UNITED STATES SECURITIES AND EXCHANGE COMMISSION



Washington, D.C. 20549



FORM
10-Q



|           |                                                                                         
|---------- | ----------------------------------------------------------------------------------------
|(Mark
One)
|þ          | QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 
|           | For the
quarterly period ended September 30, 2010                                       
| ̈          | TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|           | For the
transition period from __________ to __________                                 



Commission file number 333-131542



AdCare Health Systems, Inc.

(Exact name of registrant as specified in its charter)



|                                                    |                                                
|--------------------------------------------------- | -----------------------------------------------
|Ohio
(State or Other Jurisdiction
of Incorporation) | 31-1332119
(IRS Employer Identification
Number)









5057
Troy Rd, Springfield, OH 45502-9032

(Address of principal executive offices)



(937) 964-8974

(Registrants telephone number)



NA

(Former name, former address, or former fiscal year, if changed
since last report)





Indicate by check
mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the 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 (section 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 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 or 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



Indicate the
number of shares outstanding of each of the issuers classes of common stock, as
of the latest practicable date.

As
of November 2, 2010:  7,959,415 shares of common stock with no par value
are outstanding



---

AdCare Health Systems, Inc.

Form 10-Q

Table of Contents



|           |                                                                        |                                                                                                             |            
|---------- | ---------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------- | -----------
|           |                                                                        |                                                                                                             | Page Number
|Part I.    | Financial Information                                                  |                                                                                                            
|           | Item 1.                                                                | Financial Statements (Unaudited)                                                                            | 3          
|           |                                                                        | Consolidated Balance Sheets September 30, 2010
(unaudited) and December 31, 2009                           | 3          
|           |                                                                        | Consolidated Statements of Operations  Three
and nine months ended September 30, 2010 and 2009 (unaudited) | 4          
|           |                                                                        | Consolidated Statements of Cash Flows
Nine months ended September 30, 2010 and 2009 (unaudited)            | 5          
|           |                                                                        | Notes to Consolidated Financial
Statements (unaudited)                                                      | 6          
|           | Item 2.                                                                | Managements Discussion and Analysis of
Financial Condition and Results of
Operations                       | 20         
|           | Item 4T.                                                               | Controls and Procedures                                                                                     | 33         
|Part II.   | Other Information                                                      | 33                                                                                                         
|           | Item 1.                                                                | Legal Proceedings                                                                                           | 33         
|           | Item 6.                                                                | Exhibits                                                                                                    | 33         
|Signatures |                                                                       
|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 |                                                                                                            









---





Part I.  Financial Information

Item 1.
 Financial Statements



|                                                     |                                                             |                                                                                     |                                      |               |             |             
|---------------------------------------------------- | ----------------------------------------------------------- | ----------------------------------------------------------------------------------- | ------------------------------------ | ------------- | ----------- | ------------
|ADCARE HEALTH SYSTEMS, INC. AND
SUBSIDIARIES        
|CONSOLIDATED BALANCE SHEET                          
|                                                     |                                                             |                                                                                     |                                      |              
|                                                     |                                                             |                                                                                     |                                      | September 30, |             | December 31,
|                                                     |                                                             |                                                                                     |                                      | 2010          |             | 2009        
|                                                     |                                                             |                                                                                     | ASSETS                               | (Unaudited)   |             |             
|Current Assets:                                      |                                                             |                                                                                     |                                     
|Cash                                                 |                                                             | $5,454,714                                                                          |                                      | $4,481,100   
|Accounts receivable:                                 |                                                             |                                                                                     |                                     
|                                                     | Long-term care resident receivables, net                    | 5,886,193                                                                           |                                      | 1,838,560    
|                                                     | Management, consulting and development receivables,
net     | 396,564                                                                             |                                      | 124,761      
|                                                     | Advances and receivables from affiliates                    | 20,855                                                                              |                                      | 16,407       
|                                                     | Other receivables                                           | 438,978                                                                             |                                      | -            
|Prepaid expenses and other                           | 663,263                                                     |                                                                                     | 541,958                             
|                                                     |                                                             |                                                                                     | Total current assets                 | 12,860,567    |             | 7,002,786   
|                                                     |                                                             |                                                                                     |                                      |               |             |             
|Restricted cash                                      | 1,898,017                                                   |                                                                                     | 1,430,674                           
|Property and equipment, net                          | 23,646,931                                                  |                                                                                     | 16,445,028                          
|Intangibles, net                                     | 2,277,796                                                   |                                                                                     | 1,189,307                           
|Goodwill                                             | 2,679,482                                                   |                                                                                     | 2,679,482                           
|Escrow deposits on acquisitions                      | 2,735,301                                                   |                                                                                     | -                                   
|Lease deposits                                       | 958,633                                                     |                                                                                     | -                                   
|Other assets                                         | 2,131,043                                                   |                                                                                     | 1,357,160                           
|                                                     |                                                             |                                                                                     | Total assets                         | $49,187,770   |             | $30,104,437 
|                                                     |                                                             |                                                                                     |                                      |               |             |             
|                                                     |                                                             |                                                                                     | LIABILITIES AND STOCKHOLDERS
EQUITY |               |             |             
|Current Liabilities:                                 |                                                             |                                                                                     |                                     
|Current portion of notes payable and other
debt      | $744,101                                                    |                                                                                     | $698,504                            
|Current portion of notes payable to
stockholder      | 16,847                                                      |                                                                                     | 9,432                               
|Accounts payable                                     | 2,151,990                                                   |                                                                                     | 1,039,422                           
|Accrued expenses                                     | 5,339,474                                                   |                                                                                     | 2,597,151                           
|                                                     |                                                             |                                                                                     | Total current liabilities            | 8,252,412     |             | 4,344,509   
|                                                     |                                                             |                                                                                     |                                      |               |             |             
|Notes payable and other debt, net of current
portion | 25,831,340                                                  |                                                                                     | 16,701,028                          
|Notes payable to stockholder, net of current
portion | -                                                           |                                                                                     | 24,444                              
|Other liabilities                                    | 650,571                                                     |                                                                                     | 746,074                             
|Deferred tax liability                               | 244,499                                                     |                                                                                     | 212,574                             
|                                                     |                                                             | Total liabilities                                                                   | 34,978,822                           |               | 22,028,629 
|                                                     |                                                             |                                                                                     |                                      |               |             |             
|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; 7,959,233 and
5,628,007 shares issued and outstanding | 25,050,918                           |               | 17,571,801 
|                                                     | Accumulated deficit                                         | (11,505,553)                                                                        |                                      | (9,805,249)  
|                                                     |                                                             | Total stockholders' equity                                                          | 13,545,365                           |               | 7,766,552  
|                                                     | Noncontrolling interest in subsidiaries                     | 663,583                                                                             |                                      | 309,256      
|                                                     |                                                             | Total equity                                                                        | 14,208,948                           |               | 8,075,808  
|                                                     |                                                             | Total liabilities and stockholders' equity                                          | $49,187,770                          |               | $30,104,437
|                                                     |                                                             |                                                                                     |                                      |               |            
|See notes to consolidated financial
statements      



