | $3.25 | $2.05 | $2.65          | None
|         | Second Quarter | $3.15 | $1.85 | $1.85          | None
|         | Third Quarter  | $2.25 | $1.25 | $1.30          | None
|         | Fourth Quarter | $2.30 | $1.30 | $1.60          | None
|         |                |       |       |               
|ADK    | High           | Low   | Close | Cash Dividends
|2009     | First Quarter  | $1.37 | $0.70 | $0.94          | None
|         | Second Quarter | $2.45 | $0.94 | $2.25          | None
|         | Third Quarter  | $2.95 | $2.32 | $2.84          | None
|         | Fourth Quarter | $4.15 | $2.10 | $3.94          | None
|         |                |       |       |               
|ADK.WS | High           | Low   | Close | Cash Dividends
|2009     | First Quarter  | $0.17 | $0.02 | $0.05          | None
|         | Second Quarter | $0.70 | $0.05 | $0.36          | None
|         | Third Quarter  | $0.85 | $0.25 | $0.60          | None
|         | Fourth Quarter | $2.60 | $0.20 | $2.60          | None
|         |                |       |       |               

On
December 31, 2010, we had approximately 1,052 share owner accounts of
record.

We have never paid cash dividends on our common shares.
 However, we did pay a 5% stock dividend in the form of stock to
shareholders of record on September 30, 2010.  Holders of common shares are
entitled to receive dividends.  Our ability to pay dividends will depend
upon our future earnings and net worth.  We are restricted by Ohio law from
paying dividends on any of our outstanding shares while insolvent or if such
payment would result in a reduction of our stated capital below the required
amount.

It is the intention of our Board periodically to consider the
payment of dividends, based on future earnings, operating and financial
condition, capital requirements and other factors deemed relevant by the Board.
 There is no assurance that we will be able or will desire to pay dividends
in the near future or, if dividends are paid, in what amount.  Our Board
may decide not to pay dividends in the near future, even if funds are legally
available, in order to provide us with more funds for operations.



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On December 8, 2009, at a special shareholder meeting,
shareholders approved the sale of approximately 1,400,000 shares of stock and
warrants in a private placement.  The offering consisted of Units with each
Unit containing one share of the Companys common stock and one five-year
warrant to purchase an additional share of common stock at $2.38 per share.
 Each Unit was valued at $2.00.  The offering is not registered under
the Securities Act of 1933 and was only sold in the United States pursuant to
applicable exemptions from registration.  As a result the Company raised
approximately $2,439,000 after commissions and expenses.

On June 4, 2010, the shareholders voted to amend the articles of
incorporation to increase the number of authorized shares of common stock from
14,500,000 shares to 29,000,000 shares and to increase the number of authorized
shares of preferred stock from 500,000 shares to 1,000,000 shares.  The
amendments were effective in the second quarter of 2010.

On June 30, 2010, the Company closed a public stock offering of
1,714,286 shares of common stock at a gross price of $3.50 per share.  The
Company received net proceeds of approximately $5.4 million after deducting
underwriting discounts, commissions, legal fees and other offering-related
expenses payable by the Company.  AdCare granted a 30-day option to the
underwriter to purchase up to an additional 15% of the shares offered, or
257,143 shares, to cover over-allotments, if any.  On August 4, 2010, the
underwriter exercised their overallotment option to purchase an additional
225,400 shares of common stock at a discounted price of $3.255 per share,
resulting in net proceeds to the Company of approximately $734,000.

Equity Compensation Plan Information

The following table sets forth additional information as of
December 31, 2010, concerning shares of our common stock that may be issued upon
the exercise of options and other rights under our existing equity compensation
plans and arrangements, divided between plans approved by our shareholders and
plans or arrangements not submitted to the shareholders for approval.  The
information includes the number of shares covered by and the weighted average
exercise price of, outstanding options and other rights and the number of shares
remaining available for future grants excluding the shares to be issued upon
exercise of outstanding options, warrants, and other rights.

|                                                          |                                                                                             |                                                                             |                                                                                                                                            
|--------------------------------------------------------- | ------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------
|                                                          | (a)                                                                                         | (b)                                                                         | (c)                                                                                                                                        
|                                                          | Number of Securities to be Issued Upon Exercise of
Outstanding Options, Warrants and Rights | Weighted-Average Exercise Price of Outstanding Options,
Warrants and Rights | Number of Securities Remaining Available for Future Issuance
Under Equity Compensation Plans (Excluding Securities Reflected in Column
(a))
|Equity
compensation plans approved by security holders    | 2,104,890                                                                                   | $2.39                                                                       | 261,456                                                                                                                                    
|Equity
compensation plan not approved by security holders | 0                                                                                           | $0.00                                                                       | 0                                                                                                                                          





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Item 6.  Selected Financial Data

Not Applicable.

Item 7.  Managements Discussion and Analysis of
Financial Condition and Results of Operations

Overview



We
are a Springfield, Ohio based developer, owner and manager of retirement
communities, assisted living facilities, nursing homes, and provide home health
care services.  We currently operate twenty-nine facilities, comprised of
twenty skilled nursing centers, eight assisted living residences and one
independent living/senior housing facility, totaling nearly 2,493 units.
 Our communities are located in Ohio, Georgia and Alabama.



We
have an ownership interest in ten of the facilities we operate, comprised of
100% ownership of four of the skilled nursing centers and six assisted living
facilities.  We have lease agreements on eleven skilled nursing facilities.
 The assisted living facilities that we own operate under the name Hearth
& Home, with the tag line Home is where the hearth is  We also
maintain a development/consulting initiative which provides potential management
opportunities to our core long-term care business.  AdCare Health Systems,
Inc. and Hearth & Home are registered trademarks.



Acquisitions

We have embarked on a strategy to grow our business through
acquisitions and leases of senior care facilities and businesses providing
services to those facilities.  During 2009, we engaged a Chief Acquisitions
Officer with the primary purpose of identifying acquisition opportunities in the
Midwestern and Southeastern United States.

We
have completed a number of transactions to provide capital for our strategic
growth initiatives.  In December 2009, we completed a private placement of
stock which raised approximately $2,400,000 net of underwriters expenses.
 On June 30, 2010, we completed a public offering of stock with net
proceeds of approximately $5,400,000.  Additionally, on August 4, 2010, the
underwriter exercised their overallotment option resulting in additional net
proceeds of approximately $734,000. On October 26, 2010, we entered into a
Securities Purchase Agreement with certain accredited investors to sell and
issue to the Purchasers in reliance on Section 4(2) of the Securities Act of
1933, as amended, an aggregate of $11,050,000 in principal amount of our
Subordinated Convertible Notes, bearing 10.0% interest per annum payable
quarterly in cash in arrears beginning December 31, 2010.  On October 29,
2010, we entered into an amendment and joinder agreement to the sale of an
additional $750,000 in principal amount of Notes.  These transactions
enabled us to complete several acquisitions during 2010.



On
March 31, 2010, we completed our acquisition of Communitys Hearth & Home in
which we acquired our partners 50% interest in one assisted living facility
located in Urbana, Ohio, and two located in Springfield, Ohio.  We acquired
our partners interest primarily to exercise complete control over decisions
affecting the operations and the use and allocation of the assets and cash flow
generated by the businesses.  Additionally, we feel the bargain purchase
price presented an excellent low cost opportunity to increase our ownership to
100%.  Until this acquisition occurred, we consolidated the results of
operations of these facilities and reflected our partners share of the net
income or loss generated as income attributable to noncontrolling interests.
 Following the acquisition, we will recognize 100% of the income generated
by these facilities with no portion being attributed to the noncontrolling
interest.  Additionally, 100% of the cash flow generated by the operations
of these facilities will be available to allocate to other company initiatives
without sharing it with our partner.



On April 9, 2010, Riverchase Village ADK, LLC, (Riverchase) a
wholly owned subsidiary of AdCare Health Systems, Inc. entered into a Purchase
Agreement with CSC Enid Properties, LLC, an Oklahoma limited liability company
controlled by a bank, to acquire the assets of Riverchase Village, a 105 bed
assisted living facility located in Hoover, Alabama.  The purchase price
was approximately $5,000,000.  The right to acquire Riverchase was assigned
to Chris Brogdon, Vice Chairman of the Company, on June 22, 2010, and the
transaction closed on June 25, 2010.  As consideration for the assignment,
Riverchase granted us a one year option with a $100,000 exercise price to
acquire Riverchase under the same terms and conditions as set forth in the
Purchase Agreement.  In addition, we entered into a five year management
contract to manage Riverchase.  In connection with financing the
transaction, Riverchase borrowed from the Medical Clinic Board of the City of
Hoover the proceeds from the issuance of $5,845,000 First Mortgage Healthcare
Facility Revenue Bonds (Series 2010A) and $520,000 First Mortgage Revenue Bonds
(Series B) to acquire the Property, pay the cost of certain repairs and
improvement to the Property, fund certain reserves and pay the cost of the
issuance of the Bonds. As part of the financing, we were required to be a



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guarantor on the bonds.  Riverchase has refunded the $250,000
of earnest money to us.  The results of operations of Riverchase Village
have been consolidated in our financial statements as a result of our
determination that Riverchase Village is a variable interest entity of which
AdCare Health Systems is the primary beneficiary.

On July 30, 2010, we entered into various agreements to take over
as the operator of ten skilled nursing facilities located in Georgia.
 These facilities were previously being operated by another company (the
prior operator) that filed for bankruptcy relief under Chapter 11 of Title 11
of the United States Code in the United States Bankruptcy Court for the Northern
District of Georgia.  The prior operator was operating these facilities
under operating lease agreements with two different owners.  The lessors of
these facilities own the bed licenses required to operate them as skilled
nursing facilities.

For eight of the ten skilled nursing facilities (the G8
facilities), we entered into new long-term lease agreements with the facility
owner on July 30, 2010.  We began leasing and managing the operations of
five of the G8 facilities effective August 1, 2010 and the remaining three
facilities effective September 1, 2010.  The master lease agreement is for
10 years and requires total rent payments of $397,650 per month for the G8
facilities increasing by 2% each year.  We have paid $500,000 in security
deposits and $795,300 in advance rent to be applied at the end of the lease
term.

Effective November 1, 2010, for the remaining two skilled nursing
facilities (the G2 facilities), we entered into an assignment and transfer
agreement with the prior operator to assign the operating leases of these
facilities and transfer the operations to the Company.  Under the assigned
lease agreement, we will be operating the G2 facilities under a non-cancelable
operating lease that expires on April 30, 2022 and includes two additional ten
year renewal periods.  The lease agreement requires total monthly rent
payments of $125,000 increasing by 3% on May 1 each year.  On November 1,
2010, we were required to pay $375,000 for a security deposit.

In separate transactions under operations transfer agreements with
the prior operator, the Company acquired certain assets of the prior operator
for a total purchase price of approximately $10,870,000 including acquisition
costs of approximately $214,000.  As part of this asset acquisition, the
Company acquired approximately $3,000,000 in accounts receivable, approximately
$9,020,000 in lease acquisition costs and other assets, and assumed
approximately $870,000 in accounts payable and a $280,000 loss contingency.
 The Company paid the purchase price with approximately $7,705,000 in cash,
$1,250,000 in common stock, $475,000 (net of $25,000 discount) and contingent
consideration of $1,440,000.

Effective October 1, 2010, we acquired the operations of and
selected assets of Coosa Valley Health Care, a 124 bed skilled nursing facility
located in Gadsden, Alabama, for a purchase price of $8,700,000.  We did
not assume any liabilities in the acquisition.  Also on October 1, 2010, we
completed the acquisition of the operations of and selected assets of Attalla
Health Care, a 182 bed skilled nursing facility located in Gadsden, Alabama, for
a purchase price of $9,800,000.  We did not assume any liabilities in the
acquisition.  Both of these entities were owned by the same private
individuals.  Through the Operations Transfer Agreements, we obtained
control of the two facilities effective October 1, 2010.

Effective January 1, 2011, we acquired the operations of and
selected assets of Mountain Trace; a 106 bed skilled nursing facility located in
Sylva, North Carolina.  Through the Operations Transfer Agreement, we
obtained control of the facility effective January 1, 2011.  We had paid
$200,000 in earnest money upon entering the purchase agreement and an additional
$50,000 to extend the closing date to December 30, 2010.  To complete the
acquisition, we issued a secured promissory note (the Note) for $5,000,000.
 The Note was secured by the Mountain Trace facility and was guaranteed by
AdCare Health Systems, Inc. and personally guaranteed by Christopher Brogdon and
his spouse Connie Brogdon.  The Note, scheduled to mature on June 30, 2011,
accrued interest at a fixed rate of 7% per annum.  On February 2, 2011, the
Note was refinanced with a permanent loan for $5,000,000 from Community Bank
& Trust-West Georgia guaranteed by the United States Department of
Agriculture.  The permanent loan is for 25 years and bears interest equal
to the prime rate plus 1.75%.

We are currently evaluating acquisition opportunities in addition
to those described above and we continue to seek new opportunities to further
our growth strategy.  No assurances can be made that any of these
opportunities will be determined to be appropriate or that they may be acquired
on terms acceptable to us.



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Segments



Our
business operates in four segments: skilled nursing facilities (SNF), assisted
living facilities (ALF), home health and management and development.
 In our skilled nursing and assisted living segments, we operate, have
ownership interests in or lease twenty-one facilities for which we collect fees
from the residents of those facilities. Profits/losses are generated to the
extent that the monthly patient fees exceed the costs associated with operating
those facilities. In our home health segment profits/losses are generated to the
extent that the monthly patient fees exceed the costs associated with providing
services to patients in their homes.  In our management and development
segment, we manage an aggregate of eight assisted living facilities, nursing
homes and an independent living campus all of which are owned by third parties.
With respect to these facilities, we receive a management fee based on the
revenue generated by the facilities. Within our management and development
segment, we provide development, consulting and accounting services to third
parties. In these instances, we receive a fee for providing those services.
These fees vary from project to project, with the development fee in most cases
being based on a percentage of the total cost to develop the project.





|                   |  |                 |  |       |  |        |  |                           |  |      
|------------------ |  | --------------- |  | ----- |  | ------ |  | ------------------------- |  | -----
|                   |  | Number of Units |  | Owned |  | Leased |  | Managed for Third Parties |  | Total
|Skilled
nursing    |  | 2,087           |  | 4     |  | 11     |  | 5                         |  | 20   
|Assisted
living    |  | 323             |  | 6     |  | -      |  | 2                         |  | 8    
|Independent
living |  | 83              |  | -     |  | -      |  | 1                         |  | 1    
|Total              |  | 2,493           |  | 10    |  | 11     |  | 8                         |  | 29   



Skilled Nursing Facility Segment



We
focus on two primary indicators in evaluating the financial performance in this
segment.  Those indicators are facility occupancy and staffing.
 Facility staffing is important because payroll and related payroll costs
represent approximately 59% of our total operating costs.  Staffing levels
and the quality of staff are closely monitored by management to make sure costs
are maintained within expected levels and to assure a high level of quality
services.  Facility occupancy is important as higher occupancy generally
leads to higher revenue.  In addition, concentrating on increasing the
number of Medicare admissions helps in increasing revenue.



|                                  |                  
|--------------------------------- | -----------------
|Skilled Nursing Facilities       
|                                  | Average Occupancy
|AdCare average, December 31, 2010 | 85.6%            
|AdCare average, December 31, 2009 | 88.8%            



We
continue our work towards maximizing the number of patients covered by Medicare
where our profit margins are typically higher.  For the year ended December
31, 2010, the percentage of patients covered by Medicare in our skilled nursing
facilities was 10.8% compared to 13.9 % for the year ended December 31, 2009.
 We believe the current economic conditions that have contributed to our
lower occupancies are also contributing to our lower number of Medicare
patients.  Additionally, we believe hospitals may be responding to recent
actions by the Centers for Medicare and Medicaid Services to review hospital
admission decisions for Medicare covered patients.  Hospitals have
responded to this increased scrutiny by only admitting the patients for
observation thereby limiting a skilled nursing facilitys ability to receive
Medicare coverage for patients admitted from hospitals.



We
have undertaken several initiatives to improve census in our skilled nursing
segment including bi-weekly conference calls to discuss census development,
advertising campaigns, a sales incentive system and multiple public events at
facilities to increase community interaction and facility visibility.
 Additionally, we have added new sales/marketing positions to consult with
facility level sales staff on census development as well as make more marketing
calls to places that can generate more Medicare admissions such as hospitals and
medical offices.



The
Federal Centers for Medicare and Medicaid Services, or CMS, adopted rules that
decreased the aggregate Medicare payments to skilled nursing facilities by
approximately 1.1% in federal fiscal year 2010.  Effective as of October 1,
2008, CMS increased Medicare rates for skilled nursing facilities by
approximately 3.5% for the federal fiscal year ending September 30,



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2009, under a rule adding an annual update to account for
inflation in the cost of goods and services.  CMS then adopted rules
recalibrating the Medicare prospective payment categories for skilled nursing
facilities for federal fiscal year 2010.  The recalibration resulted in a
decrease of approximately 3.3% in projected skilled nursing facility payments,
offset by an increase of approximately 2.2% to account for inflation.  As a
result, CMS estimated that aggregate Medicare payments were reduced by
approximately 1.1% in fiscal year 2010.

Medicare reimbursement rates and procedures are subject to change
from time to time, which could materially impact our revenue. Medicare
reimburses our skilled nursing facilities under a prospective payment system
(PPS) for certain inpatient covered services. Under the PPS, facilities are
paid a predetermined amount per patient, per day, based on the anticipated costs
of treating patients. The amount to be paid is determined by classifying each
patient into a resource utilization group (RUG) category that is based upon
each patients acuity level.  As of October 1, 2010, the RUG
categories were expanded from 53 to 66 with the introduction of MDS 3.0. Should
future changes in skilled nursing facility payments reduce rates or increase the
standards for reaching certain reimbursement levels, our Medicare revenues could
be reduced, with a corresponding adverse impact on our financial condition,
results of operations, or cash flows.



The
Governor of the State of Ohio is currently preparing the state Biennial Budget
for the period covering 2011-2013.  While details of the budget proposal
are not yet fully understood, the Governor and his administration have made
several negative overtures toward Medicaid indicating that cuts in reimbursement
to nursing homes are likely.  Early estimates indicate to Medicaid spending
cuts in Ohio could be as high as 7%.  The budget process is just beginning
so it is likely the final details of budget will not be known for some time.
 At this time, no significant changes are anticipated in Alabama and
Georgia.  For the year ended December 31, 2010, Medicaid covered patients
of our skilled nursing facilities comprised approximately 77.3% of our total
skilled nursing facility patients.



Assisted Living Facility Segment



Similar to our skilled nursing segment, in our assisted living
segment, we focus on facility occupancy and staffing.



|                                  |                  
|--------------------------------- | -----------------
|Assisted Living Facilities       
|                                  | Average Occupancy
|AdCare average, December 31, 2010 | 76.4%            
|AdCare average, December 31, 2009 | 85.6%            



We
believe the current economic conditions have contributed to the decline in
occupancy.  Residents of our assisted living facilities rely on their
personal investments and wealth to pay for their stay.  Recent declines in
market values of investments could limit their ability to pay for services or
shorten the period of time for which they can pay privately for their stay.
 The depressed market for the sale of homes could limit their ability to
sell their personal assets further reducing their ability to remain in our
facilities.  Furthermore, adult children who have recently become
unemployed may decide to care for their parent at home so that their parents
income may help offset some of their own financial burdens.  We do not
believe this is a trend and we believe facility occupancy will improve.



We
have undertaken several initiatives to improve census in our assisted living
segment including advertising campaigns, a sales incentive system and multiple
public events at facilities to increase community interaction and facility
visibility.  Additionally, we have added a new sales/marketing position to
consult with facility level sales staff on census development.



Home Based Care Segment



In addition to providing home health care services to patients in
their homes, we are utilizing our home health services in our assisted living
and independent living properties in Ohio to create cross selling opportunities.
 For the year ended December 31, 2010, the percentage of our home health
patients covered by Medicare has decreased to 19.8% compared 28.4% for the year
ended December 31, 2009.  While we have experienced recent declines in the
number of patients we are serving for home health services, we dont believe
this is a trend.  We have engaged a new marketing and sales employee for
our home health segment to improve our referrals and increase the number of
patients we are providing services to.

The
Center for Medicare and Medicaid Services (CMS) has made a 2.75%
across-the-board rate reduction for home health care services for 2010, as well
as a 2.71% cut for 2011. Additionally, CMS has other initiatives directed
towards reducing payment for home health care services.  Medicare covered
services comprise approximately 19.8% of our home health total visits.



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Effective January 1, 2010, Ohio Job and Family Services (Medicaid)
made a 3% reduction in reimbursement for home health services.  Medicaid
covered services comprise approximately 72% of our home health total visits.



Management, Development and Corporate Segment



We
manage five skilled nursing facilities, two assisted living facilities and one
independent living campus for third party owners.  Additionally, we provide
accounting services to one skilled nursing facility.  During the first
quarter of 2010, we added two skilled nursing facilities bringing the number of
facilities managed to the current levels.  Our contracts for these services
are for either a fixed monthly fee or for a percentage of revenue generated by
the managed facility.  Depending on the type of contract, our revenues
increase annually according to inflationary adjustments stipulated in our
management agreements or they increase as the facilitys revenue increases for
the contracts that are based on a percentage of revenue.  Consequently,
management consulting and development fee revenue has increased $237,000 for the
year ended December 31, 2010 when compared to the year ended December 31,
2009.



This segment includes our corporate overhead expenses which are
made up of salaries of senior management team members and various other
corporate expenses including but not limited to corporate office operating
expenses, audit fees, legal fees and board activities.  Additionally, non
cash charges for compensation expense related to warrants, restricted stock and
stock options are included in corporate overhead.  We dont allocate these
expenses to the divisions or separate them from management and development
business for management review purposes.