3



---



|                                                           |                                                    |                |                    |                 |                   |             |                     |               |           
|---------------------------------------------------------- | -------------------------------------------------- | -------------- | ------------------ | --------------- | ----------------- | ----------- | ------------------- | ------------- | ----------
|ADCARE HEALTH SYSTEMS, INC. AND
SUBSIDIARIES              
|CONSOLIDATED STATEMENTS OF
OPERATIONS                     
|(Unaudited)                                               
|                                                           |                                                    |                |                    |                 |                   |             |                     |               |           
|                                                           |                                                    |                | Three-Months Ended |                 | Nine-Months Ended
|                                                           |                                                    |                | September 30,      |                 | September 30,    
|                                                           |                                                    |                | 2010               |                 | 2009              |             | 2010                |               | 2009      
|Revenues:                                                  |                                                    |                |                    |                 |                   |             |                    
|                                                           | Patient care revenues                              | $12,741,701    |                    | $
    6,434,186 |                   | $24,308,760 |                     | $  18,513,767
|                                                           | Management, consulting and development fee
revenue | 532,985        |                    | 475,313         |                   | 1,564,657   |                     | 1,393,748    
|                                                           |                                                    | Total revenue  | 13,274,686         |                 | 6,909,499         |             | 25,873,417          |               | 19,907,515
|                                                           |                                                    |                |                    |                 |                   |             |                     |               |           
|Expenses:                                                  |                                                    |                |                    |                 |                   |             |                    
|                                                           | Payroll and related payroll costs                  | 8,243,065      |                    | 3,929,280       |                   | 16,269,039  |                     | 11,376,737   
|                                                           | Other operating expenses                           | 5,488,360      |                    | 2,250,032       |                   | 9,969,524   |                     | 6,418,118    
|                                                           | Depreciation and amortization                      | 303,190        |                    | 231,773         |                   | 779,164     |                     | 682,959      
|                                                           |                                                    | Total expenses | 14,034,615         |                 | 6,411,085         |             | 27,017,727          |               | 18,477,814
|                                                           |                                                    |                |                    |                 |                   |             |                     |               |           
|(Loss) Income from Operations                              | (759,929)                                          |                | 498,414            |                 | (1,144,310)       |             | 1,429,701          
|Other Income (Expense):                                    |                                                    |                |                    |                 |                   |             |                    
|                                                           | Interest income                                    | 6,860          |                    | 520             |                   | 14,220      |                     | 2,926        
|                                                           | Interest expense                                   | (427,308)      |                    | (292,853)       |                   | (1,020,128) |                     | (888,028)    
|                                                           | Other expense                                      | (452,645)      |                    | (1,622)         |                   | (658,239)   |                     | (50,946)     
|                                                           |                                                    |                | (873,093)          |                 | (293,955)         |             | (1,664,147)         |               | (936,048) 
|                                                           |                                                    |                |                    |                 |                   |             |                     |               |           
|Gain on Acquisitions                                       | -                                                  |                | -                  |                 | 1,805,741         |             | -                  
|                                                           |                                                    |                |                    |                 |                   |             |                    
|(Loss) Income Before Income Taxes                          | (1,633,022)                                        |                | 204,459            |                 | (1,002,716)       |             | 493,653            
|Income Tax Expense                                         | (10,641)                                           |                | (10,641)           |                 | (31,925)          |             | (31,925)           
|Net (Loss) Income                                          | (1,643,663)                                        |                | 193,818            |                 | (1,034,641)       |             | 461,728            
|Net Loss (Income) Attributable to Noncontrolling
Interests | 143,899                                            |                | 6,199              |                 | (665,663)         |             | (18,796)           
|Net (Loss) Income  Attributable to AdCare
Health Systems   | $ (1,499,764)                                      |                | $   200,017        |                 | $(1,700,304)      |             | $   442,932        
|                                                           |                                                    |                |                    |                 |                   |             |                     |               |           
|Net (Loss) Income Per Share, Basic:                        | $
        (0.19)                                   |                | $
            0.05 |                 | $
        (0.26)  |             | $
             0.11
|Net (Loss) Income Per Share, Diluted:                      | $
        (0.19)                                   |                | $
            0.05 |                 | $
        (0.26)  |             | $
             0.10
|                                                           |                                                    |                |                    |                 |                   |             |                    
|Weighted Average Common Shares Outstanding,                |                                                    |                |                    |                 |                   |             |                    
|                                                           | Basic                                              | 7,925,493      |                    | 3,975,435       |                   | 6,433,129   |                     | 3,975,435    
|                                                           | Diluted                                            | 7,925,493      |                    | 4,198,728       |                   | 6,433,129   |                     | 4,198,728    
|                                                          
|See notes to consolidated financial
statements.           