The table below contains our segment information for the years
ended December 31, 2010 and 2009.

|                               |                             |         |         |             |                                     |         
|------------------------------ | --------------------------- | ------- | ------- | ----------- | ----------------------------------- | --------
|Amounts in 000s              
|                               |                             | SNF     | ALF     | Home Health | Management, Development & Corporate | Total   
|Year to Date December 31, 2010
|                               | Net Revenue                 | $40,427 | $8,270  | $2,446      | $2,094                              | $53,237 
|                               | Payroll & Associated Costs  | 21,848  | 4,131   | 1,910       | 4,501                               | 32,390  
|                               | Other Operating Expenses    | 15,317  | 2,883   | 460         | (346)                               | 18,314  
|                               | Lease Expense               | 2,908   | -       | -           | -                                   | 2,908   
|                               | Depreciation & Amortization | 585     | 554     | 16          | 123                                 | 1,278   
|                               | Operating Income (Loss)     | $(231)  | $702    | $60         | $(2,184)                            | $(1,653)
|                               | Total Assets                | $50,482 | $22,597 | $2,320      | $7,560                              | $82,959 
|                               | Capital Spending            | $510    | $347    | $9          | $275                                | $1,141  
|                               |                             |         |         |             |                                     |         
|Year to Date December 31, 2009
|                               | Net Revenue                 | $14,369 | $7,411  | $3,055      | $1,856                              | $26,691 
|                               | Payroll & Associated Costs  | 6,923   | 3,385   | 2,171       | 2,892                               | 15,371  
|                               | Other Operating Expenses    | 5,464   | 2,357   | 373         | (196)                               | 7,998   
|                               | Lease Expense               | 629     | -       | -           | -                                   | 629     
|                               | Depreciation & Amortization | 295     | 508     | 11          | 105                                 | 919     
|                               | Operating Income (Loss)     | $1,058  | $1,161  | $500        | $(945)                              | $1,774  
|                               | Total Assets                | $8,307  | $15,021 | $2,653      | $4,198                              | $30,179 
|                               | Capital Spending            | $269    | $186    | $40         | $78                                 | $573    



Skilled Nursing Facilities



For
the year ended December 31, 2010, revenue in our skilled nursing segment
increased approximately $26,058,000 as a result of acquisitions during the year.
 This increase was offset by a decrease in revenue in our properties that
we operated during 2009 (legacy properties) of approximately $1,639,000.
 This segment had a loss from operations of $231,000 as a result of lower
than optimal occupancy.  We plan to increase facility occupancy and to
increase the number of patients covered by



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Medicare.  We expect to continue to implement and refine
strategies to achieve these goals.  Total assets increased $42,174 due to
acquisitions made during the year.



Assisted Living Facilities



For
the year ended December 31, 2010, revenue in our assisted living segment
increased approximately $859,000 as a result of increased revenue from
acquisitions, an annual increase in rates charged to privately paying residents
offset by lower occupancy.  This segment had income from operations of
$702,000 which is $459,000 less than 2009 as a result of lower occupancy and
increased payroll related expenses.  We have a number of initiatives in
place to help improve the occupancy.  Total assets increased $7,577,000
primarily due acquisitions made during the year.



Home Health Segment



For the year ended December 31, 2010, revenue in our home based
care segment declined approximately $609,000 as a result of fewer patients and
fewer patients covered by Medicare.  In addition, this segment experienced
increased expenses from annual employee wage increases of approximately 3%.
 The decline in revenues and increases in expenses resulted in income from
operations of approximately $60,000 which is $440,000 less than in 2009.
 The decrease in total assets was primarily the result of depreciation.
 We have engaged a new marketing and sales employee for our home health
segment to improve our referrals and increase the number of patients we are
providing services to as well as to concentrate on improving our Medicare
referrals.

Management, Development and Corporate Segment

Management consulting and development fee revenue has increased
$238,000 for the year ended December 31, 2010 when compared to the year ended
December 31, 2009.  Net loss from operations was $2,184,000 due primarily to corporate overhead,
costs for acquisitions and non cash charges for compensation expense related to
warrants, restricted stock and employee stock options.



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Consolidated Results of Operations

Year Ended December 31, 2010 and December 31, 2009

Revenue

Approximately 96% of our revenue is derived from patient care
services provided by our skilled nursing facilities, assisted living facilities
and home health agency.  The following table compares revenue for the years
ended December 31, 2010 and 2009:

|                                                   |                   |  |                   |  |             |           
|-------------------------------------------------- | ----------------- |  | ----------------- |  | ----------- | ----------
|                                                   | December 31, 2010 |  | December 31, 2009 |  | Increase    | %   Change
|Patient
care revenue                               | $51,143,381       |  | $24,834,831       |  | $26,308,550 | 105.9%    
|Management,
consulting and development fee revenue | 2,093,334         |  | 1,856,269         |  | 237,065     | 12.8%     
|                                                   | $53,236,715       |  | $26,691,100       |  | $26,545,615 | 99.5%     



For the periods compared, patient care revenue increased
$26,308,550 or 105.9%.  Revenue increased $27,948,000 as a result of our
acquisitions during the year.  This increase was offset by a decrease in
revenue in our properties that we operated during 2009 (identified as legacy
properties) of approximately $1,639,000.  The average occupancy in our
legacy skilled nursing centers declined 6.3% while the number of residents
covered by Medicare decreased to 12.1% for the year ended December 31, 2010
compared to 13.9% for the year ended December 31, 2009 resulting in a decrease
in revenue of approximately $1,039,000.  The average occupancy in our
legacy assisted living facilities declined 3.3%; however, revenue in our
assisted living centers decreased only $8,500 as a result of an annual increase
in rates charged to privately paying residents offsetting lower occupancy
levels.  Home health revenue declined approximately $609,000 as a result of
services provided to fewer patients as well as fewer Medicare patients overall.
 Management, consulting and development fee revenue increased approximately
$237,000 or 12.8% as a result of higher management fees on properties we manage
for third parties and the addition of two new contracts for management of
skilled nursing facilities during the first quarter of 2010.

Operating
Expenses

|                                  |                   |  |                   |  |             |         
|--------------------------------- | ----------------- |  | ----------------- |  | ----------- | --------
|                                  | December 31, 2010 |  | December 31, 2009 |  | Increase    | % Change
|Payroll and
related payroll costs | $32,390,302       |  | $15,371,150       |  | $17,019,152 | 110.7%  
|Other
operating expenses          | 18,313,705        |  | 7,998,158         |  | 10,315,547  | 129.0%  
|Lease
expense                     | 2,907,530         |  | 628,829           |  | 2,278,701   | 362.4%  
|Depreciation
and amortization     | 1,277,939         |  | 918,851           |  | 359,388     | 39.1%   
|                                  | $54,889,476       |  | $24,916,988       |  | $29,972,488 | 120.3%  



Operating expenses for year ended December 31, 2010 increased
by $29,972,000 or 120.3%.  Payroll and related payroll costs increased by
$17,019,000 or 110.7%.  Payroll and related payroll costs increased
$15,196,000 as a result of our acquisitions during the year.  The remaining
increase of $1,823,000 is due primarily to $811,000 in non cash compensation
expense related to warrants and restricted stock issued to members of management
in December, 2009, annual employee wage increases of approximately 3% and
additional corporate overhead payroll as a result of our growth.



Other operating expenses increased $10,316,000 or 129.0%.
 Approximately $9,237,000 was as a result of growth during the year.
 Approximately $1,079,000 of the increase was due primarily to increased
expenses related to audit fees, higher legal fees, consulting fees for
investment bankers and investor relations and Board activities.



Lease expense increased $2,279,000 or 362.4% as a result of
entering ten new operating leases for skilled nursing facilities during
2010.





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Depreciation
and amortization expense increased by $359,000 or 39.1% primarily due to
depreciation of the assets of facilities acquired during the year and routine
additions of fixed assets and their related depreciation expense.

(Loss)
Income from Operations

Loss from operations for the year ended December 31, 2010 was
approximately $1,653,000.  When compared to the year ended December 31,
2009 income from operations of approximately $1,774,000, this represents a
decrease of approximately $3,427,000.  This is primarily a result of
increased non cash compensation expense related to warrants and restricted
stock, other increases in operating expenses and lower revenue as described
above.

Other Income and Expense

|                                               |                   |  |                   |  |                      |         
|---------------------------------------------- | ----------------- |  | ----------------- |  | -------------------- | --------
|                                               | December 31, 2010 |  | December 31, 2009 |  | Increase/ (Decrease) | % Change
|Interest
income                                | $17,739           |  | $5,472            |  | $12,267              | 224.2%  
|Interest
expense                               | (2,372,299)       |  | (1,209,926)       |  | (1,162,373)          | 96.1%   
|Gain on
acquisitions, net of acquisition costs | 2,446,483         |  | -                 |  | 2,446,483            | 100.0%  
|Derivative
loss                                | (343,144)         |  | -                 |  | (343,144)            | 100.0%  
|Loss on
debt extinguishment                    | (228,203)         |  | -                 |  | (228,203)            | 100.0%  
|Other
expense                                  | (25,027)          |  | (46,745)          |  | 21,718               | (46.5)% 
|                                               | $(504,451)        |  | $(1,251,199)      |  | $746,748             | (59.7)% 



For
the year ended December 31, 2010 compared to the year ended December 31, 2009,
interest expense increased approximately $1,162,000 primarily due to interest
expense on additional debt incurred as a result of acquisitions.  Gain on
acquisitions, net of acquisition costs were the result of gains recognized on
three business acquisitions during the year.  These gains are summarized
below.  The derivative loss of $343,000 was a result of a fair market value
adjustment to the derivative liability.  On October 29, 2010, we entered a
convertible debt agreement that included a conversion feature that was not
indexed to our common stock.  As a result, we recognized a liability that
must be adjusted to fair market value at each financial statement reporting
date.  These adjustments are recognized as a gain or loss on the derivative
depending upon the relative change in fair market value.  Loss on debt
extinguishment is the result of refinancing our convertible debenture entered
into in September, 2010, and refinanced in October, 2010, with a new convertible
debenture.



Gain on Acquisitions



On
October 1, 2010, we completed the acquisitions of Attalla Health Care and Coosa
Valley Health Care, two skilled nursing facilities located in Alabama.
 This transaction was accounted for accordance with ASC Topic 805, Business
Combinations.  As a result, we recognized a gain of approximately $960,000,
net of acquisition costs.



On
June 25, 2010, Riverchase Village ADK, LLC, a variable interest entity of which
AdCare Health Systems is the primary beneficiary, completed the acquisition of
Riverchase Village.  This transaction was accounted for accordance with ASC
Topic 805, Business Combinations.  As a result, we recognized a gain of
approximately $660,000, net of acquisition costs, which was eliminated in net
income attributable to AdCare Health Systems as it is attributed to the
noncontrolling interest.



On
March 31, 2010, we acquired our partners 50% noncontrolling interest in two
assisted living facilities located in Springfield Ohio known as Communitys
Hearth & Home.  Also on March 31, 2010, we acquired our partners 50%
noncontrolling interest in one assisted living facility located in Urbana Ohio
known as Hearth & Home of Urbana.  The combined purchase price for both
acquisitions was $500,000.  This transaction was accounted for accordance
with ASC Topic 805, Business Combinations.  As a result, we recognized a
gain of approximately $826,000.



Gain on acquisitions was approximately $2,446,483 net of
acquisition costs for the year ended December 31, 2010.





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Summary

Loss before income taxes for the year ended December 31, 2010 was
approximately $2,157,000 compared to a net income of approximately $523,000 for
the year ended December 31, 2009, a decrease of approximately $2,680,000.

Income tax expense of approximately $42,567 for the year ended
December 31, 2010, is related to the amortization of purchased goodwill under
Internal Revenue Code section 197.  However, as a result of existing loss
carry forwards no tax will actually be paid by the Company.

Net loss attributable to AdCare Health Systems for the year ended
December 31, 2010, was approximately $2,744,000 compared to a net income for the
year ended December 31, 2009, of approximately $440,000, a decrease of
approximately $3,184,000 as a result of the items described above.





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Liquidity and Capital Resources

Overview

We had net working capital as of December 31, 2010 of
approximately $708,000 as compared to net working capital of approximately
$2,856,000 for the year ended December 31, 2009, a decrease of approximately
$2,148,000.  This decrease is primarily the result of our acquisition
activities.

On November 14, 2008, we established a $100,000 line of credit
with Huntington National Bank to assist with cash flow.  On March 26, 2010,
our lender increased this line of credit to $200,000.  As of December 31,
2010, approximately $187,000 was used in operations of the Company.

We have established a $191,000 line of credit using funds from our
non-qualified deferred compensation plan.  Members of this plan, which is
only available to senior management, authorized the transfer of funds to
establish the line of credit with interest accruing at 8%.  The funds are
presently used in the operations of the Company.

Some of our properties are financed with loans secured by the
Department of Housing and Urban Development (HUD).  These loans limit our
use of the cash generated by the properties for purposes other than to fund the
operations of the HUD financed property.  In January and July each year, we
are permitted to withdraw cash from these properties if a calculation of cash
flow determines that the properties have generated cash in excess of what is
needed to fund the expenses of the property in the short term.  When the
calculation indicates there is available cash, we withdraw the funds from the
property and deposit them in an interest bearing checking account and hold them
for future use in operations.  Of our unrestricted cash balance of
approximately $3,911,000, there was approximately $1,070,000 of cash that was
subject to these requirements representing approximately 27% of our unrestricted
cash balance as of December 31, 2010.

On
October 26, 2010, we entered into a Securities Purchase Agreement with certain
accredited investors to sell and issue to the Purchasers in reliance on Section
4(2) of the Securities Act of 1933, as amended, an aggregate of $11,050,000 in
principal amount of our Subordinated Convertible Notes, bearing 10.0% interest
per annum payable quarterly in cash in arrears beginning December 31, 2010.
 On October 29, 2010, we entered into an amendment and joinder agreement to
effectuate the sale of an additional $750,000 in principal amount of Notes.
 The initial sale of $11,050,000 in principal amount of Notes occurred on
October 26, 2010, and the subsequent sale of $750,000 in principal amount of
Notes occurred on October 29, 2010.  The funds received in this financing
were used for acquisitions and working capital.



Also on October 29, 2010, AdCare subsidiaries ADK Powder Springs
Operators, LLC, ADK Lumber City Operator, LLC, ADK Jeffersonville Operator, LLC,
ADK LaGrange Operator, LLC and ADK Thomasville Operator, LLC (collectively the
Borrowers) entered into a Credit Agreement with a lender, Gemino Healthcare
Finance, LLC, to provide a credit facility in the maximum amount of $5,000,000
limited by certain borrowing base restrictions.  In addition, certain
minimum balances are required to be maintained through the initial term of the
credit facility. Borrowing under the Credit Facility is not limited to use by
the Borrowers and may be used for various business purposes.  The initial
term of the Credit Facility shall expire on October 29, 2013. The Lender
will make advances to the Borrowers from time to time in the form of revolving
loans.  The aggregate amount of the revolving loans shall not exceed the
maximum credit limit.  Initially, the Borrowers pledged their accounts
receivable as collateral.  AdCare will have the ability to add additional
subsidiaries to the credit facility subject to certain terms and conditions with
the Lender.  Each revolving loan is subject to interest on the outstanding
principal amount from the date made until such revolving loan is paid in full,
at a rate per annum equal to the LIBOR Rate plus the Applicable Margin.
 The Interest Rate on all amounts outstanding under the Credit Facility
shall be adjusted daily based on the LIBOR Rate with a LIBOR Floor of 2.50% to
2.25% depending on the principal amount outstanding.  The Applicable Margin
will be 4.75% to 5.00% depending on the principal amount outstanding.  The
loan is subject to various fees.  Subsequently, on February 25, 2011, we
joined five additional AdCare subsidiaries:  ADK Thunderbolt Operator, LLC,
ADK Savannah Beach Operator, LLC, ADK Oceanside Operator, LLC, Attalla Nursing
ADK, LLC, and Coosa Nursing ADK, LLC as additional borrowers in the Credit
Agreement.  The additional borrowers increased the amount of credit
available to us and the maximum amount of the credit facility increased to
$7,500,000.  As of December 31, 2010, approximately $1,763,000 of the
credit facility was used in the operations of the business.



We plan to further improve liquidity by 1) refinancing debt where
possible to obtain more favorable terms, 2) increasing facility occupancy, add
additional management contracts and expand our home health operations and 3)
engaged financial advisors to



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assist the Company in identifying, evaluating and securing
alternative capital, financing and investment sources to fund the our strategic
business plan.

Cash
Flow

Our cash requirements are satisfied primarily with cash generated
from operating activities, financing activities and additional indebtedness.
 Our cash flow is dependent on our ability to collect accounts receivable
in a timely manner.  The majority of our revenue is from Medicaid and
Medicare programs.  These are reliable payment sources which make our
likelihood of collection very high.  However, the time it takes to receive
payment on a claim from these sources can take up to several months.  On
average, accounts receivable were outstanding approximately 38 days before
collection as of December 31, 2010 and 26 days as of December 31, 2009.
 The status of accounts receivable collections is monitored very closely by
our senior management.

Year ended December 31, 2010

Net cash used in operating activities for the year ended December
31, 2010 was approximately $1,216,000 consisting primarily of our net loss from
operations less the noncash gain on acquisitions, and changes in working capital
partially offset by other noncash charges; all primarily the result of routine
operating activity.

Net cash used in investing activities for the year ended December
31, 2010 was approximately $14,364,000.  This is primarily the result of
deposits for acquisitions and acquisitions of leases in Georgia and Alabama
facilities, the purchase of the 50% noncontrolling interest in Communitys
Hearth & Home and Hearth & Home of Urbana, and the purchase of
additional equipment.

Net
cash provided by financing activities was approximately $15,010,000 for the year
ended December 31, 2010.  This is primarily the result of proceeds from the
convertible debt issued in October 2010, and proceeds from the sale of stock.



Year ended December 31, 2009

Net cash provided by operating activities for the year ended
December 31, 2009 was approximately $1,893,000 consisting primarily of our net
income from operations, changes in working capital, and other noncash charges;
all primarily the result of routine operating activity.

Net cash used in investing activities for the year ended December
31, 2009 was approximately $848,000.  This is primarily the result of
purchases of additional equipment and an increase from restricted cash due
certain released amounts.

Net cash provided by financing
activities was approximately $2,170,000 for the year ended December 31, 2009,
primarily as a result of proceeds from the debt and from the sale of stock
partially offset by routine principal payments on existing loans.

Inflation



The resident fees that we receive from the properties that we own
or lease and the management fees we receive from the facilities we manage for
third parties are our primary sources of income.  This source of income is
affected by the monthly rental rates and the occupancy rates.  The monthly
rental rates are dependent on various factors including competition, market
conditions and the locations of the properties.  We evaluate and prepare
budgets for our properties on an annual basis.  At that time, we assess the
impact of inflation on the operations of the properties, including but not
limited to, budgeting increases for real estate taxes, utilities, employee
expenses, food and supplies.  However, some factors are difficult to
quantify, such as potential increases in employee expenses as a result of the
current shortage of qualified nurses, and there can be no assurance that the
resident rental rates will increase or that costs will not increase due to
inflation or other causes.  We strive to be the provider of choice in each
of our markets and to charge market or better than market rates.



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Critical Accounting Policies and
Use of Estimates

We prepare our financial statements in accordance with accounting
principles generally accepted in the United States.  The preparation of
these financial statements requires us to make estimates and judgments that
affect the reported amount of assets, liabilities, revenues and expenses.
 We base our estimates on historical experience, business knowledge and on
various other assumptions that we believe to be reasonable under the
circumstances at the time.  Actual results may vary from our estimates.
 These estimates are evaluated by management and revised as circumstances
change.  We believe that the following are critical accounting
policies:

Our
financial statements reflect consolidation with entities in which we have
determined to have a controlling financial interest

Arrangements with other business enterprises are evaluated, and
those in which AdCare is determined to have controlling financial interest are
consolidated.  ASC Topic 810, Consolidation addresses the consolidation of
business enterprises to which the usual condition of consolidation (ownership of
a majority voting interest) does not apply.  This interpretation focuses on
controlling financial interests that may be achieved through arrangements that
do not involve voting interests.  It concludes that, in absences of clear
control through voting interests, a companys exposure (variable interest) to
the economic risks and potential rewards from the variable interest entitys
assets and activities are the best evidence of control.  If an enterprise
holds a majority of the variable interests of an entity, it would be considered
the primary beneficiary.  The primary beneficiary is required to
consolidate the assets, liabilities and results of operations of the variable
interest entity in its financial statements.



On
March 31, 2010, the Company obtained full control of its previously consolidated
variable interest entities Community Hearth & Home and Hearth & Home of
Urbana by acquiring the remaining 50% noncontrolling equity interests.  As
such, these entities are no longer considered variable interest entities and are
consolidated as wholly-owned subsidiaries.  See Note 17 to our Consolidated
Financial Statements for additional information about the acquisition.



AdCare has evaluated its relationship with Riverchase Village ADK,
LLC (Riverchase). Even though the Company does not have any equity interest in
Riverchase, it was determined that Riverchase is a variable interest entity as
it does not have sufficient equity at risk.  Given the related party
relationship with the common shareholder and certain other variable interests
with Riverchase, the Company determined that it is the primary beneficiary and
consolidation of Riverchase is required.  As such, the Company initially
consolidated Riverchase on June 25, 2010, the date of acquisition and initial
operations.  See Note 18 to our Consolidated Financial Statements for more
information on our variable interest entities.



Patient
Care Receivables

Patient care receivables are reported net of allowances for
doubtful accounts.  The administrators and managers of our properties
evaluate the adequacy of the allowance for doubtful accounts on a monthly basis,
and adjustments are made if necessary.  On an ongoing basis, we have
experienced very few collection problems and do not anticipate significant
increases unless the economy where our properties are located encounters a
severe down trend.  Approximately 80% of our revenue in our nursing
facilities is derived from Medicare and Medicaid qualifying residents.
 Charges to these payers are evaluated monthly to insure that revenue is
recorded properly and that any adjustments necessitated by our contractual
arrangement with these payers are recorded in the month incurred.

Asset Impairment

We evaluate our property, equipment and other long-lived assets,
other than goodwill and other indefinite lived intangibles, on an annual basis
to determine if facts and circumstances suggest that the assets may be impaired
or that the estimated depreciable life of the asset may need to be changed such
as significant physical changes in the property, significant adverse changes in
general economic conditions, and significant deteriorations of the underlying
cash flows or fair values of the property. The need to recognize impairment is
based on estimated future cash flows from a property compared to the carrying
value of that property. If recognition of impairment is necessary, it is
measured as the amount by which the carrying amount of the property exceeds the
fair value of the property.

For goodwill and other indefinite lived intangibles, we perform an
annual impairment test in the fourth quarter of each year or earlier if there
are indications of potential impairment.



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We have no assets recorded at fair value; however, our asset
impairment analysis is consistent with the fair value measurements described in
the accounting guidance for Fair Value Measurements and Disclosures.  We
did not record any asset impairments in 2010 or 2009. If our estimates or
assumptions with respect to a property change in the future, we may be required
to record additional impairment charges for our assets.

Business
Combinations

Effective January 1, 2009, we adopted the new accounting
guidance on Business Combinations which established principles and
requirements for how an acquirer recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, any
noncontrolling interest in the acquiree as well as the goodwill acquired or gain
recognized in a bargain purchase. The new guidance also establishes disclosure
requirements to enable the evaluation of the nature and financial effects of the
business combination. During 2010, we expensed approximately $1,100,000 in
acquisition costs related to the transaction discussed in Note 17 of the
Consolidated Financial Statements. Under the business combination accounting
guidance in effect prior to January 1, 2009, these costs were considered part of
the purchase price and as such were capitalized, but effective January 1,
2009 the accounting guidance required these costs be expensed as incurred. Both
the current and previous guidance require that we make certain valuations to
determine the fair value of assets acquired and the liabilities assumed. These
valuations are subject to retroactive adjustment during the twelve month period
subsequent to the acquisition date. Such valuations require us to make
significant estimates, judgments and assumptions, including projections of
future events and operating performance.

Stock-Based
Compensation

We recognize compensation cost for all share-based payments
granted after January 1, 2006 on a straight-line basis over the vesting
period. We calculated the recognized and unrecognized stock-based compensation
using the Black-Scholes-Merton option valuation method, which requires us to use
certain key assumptions to develop the fair value estimates. These key
assumptions include expected volatility, risk-free interest rate, expected
dividends and expected term. During the years ended December 31, 2010 and
2009, we recorded charges of approximately $840,000 and $364,000 in stock-based
compensation, respectively. Stock- based compensation expense is a non-cash
expense and such amounts are included as a component of payroll and related
payroll costs or other operating expense based upon the classification of cash
compensation paid to the related employees or nonemployees.

Income Taxes



We determine deferred tax assets and liabilities based upon
differences between financial reporting and tax bases of assets and liabilities
and measure them using the enacted tax laws that will be in effect when the
differences are expected to reverse. We maintain a valuation allowance of
approximately $4,414,000 to reduce the deferred tax assets by the amount we
believe is more likely than not to not be utilized through the turnaround of
existing temporary differences, future earnings, or a combination thereof. In
future periods, we will continue to assess the need for and adequacy of the
remaining valuation allowance. We follow the relevant guidance found in the FASB
codification, accounting for uncertainty in income taxes. The guidance provides
information and procedures for financial statement recognition and measurement
of tax positions taken, or expected to be taken, in tax returns.

Recent Accounting
Pronouncements

On
January 1, 2010, the Company adopted FASB Accounting Standards Update (ASU) No.
2009-17, Consolidations (Topic 810): Improvements to Financial Reporting by
Enterprises Involved with Variable Interest Entities.  ASU 2009-17
revises consolidation guidance applicable to variable interest entities (VIEs)
and requires additional disclosure regarding an enterprises continuing
involvement with VIEs.  ASU 2009-17 changes how a company determines when
an entity that is insufficiently capitalized or is controlled through other
means than voting (or similar rights) should be consolidated.  Upon
adoption, the Company evaluated the impact of ASU 2009-17 and determined that it
did not change the Companys prior consolidation considerations for existing VIE
relationships.  As such, the initial adoption of ASU 2009-17 did not have
an effect on the accompanying consolidated financial statements.  During
2010, the Company has a new VIE relationship that required consolidation and
additional disclosure under the new guidance in ASU 2009-17.



Item
7A.  Quantitative and Qualitative Disclosures About Market Risk

Not
Required



- 24
-



---

Item
8.  Financial Statements and Supplementary Data

|                                                        |     
|------------------------------------------------------- | ----
|                                                        | PAGE
|                                                        |     
|                                                        |     
|                                                        |     
|REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM | 26  
|                                                        |     
|                                                        |     
|CONSOLIDATED FINANCIAL STATEMENTS                       |     
|                                                        |     
|Balance Sheets                                          | 27  
|                                                        |     
|Statements of Operations                                | 28  
|                                                        |     
|Statements of Stockholders Equity                      | 29  
|                                                        |     
|Statements of Cash Flows                                | 30  
|                                                        |     
|Notes to Consolidated Financial
Statements              | 32  





- 25
-



---

REPORT OF INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM





To the Board of
Directors and Stockholders

AdCare Health
Systems, Inc.

Springfield,
Ohio



We
have audited the accompanying consolidated balance sheets of AdCare Health
Systems, Inc. and subsidiaries (the Company) as of December 31, 2010 and 2009,
and the related consolidated statements of operations, stockholders equity, and
cash flows for the years then ended. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits.



We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Companys internal control over financial
reporting. Accordingly, we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and significant
estimates made by management, 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of AdCare Health
Systems, Inc. and subsidiaries as of December 31, 2010 and 2009, and the results
of their operations and their cash flows for the years then ended, in conformity
with accounting principles generally accepted in the United States of
America.



As
discussed in Note 2 to the consolidated financial statements, the Company is
subject to certain risks and uncertainties.





/s/ BATTELLE
& BATTELLE LLP





Dayton, Ohio

March 31, 2011







- 26
-



---



|                                                     |                                                             |                                                                                     |                                      |                  |               |              
|---------------------------------------------------- | ----------------------------------------------------------- | ----------------------------------------------------------------------------------- | ------------------------------------ | ---------------- | ------------- | -------------
|ADCARE HEALTH SYSTEMS, INC. AND
SUBSIDIARIES        
|CONSOLIDATED BALANCE SHEETS                         
|                                                     |                                                             |                                                                                     |                                      |                 
|                                                     |                                                             |                                                                                     |                                      | December 31,    
|                                                     |                                                             |                                                                                     | ASSETS                               | 2010             |               | 2009         
|Current Assets:                                      |                                                             |                                                                                     |                                     
|Cash and cash equivalents                            | $
      3,911,140                                           |                                                                                     | $
   4,481,100                      
|Restricted cash                                      | 1,047,454                                                   |                                                                                     | 721,142                             
|Accounts receivable:                                 |                                                             |                                                                                     |                                     
|                                                     | Long-term care resident receivables, net                    | 10,943,963                                                                          |                                      | 1,929,951       
|                                                     | Management, consulting and development receivables,
net     | 271,224                                                                             |                                      | 124,761         
|Prepaid expenses and other                           | 1,243,663                                                   |                                                                                     | 420,793                             
|                                                     |                                                             |                                                                                     | Total current assets                 | 17,417,444       |               | 7,677,747    
|                                                     |                                                             |                                                                                     |                                      |                  |               |              
|Restricted cash and investments                      | 3,099,936                                                   |                                                                                     | 1,083,811                           
|Property and equipment, net                          | 37,606,301                                                  |                                                                                     | 16,445,028                          
|Intangibles, net                                     | 16,159,845                                                  |                                                                                     | 1,189,307                           
|Goodwill                                             | 2,679,482                                                   |                                                                                     | 2,679,482                           
|Escrow deposits for acquisitions                     | 1,725,086                                                   |                                                                                     | -                                   
|Lease deposits                                       | 1,670,282                                                   |                                                                                     | -                                   
|Other assets                                         | 2,600,530                                                   |                                                                                     | 1,104,046                           
|                                                     |                                                             |                                                                                     | Total assets                         | $
    82,958,906 |               | $
 30,179,421
|                                                     |                                                             |                                                                                     |                                      |                  |               |              
|                                                     |                                                             |                                                                                     | LIABILITIES AND STOCKHOLDERS
EQUITY |                  |               |              
|Current Liabilities:                                 |                                                             |                                                                                     |                                     
|                                                     | Current portion of notes payable and other
debt             | $
      3,633,401                                                                   |                                      | $
      707,935 
|                                                     | Accounts payable                                            | 3,411,772                                                                           |                                      | 1,039,422       
|                                                     | Accrued expenses                                            | 9,664,325                                                                           |                                      | 3,074,057       
|                                                     |                                                             |                                                                                     | Total current liabilities            | 16,709,498       |               | 4,821,414    
|                                                     |                                                             |                                                                                     |                                      |                  |               |              
|Notes payable and other debt, net of current
portion | 47,210,995                                                  |                                                                                     | 16,725,472                          
|Derivative liability                                 | 2,905,750                                                   |                                                                                     | -                                   
|Other liabilities                                    | 1,267,429                                                   |                                                                                     | 344,153                             
|Deferred tax liability                               | 255,141                                                     |                                                                                     | 212,574                             
|                                                     |                                                             | Total liabilities                                                                   | 68,348,813                           |                  | 22,103,613   
|                                                     |                                                             |                                                                                     |                                      |                  |               |              
|Commitments and contingencies (Note 12)              | -                                                           |                                                                                     | -                                   
|                                                     |                                                             |                                                                                     |                                      |                  |               |              
|Stockholders' equity:                                |                                                             |                                                                                     |                                     
|                                                     | Preferred stock, no par value; 1,000,000 shares
authorized; |                                                                                     |                                      |                 
|                                                     |                                                             | no shares issued or outstanding                                                     | -                                    |                  | -            
|                                                     | Common stock and additional paid-in capital, no par
value;  |                                                                                     |                                      |                 
|                                                     |                                                             | 29,000,000 shares authorized; 8,349,197 and
5,628,007 shares issued and outstanding | 26,611,870                           |                  | 17,571,801   
|                                                     | Accumulated deficit                                         | (12,548,870)                                                                        |                                      | (9,805,249)     
|                                                     |                                                             | Total stockholders' equity                                                          | 14,063,000                           |                  | 7,766,552    
|                                                     | Noncontrolling interest in subsidiaries                     | 547,093                                                                             |                                      | 309,256         
|                                                     |                                                             | Total equity                                                                        | 14,610,093                           |                  | 8,075,808    
|                                                     |                                                             | Total liabilities and stockholders' equity                                          | $
    82,958,906                     |                  | $
 30,179,421
|                                                     |                                                             |                                                                                     |                                      |                  |              
|See notes to consolidated financial
statements      



- 27
-



---



|                                                        |                                                    |                     |                |             |            
|------------------------------------------------------- | -------------------------------------------------- | ------------------- | -------------- | ----------- | -----------
|ADCARE HEALTH SYSTEMS, INC. AND
SUBSIDIARIES           
|CONSOLIDATED STATEMENTS OF
OPERATIONS                  
|                                                        |                                                    |                     | Year Ended    
|                                                        |                                                    |                     | December 31,  
|                                                        |                                                    |                     | 2010           |             | 2009       
|Revenues:                                               |                                                    |                     |               
|                                                        | Patient care revenues                              | $51,143,381         |                | $24,834,831
|                                                        | Management, consulting and development fee
revenue | 2,093,334           |                | 1,856,269  
|                                                        |                                                    | Total revenue       | 53,236,715     |             | 26,691,100 
|                                                        |                                                    |                     |                |             |            
|Expenses:                                               |                                                    |                     |               
|                                                        | Payroll and related payroll costs                  | 32,390,302          |                | 15,371,150 
|                                                        | Other operating expenses                           | 18,313,705          |                | 7,998,158  
|                                                        | Lease expense                                      | 2,907,530           |                | 628,829    
|                                                        | Depreciation and amortization                      | 1,277,939           |                | 918,851    
|                                                        |                                                    | Total expenses      | 54,889,476     |             | 24,916,988 
|                                                        |                                                    |                     |                |             |            
|(Loss) Income from Operations                           | (1,652,761)                                        |                     | 1,774,112     
|Other Income (Expense):                                 |                                                    |                     |               
|                                                        | Interest income                                    | 17,739              |                | 5,472      
|                                                        | Interest expense                                   | (2,372,299)         |                | (1,209,926)
|                                                        | Gain on acquisitions, net of acquisition
costs     | 2,446,483           |                | -          
|                                                        | Derivative loss                                    | (343,144)           |                | -          
|                                                        | Loss on debt extinguishment                        | (228,203)           |                | -          
|                                                        | Other expense                                      | (25,027)            |                | (46,745)   
|                                                        |                                                    | Total other expense | (504,451)      |             | (1,251,199)
|                                                        |                                                    |                     |                |             |            
|(Loss) Income Before Income Taxes                       | (2,157,212)                                        |                     | 522,913       
|Income Tax Expense                                      | (42,567)                                           |                     | (42,567)      
|Net (Loss) Income                                       | (2,199,779)                                        |                     | 480,346       
|Net Income Attributable to Noncontrolling
Interests     | (543,842)                                          |                     | (40,063)      
|Net (Loss) Income Attributable to AdCare Health
Systems | $(2,743,621)                                       |                     | $440,283      
|                                                        |                                                    |                     |               
|Net (Loss) Income Per Share,
Basic:                     | $
        (0.40)                                   |                     | $
        0.11
|Net (Loss) Income Per Share,
Diluted:                   | $
        (0.40)                                   |                     | $
        0.09
|                                                        |                                                    |                     |                |             |            
|Weighted Average Common Shares Outstanding,             |                                                    |                     |               
|                                                        | Basic                                              | 6,879,651           |                | 4,113,150  
|                                                        | Diluted                                            | 6,879,651           |                | 4,646,913  
|See notes to consolidated financial
statements         



- 28
-



---



|                                                |                                                |             |               |             |             |           |                 |           |               
|----------------------------------------------- | ---------------------------------------------- | ----------- | ------------- | ----------- | ----------- | --------- | --------------- | --------- | --------------
|ADCARE HEALTH SYSTEMS, INC. AND
SUBSIDIARIES   
|CONSOLIDATED STATEMENTS OF
STOCKHOLDERS EQUITY
|                                               
|                                                |                                                |             |               |             |             |           |                 |           |               
|                                                |                                                |             |               |             |             |           | Common Stock    |           |               
|                                                |                                                |             |               |             | Accumulated |           | and Additional  |           | Noncontrolling
|                                                |                                                |             | Total         |             | Deficit     |           | Paid-in Capital |           | Interest      
|                                                |                                                |             |               |             |             |           |                
|Balance, January 1, 2009:                       | $4,790,628                                     |             | $(10,245,532) |             | $14,766,967 |           | $269,193       
|                                                |                                                |             |               |             |             |           |                 |          
|                                                | Nonemployee warrants for services              | 15,908      |               | -           |             | 15,908    |                 | -        
|                                                | Stock based compensation expense               | 320,414     |               | -           |             | 320,414   |                 | -        
|                                                | Stock issuance  other                         | 30,000      |               | -           |             | 30,000    |                 | -        
|                                                | Private stock offering, net                    | 2,438,512   |               | -           |             | 2,438,512 |                 | -        
|                                                | Net income                                     | 480,346     |               | 440,283     |             | -         |                 | 40,063   
|Balance, December 31, 2009                      | $8,075,808                                     |             | $(9,805,249)  |             | $17,571,801 |           | $309,256       
|                                                |                                                |             |               |             |             |           |                 |          
|                                                | Nonemployee warrants for services              | 129,892     |               | -           |             | 129,892   |                 | -        
|                                                | Stock based compensation expense               | 818,765     |               | -           |             | 818,765   |                 | -        
|                                                | Public stock offering, net                     | 6,109,725   |               | -           |             | 6,109,725 |                 | -        
|                                                | Exercises of options and warrants              | 331,100     |               | -           |             | 331,100   |                 | -        
|                                                | Warrants issued with debt financing            | 400,587     |               | -           |             | 400,587   |                 | -        
|                                                | Stock issued in connection with an
acquisition | 1,250,000   |               | -           |             | 1,250,000 |                 | -        
|                                                | Purchase of minority interest                  | (306,005)   |               | -           |             | -         |                 | (306,005)
|                                                | Net loss                                       | (2,199,779) |               | (2,743,621) |             | -         |                 | 543,842  
|Balance, December 31, 2010                      | $14,610,093                                    |             | $(12,548,870) |             | $26,611,870 |           | $547,093       
|                                               
|See notes to consolidated financial
statements 



- 29
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---



|                                               |                                                                                              |                                           |                                                                 |                                       |             |         |           |                         |  |     
|---------------------------------------------- | -------------------------------------------------------------------------------------------- | ----------------------------------------- | --------------------------------------------------------------- | ------------------------------------- | ----------- | ------- | --------- | ----------------------- |  | ----
|ADCARE HEALTH SYSTEMS, INC. AND
SUBSIDIARIES  
|CONSOLIDATED STATEMENTS OF CASH
FLOWS         
|                                               |                                                                                              |                                           |                                                                 |                                       |             |         |           |                         |  |     
|                                               |                                                                                              |                                           |                                                                 |                                       |             |         |           |                         |  |     
|                                               |                                                                                              |                                           |                                                                 |                                       |             |         |           | Year Ended December
31,
|                                               |                                                                                              |                                           |                                                                 |                                       |             |         |           | 2010                    |  | 2009
|Cash flows from operating activities:          |                                                                                              |                                           |                                                                
|                                               | Net (Loss)  Income                                                                           | $  (2,199,779)                            |                                                                 | $  480,346                           
|                                               |                                                                                              |                                           |                                                                 |                                       |             |         |           |                         |  |     
|                                               | Adjustments to reconcile net (loss)  income
from continuing operations to net cash (used in) |                                           |                                                                
|                                               | provided by operating activities:                                                            |                                           |                                                                 |                                      
|                                               |                                                                                              |                                           | Depreciation and amortization                                   | 1,277,939                             |             | 918,851
|                                               |                                                                                              |                                           | Warrants issued for services                                    | 21,648                                |             | 43,693 
|                                               |                                                                                              |                                           | Stock based compensation expense                                | 818,765                               |             | 320,414
|                                               |                                                                                              |                                           | Provision for leases in excess of cash                          | 201,816                               |             | -      
|                                               |                                                                                              |                                           | Amortization of deferred financing costs                        | 159,665                               |             | -      
|                                               |                                                                                              |                                           | Amortization of debt discounts                                  | 330,535                               |             | -      
|                                               |                                                                                              |                                           | Derivative loss                                                 | 343,144                               |             | -      
|                                               |                                                                                              |                                           | Loss on debt extinguishment                                     | 228,203                               |             | -      
|                                               |                                                                                              |                                           | Deferred tax expense                                            | 42,567                                |             | 42,567 
|                                               |                                                                                              |                                           | Loss on disposal of assets                                      | 1,303                                 |             | 1,286  
|                                               |                                                                                              |                                           | Gain on acquisitions                                            | (2,739,949)                           |             | -      
|                                               |                                                                                              |                                           | Provision for bad debts                                         | 259,445                               |             | 190,825
|                                               |                                                                                              |                                           | Other noncash expenses                                          | 196,988                               |             | -      
|                                               |                                                                                              |                                           | Changes in certain assets and liabilities, net of
acquisitions: |                                       |             |        
|                                               |                                                                                              |                                           |                                                                 | Accounts receivable                   | (6,426,725) |         | 114,740  
|                                               |                                                                                              |                                           |                                                                 | Prepaid expenses and other            | (737,153)   |         | (110,546)
|                                               |                                                                                              |                                           |                                                                 | Other assets                          | 6,797       |         | (344,820)
|                                               |                                                                                              |                                           |                                                                 | Accounts payable and accrued expenses | 7,176,833   |         | (210,836)
|                                               |                                                                                              |                                           |                                                                 | Other liabilities                     | (178,233)   |         | 446,760  
|                                               | Net cash (used in) provided by operating
activities                                          | (1,216,191)                               |                                                                 | 1,893,280                            
|                                               |                                                                                              |                                           |                                                                 |                                       |             |         |           |                         |  |     
|Cash flow from investing activities:           |                                                                                              |                                           |                                                                
|                                               |                                                                                              | Change in restricted cash and investments | (134,378)                                                       |                                       | (275,078)  
|                                               |                                                                                              | Escrow deposits for acquisitions          | (1,725,086)                                                     |                                       | -          
|                                               |                                                                                              | Lease deposits                            | (1,670,282)                                                     |                                       | -          
|                                               |                                                                                              | Acquisitions                              | (9,693,418)                                                     |                                       | -          
|                                               |                                                                                              | Purchase of property, plant and equipment | (1,140,748)                                                     |                                       | (573,168)  
|                                               | Net cash used in investing activities                                                        | (14,363,912)                              |                                                                 | (848,246)                            
|                                               |                                                                                              |                                           |                                                                 |                                       |             |         |           |                         |  |     
|See notes to consolidated financial
statements





- 30
-



---



|                                                  |                                                                       |                               |                 |                       |                 |  |  |  |  | 
|------------------------------------------------- | --------------------------------------------------------------------- | ----------------------------- | --------------- | --------------------- | --------------- |  |  |  |  | 
|ADCARE HEALTH SYSTEMS, INC. AND
SUBSIDIARIES.    
|CONSOLIDATED STATEMENTS OF CASH
FLOWS            
|(Continued)                                      
|                                                  |                                                                      
|                                                  | Year Ended December
31,                                              
|                                                  | 2010                                                                  |                               | 2009           
|Cash flows from financing activities:             |                                                                       |                               |                
|                                                  |                                                                       | Proceeds from debt            | $
    8,827,000 |                       | $
    2,196,338
|                                                  |                                                                       | Debt issuance costs           | (1,134,938)     |                       | -              
|                                                  |                                                                       | Change in line of credit      | 1,828,084       |                       | -              
|                                                  |                                                                       | Exercise of warrants          | 331,100         |                       | -              
|                                                  |                                                                       | Proceeds from stock issuances | 6,109,725       |                       | 2,468,512      
|                                                  |                                                                       | Repayment on notes payable    | (950,828)       |                       | (2,495,099)    
|                                                  | Net cash provided by financing activities                             | 15,010,143                    |                 | 2,169,751            
|                                                  |                                                                       |                               |                 |                       |                 |  |  |  |  | 
|Net Change in Cash                                | (569,960)                                                             |                               | 3,214,785      
|                                                  |                                                                       |                               |                 |                       |                 |  |  |  |  | 
|Cash, Beginning                                   | 4,481,100                                                             |                               | 1,266,315      
|                                                  |                                                                       |                               |                 |                       |                 |  |  |  |  | 
|Cash, Ending                                      | $
   3,911,140                                                        |                               | $
   4,481,100 
|                                                  |                                                                       |                               |                 |                       |                 |  |  |  |  | 
|Supplemental Disclosure of Cash Flow
Information: |                                                                       |                               |                
|                                                  | Cash paid during the year for:                                        |                               |                 |                      
|                                                  |                                                                       | Interest                      | $
   1,953,926  |                       | $
   1,122,385 
|                                                  |                                                                       |                               |                 |                       |                 |  |  |  |  | 
|Supplemental Disclosure of Non-Cash
Activities:   |                                                                       |                               |                
|                                                  | Acquisitions in exchange for debt and equity
instruments              | $    28,914,021               |                 | $
                 - 
|                                                  | Noncash change in fair value of property &
equipment from acquisition | $
       750,287              |                 | $
                 - 
|                                                  | Discounts on debt for bifurcated derivative and
detachable warrants   | $
     2,963,193              |                 | $
                  -
|                                                  |                                                                       |                               |                 |                      
|See notes to consolidated financial
statements   



- 31
-



---

ADCARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



Description of Business



AdCare Health Systems, Inc. and Subsidiaries (AdCare or the
Company), is a developer, owner and manager of retirement communities, assisted
living facilities, skilled nursing facilities and home health care services in
the states of Ohio, Alabama and Georgia.  The Company manages 29
facilities, comprised of 20 skilled nursing facilities, 8 assisted living
facilities and 1 independent living/senior housing facility, totaling
approximately 2,500 units.  The Companys facilities provide a range of
health care services to their patients and residents including, but not limited
to, skilled nursing and assisted living services, social services, various
therapy services, and other rehabilitative and healthcare services for both
long-term residents and short-stay patients.  The Company also operates a
home health care business and provides consulting and management services to
various long-term care providers.  As of December 31, 2010, of the total 29
facilities, the Company managed 8 facilities, owned 10 facilities and operated
11 facilities through long-term lease arrangements.



Basis of Presentation



The accompanying consolidated financial statements are prepared in
conformity with accounting principles generally accepted in the United States
(GAAP) in accordance with the Financial Accounting Standards Board (FASB)
Accounting Standards Codification (ASC).