4



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|                                                                       |                                                                         |                                                                 |                                       |                        |                                 |           |     
|---------------------------------------------------------------------- | ----------------------------------------------------------------------- | --------------------------------------------------------------- | ------------------------------------- | ---------------------- | ------------------------------- | --------- | ----
|ADCARE HEALTH SYSTEMS, INC. AND
SUBSIDIARIES                          
|CONSOLIDATED STATEMENTS OF CASH
FLOWS                                 
|(Unaudited)                                                           
|                                                                       |                                                                         |                                                                 |                                       |                        | Nine Months Ended September
30,
|                                                                       |                                                                         |                                                                 |                                       |                        | 2010                            |           | 2009
|Cash flows from operating activities:                                  |                                                                         |                                                                 |                                      
|                                                                       | Net (loss) income                                                       | $    (1,034,641)                                                |                                       | $
       461,728      
|                                                                       | Adjustments to reconcile net (loss) income to net
cash (used in)        |                                                                 |                                       |                       
|                                                                       | provided by operating activities:                                       |                                                                 |                                       |                       
|                                                                       |                                                                         | Depreciation and amortization                                   | 779,164                               |                        | 682,959                        
|                                                                       |                                                                         | Warrants issued for services                                    | 9,626                                 |                        | 40,486                         
|                                                                       |                                                                         | Stock option compensation expense                               | 637,705                               |                        | 120,776                        
|                                                                       |                                                                         | Deferred tax expense                                            | 31,925                                |                        | 31,925                         
|                                                                       |                                                                         | Loss on disposal of assets                                      | 1,303                                 |                        | 892                            
|                                                                       |                                                                         | Noncash acquisition costs in other expenses                     | 171,961                               |                        | -                              
|                                                                       |                                                                         | Gain on acquisitions                                            | (1,805,740)                           |                        | -                              
|                                                                       |                                                                         | Changes in certain assets and liabilities, net of
acquisitions: |                                       |                        |                                
|                                                                       |                                                                         |                                                                 | Accounts receivable                   | (1,433,667)            |                                 | 114,039  
|                                                                       |                                                                         |                                                                 | Prepaid expenses and other            | (173,162)              |                                 | 3,830    
|                                                                       |                                                                         |                                                                 | Lease deposits                        | (958,633)              |                                 | -        
|                                                                       |                                                                         |                                                                 | Other assets                          | 189,929                |                                 | 95,653   
|                                                                       |                                                                         |                                                                 | Accounts payable and accrued expenses | 2,591,366              |                                 | (261,328)
|                                                                       |                                                                         |                                                                 | Other liabilities                     | (95,504)               |                                 | 271,377  
|                                                                       | Net cash (used in) provided by operating
activities                     | (1,088,368)                                                     |                                       | 1,562,337             
|                                                                       |                                                                         |                                                                 |                                       |                        |                                 |           |     
|Cash flows from investing activities:                                  |                                                                         |                                                                 |                                      
|                                                                       |                                                                         | Change in restricted cash                                       | 158,716                               |                        | 47,950                         
|                                                                       |                                                                         | Escrow deposits for acquisitions                                | (2,735,301)                           |                        | -                              
|                                                                       |                                                                         | Acquisitions                                                    | (3,730,747)                           |                        | -                              
|                                                                       |                                                                         | Purchase of property and equipment                              | (692,492)                             |                        | (343,245)                      
|                                                                       | Net cash used in investing activities                                   | (6,999,824)                                                     |                                       | (295,295)             
|                                                                       |                                                                         |                                                                 |                                       |                        |                                 |           |     
|Cash flows from financing activities:                                  |                                                                         |                                                                 |                                      
|                                                                       |                                                                         | Proceeds from notes payable                                     | 87,015                                |                        | -                              
|                                                                       |                                                                         | Proceeds from debt with detachable warrants                     | 3,009,000                             |                        | -                              
|                                                                       |                                                                         | Proceeds from public stock offering                             | 6,109,725                             |                        | 30,000                         
|                                                                       |                                                                         | Proceeds from exercise of warrants/options                      | 331,100                               |                        | -                              
|                                                                       |                                                                         | Repayment of notes payable to stockholder                       | (17,029)                              |                        | (5,878)                        
|                                                                       |                                                                         | Repayment of notes payable                                      | (458,005)                             |                        | (526,109)                      
|                                                                       | Net cash provided by (used in) financing
activities                     | 9,061,806                                                       |                                       | (501,987)             
|                                                                       |                                                                         |                                                                 |                                       |                        |                                 |           |     
|Net Increase in Cash                                                   | 973,614                                                                 |                                                                 | 765,055                              
|Cash, Beginning                                                        | 4,481,100                                                               |                                                                 | 1,266,315                            
|Cash, Ending                                                           | $
    5,454,714                                                         |                                                                 | $
    2,031,370                      
|                                                                       |                                                                         |                                                                 |                                       |                        |                                 |           |     
|Supplemental Disclosure of Cash Flow
Information:                      |                                                                         |                                                                 |                                      
|                                                                       | Cash paid during the year for interest                                  | $
       997,343                                                |                                       | $
       876,987      
|Supplemental Disclosure of Noncash Investing and
Financing Activities: |                                                                         |                                                                 |                                      
|                                                                       | Noncash change in fair value of property and
equipment from acquisition | $
       750,287                                                |                                       | $
                   -
|                                                                       | Acquisition in exchange for debt                                        | $
    6,365,000                                                 |                                       | $
                   -
|                                                                       |                                                                         |                                                                 |                                       |                       
|See notes to consolidated financial
statements.                       



5



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ADCARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)





NOTE 1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



Basis of Presentation



The consolidated financial statements are presented in accordance
with accounting principles generally accepted in the United States.  These
statements include the accounts of AdCare Health Systems, Inc. and its
controlled subsidiaries.  All inter-company accounts and transactions were
eliminated in the consolidation.  The accompanying unaudited consolidated
financial statements have been prepared in accordance with U.S. generally
accepted accounting principles for interim financial information and with the
instructions to Form 10-Q and Rule 8-03 of Regulation S-X.  Accordingly
they do not include all of the information and notes required for complete
annual financial statements and should be read in conjunction with the AdCare
Health Systems, Inc.s audited consolidated financial statements and notes
included in the Annual Report on Form 10-K/A for the year ended December 31,
2009.  In the opinion of the management of AdCare Health Systems, Inc., all
adjustments considered for a fair presentation are included and are of a normal
recurring nature.  Operating results for the nine months ended September
30, 2010 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2010.  Certain prior year amounts have been
reclassified to conform to the current year presentation.



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 three and nine months ended September 30, 2010, no
potentially dilutive securities have been included in the diluted earnings per
share calculation because they would automatically result in anti-dilution.





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.



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.  The Company records rent expense for 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.





6



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NOTE 1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)



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 10 years.  We evaluate the
recoverability of our 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.  We
do not amortize goodwill or indefinite lived intangibles.  On an annual
basis, we evaluate the recoverability of our 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 the nine months ended September 30, 2010.



Intangible assets consist of the following:



|             |                    |  |                   |  |            |  |            |  |                  |  |            
|------------ | ------------------ |  | ----------------- |  | ---------- |  | ---------- |  | ---------------- |  | -----------
|             | September 30, 2010 |  | December 31, 2009
|             | Gross              |  |                   |  | Net        |  | Gross      |  |                  |  | Net        
|             | Carrying           |  | Accumulated       |  | Carrying   |  | Carrying   |  | Accumulated      |  | Carrying   
|             | Amount             |  | Amortization      |  | Amount     |  | Amount     |  | Amortization     |  | Amount     
|Bed
Licenses | $1,189,307         |  | $
          -     |  | $1,189,307 |  | $1,189,307 |  | $
             - |  | $ 1,189,307
|Lease
Rights | 1,106,940          |  | (18,451)          |  | 1,088,489  |  | -          |  | -                |  | -          
|Totals       | $2,296,247         |  | $(18,451)         |  | $2,277,796 |  | $1,189,307 |  | $
             - |  | $ 1,189,307





Estimated amortization expense for each of the years ending
December 31 is as follows:



|                 |                
|---------------- | ---------------
|2010 (remainder) | $27,674        
|2011             | 110,694        
|2012             | 110,694        
|2013             | 110,694        
|2014             | 110,694        
|2015             | 110,694        
|Thereafter       | 507,345        
|                 | $     1,088,489





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 9 for additional information about the Companys
VIEs.



7



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NOTE 2.

LIQUIDITY AND PROFITABILITY



The Company had a net loss of approximately $1,700,000 and a net
income of approximately $423,000 for the nine months ended September 30, 2010
and 2009, respectively, and has working capital of approximately $4,608,000 at
September 30, 2010.  The Companys ability to achieve sustained profitable
operations is dependent on continued growth in revenue and controlling costs.



Managements plans with the objective of improving 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.



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.



NOTE 3.

SEGMENTS



In 2010, we organized our operating businesses into six business
units based upon their geographical location and the services provided.  We
re-evaluated our reportable segments based upon the growth of the organization
into new divisions, the additions to the management team, our internal
reporting, and how our chief operating decision maker evaluates performance and
allocates resources. As a result, our new reportable segments are geographically
and care-type based. 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 three and nine months ended September 30, 2010 and 2009,
the Company is reporting in six segments:  Midwest and Southeast divisions
divided between skilled nursing facilities and assisted living facilities, home
based care and management, development and corporate.  The divisional
segments provide services to individuals needing long term care in a nursing
home or assisted living setting and management of those facilities.  The
home based care 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.



8



---

NOTE 3.

SEGMENTS(continued)



|                                  |                   |                  |                    |             |                                     |       |         |        
|--------------------------------- | ----------------- | ---------------- | ------------------ | ----------- | ----------------------------------- | ----- | ------- | -------
|Amounts in 000s                 
|                                  |                   | Midwest Division | Southeast Division | Home Health | Management, Development & Corporate | Total
|                                  |                   | SNF              | AL                 | SNF         | AL                                  |       |         |        
|Quarter Ending September 30, 2010
|                                  | Net Revenue       | 3,314            | 1,782              | 6,628       | 449                                 | 568   | 534     | 13,275 
|                                  | Net Income (Loss) | 46               | (74)               | (516)       | (143)                               | (29)  | (928)   | (1,644)
|                                  | Total Assets      | 7,945            | 15,209             | 7,250       | 7,295                               | 2,392 | 9,097   | 49,188 
|                                  |                   |                  |                    |             |                                     |       |         |        
|Quarter Ending September 30, 2009
|                                  | Net Revenue       | 3,817            | 1,815              | -           | -                                   | 802   | 475     | 6,909  
|                                  | Net Income (Loss) | 270              | 65                 | -           | -                                   | 99    | (240)   | 194    
|                                  | Total Assets      | 8,190            | 14,453             | -           | -                                   | 2,595 | 1,740   | 26,978 
|                                  |                   |                  |                    |             |                                     |       |         |        
|Year to Date September 30, 2010  
|                                  | Net Revenue       | 9,852            | 5,548              | 6,628       | 449                                 | 1,832 | 1,564   | 25,873 
|                                  | Net Income (Loss) | 52               | (96)               | (516)       | (318)                               | 4     | (1,966) | (2,840)
|                                  | Total Assets      | 7,945            | 15,209             | 7,250       | 7,295                               | 2,392 | 9,097   | 49,188 
|                                  |                   |                  |                    |             |                                     |       |         |        
|Year to Date September 30, 2009  
|                                  | Net Revenue       | 10,797           | 5,457              | -           | -                                   | 2,260 | 1,394   | 19,908 
|                                  | Net Income (Loss) | 709              | 250                | -           | -                                   | 248   | (745)   | 462    
|                                  | Total Assets      | 8,190            | 14,453             | -           | -                                   | 2,595 | 1,740   | 26,978 



We
evaluate financial performance and allocate resources primarily based on net
income or loss before gains on acquisitions. The following table reconciles net
segment income to consolidated income attributable to AdCare Health Systems,
Inc. (in thousands):



|                                                            |                    |                   |         |     
|----------------------------------------------------------- | ------------------ | ----------------- | ------- | ----
|                                                            | Three-Months Ended | Nine-Months Ended
|                                                            | September 30,      | September 30,    
|                                                            | 2010               | 2009              | 2010    | 2009
|Net Income (Loss)-Segment                                   | (1,644)            | 194               | (2,840) | 462 
|Gain on Acquisitions  Midwest Region - AL                  | -                  | -                 | 826     | -   
|Gain on Acquisitions  Southeast Region - AL                | -                  | -                 | 980     | -   
|Net (Income)
Loss Attributable to Non-Controlling Interests | 144                | 6                 | (666)   | (19)
|Net Income (Loss) Attributable to AdCare Health
Systems     | (1,500)            | 200               | (1,700) | 443 





9



---

NOTE 4.

COMMITMENTS AND CONTINGENCIES



Operating Leases



The Company leases certain office space and 9 facilities under
non-cancelable operating leases, most of which have initial lease terms of 10
years and all but one of the facilities was initiated in the third quarter of
2010.



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 September 30, 2010.