Principles of Consolidation



The consolidated financial statements include the Companys
majority owned and controlled subsidiaries.  Variable interest entities
(VIEs) in which we have a variable interest have been consolidated as
controlled subsidiaries when we are identified as the primary beneficiary.
 All intercompany transactions and balances have been eliminated in
consolidation.  For subsidiaries that are not wholly owned by the Company,
the portions not controlled by the Company are presented as noncontrolling
interests in the consolidated financial statements.





Use of Estimates



The preparation of consolidated financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make certain estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported results of operations during the reporting period.  Examples of
significant estimates include allowance for doubtful accounts, contractual
allowances for Medicare and Medicaid, deferred taxes, tax valuation allowance,
fair value of derivative instruments, fair value of employee and nonemployee
stock based awards, and impairment analysis of goodwill and other long-lived
assets.  Actual results could differ materially from those estimates.



Cash and Cash Equivalents



The Company considers all unrestricted short-term investments with
original maturities less than three months, which are readily convertible into
cash, to be cash equivalents.  Certain cash, cash equivalents and
investment amounts are restricted for specific purposes such as mortgage escrow
requirements and reserves for capital expenditures on HUD-insured facilities,
self-restricted cash for various group insurance charges, and other restricted
investments held as collateral for other debt obligations.











- 32
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NOTE 1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)





Investments



The Company has certain restricted investments in debt instruments
that are limited as to use by certain debt obligations. These investments are
classified as held-to-maturity investments because the Company has the positive
intent and ability to hold the securities until maturity.  Held-to-maturity
investments are carried at amortized cost.  These restricted investments
are classified as noncurrent assets given their related maturity dates and the
restrictions required by the long-term debt obligations.



Patient Care Receivables and Revenues



Patient care accounts receivable and revenues for the Company are
recorded in the month that services are provided. For private patients, accounts
receivable with invoice dates greater than 30 days are considered delinquent and
are charged interest of 1.5% per month.



The Company provides services to certain patients under
contractual arrangements with third-party payors, primarily under the Medicare
and Medicaid programs. Amounts paid under these contractual arrangements are
subject to review and final determination by the appropriate government
authority or its agent.  In the opinion of management, adequate provision
was made in the consolidated financial statements for any adjustments resulting
from the respective government authorities review.



Contractual adjustments for the Medicare and Medicaid programs are
recognized in the month that the related revenues are recorded. These
contractual adjustments represent the difference between established rates and
the amounts estimated to be reimbursable by Medicare and Medicaid. Differences
between these estimates and amounts subsequently determined are recorded as
additions to or deductions from contractual adjustments in the period such
determination is made. Laws and regulations governing the Medicare and Medicaid
programs are complex and subject to interpretation. As a result, there is at
least a reasonable possibility that recorded estimates could change by a
material amount in the near term.



Potentially uncollectible patient accounts are provided for on the
allowance method based on managements evaluation of outstanding accounts
receivable at year-end and historical experience. For the years ended December
31, 2010 and 2009, management recorded an allowance for uncollectible accounts
estimated at approximately $306,000 and $156,000, respectively increased due to
the growth in revenue.



Management, Consulting and Development Fee Receivables and
Revenue



Management, consulting and development fee receivables and revenue
are recorded in the month that services are provided. For the years ended
December 31, 2010 and 2009, management recorded an allowance for uncollectible
accounts estimated at approximately $120,000.



Leases and Leasehold Improvements



At the inception of each lease, the Company performs an evaluation
to determine whether the lease should be classified as an operating or capital
lease.  At December 31, 2010, all of the Companys 11 leased facilities are
accounted for as operating leases.  The Company records rent expense for
operating leases that contain scheduled rent increases on a straight-line basis
over the term of the lease.  The lease term is also used to provide the
basis for establishing depreciable lives for buildings subject to lease and
leasehold improvements.











- 33
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NOTE 1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)



Earnings per Share



Basic earnings per share is computed by dividing net income by the
weighted-average number of common shares outstanding during the period.
 Diluted earnings per share is computed by dividing net income by the
weighted-average number of common shares and potentially dilutive securities,
such as options, warrants, and nonvested shares outstanding during the period.
 Potentially dilutive securities are calculated in accordance with the
treasury stock method, which assumes that proceeds from the exercise of all
options and warrants with exercise prices exceeding the average market value are
used to repurchase common stock at market value.  The incremental shares
remaining after the proceeds are exhausted represent the potentially dilutive
effect of the securities.  Due to the net losses attributable to AdCare
Health Systems, Inc. for the year ended December 31, 2010, no potentially
dilutive securities have been included in the diluted earnings per share
calculation because they would automatically result in anti-dilution.



Deferred Financing Costs



The Company records deferred financing costs associated with debt
obligations.  Costs are amortized over the term of the related debt using
the straight-line method and are reflected as interest expense.  The
straight-line method yields results substantially similar to those that would be
produced under the effective interest rate method.



Intangible Assets and Goodwill



Intangible assets consist of finite lived and indefinite lived
intangibles.  The Companys finite lived intangibles consist of favorable
leases and lease acquisition costs.  Finite lived intangibles are amortized
over their estimated useful lives.  For the Companys lease related
intangibles, the estimated useful life is based on the terms of the underlying
facility leases, currently averaging approximately 10 years.  The Company
evaluates the recoverability of the finite lived intangibles whenever an
impairment indicator is present.



The Companys indefinite lived intangibles consist primarily of
values assigned to bed licenses obtained through business acquisitions. 
The Company does not amortize goodwill or indefinite lived intangibles.  On
an annual basis, the Company evaluates the recoverability of the indefinite
lived intangibles and goodwill, by performing an annual impairment test.
 The Company performs its annual test for impairment during the fourth
quarter of each year. There have been no required impairment adjustments to
intangible assets and goodwill during 2010 or 2009.



Of the Companys total consolidated goodwill of $2,679,482,
$1,773,628 is allocated to the Home Health segment and $905,854 is allocated to
the ALF segment.  Intangible assets consist of the following:



|             |                   |  |                    |  |              |  |            |  |                  |  |            
|------------ | ----------------- |  | ------------------ |  | ------------ |  | ---------- |  | ---------------- |  | -----------
|             | December 31, 2010 |  | December 31, 2009 
|             | Gross             |  |                    |  | Net          |  | Gross      |  |                  |  | Net        
|             | Carrying          |  | Accumulated        |  | Carrying     |  | Carrying   |  | Accumulated      |  | Carrying   
|             | Amount            |  | Amortization       |  | Amount       |  | Amount     |  | Amortization     |  | Amount     
|Bed
Licenses | $  7,309,307      |  | $
               - |  | $  7,309,307 |  | $1,189,307 |  | $
             - |  | $ 1,189,307
|Lease
Rights | 9,020,018         |  | (169,480)          |  | 8,850,538    |  | -          |  | -                |  | -          
|Totals       | $ 16,329,325      |  | $  (169,480)       |  | $ 16,159,845 |  | $1,189,307 |  | $
             - |  | $ 1,189,307



Amortization expense was $169,480 for 2010.  No amortization
expense was recorded in 2009.  Estimated amortization expense for each of
the future years ending December 31 is as follows:



|           |                 
|---------- | ----------------
|2011       | $        884,790
|2012       | 884,790         
|2013       | 884,790         
|2014       | 884,790         
|2015       | 884,790         
|Thereafter | 4,426,588       
|           | $     8,850,538 



- 34
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| | 
| | 

NOTE 1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)



Income Taxes



An asset or liability is recognized for the deferred tax
consequences of temporary differences between the tax bases of assets and
liabilities and their reported amounts in the consolidated financial statements.
 These temporary differences would result in taxable or deductible amounts
in future years when the reported amounts of the assets are recovered or
liabilities are settled.  Deferred tax assets are also recognized for the
future tax benefits from net operating loss and other carryforwards.  A
valuation allowance is provided if it is more likely than not that some portion
or all of the net deferred tax assets will not be realized.  In evaluating
the need to record or continue to reflect a valuation allowance, all items of
positive evidence and negative evidence are considered.



The Company is subject to income taxes in the U.S. and numerous
state and local jurisdictions.  Significant judgment is required in
evaluating uncertain tax positions.  The Company recognizes a tax benefit
only if it is more likely than not that a particular tax position will be
sustained upon examination or audit.  In general, the Companys tax returns
filed for the 1996 through 2010 tax years are still subject to potential
examination by taxing authorities.



Concentrations of Credit Risk



Financial instruments which potentially expose the Company to
concentrations of credit risk consist primarily of cash and cash equivalents,
restricted cash, restricted investments, and accounts receivable.  Cash and
cash equivalents, restricted cash and restricted investments are held with
various financial institutions.  From time to time, these balances exceed
the federally insured limits.  These balances are maintained with high
quality financial institutions which management believes limits the risk.



Accounts receivable are recorded at net realizable value.
 The Company performs ongoing evaluations of its residents and significant
third-party payers with which they contract, generally not requiring collateral.
 Management believes that credit risk with respect to accounts receivable
is limited based on the stature and diversity of the third-party payers with
which they contract.  The Company maintains an allowance for doubtful
accounts which management believes is sufficient to cover potential losses.



Delinquent accounts receivable are charged against the allowance
for doubtful accounts once likelihood of collection has been determined.
 Accounts receivable are considered to be past due and placed on delinquent
status based on contractual terms, as well as how frequently payments are
received, on an individual account basis.



Property and Equipment



Property and equipment are stated at cost. Expenditures for major
improvements are capitalized. Depreciation commences when the assets are placed
in service.  Maintenance and repairs, which do not improve or extend the
life of the respective assets, are charged to expense as incurred. Upon disposal
of assets, the cost and related accumulated depreciation are removed from the
accounts and any gain or loss is included in income.  Depreciation is
recorded on a straight-line basis over the estimated useful lives of the
respective assets.  The Company reviews property and equipment for
potential impairment whenever events or changes in circumstances indicate that
the carrying amounts of assets may not be recoverable.





















- 35
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NOTE 1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)



Acquisition Policy



The Company periodically enters into agreements to acquire assets
and/or businesses.  The considerations involved in each of these agreements
may include cash, financing, and/or long-term lease arrangements for real
properties.  The Company evaluates each transaction to determine whether
the acquired interests are assets or businesses.  A business is defined as
a self-sustaining integrated set of activities and assets conducted and managed
for the purpose of providing a return to investors.  A business consists of
(a) inputs, (b) processes applied to those inputs, and (c) resulting outputs
that are used to generate revenues.  In order for an acquired set of
activities and assets to be a business, it must contain all of the inputs and
processes necessary for it to continue to conduct normal operations after the
acquired entity is separated from the seller, including the ability to sustain
revenue streams by providing its outputs to customers.  An acquired set of
activities and assets fail the definition of a business if it excludes one or
more of the above items such that it is not possible to continue normal
operations and sustain a revenue stream by providing its products and/or
services to customers.



Advertising



Advertising costs are expensed as incurred.  Advertising
costs for the years ended December 31, 2010 and 2009 were approximately $425,700
and $319,100, respectively.



Stock Based Compensation



Stock based compensation for employee awards is measured at the
grant date based on the fair value of the awards and is recognized as
compensation expense over the requisite service period only for those awards
that are expected to vest.  Restricted stock awards are based on the stock
price on the date of grant.  The Company estimates the value of stock
options and employee warrants using the Black-Scholes option-pricing model.



The Company issues warrants to non-employees from time to time for
various services.  The Company estimates the value of warrants using the
Black-Scholes option-pricing model.



Fair Value Measurements and Financial
Instruments



Accounting guidance establishes a three-level valuation hierarchy
for disclosure of fair value measurements.  The valuation hierarchy is
based upon the transparency of inputs to the valuation of an asset or liability
as of the measurement date.  The categorization within the valuation
hierarchy is based upon the lowest level of input that is significant to the
fair value measurement.  The three levels are defined as follows:



Level 1

- Quoted market prices in active markets for identical
assets or liabilities

Level 2

- Observable market-based inputs or unobservable inputs that
are corroborated by market data

Level 3

- Unobservable inputs



The respective carrying value of certain financial instruments
approximated their fair value.  These instruments include cash and cash
equivalents, restricted cash and investments, accounts receivable, notes payable
and other debt, accounts payable and accrued expenses.  Fair values were
assumed to approximate carrying values for these financial instruments since
they are short-term in nature and their carrying amounts approximate fair
values, they are receivable or payable on demand, or the interest rates earned
and/or paid approximate current market rates.

















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NOTE 1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)



Derivative Instruments



The Company generally does not use derivative instruments to hedge
exposures to certain risks.  However, the Company has entered into a
convertible debt agreement with a conversion feature that is not afforded equity
classification and embodies risks that are not clearly and closely related to
the host debt agreement.  As such, this conversion feature is an embedded
derivative instrument that is required to be bifurcated from the debt instrument
and reported separately as a derivative liability at fair value.



The Company estimates the conversion feature derivative instrument
by using the Black-Scholes option-pricing model because it embodies the
requisite assumptions necessary to estimate the fair value of this instrument.
 Changes in fair value of this derivative instrument are reported in the
statement of operations.



Recently Adopted Accounting Pronouncements



On January 1, 2010, the Company adopted FASB Accounting Standards
Update (ASU) No. 2009-17, Consolidations (Topic 810): Improvements to
Financial Reporting by Enterprises Involved with Variable Interest Entities.
 ASU 2009-17 revises consolidation guidance applicable to variable interest
entities (VIEs) and requires additional disclosure regarding an enterprises
continuing involvement with VIEs.  ASU 2009-17 changes how a company
determines when an entity that is insufficiently capitalized or is controlled
through other means than voting (or similar rights) should be consolidated.
 Upon adoption, the Company evaluated the impact of ASU 2009-17 and
determined that it did not change the Companys prior consolidation
considerations for existing VIE relationships.  As such, the initial
adoption of ASU 2009-17 did not have an effect on the accompanying consolidated
financial statements.  During 2010, the Company has a new VIE relationship
that required consolidation and additional disclosure under the new guidance in
ASU 2009-17.  See Note 18 for additional information about the Companys
VIEs.



Reclassifications



Certain reclassifications have been made to the 2009 financial
information to conform to the 2010 presentation.



NOTE 2.

LIQUIDITY AND PROFITABILITY



The accompanying consolidated financial statements have been
prepared assuming that the Company will continue as a going concern.  At
December 31, 2010, the Company has an accumulated deficit of $12,548,870.
 The Company incurred a net loss attributable to the Company of
approximately $2,744,000 and achieved net income attributable to the Company of
approximately $440,000 for the years ended December 31, 2010 and 2009,
respectively.  The company has working capital of approximately $708,000 at
December 31, 2010.  The Companys ability to sustain profitable operations
is dependent on continued growth in revenue and controlling costs.



Managements plans for sustaining liquidity and profitability in
future years encompass the following:



·

increase facility occupancy.



·

add additional management contracts.



·

acquire existing cash flowing operations to expand our operations
and branch out into other related areas of business.





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NOTE 2.

LIQUIDITY AND PROFITABILITY(continued)



Management believes that the actions that will be taken by the
Company provide the opportunity for the Company to improve liquidity and sustain
profitability.  However, there can be no assurance that such events will
occur.  The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.



NOTE 3.

SEGMENTS



In 2010, we organized our operating businesses into four business
units based upon the services provided.  We re-evaluated our reportable
segments based upon the growth of the organization, our internal reporting, and
how our chief operating decision maker evaluates performance and allocates
resources.  Segment information for 2009 has been revised from previously
reported information to reflect the current presentation. A description of the
new reportable segments is provided below.



For the years ended December 31, 2010 and 2009, the Company is
reporting in four segments:  skilled nursing facilities (SNF), assisted
living facilities (ALF), home based care (Home Health), and Management,
Development and Corporate.  The SNF and ALF segments provide services to
individuals needing long term care in a nursing home or assisted living setting
and management of those facilities.  The Home Health segment provides home
health care services to patients while they are living in their own homes.
 The Management, Development and Corporate segment engages in the
management of facilities, developmental work on new projects and accounting
services.  All the Companys revenues and assets are within the United
States.  We evaluate financial performance and allocate resources primarily
based on segment operating income (loss).  Segment operating income (loss)
excludes interest expenses and other non-operating income and expenses.



|                               |                             |         |         |             |                                     |         
|------------------------------ | --------------------------- | ------- | ------- | ----------- | ----------------------------------- | --------
|Amounts in 000s              
|                               |                             | SNF     | ALF     | Home Health | Management, Development & Corporate | Total   
|Year to Date December 31, 2010
|                               | Net Revenue                 | $40,427 | $8,270  | $2,446      | $2,094                              | $53,237 
|                               | Payroll & Associated Costs  | 21,848  | 4,131   | 1,910       | 4,501                               | 32,390  
|                               | Other Operating Expenses    | 15,317  | 2,883   | 460         | (346)                               | 18,314  
|                               | Lease Expense               | 2,908   | -       | -           | -                                   | 2,908   
|                               | Depreciation & Amortization | 585     | 554     | 16          | 123                                 | 1,278   
|                               | Operating Income (Loss)     | $(231)  | $702    | $60         | $(2,184)                            | $(1,653)
|                               | Total Assets                | $50,482 | $22,597 | $2,320      | $7,560                              | $82,959 
|                               | Capital Spending            | $510    | $347    | $9          | $275                                | $1,141  
|                               |                             |         |         |             |                                     |         
|Year to Date December 31, 2009
|                               | Net Revenue                 | $14,369 | $7,411  | $3,055      | $1,856                              | $26,691 
|                               | Payroll & Associated Costs  | 6,923   | 3,385   | 2,171       | 2,892                               | 15,371  
|                               | Other Operating Expenses    | 5,464   | 2,357   | 373         | (196)                               | 7,998   
|                               | Lease Expense               | 629     | -       | -           | -                                   | 629     
|                               | Depreciation & Amortization | 295     | 508     | 11          | 105                                 | 919     
|                               | Operating Income (Loss)     | $1,058  | $1,161  | $500        | $(945)                              | $1,774  
|                               | Total Assets                | $8,307  | $15,021 | $2,653      | $4,198                              | $30,179 
|                               | Capital Spending            | $269    | $186    | $40         | $78                                 | $573    









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NOTE 4.  PROPERTY AND EQUIPMENT



Property and equipment consisted of the following:



|                                |               |              |  |            
|------------------------------- | ------------- | ------------ |  | -----------
|                                | Estimated     |              |  |            
|                                | Useful        | December 31,
|                                | Lives (Years) | 2010         |  | 2009       
|Buildings and improvements      | 5 to 40       | $33,748,211  |  | $15,989,300
|Equipment                       | 2-10          | 3,954,391    |  | 3,084,940  
|Land                            | -             | 4,719,390    |  | 2,945,928  
|Furniture and fixtures          | 2-5           | 489,686      |  | 689,090    
|Construction in process         | -             | 196,589      |  | 66,773     
|                                |               | 43,108,267   |  | 22,776,031 
|Less:  accumulated depreciation |               | 5,501,966    |  | 6,331,003  
|                                |               | $37,606,301  |  | $16,445,028



For the years ended December 31, 2010 and 2009 depreciation
expense was approximately $1,108,500 and $899,500 respectively.



NOTE 5.

RESTRICTED CASH AND INVESTMENTS



The following is a reconciliation of the Companys various
restricted cash, escrow deposits and investments as of December 31:

|                                                  |                 |                
|------------------------------------------------- | --------------- | ---------------
|                                                  | 2010            | 2009           
|HUD escrow deposits                               | $
      336,993 | $
      271,993
|Funds held in trust for residents                 | 113,835         | 102,541        
|Self-restricted cash                              | 596,626         | 346,608        
|Total current portion                             | 1,047,454       | 721,142        
|HUD reserves for capital improvements             | 1,035,851       | 1,083,811      
|Restricted investments for other debt obligations | 2,064,085       | -              
|Total noncurrent portion                          | 3,099,936       | 1,083,811      
|                                                  |                 |                
|Total restricted cash and
investments             | $
  4,147,390   | $
  1,804,953  
|                                                  |                 |                

The Regulatory Agreements established with the financing secured
through the Department of Housing and Urban Development (HUD) for 7 of the
Companys facilities require monthly escrow deposits for taxes, insurance and
replacement of project assets.



During 2010, the Companys consolidated variable interest entity
entered into a bond agreement that sets forth requirements for a project fund
and a debt service reserve fund.  For the year ended December 31, 2010, the
balance of these funds was $482,000 and is included as noncurrent restricted
investments.



In addition, mortgages obtained for 2 new facilities in 2010
required certificates of deposit to be held as collateral in the amount of
$1,582,000 as reflected in noncurrent restricted investments.  The
certificates of deposit are required to be held to maturity through October 2015
and will automatically renew if the lender continues to require them as
collateral.



Self-restricted cash is set aside for group health insurance and
workers compensation premiums.









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NOTE 5.

RESTRICTED CASH AND INVESTMENTS(continued)



In the State of Ohio, nursing homes are required to maintain a
savings account for the use of the residents to deposit their personal funds.
 The Company maintains such accounts for their nursing home residents with
an offsetting liability as these funds are payable to the residents on demand.
 For the years ended December 31, 2010 and 2009, the balance in these
accounts was approximately $86,400 and $63,800, respectively.  Other funds
held in trust for residents include security deposits required at certain
facilities.  For the years ended December 31, 2010 and 2009, the balance
for security deposits was approximately $27,400 and $38,700, respectively.



NOTE 6.  ACCRUED EXPENSES



Accrued expenses consist of the following as of December 31:



|                 |                           |       |       | 
|---------------- | ------------------------- | ----- | ----- | 
|Amounts in 000s
|                 |                           | 2010  | 2009 
|                 | Accrued Payroll Related   | 3,386 | 870  
|                 | Accrued Employee Benefits | 1,405 | 666  
|                 | Real Estate & Other Taxes | 761   | 529  
|                 | Other Accrued Expenses    | 4,112 | 1,009
|Accrued expenses | 9,664                     | 3,074





NOTE 7.

NOTES PAYABLE AND OTHER DEBT



Notes payable and other debt consists of the following:



|                                                     |                   |  |                  
|---------------------------------------------------- | ----------------- |  | -----------------
|                                                     | December 31,
2010 |  | December 31,
2009
|Lines of
credit                                      | $ 1,950,132       |  | $
      49,687   
|Mortgage notes
payable                               | 32,378,012        |  | 17,019,751       
|Bonds payable, net
of discount                       | 6,165,553         |  | -                
|Convertible debt,
net of discount                    | 9,379,761         |  | -                
|Other debt                                           | 970,938           |  | 363,969          
|Total notes payable and other
debt                   | 50,844,396        |  | 17,433,407       
|Less current
portion of notes payable and other debt | 3,633,401         |  | 707,935          
|Notes payable and other debt, net of
current portion | $
47,210,995      |  | $16,725,472      



The following is a summary of the scheduled maturities as of
December 31, 2010 for each of the next five years and thereafter:



|                            |               
|--------------------------- | --------------
|2011                        | $   3,633,401 
|2012                        | 884,063       
|2013                        | 12,530,343    
|2014                        | 738,442       
|2015                        | 781,387       
|Thereafter                  | 34,896,446    
|                            | 53,464,082    
|Less: unamortized discounts | (2,619,686)   
|                            | $   50,844,396





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NOTE 7.