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



|                 |  |            
|---------------- |  | -----------
|2010
(remainder) |  | $1,318,950 
|2011             |  | 5,371,565  
|2012             |  | 5,512,796  
|2013             |  | 5,625,952  
|2014             |  | 5,261,071  
|2015             |  | 5,208,193  
|Thereafter       |  | 25,373,828 
|                 |  | $53,672,355



In addition to the future minimum lease payments at September 30,
2010, the Company subsequently entered into 2 additional facility leases
effective November 1, 2010 that will require total future minimum lease payments
of approximately $20,000,000 through April 2022.



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 September 30, 2010, estimated loss liabilities
due to litigation were recorded in the amount of $283,000.



NOTE 5.  PROPERTY AND EQUIPMENT



|                                |                                |                    |  |                  
|------------------------------- | ------------------------------ | ------------------ |  | -----------------
|                                | Estimated Useful Lives (Years) | September 30, 2010 |  | December 31, 2009
|Buildings and improvements      | 5 to 40                        | $20,927,399        |  | $15,989,300      
|Equipment                       | 2-10                           | 3,466,140          |  | 3,084,940        
|Land                            | -                              | 3,858,415          |  | 2,945,928        
|Furniture and fixtures          | 2-5                            | 489,685            |  | 689,090          
|Construction in process         | -                              | 38,371             |  | 66,773           
|                                |                                | 28,780,010         |  | 22,776,031       
|Less:  accumulated depreciation |                                | 5,133,079          |  | 6,331,003        
|                                |                                | $23,646,931        |  | $16,445,028      





10



---



NOTE 6.  ACCRUED EXPENSES



Accrued expenses consist of the following:



|                                                             |                    |  |                  
|------------------------------------------------------------ | ------------------ |  | -----------------
|                                                             | September 30,
2010 |  | December 31,
2009
|Accrued wages,
payroll taxes and payroll related expenses    | 2,310,529          |  | 870,160          
|Accrued employee
benefits                                    | 632,460            |  | 413,199          
|Lease
payable                                                | 138,669            |  | 51,600           
|Real estate and
other taxes                                  | 599,133            |  | 531,870          
|Third party
overpayments and accrued cost report settlements | 358,744            |  | 109,483          
|Accrued fines and
penalties                                  | 283,000            |  | -                
|Audit fees                                                   | 112,420            |  | 110,867          
|Other accrued
expenses                                       | 904,519            |  | 509,972          
|                                                             | $
  5,339,474      |  | $
  2,597,151    





NOTE 7.  DEBT



Notes payable and other debt consists of the following:



|                                               |                    |  |                  
|---------------------------------------------- | ------------------ |  | -----------------
|                                               | September 30,
2010 |  | December 31,
2009
|Mortgage notes
payable                         | 16,204,619         |  | 16,418,413       
|Debt with
detachable warrants, net of discount | 3,181,899          |  | -                
|Bonds
payable                                  | 6,365,000          |  | -                
|Other                                          | 823,923            |  | 981,119          
|                                               | 26,575,441         |  | 17,399,532       
|                                               |                    |  |                  
|Less current
portion of long term debt         | 744,101            |  | 698,504          
|Total long-term
debt                           | $25,831,340        |  | $16,701,028      



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 September 30, 2010 the rate was 3.507% and the balance payable on the line of
credit was approximately $87,000.

Bond Issue

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%.





11



---



NOTE 7.  DEBT(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 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       | $
       25,000
|2012       | $
       75,000
|2013       | $
       75,000
|2014       | $
       85,000
|2015       | $
       90,000
|Thereafter | $   6,015,000  
|           | $   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.  As of September 30, 2010, an initial tranche of $3,009,000
was disbursed (net of $141,000 financing costs) and 315,000 warrants were
issued.  The second tranche was disbursed on October 7, 2010 for $336,000
(net of $14,000 financing costs) with the remaining 35,000 warrants.
 Proceeds from this financing agreement were used in the Alabama Nursing
Home Acquisitions (see Note 8).  The promissory note was subsequently
refinanced on October 26, 2010 with a portion of the proceeds obtained from a
convertible debt issuance (see Note 12).  The warrants continued to be
outstanding and exercisable after the refinancing of the promissory note.

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 $394,000 (net of approximately $24,000
stock issuance costs).

The warrants are exercisable at $4.25 per share and expire on
October 1, 2013.  The loan matures on January 1, 2011, but may, at the
election of the Company, be initially extended to April 1, 2011.  The
placement agent received compensation equal to 4% of the note for its services
plus a non-accountable expense allowance of $15,000.  Additionally, the
Company issued to the placement agent 116,900 additional warrants exercisable at
$4.25 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.  The Company will also pay the placement agent a
semi-annual administrative fee in the amount of $7,500, on the fifteenth day of
each January and July beginning January 15, 2012.



12



---

NOTE
8.  ACQUISITIONS

Alabama Nursing Home Acquisitions

On March 7, 2010, two wholly-owned subsidiaries of the Company
entered separate purchase agreements with 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 paid in cash.
 The Company acquired selected assets, primarily the facility and related
bed licenses, and did not assume any liabilities.  This acquisition was
financed with various financing arrangements as further described in Note 7 and
Note 12.

At September 30, 2010, the Company had paid $600,000 in escrow
deposits for these acquisitions.  Since control of these facilities was not
obtained until subsequent to the quarter, no revenue or earnings are included in
the consolidated income statement for the three or nine months ended September
30, 2010.  The initial accounting for the business acquisition is not
complete at the time these financial statements are issued and will be completed
during the fourth quarter including the amounts of the net assets acquired as
recognized at fair value on the acquisition date.

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.



13



---

NOTE
8.  ACQUISITIONS(continued)

Acquisition of Community Hearth & Home and Hearth &
Home of Urbana(continued)

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.

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 9 for additional information).  Since the Company has
no direct ownership in Riverchase, 100% of the facility financial results are
reported as non controlling interest.

In connection with the acquisition, the Company recognized a total
gain of approximately $980,000 in the 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 in other expense in the
accompanying consolidated statement of operations.



14



---

NOTE
8.  ACQUISITIONS(continued)

Alabama Assisted Living Acquisition(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:            
|                                       | 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
|                                       |                                |                



The actual amounts of Riverchases revenue and earnings included
in the consolidated income statement for the quarter ended September 30, 2010
and the supplemental pro forma revenue and earnings of the combined entity for
the nine months ended September 30, 2010 and 2009 had the acquisition date been
January 1, 2009 are:

|                                          |                   |                               |                                              |                                                    
|----------------------------------------- | ----------------- | ----------------------------- | -------------------------------------------- | ---------------------------------------------------
|                                          | Revenue           | Income (Loss) from Operations | Loss Attributable to Noncontrolling Interest | Income (Loss) Attributable to AdCare Health Systems
|Actual from
6/25/10  9/30/10             | $
        449,190 | $
      (317,866)             | $       (317,866)                            | $
                    -                            
|Supplemental
pro forma for 1/1/10-9/30/10 | $    26,707,117   | $
   (1,176,474)              | $       (357,166)                            | $
      (819,308)                                  
|Supplemental
pro forma for 1/1/09-9/30/09 | $    21,148,146   | $
     1,080,339              | $       (349,362)                            | $
     1,429,701                                   



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.

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 $375,000 in security deposits and $583,633 in advance
rent to be applied at the end of the lease term.

In a separate operations transfer agreement with the prior
operator, the Company acquired certain assets of the prior operator for a total
purchase price of approximately $3,250,000 including acquisition costs of
approximately $100,000.  As part of this asset acquisition, the Company
acquired approximately $3,000,000 in accounts receivable, $1,400,000 in lease
acquisition costs and other assets, and assumed approximately $870,000 in
accounts payable and a $280,000 loss contingency.



15



---

NOTE
8.  ACQUISITIONS(continued)

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 and $125,000 in advance rent to be applied at the end of the lease
term.

In a separate transaction with the prior operator, the Company
acquired the remaining lease and operating rights and is required to provide the
prior operator $4,350,000 in cash, $1,250,000 in common stock of the Company,
and a promissory note for $500,000.  Additionally, the Company has agreed
to enter into consulting agreements with certain principles of the prior
operator.  The consulting agreements will be for a period of three years
with combined consulting fees of $500,000 per year.  As of September 30,
2010, the Company has paid $1,400,000 in escrow deposits.

NOTE 9.  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 8 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 8 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 September 30, 2010:



16



---

NOTE 9.  VARIABLE INTEREST ENTITIES(continued)



Riverchase Village ADK, LLC(continued)





|                                   |                              |                         
|---------------------------------- | ---------------------------- | ------------------------
|Riverchase
Assets and Liabilities:
|                                   | (Amounts in
000s)           | September 30, 2010      
|                                   |                              |                         
|                                   | Cash                         | $
                    25
|                                   | Accounts
receivable          | 5                       
|                                   | Restricted
cash              | 608                     
|                                   | Prepaids                     | 13                      
|                                   | Property
and equipment, net  | 6,000                   
|                                   | Other
assets                 | 644                     
|                                   | Total
assets                 | 7,295                   
|                                   |                              |                         
|                                   | Accounts
Payable             | 229                     
|                                   | Other
Liabilities            | 40                      
|                                   | Notes
payable and other debt | 6,365                   
|                                   | Non-controlling
interest     | 661                     
|                                   | Total
liabilities            | $
              7,295   



The restricted cash of Riverchase is limited for purposes
specified by the bond issuance (see Note 7 for additional information about the
bond issue).

NOTE
10.  COMMON STOCK

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 $5.5 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.

NOTE 11.  STOCK DIVIDEND

On August 11, 2010, the board of directors declared a 5% stock
dividend to be issued on or about 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.  As
the stock dividend was declared before the release of the accompanying
consolidated financial statements, all references to the number of common shares
and per-share amounts are restated based on the increased number of shares
giving retroactive effect to the stock dividend.







17



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NOTE 12.  SUBSEQUENT EVENTS

The Company has evaluated for disclosure all subsequent events
through the date the financial statements were issued and filed with the United
States Securities and Exchange Commission.

Secured
Promissory Notes



On October 1, 2010, the Company issued two secured promissory
notes totaling $15,820,000 with Metro City Bank.  The loans mature on
September 30, 2035 and accrue interest at a variable  rate equal to the
published Wall Street Journal prime interest rate (currently 3.25%) plus 1.5%,
adjusted quarterly; but no less than 5.5% per annum.  The loans have a
prepayment penalty of 10% for any prepayment prior to September 30, 2011 which
is reduced by 1% each year until September 30, 2019 when it remains at 1%
thereafter.

The loans are collateralized by the real and personal property of
the Attalla and Coosa facilities described in Note 8, Acquisitions.  The
Company is also required to maintain a certificate of deposit in the amount of
$1,582,000 as collateral.  The loans have a conditionally approved loan
guarantee from the United States Department of Agriculture Rural Development
(USDA RD) for 70% of the outstanding loan amount.  The notes are also
personally guaranteed by Christopher Brogdon, a significant shareholder,
director and the Companys Chief Acquisition Officer.  The Company
compensated Mr. Brogdon $100,000 for his personal guarantee.  The Company
is also required to maintain certain financial covenants.

The loans have a one-time guarantee and structuring fees totaling
3% of the loan amounts which was paid on the closing date.  In addition to
the one-time fees, the loans are subject to an annual renewal fee due to the
USDA RD in an amount equal to 0.25% of the guaranteed portion of the outstanding
principal balance as of December 31 each year.

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 in reliance on Section
4(2) of the Securities Act of 1933, as amended, 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.

Gemino Revolving Credit Agreement

On October 29, 2010, subsidiaries of the Company, 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.  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 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.Conditions of the Agreement require the Borrowers to pay interest
on a minimum balance of $1,000,000.



18



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NOTE 12.  SUBSEQUENT EVENTS(continued)

Consequently, the Borrowers drew $1,000,000 at closing and we have
retained the proceeds for use as working capital in the operations of our
facilities.

Mountain Trace Acquisition

On November 4, 2010, the Company entered a purchase agreement to
acquire a 106 bed skilled nursing facility located in Sylva, North Carolina.
 The purchase price is $6,100,000.  The Company paid a $200,000
earnest money deposit upon signing the purchase agreement.  If the Company
terminates the purchase agreement because of sellers failure to satisfy certain
conditions of the purchase agreement, the earnest money will be returned to the
Company.  Conversely, if the Company fails to complete the purchase for
reasons other than the defined conditions within the purchase agreement, then
the seller will retain the earnest money.  Upon closing of the purchase,
the earnest money will be applied against the purchase price.