NOTES PAYABLE AND OTHER DEBT(continued)



Lines of Credit

Corporate Revolving Line of Credit

In March 2010, the Company increased its line of credit with
Huntington National Bank from $100,000 to $200,000.  It is a revolving line
of credit with a variable interest rate of the LIBOR rate plus 3.25%.  As
of December 31, 2010 the rate was 3.511% and the balance payable on the line of
credit was approximately $187,200.

Gemino Revolving Line of Credit

In October 2010, 5 of the Companys subsidiaries (the Borrowers)
entered into a Credit Agreement (the Agreement) with Gemino Healthcare
Finance, LLC, (the Lender) to provide a credit facility (the Credit
Facility) in the maximum amount of $5,000,000 limited by certain borrowing base
restrictions.  Borrowing under the Credit Facility is not limited to use by
the Borrowers and may be used by the Company for various business purposes.
 The initial term of the Credit Facility shall expire on October 29,
2013.  The credit facility requires a lockbox arrangement which provides
for all receipts of the borrowers to be automatically swept to reduce borrowings
outstanding.  This arrangement, combined with the existence of a subjective
acceleration clause, necessitates the revolving credit facility to be classified
as a current liability on the consolidated balance sheet.  At December 31,
2010, management believes that there are no adverse changes that would trigger
the subjective acceleration clause and that the Company will continue to borrow
on the credit facility over the term of the agreement.  At December 31,
2010, the balance outstanding was approximately $1,763,000.

The Lender will make advances to the Borrowers from time to time
in the form of revolving loans.  The aggregate amount of the revolving
loans shall not exceed the maximum credit limit.  Initially, the Borrowers
pledged as collateral their accounts receivable.  The Company will have the
ability to add additional subsidiaries to the credit facility subject to certain
terms and conditions with the Lender.  Each revolving loan is subject to
interest on the outstanding principal amount thereof from the date made until
such revolving loan is paid in full, at a rate per annum equal to the LIBOR rate
plus the Applicable Margin (together, the "Interest Rate").  The Interest
Rate on all amounts outstanding under the Credit Facility shall be adjusted
daily based on the LIBOR rate with a LIBOR Floor of 2.50% to 2.25% depending on
the principal amount outstanding.  The Applicable Margin will be 5.00% to
4.75% depending on the principal amount outstanding.  The loan is subject
to various fees including but not limited to the following:

·

A one time commitment fee of $50,000 paid to Lender.

·

An early termination fee of two percent (2.0%), if such early
termination occurs on or prior to the first anniversary of the date of the
Agreement; one percent (1.0%) if such early termination occurs after the first
anniversary date of the Agreement but on or prior to the second anniversary of
the date of this Agreement; and no Termination Fee shall be due if such early
termination occurs after the second anniversary of the date of this
Agreement.

·

An unused line fee equal to one-half percent (0.5%) per annum of
the unused portion of the Credit Facility.

·

A collateral monitoring fee equal to one-half percent (0.5%) per
annum of the average daily outstanding balance of the Revolving Loans during
each month.

Borrowing under the Credit Facility is limited to 85% of certain
eligible accounts receivable of the Borrowers.  The initial borrowing limit
established by the lender at closing was approximately $1,300,000.  The
borrowing limit is reevaluated monthly based on the collateral provided by the
accounts receivable of the Borrowers.  Conditions of the Agreement require
the Borrowers to pay interest on a minimum balance of $1,000,000 through October
2011 and $2,000,000 thereafter.  The Credit Facility is secured by
substantially all assets of the Borrowers and is guaranteed by the Company.
 Certain other financial covenants apply of which the Company was in
compliance at December 31, 2010.



- 41
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NOTE 7.

NOTES PAYABLE AND OTHER DEBT(continued)



Mortgage Notes

For 7 facilities, the Company has mortgage notes payable insured
by HUD with a financial institution that totaled approximately $15,951,000 at
December 31, 2010.  The combined HUD mortgage notes require monthly
principal and interest payments of approximately $108,000.  At December 31,
2010, the weighted average interest rate for these notes is approximately 6.82%.
 The notes mature at various dates starting in 2027 through 2044.
   The notes have various restrictive covenants and HUD
regulatory compliance requirements including maintenance of certain restricted
escrow deposits and reserves for replacement.  The notes all have
prepayment penalties.  There have been no changes to the HUD mortgage notes
in 2010.

During 2010, the Company acquired 2 new facilities through the
issuance of mortgage notes payable insured 70% by the USDA with a financial
institution for a total amount of $15,820,000 that mature in 2035.  At
December 31, 2010, the outstanding balance was approximately $15,774,000.
 The combined USDA mortgage notes require monthly principal and interest
payments of approximately $98,000 adjusted quarterly with a variable interest
rate of prime plus 1.5% with a floor of 5.5%.  Deferred financing costs
incurred on these loans amounted to approximately $303,000 and are being
amortized to interest expense over the life of the notes.  In addition, the
loans have an annual renewal fee for the USDA guarantee of 0.25% of the
guaranteed portion.  The loans have prepayment penalties of 10% through
2011 declining by 1% each year capped at 1% for the remainder of the term.
 The loans have certain financial covenants of which the Company was in
compliance at December 31, 2010.

The remainder of the mortgage notes balance relate to first and
second mortgages with a financing institution on the Companys corporate
headquarters with a combined balance of approximately $654,000 at December 31,
2010.  The first mortgage requires fixed monthly payments of approximately
$3,000 plus interest at LIBOR plus 3.00% maturing in 2017.  The second
mortgage requires monthly payments of principal and interest of approximately
$17,000 at a variable interest rate of prime plus 1.50% maturing in 2013.

Bonds Payable

On June 25, 2010, the Medical Clinical Board of the City of Hoover
in the state of Alabama issued revenue bonds, in two series, with aggregate
principal of $6,365,000 to the Companys consolidated variable interest entity
Riverchase Village ADK, LLC (Riverchase).  The proceeds were used
primarily to acquire a 108-unit assisted living facility in Alabama.  The
Company has guaranteed Riverchases obligations under the bonds.



The Series 2010A portion of $5,845,000 matures on June 1, 2039.
 The Series 2010B portion of $520,000 matures serially beginning June 1,
2012 through June 1, 2017, with annual redemption amounts ranging from $75,000
to $100,000.  The Series 2010A and 2010B bonds may be redeemed early
beginning June 1, 2012 through May 31, 2015 at a redemption price ranging from
101% to 103% of the principal amount plus accrued interest.  Any early
redemption after May 31, 2015 is at a redemption price of 100% of the principal
amount plus accrued interest.  The bonds require monthly payments of fixed
interest commencing on September 1, 2010 at a weighted average effective
interest rate of 7.896%.



Proceeds obtained were net of original issue discounts of
$204,811.  At December 31, 2010, the unamortized discount was $199,447
resulting in the amortization of the discount to interest expense of $5,364.
 This discount is being amortized over the term of the bonds.





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NOTE 7.

NOTES PAYABLE AND OTHER DEBT(continued)



Bonds Payable(continued)

The bonds are subject to certain covenants and a mandatory sinking
fund redemption requirement.  Portions of the proceeds were required to be
held in trust including an amount of $300,000 for a debt service reserve fund
and $326,000 for a project fund for various capital improvements to the
facility.  The debt service fund and the project fund are reflected as
restricted cash and investments in the accompanying consolidated balance sheet.
 The following is a summary of the mandatory redemption and sinking fund
requirements for each of the next five years and thereafter:

|           |                    
|---------- | -------------------
|2011       | $
                -
|2012       | $
       75,000    
|2013       | $
       75,000    
|2014       | $
       85,000    
|2015       | $
       90,000    
|Thereafter | $   6,040,000      
|           | $   6,365,000      



Debt with Detachable Warrants

On September 30, 2010, the Company entered into a financing
agreement for a promissory note up to a maximum of $3,500,000 bearing interest
at 10% per annum plus a maximum of 350,000 warrants to purchase common stock of
the Company.  The Company received proceeds of $3,345,000 net of financing
costs. Proceeds from this financing agreement were used in the Alabama Nursing
Home Acquisitions (see Note 20).  The promissory note was subsequently
refinanced on October 26, 2010 with a portion of the proceeds obtained from a
convertible debt issuance.  The warrants continued to be outstanding and
exercisable after the refinancing of the promissory note.  At the time of
the refinancing, the Company had recognized approximately $106,000 of
amortization of discounts to interest expense and $228,203 as loss on the
extinguishment of debt primarily related to the unamortized portion of the
discounts.

A portion of the proceeds obtained was allocated to the warrants
issued based on their estimated grant date fair value of $0.91 per share with an
offsetting discount issued on the promissory note.  The total fair value of
the warrants issued was approximately $318,500 (net of approximately $24,000
stock issuance costs).The warrants are exercisable at $4.13 per share and expire
on October 1, 2013.  Additionally, the Company issued to the placement
agent 116,900 additional warrants exercisable at $4.13 per share for a total
value of approximately $106,000.

Also, the Company will pay the placement agent, in cash, an amount
equal to 6% of the cash received by the Company, from time to time, upon the
exercise of each warrant.

Convertible Debt Issuance

On October 26, 2010, the Company entered into a Securities
Purchase Agreement (the Purchase Agreement) with certain accredited investors
(the Purchasers) to sell and issue to the Purchasers an aggregate of
$11,050,000 in principal amount of the Companys Subordinated Convertible Notes
(the Notes), bearing 10.0% interest per annum payable quarterly in cash in
arrears beginning December 31, 2010.  On October 29, 2010, the Company
entered into an amendment and joinder agreement to effectuate the sale of an
additional $750,000 in principal amount of Notes.  The initial sale of
$11,050,000 in principal amount of Notes occurred on October 26, 2010, and the
subsequent sale of $750,000 in principal amount of Notes occurred on October 29,
2010.  The notes mature in October 2013.



- 43
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NOTE 7.

NOTES PAYABLE AND OTHER DEBT(continued)



Convertible Debt Issuance(continued)

The Notes are convertible into shares of common stock of the
Company at a current conversion price of $4.13 that is subject to future
reductions if the Company issues equity instruments at a lower price.
 Since there is no minimum conversion price resulting in an indeterminate
number of shares to be issued in the future, the Company determined an embedded
derivative existed that was required to be bifurcated from the Notes and
accounted for separately as a derivative liability recorded at fair value (see
Note 14).  At the time of initial measurement, the derivative had an
estimated fair value of $2,562,606 resulting in a discount on the Notes.
 The discount is being amortized over the term of the Notes.  At
December 31, 2010, the unamortized discount on the Notes was $2,420,239
resulting in the amortization of the discount to interest expense of
$142,367.

Other Debt

The Company has a number of other miscellaneous subordinated debt
agreements that mature primarily in 2011.  The majority of the balance
relates to seller notes associated with the Companys current year acquisitions.

NOTE
8.  COMMON STOCK

In December, 2009, at a special shareholder meeting, shareholders
approved the sale of 1,382,500 shares of stock and warrants in a private
offering of the Companys stock.  The offering consisted of Units with each
Unit containing one share of the Companys common stock and one five-year
warrant to purchase an additional share of common stock at $2.38 per share
(adjusted for stock dividend).  As a result, 1,382,500 new shares of common
stock and 1,382,500 warrants were issued.  Gross proceeds of the private
sale were $2,765,000.  Proceeds, net of the underwriters expenses, were
approximately $2,439,000.

On June 4, 2010, the shareholders voted to amend the articles of
incorporation to increase the number of authorized shares of common stock from
14,500,000 shares to 29,000,000 shares and to increase the number of authorized
shares of preferred stock from 500,000 shares to 1,000,000 shares.  The
amendments were effective in the second quarter of 2010.

On June 30, 2010, the Company closed a public stock offering of
1,714,286 shares of common stock at a gross price of $3.50 per share.  The
Company received net proceeds of approximately $5,376,000 after deducting
underwriting discounts, commissions, legal fees and other offering-related
expenses payable by the Company.  AdCare granted a 30-day option to the
underwriter to purchase up to an additional 15% of the shares offered, or
257,143 shares, to cover over-allotments, if any.  On August 4, 2010, the
underwriter exercised their overallotment option to purchase an additional
225,400 shares of common stock at a discounted price of $3.255 per share,
resulting in net proceeds to the Company of approximately $734,000.

On August 11, 2010, the board of directors declared a 5% stock
dividend to be issued on October 15, 2010 based on the shareholders of record at
the close of business on September 30, 2010.  As the Company is in a
deficit position, there is no recorded impact to the reported amounts of
stockholders equity in the accompanying consolidated balance sheet.  All
references to the number of common shares and per-share amounts included in
these consolidated financial statements are restated based on the increased
number of shares giving retroactive effect to the stock dividend to prior year
amounts.





- 44
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NOTE 9.

STOCK BASED COMPENSATION



The following table summarizes employee and nonemployee stock
based compensation for the years ended December 31, 2010 and 2009:



|                       |                                     |                  |  |                 
|---------------------- | ----------------------------------- | ---------------- |  | ----------------
|                       |                                     | December 31,     |  | December
31,    
|                       |                                     | 2010             |  | 2009            
|Employee compensation: |                                     |                  | 
|                       | Stock options                       | $
        35,477 |  | $
        20,892
|                       | Employee warrants                   | 327,708          |  | 258,106         
|                       | Restricted stock                    | 455,580          |  | 41,416          
|                       | Total
Employee Compensation Expense | $
      818,765  |  | $
      320,414 



|                           |                                              |                 |  |                 
|-------------------------- | -------------------------------------------- | --------------- |  | ----------------
|Non-employee
compensation: |                                              |                 | 
|                           | Warrants                                     | $
      236,138 |  | $
        43,693
|                           | Less:  Deferred financing
& prepaid services | (236,138)       |  | -               
|                           | Amortization of prepaid
services             | 21,648          |  | -               
|                           | Total
Nonemployee Compensation Expense       | $
      21,648  |  | $
        43,693



The Company uses the Black-Scholes option-pricing model for
estimating the fair values of employee share options, employee and nonemployee
warrants and similar instruments with the following key assumptions:



Expected Dividend Yield:  The Company has not
historically paid dividends and does not expect to pay dividends in the near
future.  As such, there is no expected dividend yield.



Expected Volatility:The Company
estimates the expected volatility factor using a mix of the Companys historical
stock price volatility and the weighted-average historical volatility of similar
companies within the industry whose stock prices are publicly available.



Risk-Free Interest Rate:The Company bases the
risk-free interest rate on the implied yield currently available on U.S.
Treasury zero-coupon issues with a remaining term equivalent to the expected
term of the options and warrants being valued.



Expected Term:  The Company currently uses a
simplified method for calculating the expected term based on the vesting and
contractual expiration dates.



Employee Stock Options



The Company has two active employee stock option plans.  The
2004 plan expires on March 31, 2014 and provides for a maximum of 126,000 shares
of common stock to be issued.  The 2005 plan expires on September 30, 2015
and provides for a maximum of 525,000 shares of common stock to be issued.
 Both plans permit the granting of incentive or nonqualified stock options.
 The Plans are administered by the Board of Directors who has the authority
to determine the employees to whom awards will be made, the amount of the
awards, and the other terms and conditions of the awards.



Under the 2004 plan, the Company granted 114,200 options,
primarily incentive stock options, with a weighted-average fair value estimated
at $0.36 per share.  The options vested 40% on the date of grant and 20%
for each of the three years from the date of grant.  Each vested portion is
exercisable for 5 years after vesting and the exercise price per share was equal
to the fair market value on the grant date.



- 45
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NOTE 9.

STOCK BASED COMPENSATION(continued)



Employee Stock Options(continued)



Under the 2005 plan, in May 2007, the Company granted 199,000
options, primarily incentive stock options, with a weighted-average fair value
estimated at $0.58 per share.  The stock options vested 20% on the date of
grant and 20% for each of the 4 years from the date of grant.  Each vested
portion is exercisable for 5 years after vesting and the exercise price per
share was equal to the fair market value on the grant date.  During 2010,
the Company granted an additional 25,000 options under this plan with a
weighted-average fair value estimated at $1.56.  Options granted under this
plan begin to expire in May 2012.



The following summarizes the Companys stock option activity for
the period ending December 31, 2010:



|                                 |          |  |          |  |           |  |               
|-------------------------------- | -------- |  | -------- |  | --------- |  | --------------
|                                 |          |  |          |  | Weighted  |  |               
|                                 |          |  | Weighted |  | Average   |  |               
|                                 | Number   |  | Average  |  | Remaining |  | Aggregate     
|                                 | of       |  | Exercise |  | Contract  |  | Intrinsic     
|                                 | Shares   |  | Price    |  | Life      |  | Value         
|Outstanding at January 1,
2010   | 219,080  |  | $1.67    |  |           |  |               
|Stock
Dividend                   | 8,924    |  | $1.58    |  |           |  |               
|Granted                          | 25,000   |  | $4.13    |  |           |  |               
|Exercised                        | (18,400) |  | $2.36    |  |           |  |               
|Forfeited                        | (15,760) |  | $1.56    |  |           |  |               
|Expired                          | (6,440)  |  | $2.38    |  |           |  |               
|Outstanding at December 31,
2010 | 212,404  |  | $1.88    |  | 3.4
years |  | $
     434,219
|Exercisable at December 31, 2010 | 166,169  |  | $1.74    |  | 2.7
years |  | $
     361,038



At December 31, 2010 the Company has approximately $45,000 of
unrecognized compensation expense related to outstanding stock options.
 Assuming no pre-vesting forfeitures, this expense will be recognized as a
charge to earnings over a weighted-average remaining service period of 0.85
years.  The total intrinsic
value of options exercised during 2010 was $29,440.



Employee Common Stock Warrants



In addition to the Companys stock option plans, from time to time
as determined by the Board of Directors, the Company grants stock warrants to
officers, directors, employees and certain consultants to the Company.  The
Board of Directors administers the granting of warrants, determines the persons
to whom awards will be made, the amount of the awards, and the other terms and
conditions of the awards.



In November 2007, the Board recommended a new warrant incentive
plan (the Incentive Plan) and, at a special meeting of shareholders held on
August 15, 2008, the Companys shareholders approved the issuance of warrants to
purchase up to 1,092,305 shares of the Companys common stock to certain
officers and directors of the Company.



The warrants issued in connection with the incentive plan are
exercisable for a period of 10 years and vest equally over a period of five
years.  The exercise price per share of the warrants vesting in calendar
years 2008, 2009 and 2010 was $1.15, $2.14, and $2.85, respectively.  The
weighted-average fair value of the warrants vesting in 2008-2010 was estimated
at $0.94 per share.



- 46
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NOTE 9.  STOCK BASED COMPENSATION(continued)



Employee Common Stock Warrants(continued)



In December 2009, shareholders approved modifying the Incentive
Plan warrants scheduled to vest in 2011 so that the exercise price is fixed at
$3.80 per share.  Subsequently, the Company granted 171,378 warrants with a
fair value estimated at $1.05 per share.  One third of the warrants vested
in December 2009 with the remaining scheduled to vest equally in December 2010
and December 2011.  The warrants are exercisable until the term expires in
August 2018.  In

addition, shareholders approved eliminating the Incentive Plan
warrants scheduled to vest in 2012 and approved issuing 171,378 shares of the
Companys common stock to certain officers and directors with a one year
restriction on transfer.



In September 2009, the company granted 300,000 warrants to its
Vice Chairman and Chief Acquisitions Officer.  One third of the warrants
vested on the grant date with an exercise price of $2.85 per share and the
remaining two thirds vest equally in 2010 and 2011 with exercise prices of $3.80
and $4.75, respectively.  The Company estimated the weighted average fair
value at $0.97 per share.  The warrants expire in September 2017.



In December 2009, the Company granted 125,000 warrants to members
of senior management with a fair value estimated at $0.97 per share.  The
warrants have a term of 5 years and an exercise price of $2.85 per share.
 One third of the warrants vested in December 2009 with the remaining two
thirds scheduled to vest equally in December 2010 and December 2011.  The
warrants are exercisable until the term expires in December 2014.



The significant assumptions used to estimate the fair value of
employee common stock warrants granted using the Black Scholes option-pricing
model is as follows:



|                        |        
|----------------------- | -------
|                        | 2009   
|Dividend
Yield          | 0.0%   
|Expected
Volatility     | 48.0%  
|Risk-Free
Interest Rate | 2.53%  
|Expected
Term           | 7 years



There were no employee common stock warrants granted during
2010.



The following summarizes the Companys employee common stock
warrant activity for the period ending December 31, 2010:



|                                 |           |  |          |  |           |  |           
|-------------------------------- | --------- |  | -------- |  | --------- |  | ----------
|                                 |           |  |          |  | Weighted  |  |           
|                                 |           |  | Weighted |  | Average   |  |           
|                                 | Number    |  | Average  |  | Remaining |  | Aggregate 
|                                 | of        |  | Exercise |  | Contract  |  | Intrinsic 
|                                 | Shares    |  | Price    |  | Life      |  | Value     
|Outstanding at January 1,
2010   | 1,311,539 |  | $2.22    |  |           |  |           
|Stock
Dividend                   | 61,401    |  | $2.22    |  |           |  |           
|Granted                          | -         |  | -        |  |           |  |           
|Exercised                        | (40,000)  |  | $2.38    |  |           |  |           
|Forfeited                        | (43,528)  |  | $2.13    |  |           |  |           
|Cancelled or
Modified            | -         |  | -        |  |           |  |           
|Expired                          | -         |  | -        |  |           |  |           
|Outstanding at December 31,
2010 | 1,289,412 |  | $2.22    |  | 6.4
years |  | $2,254,861
|Exercisable at December 31,
2010 | 969,462   |  | $2.21    |  | 6.4
years |  | $1,639,454



The Company has approximately $46,000 of unrecognized compensation
expense related to these warrants as of December 31, 2010.  Assuming no
pre-vesting forfeitures, this expense will be recognized as a charge to earnings
in 2011.  The total intrinsic value of options exercised during 2010 was
$60,800.





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NOTE 9.

STOCK BASED COMPENSATION(continued)



Restricted Stock



In December 2009, shareholders approved eliminating the incentive
plan warrants scheduled to vest in 2012 and approved issuing 171,378 shares of
the Companys common stock with a one year restriction on transfer to certain
directors and members of management.  The restricted stock is subject to
forfeiture if the recipient is not a director or employed by the Company at the
end of the one year restriction.  The Company determined the fair value of
the restricted stock to be equal to the grant date stock price of $2.90.
 The related compensation expense is being recognized over the one year
restricted period.



The following summarizes the Companys restricted stock activity
for the period ending December 31, 2010:



|                               |           |  |              
|------------------------------ | --------- |  | -------------
|                               | Number    |  | Weighted
Avg.
|                               | of        |  | Grant
Date   
|                               | Shares    |  | Fair
Value   
|Nonvested at January 1,
2010   | 171,378   |  | $2.90        
|Stock
Dividend                 | 8,569     |  | $2.90        
|Granted                        | -         |  | -            
|Vested                         | (179,947) |  | $2.90        
|Forfeited                      | -         |  | -            
|Nonvested at December 31,
2010 | -         |  | -            



At December 31, 2010, the Company has no unrecognized compensation
expense related to restricted stock.  The total fair value of restricted
shares vested during 2010 was $685,600.