19



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Item 2.  Managements Discussion and
Analysis of Financial Condition and Results of Operations.

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.



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 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
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.



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 $5,500,000.  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 have
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
effecting 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.





20



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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 $5,000,000 and we paid $150,000 upon signing the purchase agreement as
earnest money. The closing conditions were amended and we paid another $100,000
as earnest money on May 27, 2010.  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
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.  As of September 30, 2010, the
Company has paid $375,000 in security deposits and $583,633 in advance rent to
be applied at the end of the lease term.

In a separate operations transfer agreement with the prior
operator, we acquired certain assets of the prior operator for a total purchase
price of approximately $3,250,000 including acquisition costs of approximately
$100,000.  As part of this asset acquisition, we acquired approximately
$3,000,000 in accounts receivable, $1,400,000 in lease acquisition costs and
other assets, and assumed approximately $870,000 in accounts payable and a
$280,000 loss contingency.

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 and $125,000 in
advance rent to be applied at the end of the lease term.

In a separate transaction with the prior operator, we acquired the
remaining lease and operating rights and are required to provide the prior
operator $4,350,000 in cash, $1,250,000 in common stock of the Company, and a
promissory note for $500,000.  Additionally, we have agreed to enter into
consulting agreements with certain principles of the prior operator.  The
consulting agreements will be for a period of three years with combined
consulting fees of $500,000 per year.  As of September 30, 2010, we have
paid $1,400,000 in escrow deposits.

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.

On November 4, 2010, we entered a purchase agreement to acquire a
106 bed skilled nursing facility located in Sylva, North Carolina.  The
purchase price is $6,100,000.  We paid a $200,000 earnest money deposit
upon signing the purchase agreement.



21



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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.

Segments



Our
business operates in six segments: Midwest and southeast division skilled
nursing facilities (SNF), Midwest and southeast division assisted living
facilities (ALF), home health and management and development. Our company
operates facilities in two regions of the United States which we identify as the
Midwest Division and the Southeast Division.  The Midwest Division includes
skilled nursing facilities, assisted living facilities and home health
operations located in Ohio.  The Southeast Division includes skilled
nursing facilities and an assisted living facility which are located in Alabama
and Georgia.  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.



|                           |                  |                    |       |     |       |    
|-------------------------- | ---------------- | ------------------ | ----- | --- | ----- | ---
|Facilities Owned or Leased
|                           | Midwest Division | Southeast Division | Total
|                           | SNF              | ALF                | SNF   | ALF | SNF   | ALF
|Number
Facilities          | 3                | 6                  | 12    | 0   | 15    | 6  
|Number
Units               | 194              | 196                | 1,490 | 0   | 1,684 | 196
|                           |                  |                    |       |     |       |    



|                                                                                                    |                  |                    |       |     |     |    
|--------------------------------------------------------------------------------------------------- | ---------------- | ------------------ | ----- | --- | --- | ---
|Facilities Managed for Third
Parties(1)                                                            
|                                                                                                    | Midwest Division | Southeast Division | Total
|                                                                                                    | SNF              | ALF                | SNF   | ALF | SNF | ALF
|Number
Facilities                                                                                   | 5                | 1                  | 0     | 1   | 5   | 2  
|Number
Units                                                                                        | 403              | 34                 | 0     | 105 | 403 | 139
|(1)We manage one independent living
campus with 83 units for a third party in the Midwest
Division.





22



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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 60% 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.



|                                                           |                  |                   
|---------------------------------------------------------- | ---------------- | ------------------
|Skilled Nursing Facility Occupancy                        
|                                                           | Midwest Division | Southeast Division
|AdCare average, September 30, 2010 (1)                     | 82.4%            | 86.7%             
|AdCare average, September 30, 2009 (1)                     | 89.5%            | (2)               
|(1)For the nine months ended
September 30, 2009 and 2010. 
|(2)The Southeast Division began operations August
1, 2010.





According to www.statehealthfacts.org, 2008 average statewide
nursing home occupancy for states in AdCares Midwest Division was 86.8% and
87.2% for states in AdCares Southeast Division.  Average nursing facility
occupancy rates were 84.2% nationally.  AdCares Midwest Division skilled
nursing facilities averaged 82.4% for the nine months ended September 30, 2010
and the Southeast Division averaged 86.7%.  We believe the current economic
conditions have contributed to our lower occupancies during 2010.
 Potential residents may be delaying their decision to enter a skilled
nursing facility and choosing to stay in their homes longer with care being
provided by family members.  We do not believe this
is a trend and we believe facility occupancy will improve.



We
continue our work towards maximizing the number of patients covered by Medicare
where our profit margins are typically higher.  However, in our Midwest
Division, during the three months ended September 30, 2010, the number of
patients covered by Medicare has declined from previous levels.  For the
three months ended September 30, 2010, compared to the three months ended
September 30, 2009, the number of patients covered by Medicare decreased from
14.2% to 12.1%.   For the nine months ended September 30, 2010, the
percentage of patients covered by Medicare was 11.8% compared to 14.9 % for the
nine months ended September 30, 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 a new sales/marketing position in the Midwest
Division to consult with facility level sales staff on census development.



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, 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 estimates
that aggregate Medicare payments will be 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.



23



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Effective October 1, 2010, CMS implemented MDS 3.0, a new
patient assessment tool for the collection of clinical data to be used for
classification into the RUG categories for all Medicare patients and those
Medicaid patients in RUGS-based reimbursement states. In addition to the patient
assessment tool, CMS has temporarily expanded RUG categories to 66 under RUGS IV
up from 53 under RUGS III. While the MDS 3.0 patient assessment tool is not
expected to change or require further legislation for CMS to continue, the RUGS
IV change is only temporary unless the RUG category expansion is officially
accelerated via legislation. The other alternative is that effective
January 2011, CMS implements a hybrid RUGS III system (RUGS III Hybrid)
and retroactively adjusts claims for services after October 1, 2010
according to this proposed RUGS III Hybrid model. Currently, we are unable to
estimate the effect that the new RUG categories and the new assessment tool will
have on our Medicare revenues, though CMS has previously stated that the
expansion of RUG categories is expected to be budget neutral.



For
the nine months ended September 30, 2010, Medicare covered residents of our
skilled nursing facilities comprised approximately 11.3% of our total skilled
nursing facility patients in the Midwest Division.  In our Southeast
Division, Medicare covered patients represented 9.5% of our patients for the
three months ended September 30, 2010.  We began operating skilled nursing
facilities in the Southeast division on August 1, 2010.