Nonemployee Common Stock Warrants



During 2009 and 2010, the Company granted various awards to
nonemployees in connection with stock offerings and other financing arrangements
for various financing related services with a weighted-average per share fair
value estimated at $1.42 and $0.91, respectively.  The warrants have terms
between 3-5 years and vested immediately at grant.



The significant assumptions used to estimate the fair value of
nonemployee common stock warrants granted using the Black Scholes option-pricing
model is as follows:



|                        |           |  |          
|----------------------- | --------- |  | ---------
|                        | 2010      |  | 2009     
|Dividend
Yield          | 0.0%      |  | 0.0%     
|Expected
Volatility     | 60.0%     |  | 48.0%    
|Risk-Free
Interest Rate | .49%      |  | 2.53%    
|Expected
Term           | 1.7 years |  | 3.4 years





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NOTE 9.

STOCK BASED COMPENSATION(continued)



The following summarizes the Companys non-employee common stock
warrant activity for the period ending December 31, 2010:



|                                 |           |  |          |  |           |  |          
|-------------------------------- | --------- |  | -------- |  | --------- |  | ---------
|                                 |           |  |          |  | Weighted  |  |          
|                                 |           |  | Weighted |  | Average   |  |          
|                                 | Number    |  | Average  |  | Remaining |  | Aggregate
|                                 | of        |  | Exercise |  | Contract  |  | Intrinsic
|                                 | Shares    |  | Price    |  | Life      |  | Value    
|Outstanding at January 1,
2010   | 500,000   |  | $1.79    |  |           |  |          
|Stock
Dividend                   | 16,008    |  | $1.97    |  |           |  |          
|Granted                          | 291,900   |  | $3.90    |  |           |  |          
|Exercised                        | (118,740) |  | $1.42    |  |           |  |          
|Forfeited                        | (16,094)  |  | $1.90    |  |           |  |          
|Outstanding at December 31,
2010 | 603,074   |  | $2.92    |  | 2.9
years |  | $650,141 
|Exercisable at December 31,
2010 | 603,074   |  | $2.92    |  | 2.9
years |  | $650,141 



For the years ended December 31, 2010 and 2009, the Company
recognized approximately $21,648 and $43,693, respectively, of related
nonemployee compensation expense.  During 2010, the Company deferred
approximately $236,000 in nonemployee compensation expense related to deferred
financing costs and prepaid services.  Of this amount, $21,648 was
amortized as nonemployee compensation expense during 2010 with approximately
$108,000 unrecognized as of December 31, 2010 with a remaining recognition
period of 0.75 years.  For the remainder, approximately $6,000 was from the
amortization of the deferred financing costs to interest expense with
approximately $100,000 unrecognized as of December 31, 2010 with a remaining
recognition period of 2.75 years.



NOTE 10.

COMMON STOCK WARRANTS



A summary of the status of the Companys common stock warrants as
of December 31, 2010 and December 31, 2009 is presented below:



|                  |  |              |  |          
|----------------- |  | ------------ |  | ---------
|                  |  | December
31,
|                  |  | 2010         |  | 2009     
|Beginning balance |  | 2,788,500    |  | 1,406,000
|Stock
Dividend    |  | 139,425      |  | -        
|Issued            |  | 350,000      |  | 1,382,500
|Exercised         |  | -            |  | -        
|Expired           |  | -            |  | -        
|Ending balance    |  | 3,277,925    |  | 2,788,500



In connection with the Companys private sale of stock and
warrants in December 2009 (see Note 8), the Company issued 1,382,500 warrants.
 The warrants have an exercise price of $2.38 per share and expire in
December 2014.



In December 2009, shareholders approved amending the 1,406,000
warrants issued in November 2006 in connection with the Companys initial public
offering.  The amendments included reducing the exercise price from $5.40
to $2.50 (now adjusted to $2.38 as a result of the stock dividend), extending
the expiration date from November 2011, to December 2014, and adding a callable
option that will allow the Company to call for repurchase of all, or any portion
of, the warrants for $.10 per warrant provided that (i) the common stock
underlying the warrants is registered and (ii) the common stock trades at or
above $6.00 per share for ten consecutive trading days during which the average
daily volume for the ten day period is at least 40,000 shares.  The
callable feature has been accounted for in accordance with ASC 480-10-25,
Distinguishing Liabilities from Equity.  The Company has
determined that since the warrants will be redeemed only upon the occurrence of
conditional events, the call option does not meet the definition of a
mandatorily redeemable financial instrument in ASC 480-10-25 and, therefore, no
liability has been recorded.



- 49
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NOTE 10.

COMMON STOCK WARRANTS(continued)



However, the call option will be assessed at each reporting period
to determine whether circumstances have changed such that the instrument now
meets the definition of a mandatorily redeemable instrument (that is, the call
option is no longer conditional). If conditions have occurred or have become
certain to occur, the financial instrument will be reclassified as a liability.



On September 30, 2010, the Company entered into a financing
arrangement for a promissory note up to a maximum of $3,500,000 bearing interest
at 10% per annum plus a maximum of 350,000 warrants to purchase common stock of
the Company (see Note 7).  The Warrants are exercisable at $4.13 per share
and expire on October 1, 2013.



NOTE 11.

INCOME TAXES



The provision for income taxes attributable to continuing
operations for the years ended December 31, 2010 and December 31, 2009 is
presented below.



|                                   |                      |  |                     
|---------------------------------- | -------------------- |  | --------------------
|                                   | December 31,        
|                                   | 2010                 |  | 2009                
|Current Tax Expense (Benefit):     |                      |  |                     
|Federal                            | $
                 - |  | $
                 -
|State                              | -                    |  | -                   
|                                   | -                    |  | -                   
|Deferred Tax Expense (Benefit):    |                      |  |                     
|Federal                            | 42,567               |  | 42,567              
|State                              | -                    |  | -                   
|                                   | 42,567               |  | 42,567              
|Total income tax expense
(benefit) | $
       42,567      |  | $
       42,567     



At December 31, 2010 and 2009, the tax effect of significant
temporary differences representing deferred tax assets are as follows:



|                                              |              |  |             
|--------------------------------------------- | ------------ |  | ------------
|                                              | December
31,
|                                              | 2010         |  | 2009        
|Net current deferred tax
asset:               |              |  |             
|Allowance for
doubtful accounts               | $
   144,757 |  | $
    92,376
|Accrued
expenses                              | 373,500      |  | 130,539     
|                                              | $
   518,257 |  | $
  222,915 
|Net long-term deferred tax asset
(liability): |              |  |             
|Net operating
loss carry forwards             | $
3,653,013  |  | $
2,700,232 
|Noncontrolling
interests                      | (53,419)     |  | (212,630)   
|Property,
equipment & intangibles             | (548,586)    |  | (252,103)   
|Stock based
compensation                      | 398,489      |  | 268,300     
|Other                                         | 191,337      |  | -           
|                                              | 3,640,834    |  | 2,503,799   
|Total deferred tax assets                     | 4,159,091    |  | 2,726,714   
|Valuation allowance                           | (4,414,232)  |  | (2,939,288) 
|Net deferred tax
liability                    | $
(255,141)  |  | $
(212,574) 





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NOTE 11.

INCOME TAXES(continued)



The items accounting for the differences between income taxes
computed at the federal statutory rate and the provision for income taxes are as
follows:



|                              |  |              |  |         
|----------------------------- |  | ------------ |  | --------
|                              |  | December 31,
|                              |  | 2010         |  | 2009    
|Income tax at
statutory rate  |  | 34.00%       |  | 34.00%  
|Nondeductible
expenses        |  | (0.99)%      |  | 7.20%   
|Noncontrolling
interests      |  | 8.41%        |  | 8.26%   
|Change in
valuation allowance |  | (43.39)%     |  | (41.32)%
|Effective tax
rate            |  | (1.97)%      |  | 8.14%   



As of December 31, 2010 AdCare had consolidated federal net
operating loss (NOL) carry forwards of approximately $10,744,000.  These
NOLs begin to expire in 2012 through 2029.



Given the Companys continued net operating losses, a full
valuation allowance has been established on the Companys net deferred tax
assets.  The Company has generated additional deferred tax liabilities
related to its tax amortization of certain acquired indefinite lived intangible
assets because these assets are not amortized for book purposes.  The tax
amortization in current and future years gives rise to a deferred tax liability
which will only reverse at the time of ultimate sale or book impairment.
 Due to the uncertain timing of this reversal, the temporary differences
associated with indefinite lived intangibles cannot be considered a source of
future taxable income for purposes of determining a valuation allowance.
 As such, the deferred tax liability cannot be used to support an equal
amount of the deferred tax asset related to the NOL carry forward (naked
credit).  This resulted in recognized deferred tax expense of $42,567 for
each of the years ending December 31, 2010 and 2009, and a deferred tax
liability of $255,141 and $212,574 as of December 31, 2010 and 2009,
respectively.



Under Section 382 of the Internal Revenue Code of 1986, as amended
(the Code), the utilization of net operating loss carry forwards may be limited
under the change in stock ownership rules of the Code.  As a result of
ownership changes, which occurred in November 2006 in connection with the
Companys initial public offering and subsequent stock issuances, the Company
may have substantially limited or eliminated the availability of its net
operating loss carry forwards.



NOTE 12.

COMMITMENTS AND CONTINGENCIES



Operating Leases



The Company leases certain office space and 11 facilities under
non-cancelable operating leases, most of which have initial lease terms of 10-12
years with rent escalation clauses and provisions for payments by the Company of
real estate taxes, insurance and maintenance costs. Eight of the facilities were
initiated in the third quarter of 2010, and two additional in the fourth quarter
of 2010. For the years ending December 31, 2010 and 2009, lease expense totaled
approximately $2,908,000 and $629,000, respectively.



Eight of the Companys facilities are operated under a single
master lease arrangement. Under the master lease, a breach at a single facility
could subject one or more of the other facilities covered by the same master
lease to the same default risk. Failure to comply with regulations or
governmental authorities, such Medicare and Medicaid provider requirements, is a
default under the Companys master lease agreement. In addition, other potential
defaults related to an individual facility may cause a default of the entire
master lease agreement. With an indivisible lease, it is difficult to
restructure the composition of the portfolio or economic terms of the lease
without the consent of the landlord. The Company is not aware of any defaults as
of December 31, 2010.







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NOTE 12.

COMMITMENTS AND CONTINGENCIES(continued)



Operating Leases(continued)



Two of the Companys facilities are operated under a separate
lease agreement.  The lease is a single indivisible lease; therefore a
breach at a single facility could subject the second facility to the same
default risk.  The lease has a term of 12 years and includes covenants and
restrictions.  A commitment is included that requires minimum capital
expenditures of $375 per licensed bed per lease year at each facility which
amounts to approximately $115,000 per year for both facilities.  The
Company is not aware of any defaults as of December 31, 2010.



Future minimum lease payments for each of the years ending
December 31 are as follows:



|           |  |            
|---------- |  | -----------
|2011       |  | $ 6,901,565
|2012       |  | 7,088,696  
|2013       |  | 7,249,129  
|2014       |  | 6,932,944  
|2015       |  | 6,930,221  
|Thereafter |  | 37,538,894 
|           |  | $72,641,449

Legal Matters



Certain claims and suits arising in the ordinary course of
business in managing certain nursing facilities were filed or are pending
against the Company.  Management provides for loss contingencies where the
possibility of a loss is probable.  The Company carries liability insurance
that is available to fund certain defined losses, should any arise, net of a
deductible amount.  As of December 31, 2010, estimated loss liabilities due
to litigation were recorded in the amount of $283,000.



NOTE 13.

THIRD-PARTY REIMBURSEMENT



Medicare



Payments for Medicare resident services are made under a
prospective payment system.  There is no retroactive adjustment to
allowable cost.  The Company is paid one of several prospectively set rates
that vary depending on the residents service needs.  Payment rates are
established on a federal basis by the Centers for Medicare and Medicaid Services
(CMS).



The final settlement process is primarily a reconciliation of
services provided and rates paid.  As a result, no material settlement
estimates are expected.



Medicaid



Payments for Medicaid resident services are calculated and made
under a prospective reimbursement system.  Payment rates are based on
actual cost, limited by certain ceilings, adjusted by a resident service needs
factor and updated for inflation.  The direct care portion of the rate can
be adjusted prospectively for changes in residents service needs. While interim
rates are subject to reconsideration and appeal, once this process is completed,
they are not subject to subsequent retroactive adjustment.  However, the
states in which the Company operates have the opportunity to audit the cost
report used to establish the prospective rate. If the state departments discover
non-allowable or misclassified costs that resulted in overpayments to the
Company, then the funds will be recovered by the state departments through the
final rate recalculation process.



For the years ended December 31, 2010 and 2009, management
estimated that no amounts are due to the Medicaid program resulting from
non-allowable or misclassified costs for any open Medicaid reimbursement
years.



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NOTE 13.

THIRD-PARTY REIMBURSEMENT(continued)



Third-Party Overpayments



Medicaid providers overpaid the Company on certain of its
residents.  Medicaid overpayments were approximately $674,800 and $172,100
for the years ended December 31, 2010 and 2009, respectively, and are included
in accrued expense in the accompanying consolidated balance sheet.  The
Company received Medicaid payments for residents who were previously discharged
or for residents who were covered by the Medicare program or other payers.
 The overpayments are primarily due to the lack of processing status
changes on a timely basis despite the Companys submission of such changes.



Laws and Regulations



Laws and regulations governing the Medicare and Medicaid programs
are complex and subject to interpretation.  The Company believes that it is
in compliance with all applicable laws and regulations and is not aware of any
pending or threatened investigation involving allegations of potential
wrongdoing.  While no such regulatory inquiries have been made, compliance
with such laws and regulations can be subject to future government review and
interpretation, as well as significant regulatory action including fines,
penalties and exclusion from the Medicare and Medicaid programs.



NOTE 14.

FAIR VALUE MEASUREMENTS



The following are the major categories of assets and liabilities
measured at fair value on a recurring basis during the year ended December 31,
2010, using quoted prices in active markets for identical assets (Level 1);
significant other observable inputs (Level 2); and significant unobservable
inputs (Level 3).



|                     |                                                      |  |                                     |  |                                 |  |                           
|-------------------- | ---------------------------------------------------- |  | ----------------------------------- |  | ------------------------------- |  | --------------------------
|                     | Level 1:                                             |  | Level 2:                            |  | Level 3:                        |  |                           
|                     | Quoted Prices in
Active Markets for Identical Assets |  | Significant Other
Observable Inputs |  | Significant
Unobservable Inputs |  | Total at December
31, 2010
|Derivative Liability | $
                    -                              |  | $
                    -             |  | $
     2,905,750                |  | $
   2,905,750            



Following is a reconciliation of the beginning and ending balances
for assets and liabilities measured at fair value on a recurring basis using
significant unobservable inputs (Level 3) during the period ended December 31,
2010:



|                  |                          
|----------------- | -------------------------
|                  | Derivative Liability     
|Beginning
Balance | $
                      -
|Additions         | 2,562,606                
|Total
losses      | 343,144                  
|Ending
Balance    | $
       2,905,750       



During 2010, the Company issued subordinated convertible notes
(see Note 7) in which it was determined that the conversion feature was required
to be bifurcated from the debt host and accounted for separately as a derivative
liability recorded at fair value.  The Company estimates the fair value of
the derivative liability using the Black-Scholes option-pricing model with
changes in fair value being reported in the consolidated statement of
operations.



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NOTE 15.

CURRENT VULNERABILITY DUE TO CERTAIN CONCENTRATIONS



The Companys operations are concentrated in the long-term care
market, which is a heavily regulated environment.  The operations of the
Company are subject to the administrative directives, rules and regulations of
federal and state regulatory agencies, including, but not limited to, CMS, and
the Department of Health and Aging in all states in which the Company operates.
 Such administrative directives, rules and regulations, including budgetary
reimbursement funding, are subject to change by an act of Congress, the passage
of laws by the General Assembly or an administrative change mandated by one of
the executive branch agencies.  Such changes may occur with little notice
or inadequate funding to pay for the related costs, including the additional
administrative burden, to comply with a change.



The Company has 100% of its 1,687 skilled nursing facility beds
that it owns or leases certified under the Medicaid and Medicare programs.
 A summary of occupancy utilization and net revenues for these nursing
facility beds is as follows:



|                   |                 |                  |             
|------------------ | --------------- | ---------------- | ------------
|                   |                 | Percent of       | Percent of  
|                   | Percent of      | Long-Term        | Patient     
|For the Year Ended | Total Occupancy | Care Receivables | Care Revenue
|                   |                 |                  |             
|Medicaid           |                 |                  |             
|December
31, 2010  | 77%             | 36%              | 49%         
|December
31, 2009  | 67%             | 38%              | 50%         
|                   |                 |                  |             
|Medicare           |                 |                  |             
|December
31, 2010  | 11%             | 38%              | 22%         
|December
31, 2009  | 15%             | 23%              | 30%         
|                   |                 |                  |             
|Other
Payers       |                 |                  |             
|December
31, 2010  | 12%             | 26%              | 29%         
|December
31, 2009  | 18%             | 39%              | 20%         



NOTE 16.

DEFERRED COMPENSATION PLAN



The Company maintains a non-qualified deferred compensation plan
available to a select group of management or highly compensated employees.
 Contributions to the plan are made by the participants. The Company does
not provide any matching contributions.  The benefits of the plan are
payable upon the employees separation of employment with the Company.



As of December 31, 2010, the Company had a gross asset of
approximately $261,000 to reflect the amount of investments held in the plan and
a corresponding liability acknowledging the Companys obligation to employees
participating in the plan (included in other assets and other liabilities in the
accompanying balance sheet).  During 2010, two participants loaned the
Company $191,000 from the plan assets which is presented net against the assets
with an immaterial amount of accrued interest at 8% per year.  The
underlying assets are recorded at fair value and primarily represent short term
fixed income assets invested at the participants' direction.  Contributions
to and payments from the plan in 2010 were not material.



As of December 31, 2009, the Company had a gross asset of
approximately $293,000 to reflect the amount of investments held in the plan and
a corresponding liability.  In 2009, the Company withdrew $150,000 from the
plan and repaid it before the end of the year.  The Company paid 8%
interest on the funds withdrawn until they were repaid.  There were no
material contributions to or payments from the plan in 2009.





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NOTE
17.  ACQUISITIONS

Acquisition of Community Hearth & Home and Hearth &
Home of Urbana

Prior to March 31, 2010, the Company had 50% joint ownership of
two assisted living facilities located in Springfield, Ohio known as Communitys
Hearth & Home (CH&H) and one assisted living facility located in Urbana,
Ohio known as Hearth & Home of Urbana (H&H).  The Company
previously determined that CH&H and H&H were variable interest entities
and that the Company was the primary beneficiary of those variable interests.
 As such, CH&H and H&H were previously consolidated with
noncontrolling interests presented accordingly.

On March 31, 2010, the Company obtained control of CH&H and
H&H by acquiring the remaining 50% noncontrolling equity interest for a
total purchase price of $500,000.  The Company acquired CH&H and
H&H primarily to exercise complete control over decisions effecting the
operations and the use and allocation of the assets and cash flow generated by
the businesses.

In connection with the acquisition, the Company recognized a total
gain of approximately $826,000 in the statement of operations.  This
includes a gain of approximately $530,000 as a result of remeasuring to fair
value the original 50% equity interest held by the Company prior to the
acquisition of the remaining 50% noncontrolling equity interest.  The
remaining gain of approximately $296,000 is a result of the bargain purchase
based on the excess of the net identifiable assets acquired over the
consideration transferred.  The transaction resulted in a bargain purchase
because the minority partner considered this business to be not material and it
was not an important part of their overall organization.  Additionally,
they wanted to utilize the proceeds to pursue other opportunities which they
felt fit better with their business strategy.  Acquisition related costs
were not material and were expensed as incurred.

The following table summarizes the consideration transferred for
the remaining 50% noncontrolling interest and the amounts of the assets acquired
and the liabilities assumed recognized at fair value on the acquisition
date:

|                                       |                                                     |               
|-------------------------------------- | --------------------------------------------------- | --------------
|Consideration
Transferred:            
|                                       | Cash                                                | $      500,000
|                                       |                                                     |               
|Assets
Acquired & Liabilities Assumed:
|                                       | Current
assets                                      | 527,258       
|                                       | Property
and equipment                              | 5,000,000     
|                                       | Other
assets                                        | 309,494       
|                                       | Other
current liabilities                           | (284,076)     
|                                       | Notes
payable                                       | (3,961,275)   
|                                       | Total
identifiable net assets                       | 1,591,401     
|                                       | Less: fair
value of previously held equity interest | (795,700)     
|                                       | Less: gain
on bargain purchase                      | (295,701)     
|                                       | Total
consideration                                 | $
     500,000



Since these entities were previously consolidated, the only
significant changes relate to the impact of adjusting the net assets acquired to
fair value at the date of acquisition, primarily related to an increase in value
in the property and equipment acquired.  As such, no pro forma financial
information is being provided as the statements of financial position, results
of operations and cash flows of CH&H and H&H have been previously
included in the Companys consolidated financial statements for all periods
presented.



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NOTE
17.  ACQUISITIONS(continued)

Alabama Assisted Living Acquisition

On June 25, 2010, the Companys consolidated variable interest
entity Riverchase Village ADK, LLC (Riverchase) acquired a 105-unit assisted
living facility in Alabama that is accounted for as a business combination for
an adjusted purchase price of approximately $4.9 million.  The acquisition
was financed through the issuance of bonds (see Note 7).  Riverchase was
acquired as part of the Companys strategy to grow its presence outside of Ohio
and within the assisted living industry.

Riverchase is owned 100% by Christopher Brogdon, a significant
shareholder, director and officer of the Company and the Company has entered
into a five year agreement to manage this facility.  Although the Company
does not have any voting interests or equity ownership of Riverchase, the
Company has guaranteed the bond obligations of Riverchase and has an agreement
to purchase Riverchase through an option agreement that expires in one year for
an exercise price of $100,000.  Riverchase has been determined to be a
variable interest entity and given the Companys significant variable interests
in Riverchase, the Company has determined that it is the primary beneficiary and
therefore the results of operations are included in the consolidated financial
statements (see Note 18 for additional information).  Since the Company has
no direct ownership in Riverchase, 100% of the facility financial results are
reported as noncontrolling interest.

In connection with the acquisition, the Company recognized a total
gain of approximately $980,000 in the consolidated statement of operations.
 The transaction resulted in a bargain purchase because the previous
business was in foreclosure and the facility was being operated under
receivership.  Acquisition related costs of approximately $170,000 were
paid from proceeds from the bond issue and are reflected net of gains on
acquisitions in the accompanying consolidated statement of operations.

The following table summarizes the consideration transferred and
the amounts of the assets acquired recognized at fair value on the acquisition
date:

|                                       |                                |                
|-------------------------------------- | ------------------------------ | ---------------
|Consideration
Transferred:            
|                                       | Proceeds
from bond issuance    | $     4,914,005
|                                       |                                |                
|Assets
Acquired & Liabilities Assumed:
|                                       | Land                           | 940,900        
|                                       | Building                       | 4,985,600      
|                                       | Equipment
and Furnishings      | 73,500         
|                                       | Other
accrued liabilities      | (106,243)      
|                                       | Total
identifiable net assets  | 5,893,757      
|                                       | Less: gain
on bargain purchase | (979,752)      
|                                       | Total
consideration            | $     4,914,005
|                                       |                                |                



Lease of Georgia Skilled Nursing Facilities

On July 30, 2010, the Company entered into various agreements to
take over as the operator of ten skilled nursing facilities located in Georgia.
 These facilities were previously being operated by another company (the
prior operator) that filed for bankruptcy relief under Chapter 11 of Title 11
of the United States Code in the United States Bankruptcy Court for the Northern
District of Georgia.  The prior operator was operating these facilities
under operating lease agreements with two different owners.  The lessors of
these facilities own the bed licenses required to operate them as skilled
nursing facilities.



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NOTE 17.  ACQUISITIONS(continued)

Lease of Georgia Skilled Nursing Facilities(continued)

For eight of the ten skilled nursing facilities (the G8
facilities), the Company entered into new long-term lease agreements with the
facility owner on July 30, 2010.  The Company began leasing and managing
the operations of five of the G8 facilities effective August 1, 2010 and the
remaining three facilities effective September 1, 2010.  The master lease
agreement is for 10 years and requires total rent payments of $397,650 per month
for the G8 facilities increasing by 2% each year.  As of September 30,
2010, the Company has paid $500,000 in security deposits and $795,300 in advance
rent to be applied at the end of the lease term.

Effective November 1, 2010, for the remaining two skilled nursing
facilities (the G2 facilities), the Company entered into an assignment and
transfer agreement with the prior operator to assign the operating leases of
these facilities and transfer the operations to the Company.  Under the
assigned lease agreement, the Company will be operating the G2 facilities under
a non-cancelable operating lease that expires on April 30, 2022 and includes two
additional ten year renewal periods.  The lease agreement requires total
monthly rent payments of $125,000 increasing by 3% on May 1 each year.  On
November 1, 2010, the Company was required to pay $375,000 for a security
deposit.

In separate transactions under operations transfer agreements with
the prior operator, the Company acquired certain assets of the prior operator
for a total purchase price of approximately $10,870,000 including acquisition
costs of approximately $214,000.  As part of this asset acquisition, the
Company acquired approximately $3,000,000 in accounts receivable, approximately
$9,020,000 in lease acquisition costs and other assets, and assumed
approximately $870,000 in accounts payable and a $280,000 loss contingency.
 The Company paid the purchase price with approximately $7,705,000 in cash,
$1,250,000 in common stock, $475,000 (net of $25,000 discount) and contingent
consideration of $1,440,000.

Alabama Nursing Home Acquisitions

On March 7, 2010, two wholly-owned subsidiaries of the Company
entered separate purchase agreements with the previous owner of Coosa Valley
Health Care Inc. and Attalla Health Care Inc., two Alabama corporations, to
acquire the assets of a 124 bed skilled nursing facility located in Gadsden,
Alabama (Coosa) and a 182 bed skilled nursing facility located in Attalla,
Alabama (Attalla).   These facilities are being acquired as part of
the Companys strategy to grow its presence outside of Ohio within the skilled
nursing industry.

Effective October 1, 2010, the acquisition date, through the
operations transfer agreement the Company obtained control of the Coosa and
Attalla facilities for a total purchase price of $18,500,000.  The Company
acquired selected assets, primarily the facility and related bed licenses, and
did not assume any liabilities.  In connection with the acquisition, the
Company recognized a total gain of approximately $1,500,000 in the consolidated
statement of operations.  The transaction resulted in a bargain purchase
because the seller was motivated to sell the facilities in order to retire from
skilled nursing facility ownership and management.  Additionally, these
facilities were the only facilities owned by the seller.  The Company has
incurred direct costs of approximately $540,000 for various acquisition related
costsand are reflected net of gains on
acquisitions in the accompanying consolidated statement of operations.



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NOTE
17.  ACQUISITIONS(continued)

Alabama Nursing Home Acquisitions(continued)

The following table summarizes the consideration transferred and
the amounts of the assets acquired recognized at fair value on the acquisition
date:

|                           |                                                 |                   
|-------------------------- | ----------------------------------------------- | ------------------
|Consideration
Transferred:
|                           | Net
proceeds from USDA Loans                    | $       15,516,985
|                           | Net
proceeds from debt with detachable warrants | 1,427,000         
|                           | Sellers
note                                    | 600,000           
|                           | Cash                                            | 956,015           
|                           | Total
consideration transferred                 | $       18,500,000
|Assets
Acquired:          
|                           | Land                                            | 840,000           
|                           | Building                                        | 12,763,100        
|                           | Equipment
and Furnishings                       | 276,900           
|                           | Intangibles
 Bed Licenses                      | 6,120,000         
|                           | Total
identifiable net assets                   | 20,000,000        
|                           | Less: gain
on bargain purchase                  | (1,500,000)       
|                           | Total
consideration                             | $
    18,500,000  



Unaudited
Pro forma Financial Information

Acquisitions have been included in the consolidated financial
statements since the dates the Company gained effective control.  For 2010,
combined revenue for all acquisitions since gaining effective control is
approximately $28,000,000 and resulted in a loss from operations of
approximately $686,000.



The following table represents pro forma results of consolidated
operations as if the 2010 acquisitions had occurred at the beginning of the
earliest fiscal year being presented, after giving effect to certain
adjustments.

|                                 |              |  |             
|-------------------------------- | ------------ |  | ------------
|                                 | December 31,
|                                 | 2010         |  | 2009        
|Pro Forma Revenue                | $117,575,000 |  | $118,975,000
|Pro Forma Operating Expenses     | $114,990,000 |  | $113,655,000
|Pro Forma Income from Operations | $2,581,000   |  | $5,322,000  



Revenue and operating expense assumptions used in the Companys
pro forma financial information primarily include those related to enhancement
and efficiencies that were identified prior to the acquisition of the facilities
and expected to occur under the Companys more capable management of the
operations of the facilities.

The forgoing pro forma information is not indicative of what the
results of operations would have been if the acquisitions had actually occurred
at the beginning of the periods presented and is not intended as a projection of
future results or trends.



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NOTE 18.  VARIABLE INTEREST ENTITIES

Community Hearth & Home and Hearth & Home of
Urbana



On March 31, 2010, the Company obtained full control of its
previously consolidated variable interest entities Community Hearth & Home
and Hearth & Home of Urbana by acquiring the remaining 50% noncontrolling
equity interests.  As such, these entities are no longer considered
variable interest entities and are consolidated as wholly-owned subsidiaries.
 See Note 17 for additional information about the acquisition.



Riverchase Village ADK, LLC



Riverchase Village ADK, LLC (Riverchase), a newly formed entity,
was established during 2010 by the Company.  After formation, 100% of the
membership interests of Riverchase were assigned to Christopher Brogdon, a
significant shareholder, director and officer of the Company.  On June 25,
2010, Riverchase acquired a business and began operations (see Note 17 for
additional information about the Alabama Assisted Living acquisition).
 Even though the Company does not have any equity interest in Riverchase,
it was determined that Riverchase is a variable interest entity as it does not
have sufficient equity at risk.  Given the related party relationship with
the common shareholder and certain other variable interests with Riverchase, the
Company determined that it is the primary beneficiary and consolidation of
Riverchase is required.  As such, the Company initially consolidated
Riverchase on June 25, 2010, the date of acquisition and initial operations.



The Companys primary variable interest is a guarantee agreement
for Riverchases revenue bonds that were used to finance the acquisition (see
Note 7 for additional information about the bond issue).  The Companys
maximum exposure is the outstanding principal of the revenue bonds and any
accrued interest.  At June 30, 2010, the maximum exposure to the Company
under the guarantee agreement is $6,365,000.  In addition to the guarantee
agreement, the Company has entered into a management agreement to operate
Riverchase.  The Company also has an option agreement that allows the
Company to exercise its right to purchase 100% of the membership interest rights
by June 25, 2011 for $100,000.



As the primary beneficiary of Riverchase, its assets, liabilities
and results of operations are included in the Companys consolidated financial
statements beginning June 25, 2010.  As the Company does not have any
equity interest, the other equity holders 100% interest is reflected in Net
Income Attributable to Noncontrolling Interests in the consolidated statement
of operations and Noncontrolling interest in subsidiaries in the consolidated
balance sheet.  The following summarizes the carrying amounts of
Riverchases assets and liabilities included in the consolidated balance sheet
at December 31, 2010:



|                                   |                             |                        
|---------------------------------- | --------------------------- | -----------------------
|Riverchase
Assets and Liabilities:
|                                   | (Amounts in
000s)          | December 31, 2010      
|                                   | Cash                        | $
                    6
|                                   | Accounts
receivable         | 4                      
|                                   | Prepaid
expenses            | 6                      
|                                   | Restricted
investments      | 482                    
|                                   | Property
and equipment, net | 6,093                  
|                                   | Other
assets                | 436                    
|                                   | Total
assets                | $
             7,027   
|                                   |                             |                        
|                                   | Accounts
Payable            | $
                 111 
|                                   | Accrued
expenses            | 205                    
|                                   | Bonds
payable               | 6,165                  
|                                   | Noncontrolling
interest     | 546                    
|                                   | Total
liabilities           | $
              7,027  



The
restricted investments of Riverchase are limited for purposes specified by the
bond issuance.







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NOTE 19.

BENEFIT PLANS



The Company sponsors a 401(k) plan, which provides retirement
benefits to eligible employees.  All employees are eligible once they reach
age 21.  The Company matches employee contributions at 50% up to 2% of the
employees salary.  Total matching contributions during 2010 and 2009 were
approximately $60,675 and $59,000, respectively.



NOTE
20.  SUBSEQUENT EVENTS

The Company has evaluated all subsequent events through the date
the financial statements were issued and filed with the United States Securities
and Exchange Commission.  The following is a summary of the material
subsequent events.

Mountain Trace Acquisition

On December 30, 2010, Mountain Trace Nursing ADK, LLC, a wholly
owned subsidiary of the Company, completed the acquisition of the operations of
and selected assets of 417 Mountain Trace LLC, a 106 bed skilled nursing
facility located in Sylva, North Carolina, for a purchase price of $6,100,000.
 Through the Operations Transfer Agreement, the Company obtained control of
the facility effective January 1, 2011.  The Company had paid $200,000 in
earnest money upon entering the purchase agreement and an additional $50,000 to
extend the closing date to December 30, 2010.  To complete the acquisition,
the Company issued a secured promissory note (the Note) for $5,000,000.
 The Note matures on June 30, 2011, accrues interest at a fixed rate of 7%
per annum and may be prepaid at any time without penalty.  The Note is
secured by the Mountain Trace facility and is guaranteed by AdCare Health
Systems, Inc. and personally guaranteed by Christopher Brogdon and his spouse
Connie Brogdon.

On February 11, 2011, the Company refinanced the short term note
that was entered for the Mountain Trace acquisition with a long term note.
 The new note is also for $5,000,000, has a term of 25 years and bears
interest at prime rate of no less than 4% plus 1.75%.

Since control of this facility was not obtained until subsequent
to December 31, 2010, no revenue or earnings are included in the consolidated
statement of operations.  The initial accounting for the business
acquisition is not complete at the time these financial statements are issued
and will be completed in the first quarter of 2011 including the amounts of the
net assets acquired as recognized at fair value on the acquisition date.

Gemino Revolving Credit Agreement



On February 25, 2011, we joined five additional AdCare
subsidiaries as additional borrowers in the Credit Agreement that was initially
entered into on October 29, 2010, with Gemino Healthcare Finance, LLC.  The
additional borrowers increased the amount of credit available to us and the
maximum amount of the credit facility increased from $5,000,000 to $7,500,000.
 See Note 7 Notes Payable and Other Debt for additional
information.



Nursing Facilities Acquisitions

On November 29, 2010, Erin Nursing, LLC, a wholly owned subsidiary
of the Company entered a purchase agreement dated November 23, 2010 to acquire
the assets of three skilled nursing facilities:  consisting of a 100 bed
skilled nursing facility located in College Park, Georgia, a 126 bed skilled
nursing facility located in Dublin, Georgia, and a 109 bed skilled nursing
center located in Marietta, Georgia (the Facilities).  The purchase price
is $18,000,000.  The Company was required to pay a $500,000 earnest money
deposit upon signing the purchase agreement.   The Company expects to
close and obtain control sometime between April 1, 2011 and July 1, 2011.





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NOTE 20.  SUBSEQUENT EVENTS(continued)

Nursing Facilities Acquisitions(continued)



On March 14, 2011, the Company entered a purchase agreement for
the asset purchase of four skilled nursing facilities in Arkansas, the
acquisition of a 10-year lease for one skilled nursing facility in Missouri and
certain corporate office space all owned by a private seller.  The five
facilities have 506 beds in total (416 in Arkansas and 90 in Missouri).
 The purchase price is $20,000,000.  The Company paid a $250,000
earnest money deposit upon signing the purchase agreement.  The earnest
money deposit is refundable subject to certain terms and conditions.  The
Company expects to close and obtain control sometime between June 1, 2011 and
August 1, 2011.



Convertible Debt Issuance

On March 31, 2011, the Company entered into a Securities Purchase
Agreement (the Purchase Agreement) with certain accredited investors (the
Purchasers) to sell and issue to the Purchasers in reliance on Section 4(2) of
the Securities Act of 1933, as amended, an aggregate of $5,500,000 in principal
amount of the Companys Subordinated Convertible Notes (the Notes), bearing
10.0% interest per annum payable quarterly in cash.  The Notes mature in
thirty six months.







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Item 9.  Changes In and Disagreements With Accountants
on Accounting and Financial Disclosure

None.

Item
9A.  Controls and Procedures

Evaluation
of Disclosure Controls and Procedures

We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our reports filed pursuant to the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the rules and forms of the Securities and
Exchange Commission (SEC) and that such information is accumulated and
communicated to our management, including our chief executive officer and chief
financial officer, as appropriate, to allow for timely decisions regarding
required disclosure. In designing and evaluating the disclosure controls and
procedures, management recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management is required to apply
its judgment in evaluating the cost-benefit relationship of possible controls
and procedures.



As
required by Rule 13a-15(b) of the Securities Exchange Act of 1934, we
carried out an evaluation, under the supervision and with the participation of
our management, including our chief executive officer and chief financial
officer, of the effectiveness of the design and operation of our disclosure
controls and procedures as of the end of the period covered by this report.
Based on the foregoing, our chief executive officer and chief financial officer
concluded that our disclosure controls and procedures were effective at the
reasonable assurance level.



Managements
Report on Internal Control Over Financial Reporting



Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act. Our internal control over financial reporting is
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. Our internal control
over financial reporting includes those policies and procedures that:



(1) pertain to the maintenance of records that in reasonable
detail accurately and fairly reflect the transactions and dispositions of our
assets;



(2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with U.S.
GAAP, and that our receipts and expenditures are being made only in accordance
with the authorization of our management and directors; and



(3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of our assets that
could have a material effect on the financial statements.



Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements. Also, projections
of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
 A control system, no matter how well designed and operated, can provide
only reasonable, but not absolute, assurance that the control systems
objectives will be met.  The design of a control system must reflect the
fact that there are resource constraints, and the benefit of controls must be
considered relative to their costs.



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Management assessed the effectiveness of our internal control over
financial reporting as of December 31, 2010. In making this assessment,
management used the framework set forth in the report entitled Internal
ControlIntegrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission, or COSO. The COSO framework summarizes
each of the components of a companys internal control system, including
(i) the control environment, (ii) risk assessment, (iii) control
activities, (iv) information and communication, and (v) monitoring.
Based on our assessment, management concluded that the Company maintained
effective internal control over financial reporting as of December 31, 2010.



This annual report does not include an attestation report of our
registered public accounting firm regarding internal control over financial
reporting. Management's report was not subject to attestation by our registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permits us to provide only management's report in this
annual report.



Item 9B.  Other Information

None

PART III

Item 10.  Directors, Executive Officers and Corporate
Governance

The information required by this item is included under the
captions Election of Directors, Executive Officersand Section
16(a) Beneficial Ownership Reporting Compliance in our proxy statement
relating to our 2011 Annual Meeting of Shareholders to be held June 3, 2011, and
is incorporated herein by reference.

We have a Business Conduct Policy applicable to all employees of
AdCare.  Additionally, the Chief Executive Officer (CEO) and all senior
financial officers, including the principal financial officer, the principal
accounting officer or controller, or any person performing a similar function
(collectively, the Senior Financial Officers) are bound by the provisions of
our code of ethics relating to ethical conduct, conflicts of interest, and
compliance with the law.

We intend to satisfy the disclosure requirement under Item 10 of
Form 8-K regarding any amendment to, waiver of, any provision of this code of
ethics by posting such information on our website at the address and location
specified.

Item 11.  Executive Compensation

We incorporate by reference information on executive compensation
under the heading Executive Compensation in our Proxy Statement, which we will
file with the SEC on or prior to April 20, 2011.

Item 12.  Security Ownership of Certain Beneficial
Owners and Management and Related Stockholder Matters

We incorporate by reference information on security ownership of
some beneficial owners under the heading Security Ownership of Certain
Management and Beneficial Owners in our Proxy Statement, which we will file
with the SEC on or prior to April 20, 2011.

Item 13.  Certain Relationships and Related
Transactions, and Director Independence

We incorporate by reference information on certain relationships
and related transactions under the heading Certain Relationships and Related
Transactions in our Proxy Statement, which we will file with the SEC on or
prior to April 20, 2011.



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Item 14.  Principal Accountant Fees and
Services

We incorporate by reference information on principal accountant
fees and services under the heading Fees of the Registered Independent Public
Accounting Firm for the Year Ended December 31, 2010 in our Proxy Statement,
which we will file with the SEC on or prior to April 20, 2011.

PART IV

Item 15.  Exhibits and Financial Statement
Schedules

Reports
on Form 8-K.



The
Company filed the following Reports on Form 8-K during 2010:



|                  |                                                                                                
|----------------- | -----------------------------------------------------------------------------------------------
|Date              | Description                                                                                    
|January 4,
2010   | Election of
directors and related press release.                                               
|March 11,
2010    | Entry into
a Material definitive agreements and press release announcing potential
acquisitions
|April 14,
2010    | Entry into
a Material definitive agreement and press release announcing potential
acquisition  
|May 18,
2010      | Financial
Statements and Exhibits                                                              
|June 10,
2010     | Submission
of Matters to a Vote of Security Holders.                                           
|June 28,
2010     | Entry into
a Material Definitive Agreement.                                                    
|July 6,
2010      | Entry into
a Material Definitive Agreement                                                     
|August 5,
2010    | Announcing
the Completion of the Acquisition of Assets                                         
|August 16,
2010   | Amendment
to 8-K filed on August 5, 2010                                                       
|August 25,
2010   | Financial
Statements and Exhibits                                                              
|September
7, 2010 | Press
release dated September 2, 2010                                                          
|October 6,
2010   | Completion
of Acquisitions and Material Definitive Agreements                                  
|November 1,
2010  | Material
Definitive Agreement and Direct Financing Obligation                                  
|November 4,
2010  | Material
Definitive Agreement and Direct Financing Obligation                                  
|November
10, 2010 | Material
Definitive Agreement and Press Release dated November 8, 2010.                        
|November
22, 2010 | Financial
Statements and Exhibits                                                              
|December 3,
2010  | Entry into
a Material definitive agreements and press release announcing potential
acquisitions
|December
15, 2010 | Financial
Statements of businesses acquired                                                    



The
Company filed the following Reports on Form 8-K subsequent to December 31,
2010:



|                 |                                                                              
|---------------- | -----------------------------------------------------------------------------
|Date             | Description                                                                  
|January 6,
2011  | Financial
Statements of businesses acquired                                  
|January 6,
2011  | Completion
of the Acquisition of Assets                                      
|January 14,
2011 | Departure
of Directors or Certain Officers, Other Events                     
|March 29,
2011   | Material
Definitive Agreement and Press Releases dated March 15 and 24,
2011.
|                 |                                                                              





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Exhibits.
 Exhibits included or incorporated by reference herein:  See Exhibit
Index below.



|        |                                                                                                           |              |                                                                                                                                                 
|------- | --------------------------------------------------------------------------------------------------------- | ------------ | ------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit | Description
of Exhibit                                                                                    | Location     |                                                                                                                                                 
|3.1     | Amended and
Restated Articles of Incorporation of Registrant                                              | Exhibit
3.1  | incorporated
by reference from Exhibit 3.1 of the Companys Registration Statement Form
SB (Registration No. 333-131542) filed
February 3, 2006 
|3.2     | Code of
Regulations of the Registrant                                                                     | Exhibit
3.2  | incorporated
by reference from Exhibit 3.2 of the Companys Registration Statement Form
SB (Registration No. 333-131542) filed
February 3, 2006 
|4.1     | Specimen
Common Share Certificate                                                                         | Exhibit
4.1  | incorporated
by reference from Exhibit 4.1 of the Companys Registration Statement Form
SB (Registration No. 333-131542) filed
February 3, 2006 
|4.2     | Specimen
Unit Certificate                                                                                 | Exhibit
4.2  | incorporated
by reference from Exhibit 4.2 of the Companys Registration Statement Form
SB (Registration No. 333-131542) filed
February 3, 2006 
|4.3     | Specimen
Warrant Certificate                                                                              | Exhibit
4.3  | incorporated
by reference from Exhibit 4.3 of the Companys Registration Statement Form
SB (Registration No. 333-131542) filed
February 3, 2006 
|4.4     | Form of
Warrant Agreement, dated ________, 2006                                                           | Exhibit
4.4  | incorporated
by reference from Exhibit 4.4 of the Companys Registration Statement Form
SB (Registration No. 333-131542) filed
February 3, 2006 
|4.5     | 2004
Non-Qualified and Incentive Stock Option Plan of Registrant                                          | Exhibit
4.5  | incorporated
by reference from Exhibit 4.5 of the Companys Registration Statement Form
SB (Registration No. 333-131542) filed
February 3, 2006 
|4.6     | Form of
Representatives Warrant                                                                          | Exhibit
4.6  | incorporated
by reference from Exhibit 4.6 of the Companys Registration Statement Form
SB (Registration No. 333-131542) filed
February 3, 2006 
|10.1    | Employment
Agreement between AdCare Health Systems, Inc. and David A. Tenwick, dated
September 1, 2008    | Exhibit
10.1 | incorporated
by reference from Exhibit 99 of the Companys Form 8-K filed September
8, 2008                                                     
|10.2    | Employment
Agreement between AdCare Health Systems, Inc. and Gary L. Wade, dated
September 1, 2008        | Exhibit
10.2 | incorporated
by reference from Exhibit 99 of the Companys Form 8-K filed September
8, 2008                                                     
|10.3    | Employment
Agreement between AdCare Health Systems, Inc. and J. Scott Cunningham,
dated September 1, 2008 | Exhibit
10.3 | incorporated
by reference from Exhibit 99 of the Companys Form 8-K filed September
8, 2008                                                     
|10.4    | Form of
Secured Promissory Debenture dated _________, 2005                                                | Exhibit
10.4 | incorporated
by reference from Exhibit 10.4 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006



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|        |                                                                                                                                                                  |               |                                                                                                                                                  
|------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------- | -------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit | Description
of Exhibit                                                                                                                                           | Location      |                                                                                                                                                  
|10.5    | Form of
Warrant to Purchase Common Stock dated _________, 2005                                                                                                   | Exhibit
10.5  | incorporated
by reference from Exhibit 10.5 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006 
|10.6    | Form of
Subordinated Note dated October 31, 2004                                                                                                                 | Exhibit
10.6  | incorporated
by reference from Exhibit 10.6 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006 
|10.7    | Form of
Warrant to Purchase Shares of AdCare Health Systems, Inc. dated
October 31, 2004                                                                         | Exhibit
10.7  | incorporated
by reference from Exhibit 10.7 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006 
|10.8    | Promissory
Note between Assured Health Care, Inc., AdCare Health Systems, Inc. and
WesBanco Bank, Inc., in the original amount of $1,650,000                     | Exhibit
10.8  | incorporated
by reference from Exhibit 10.8 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006 
|10.9    | Promissory
Note between AdCare Health Systems, Inc. and WesBanco Bank, Inc., in the
original amount of $300,000                                                  | Exhibit
10.9  | incorporated
by reference from Exhibit 10.9 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006 
|10.10   | Promissory
Note between AdCare Health Systems, Inc. and Cornerstone Bank in the
original amount of $96,000                                                       | Exhibit
10.10 | incorporated
by reference from Exhibit 10.10 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006
|10.11   | Promissory
Note between AdCare Health Systems, Inc. and Cornerstone Bank in the
original amount of $2,041,000                                                    | Exhibit
10.11 | incorporated
by reference from Exhibit 10.11 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006
|10.12   | Promissory
Note between AdCare Health Systems, Inc. and Cornerstone Bank in the
original amount of $190,000                                                      | Exhibit
10.12 | incorporated
by reference from Exhibit 10.12 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006
|10.13   | Promissory
Note between Hearth & Care of Greenfield, LLC and Cornerstone Bank in
the original amount of $1,412,000                                               | Exhibit
10.13 | incorporated
by reference from Exhibit 10.13 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006
|10.14   | Reimbursement
Agreement between Communitys Hearth & Home, Ltd. and Cornerstone Bank
dated December 1, 2002                                                      | Exhibit
10.14 | incorporated
by reference from Exhibit 10.14 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006
|10.15   | Regulatory
Agreement and Mortgage Note between Hearth and Home of Vandalia, Inc. and
Banc One Capital Funding Corporation, in the original amount of $
3,721,500 | Exhibit
10.15 | incorporated
by reference from Exhibit 10.15 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006
|10.16   | Regulatory
Agreement and Mortgage Note between The Pavilion Care Center, LLC and
 Red Mortgage Capital, Inc, in the original amount of
$2,295,000                | Exhibit
10.16 | incorporated
by reference from Exhibit 10.16 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006



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|        |                                                                                                                                                                           |               |                                                                                                                                                  
|------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------- | -------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit | Description
of Exhibit                                                                                                                                                    | Location      |                                                                                                                                                  
|10.17   | Promissory
Note between Covington Realty, LLC and AdCare Health Systems, Inc., in the
original amount of $100,000                                                         | Exhibit
10.17 | incorporated
by reference from Exhibit 10.17 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006
|10.18   | Promissory
Note between AdCare Health Care Systems, Inc, and Assured Health Care,
Inc. and Mary Fair, in the original amount of $450,000                                  | Exhibit
10.18 | incorporated
by reference from Exhibit 10.18 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006
|10.19   | Promissory
Note between AdCare Health Care Systems, Inc, and Homer McKnight, in the
original amount of $835,000                                                           | Exhibit
10.19 | incorporated
by reference from Exhibit 10.19 of the Companys annual report on form
10-KSB as amended April 30, 2007.                            
|10.20   | Investment
Banking Agreement entered into with Capital City Partners dated December
29, 2006                                                                              | Exhibit
10.20 | incorporated
by reference from Exhibit 10.19 of the Companys annual report on form
10-KSB as amended April 30, 2007.                            
|10.21   | Consulting
Agreement entered into with The McKnight Group dated March 5, 2007                                                                                             | Exhibit
10.21 | incorporated
by reference from Exhibit 10.19 of the Companys annual report on form
10-KSB as amended April 30, 2007.                            
|10.22   | Reimbursement
Agreement between Communitys Hearth & Home, Ltd. and The Huntington
National Bank dated September 13, 2007                                                 | Exhibit
10-22 | incorporated
by reference from Exhibit 10.19 of the Companys annual report on form
10-KSB as amended March 31, 2008.                            
|10.23   | Form
of Warrant granted to management to Purchase Shares of AdCare Health
Systems, Inc. dated November 20, 2007                                                           | Exhibit
10-23 | incorporated
by reference from Exhibit 10.19 of the Companys annual report on form
10-KSB as amended March 31, 2008.                            
|10.24   | Regulatory
Agreement and Mortgage Note between The Pavilion Care Center, LLC and
 Red Mortgage Capital, Inc, in the original amount of $2,108,800
dated November 27, 2007 | Exhibit
10.24 | incorporated
by reference from Exhibit 10.19 of the Companys annual report on form
10-KSB as amended March 31, 2008.                            
|10.25   | Letter
Agreement with Prospect Financial Advisors and GCC Capital dated January
30, 2008                                                                                  | Exhibit
10.25 | incorporated
by reference from Exhibit 10.19 of the Companys annual report on form
10-KSB as amended March 31, 2008.                            
|10.26   | Regulatory
Agreement and Mortgage Note between Hearth & Home of Urbana and
 Red Mortgage Capital, Inc, in the original amount of $2,142,700
dated June 26, 2008           | Exhibit
10.26 | incorporated
by reference from Exhibit 10.26 of the Companys annual report on form
10-K filed March 31, 2009.                                   
|10.27   | Regulatory
Agreement and Mortgage Note between Communitys Hearth & Home and
 Red Mortgage Capital, Inc, in the original amount of $1,863,800
dated June 26, 2008         | Exhibit
10.27 | incorporated
by reference from Exhibit 10.27 of the Companys annual report on form
10-K filed March 31, 2009.                                   
|10.28   | Promissory
Note between Assured Health Care and Huntington National Bank in the
original amount of $760,000 dated July 24, 2008                                           | Exhibit
10.28 | incorporated
by reference from Exhibit 10.28 of the Companys annual report on form
10-K filed March 31, 2009.                                   



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|        |                                                                                                                                                                                                                                                               |               |                                                                                                                                                 
|------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------- | ------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit | Description
of Exhibit                                                                                                                                                                                                                                        | Location      |                                                                                                                                                 
|10.29   | Promissory
Note between AdCare Health Systems, Inc. and Huntington National Bank in
the original amount of $300,000 dated October 17, 2008                                                                                                                    | Exhibit
10.29 | incorporated
by reference from Exhibit 10.29 of the Companys annual report on form
10-K filed March 31, 2009.                                  
|10.30   | Promissory
Note between AdCare Health Systems, Inc. and Huntington National Bank in
the original amount of $100,000 dated November 14, 2008                                                                                                                   | Exhibit
10.30 | incorporated
by reference from Exhibit 10.30 of the Companys annual report on form
10-K filed March 31, 2009.                                  
|10.31   | Regulatory
Agreement and Mortgage Note between Hearth & Care of Greenfield and
 Red Mortgage Capital, Inc, in the original amount of $2,524,800
dated July 29, 2008                                                                                           | Exhibit
10.31 | incorporated
by reference from Exhibit 10.31 of the Companys annual report on form
10-K filed March 31, 2009.                                  
|10.32   | Promissory
Note between AdCare Health Systems and the AdCare Deferred Compensation
plan for a $150,000 line of credit dated January 2008.                                                                                                                     | Exhibit
10.32 | incorporated
by reference from Exhibit 10.32 of the Companys annual report on form
10-K filed March 31, 2009.                                  
|10.33   | Regulatory
Agreement and Mortgage Note between Hearth & Home of Van Wert and
 Red Mortgage Capital, Inc, in the original amount of $2,181,200
dated November 1, 2009                                                                                          | Exhibit
10.33 | incorporated
by reference from Exhibit 10.33 of the Companys annual report on form
10-K filed March 31, 2010.                                  
|10.34   | Loan
Agreement and Secured Promissory Note between Coosa Nursing ADK, LLC, and
Metro City Bank in the original amount of $7,500,000 dated September 30,
2010                                                                                                  | Exhibit
10.34 | incorporated
by reference from Exhibits 10.1 and 10.2 of the Companys Form 8-K filed
October 6, 2010.                                          
|10.35   | Promissory
Note between Coosa Nursing ADK, LLC, and Coosa Valley Health Care Inc. in
the original amount of $600,000 dated September 30, 2010                                                                                                                 | Exhibit
10.35 | incorporated
by reference from Exhibits 10.1 and 10.2 of the Companys Form 8-K filed
October 6, 2010.                                          
|10.36   | Loan
Agreement and Secured Promissory Note between Attalla Nursing ADK, LLC,
and Metro City Bank in the original amount of $8,320,000 dated September
30, 2010                                                                                                | Exhibit
10.36 | incorporated
by reference from Exhibits 10.1 and 10.6 of the Companys Form 8-K filed
October 6, 2010.                                          
|10.37   | Form
of Subordinated Convertible Note dated October 26, 2010                                                                                                                                                                                                  | Exhibit
10.37 | incorporated
by reference from Exhibit 10.3 of the Companys Form 8-K filed November 1,
2010.                                                   
|10.38   | Credit
Agreement between ADK Georgia, LLC, ADK Powder Springs Operator, LLC, ADK
Lumber City Operator, LLC, ADK Jeffersonville Operator, LLC, ADK LaGrange
Operator, LLC, ADK Thomasville Operator, LLC with Gemino Healthcare
Finance dated October 29, 2010 | Exhibit
10.38 | incorporated
by reference from Exhibit 10.3 of the Companys Form 8-K filed November 4,
2010.                                                   
|14      | Code
of Ethics                                                                                                                                                                                                                                                | Exhibit
14    | incorporated
by reference from Exhibit 10.19 of the Companys annual report on form
10-KSB as amended April 30, 2007                            
|21.1    | Subsidiaries
of the Registrant                                                                                                                                                                                                                                | Exhibit
21.1  | incorporated
by reference from Exhibit 21.1 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006
|23.1    | Consent
of Battelle & Battelle LLP                                                                                                                                                                                                                            | Exhibit
23.1  | attached
hereto                                                                                                                                 
|31.1    | Certification
of CEO pursuant to Section 302 of the Sarbanes-Oxley Act                                                                                                                                                                                        | Exhibit
31.1  | attached
hereto                                                                                                                                 



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|        |                                                                        |              |                                                                                                                                                 
|------- | ---------------------------------------------------------------------- | ------------ | ------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit | Description
of Exhibit                                                 | Location     |                                                                                                                                                 
|31.2    | Certification
of CFO pursuant to Section 302 of the Sarbanes-Oxley Act | Exhibit
31.2 | attached
hereto                                                                                                                                 
|32.1    | Certification
of CEO pursuant to Section 906 of the Sarbanes-Oxley Act | Exhibit
32.1 | attached
hereto                                                                                                                                 
|32.2    | Certification
of CFO pursuant to Section 906 of the Sarbanes-Oxley Act | Exhibit
32.2 | attached
hereto                                                                                                                                 
|99.1    | Audit
Committee Charter                                                | Exhibit
99.1 | incorporated
by reference from Exhibit 99.1 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006
|99.2    | Compensation
Committee Charter                                         | Exhibit
99.2 | incorporated
by reference from Exhibit 99.2 of the Companys Registration Statement
Form SB (Registration No. 333-131542) filed
February 3, 2006
|        |                                                                        |              |                                                                                                                                                 



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Signatures

In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

AdCare
Health Systems, Inc. (Registrant)



by

/s/
Gary L. Wade

Boyd
P. Gentry, President and Co-Chief Executive Officer

March
31, 2011



by

/s/
Boyd P. Gentry

Boyd
P. Gentry, Co-Chief Executive Officer

March
31, 2011



March
31, 2011

In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.

|                           |  |                                                        |  |               
|-------------------------- |  | ------------------------------------------------------ |  | --------------
|SIGNATURE                  |  | TITLE                                                  |  | DATE          
|                           |  |                                                        |  |               
|/s/ David
A. Tenwick       |  | Director,
Chairman                                     |  | March 31,
2011
|David
A. Tenwick           |  |                                                        |  |               
|                           |  |                                                        |  |               
|/s/ Gary L.
Wade           |  | Director,
President and Co-Chief Executive Officer     |  | March 31,
2011
|Gary
L. Wade               |  |                                                        |  |               
|                           |  |                                                        |  |               
|/s/
Christopher F. Brogdon |  | Director,
Vice Chairman and Chief Acquisitions Officer |  | March 31,
2011
|Christopher
F. Brogdon     |  |                                                        |  |               
|                           |  |                                                        |  |               
|/s/ Scott
Cunningham       |  | Chief Financial Officer                                |  | March 31,
2011
|Scott
Cunningham           |  |                                                        |  |               
|                           |  |                                                        |  |               
|/s/ Jeffrey
L. Levine      |  | Director                                               |  | March 31,
2011
|Jeffrey
L. Levine          |  |                                                        |  |               
|                           |  |                                                        |  |               
|/s/ Philip
S. Radcliffe    |  | Director                                               |  | March 31,
2011
|Philip
S. Radcliffe        |  |                                                        |  |               
|                           |  |                                                        |  |               
|/s/
Laurence E. Sturtz     |  | Director                                               |  | March 31,
2011
|Laurence
E. Sturtz         |  |                                                        |  |               
|                           |  |                                                        |  |               
|/s/ Peter
J. Hackett       |  | Director                                               |  | March 31,
2011
|Peter
J. Hackett           |  |                                                        |  |               
|                           |  |                                                        |  |               
|/s/ Boyd P.
Gentry         |  | Director,
Co-Chief Executive Officer                   |  | March 31,
2011
|Boyd P.
Gentry             |  |                                                        |  |               
|                           |  |                                                        |  |               
|/s/ Joshua
J. McClellan    |  | Director                                               |  | March 31,
2011
|Joshua J.
McClellan        |  |                                                        |  |               



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EXHIBIT
23.1





















CONSENT OF INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM







We hereby consent to the incorporation by reference in the
Registration Statements (File No.s 333-131542, 333-166488 and 333-171184) of
AdCare Health Systems, Inc. of our report dated March 31, 2011, relating to the
consolidated financial statements which appears in this Form 10-K.





/s/
BATTELLE & BATTELLE LLP





Dayton, Ohio

March 31, 2011











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Exhibit 31.1

CERTIFICATIONS

I,
Gary L. Wade, certify that:



1.

I
have reviewed this annual report on Form 10-K of AdCare Health Systems,
Inc.;

2.

Based
on my knowledge, this report does not contain any untrue statement of a material
fact or omit to state a material fact necessary to make the statements made, in
light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;

3.

Based
on my knowledge, the financial statements, and other financial information
included in this report, fairly present in all material respects the financial
condition, results of operations and cash flows of the small business issuer as
of, and for, the periods presented in this report;

4.

The
small business issuers other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15 d-15(f))
for the small business issuer and have:

a.

Designed
such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material
information relating to the small business issuer, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;

b.

Designed
such internal control over financial reporting, or caused such internal control
over financial reporting to be designed under our supervision, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;

c.

Evaluated
the effectiveness of the small business issuers disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and

d.

Disclosed
in this report any change in the small business issuers internal control over
financial reporting that occurred during the small business issuers most recent
fiscal quarter (the small business issuers fourth fiscal quarter in the case of
an annual report) that has materially affected, or is reasonably likely to
materially affect, the small business issuers internal control over financial
reporting.

5.

The
small business issuers other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
small business issuers auditors and the audit committee of the small business
issuers board of directors (or persons performing the equivalent
functions):

a.

All
significant deficiencies and material weaknesses in the design or operation of
internal control over financial reporting which are reasonably likely to
adversely affect the small business issuers ability to record, process,
summarize and report financial information; and

b.

Any
fraud, whether or not material, that involves management or other employees who
have a significant role in the small business issuers internal control over
financial reporting.



|                      |    |                                         
|--------------------- | -- | ----------------------------------------
|Date:
 March 31, 2011 | By | /s/Gary L.
Wade                         
|                      |    | President
and Co-Chief Executive Officer





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CERTIFICATIONS

I,
Boyd P. Gentry, certify that:



1

I
have reviewed this annual report on Form 10-K of AdCare Health Systems,
Inc.;

2

Based
on my knowledge, this report does not contain any untrue statement of a material
fact or omit to state a material fact necessary to make the statements made, in
light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;

3

Based
on my knowledge, the financial statements, and other financial information
included in this report, fairly present in all material respects the financial
condition, results of operations and cash flows of the small business issuer as
of, and for, the periods presented in this report;

4

The
small business issuers other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15 d-15(f))
for the small business issuer and have:

a.

Designed
such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material
information relating to the small business issuer, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;

b.

Designed
such internal control over financial reporting, or caused such internal control
over financial reporting to be designed under our supervision, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;

c.

Evaluated
the effectiveness of the small business issuers disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and

d.

Disclosed
in this report any change in the small business issuers internal control over
financial reporting that occurred during the small business issuers most recent
fiscal quarter (the small business issuers fourth fiscal quarter in the case of
an annual report) that has materially affected, or is reasonably likely to
materially affect, the small business issuers internal control over financial
reporting.

5

The
small business issuers other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
small business issuers auditors and the audit committee of the small business
issuers board of directors (or persons performing the equivalent
functions):

a.

All
significant deficiencies and material weaknesses in the design or operation of
internal control over financial reporting which are reasonably likely to
adversely affect the small business issuers ability to record, process,
summarize and report financial information; and

b.

Any
fraud, whether or not material, that involves management or other employees who
have a significant role in the small business issuers internal control over
financial reporting.



|                      |    |                            
|--------------------- | -- | ---------------------------
|Date:
 March 31, 2011 | By | /s/Boyd P.
Gentry          
|                      |    | Co- Chief
Executive Officer





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Exhibit 31.2

CERTIFICATIONS

I,
Scott Cunningham, certify that:



1.

I
have reviewed this annual report on Form 10-K of AdCare Health Systems,
Inc.;

2.

Based
on my knowledge, this report does not contain any untrue statement of a material
fact or omit to state a material fact necessary to make the statements made, in
light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;

3.

Based
on my knowledge, the financial statements, and other financial information
included in this report, fairly present in all material respects the financial
condition, results of operations and cash flows of the small business issuer as
of, and for, the periods presented in this report;

4.

The
small business issuers other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15 d-15(f))
for the small business issuer and have:

a.

Designed
such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material
information relating to the small business issuer, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;

b.

Designed
such internal control over financial reporting, or caused such internal control
over financial reporting to be designed under our supervision, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;

c.

Evaluated
the effectiveness of the small business issuers disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and

d.

Disclosed
in this report any change in the small business issuers internal control over
financial reporting that occurred during the small business issuers most recent
fiscal quarter (the small business issuers fourth fiscal quarter in the case of
an annual report) that has materially affected, or is reasonably likely to
materially affect, the small business issuers internal control over financial
reporting.

5.

The
small business issuers other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
small business issuers auditors and the audit committee of the small business
issuers board of directors (or persons performing the equivalent
functions):

a.

All
significant deficiencies and material weaknesses in the design or operation of
internal control over financial reporting which are reasonably likely to
adversely affect the small business issuers ability to record, process,
summarize and report financial information; and

b.

Any
fraud, whether or not material, that involves management or other employees who
have a significant role in the small business issuers internal control over
financial reporting.







|                      |    |                        
|--------------------- | -- | -----------------------
|Date:
 March 31, 2011 | By | /s/Scott
Cunningham    
|                      |    | Chief
Financial Officer





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Exhibit 32.1

CERTIFICATION PURSUANT TO

18
U.S.C. SECTION 1350,

AS
ADDED BY

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In
connection with the Annual Report of AdCare Health Systems, Inc. (the Company)
on Form 10-K for the year ended December 31, 2010 as filed with the Securities
and Exchange Commission (the Report), I, Gary L. Wade, President and Co-Chief
Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as
added by § 906 of the Sarbanes-Oxley Act of 2002, that:



|   |                                                                                                                                                                                                                     
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | The Report
fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934; and                                                                                               
|2. | To my
knowledge, the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
the Company as of and for the period covered by the Report.



|                      |  |     |  |                                                       
|--------------------- |  | --- |  | ------------------------------------------------------
|                      |  |     |  |                                                       
|Date:
 March 31, 2011 |  | By: |  | /s/
Gary L. Wade                                      
|                      |  |     |  | Gary L.
Wade, President and Co-Chief Executive Officer





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CERTIFICATION PURSUANT TO

18
U.S.C. SECTION 1350,

AS
ADDED BY

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In
connection with the Annual Report of AdCare Health Systems, Inc. (the Company)
on Form 10-K for the year ended December 31, 2010 as filed with the Securities
and Exchange Commission (the Report), I, Boyd P. Gentry, Co-Chief Executive
Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as added by § 906
of the Sarbanes-Oxley Act of 2002, that:



|   |                                                                                                                                                                                                                     
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | The Report
fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934; and                                                                                               
|2. | To my
knowledge, the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
the Company as of and for the period covered by the Report.



|                      |  |     |  |                                            
|--------------------- |  | --- |  | -------------------------------------------
|                      |  |     |  |                                            
|Date:
 March 31, 2011 |  | By: |  | /s/
Boyd P. Gentry                         
|                      |  |     |  | Boyd P.
Gentry, Co- Chief Executive Officer



- 76
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Exhibit 32.2

CERTIFICATION PURSUANT TO

18
U.S.C. SECTION 1350,

AS
ADDED BY

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In
connection with the Annual Report of AdCare Health Systems, Inc. (the Company)
on Form 10-K for the period ended December 31, 2010 as filed with the Securities
and Exchange Commission (the Report), I, Scott Cunningham, Chief Financial
Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as added by § 906
of the Sarbanes-Oxley Act of 2002, that:



|   |                                                                                                                                                                                                                     
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | The Report
fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934; and                                                                                               
|2. | To my
knowledge, the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
the Company as of and for the period covered by the Report.



|                     |  |     |  |                                          
|-------------------- |  | --- |  | -----------------------------------------
|                     |  |     |  |                                          
|Date: March
31, 2011 |  | By: |  | /s/
Scott Cunningham                     
|                     |  |     |  | Scott
Cunningham, Chief Financial Officer





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