In
July 2009, the Governor of the State of Ohio signed into law the state Biennial
Budget 2009-2010.  Certain provisions of this budget contain modifications
to Medicaid reimbursement that affect our reimbursement beginning July 1, 2009.
 We have implemented operating changes in our skilled nursing facilities to
help offset some of the negative impacts of the state budget changes.
 However, we are receiving limited positive adjustments in our
reimbursement while our costs of providing services continue to rise.  For
the nine months ended September 30, 2010, Medicaid covered patients of our
skilled nursing facilities comprised approximately 66.9% 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 Facility Occupancy                                       
|                                                                          | Midwest Division | Southeast Division
|AdCare average, September 30, 2010 (1)                                    | 83.0%            | 54.6%             
|AdCare average, September 30, 2009 (1)                                    | 85.3%            | (2)               
|(1)For the nine months ended
September 30, 2009 and 2010.                
|(2)The Southeast Division began
assisted living operations June 24,
2010.



According to www.nic.org, the national average occupancy
for assisted living facilities was 88% as of March 31, 2010.  Assisted
living occupancy in our Midwest Division was 83% for the nine months ended
September 30, 2010 or 2.3% less than the nine months ended September 30, 2009.
 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.



Average Occupancy in our Southeast Division was 54.6%.  We
began managing this facility in late June, 2010.  Prior to management, the
facility was in receivership and had been operated by the receiver for several
years.  We are in the process of improving the aesthetic appearance of the
buildings interior which we believe will improve our ability to market and
increase the facilitys occupancy.



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
the Midwest Division to consult with facility level sales staff on census
development.



24



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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 our Midwest Division to create cross
selling opportunities.  For the nine months ended September 30, 2010, the
percentage of our home health patients covered by Medicare has decreased to
20.2% compared 28.5% for the six months ended September 30, 2009.  While we
have experienced recent declines in the number of patients we are serving for
home health services, we dont feel 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 20.2% of our home health total visits.
 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 $59,000 for the
three months ended September 30, 2010 when compared to the three months ended
September 30, 2009.  It has increased $170,000 for the nine months ended
September 30, 2010 when compared to the nine month ended September 30, 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.





25



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The table below contains our segment information for the three and
nine months ended September 30, 2010 and 2009.

|                                  |                   |                  |                    |             |                                     |       |         |        
|--------------------------------- | ----------------- | ---------------- | ------------------ | ----------- | ----------------------------------- | ----- | ------- | -------
|Amounts in 000s                 
|                                  |                   | Midwest Division | Southeast Division | Home Health | Management, Development & Corporate | Total
|                                  |                   | SNF              | ALF                | SNF         | ALF                                
|Quarter Ending September 30, 2010
|                                  | Net Revenue       | 3,314            | 1,782              | 6,628       | 449                                 | 568   | 534     | 13,275 
|                                  | Net Income (Loss) | 46               | (74)               | (516)       | (143)                               | (29)  | (928)   | (1,644)
|                                  | Total Assets      | 7,945            | 15,209             | 7,250       | 7,295                               | 2,392 | 9,097   | 49,188 
|                                  |                   |                  |                    |             |                                     |       |         |        
|Quarter Ending September 30, 2009
|                                  | Net Revenue       | 3,817            | 1,815              | -           | -                                   | 802   | 475     | 6,909  
|                                  | Net Income (Loss) | 270              | 65                 | -           | -                                   | 99    | (240)   | 194    
|                                  | Total Assets      | 8,190            | 14,453             | -           | -                                   | 2,595 | 1,740   | 26,978 
|                                  |                   |                  |                    |             |                                     |       |         |        
|Year to Date September 30, 2010  
|                                  | Net Revenue       | 9,852            | 5,548              | 6,628       | 449                                 | 1,832 | 1,564   | 25,873 
|                                  | Net Income (Loss) | 52               | (96)               | (516)       | (318)                               | 4     | (1,966) | (2,840)
|                                  | Total Assets      | 7,945            | 15,209             | 7,250       | 7,295                               | 2,392 | 9,097   | 49,188 
|                                  |                   |                  |                    |             |                                     |       |         |        
|Year to Date September 30, 2009  
|                                  | Net Revenue       | 10,797           | 5,457              | -           | -                                   | 2,260 | 1,394   | 19,908 
|                                  | Net Income (Loss) | 709              | 232                | -           | -                                   | 248   | (745)   | 462    
|                                  | Total Assets      | 8,190            | 14,453             | -           | -                                   | 2,595 | 1,740   | 26,978 



Midwest Division-Skilled Nursing Facilities



For
the three months ended September 30, 2010, revenue in our skilled nursing
segment decreased approximately $503,000 as a result of lower occupancy and
fewer Medicare patients as described above.  This segment had a net income
of $46,000 as a result of expense reductions made to offset lower occupancy.



For
the nine months ended September 30, 2010, revenue in our skilled nursing segment
decreased approximately $945,000 as a result of lower occupancy and fewer
Medicare patients.  This segment had a net income of $52,000 as a result of
expense reductions made to offset lower occupancy.  Total assets decreased
$245,000 due to routine capital expenditures offset by depreciation.



Midwest Division-Assisted Living Facilities



For
the three months ended September 30, 2010, revenue in our assisted living
segment decreased approximately $33,000 as a result of lower occupancy as
described above partially offset by an annual increase in rates charged to
privately paying residents.  Additionally, operating expenses have
increased as a result of annual wage increases and inflationary increases in
operating expenses.  As a result, this segment had a net loss of
$74,000.



For
the nine months ended September 30, 2010, revenue in our assisted living segment
increased approximately $91,000 as a result of an annual increase in rates
charged to privately paying residents offset by lower occupancy.  This
segment had a net loss of $96,000 as a result of low occupancy and increased
payroll related expenses.  Total assets increased $756,000 primarily due to
recognizing the fair value of Communitys Hearth & Home when it was
acquired.  This is partially offset by the net effects of routine capital
expenditures and depreciation expense.



Southeast Division-Skilled Nursing Facilities



Our
skilled nursing facilities in our Southeast Division began operations starting
on August 1, 2010, with the addition of five facilities in Georgia followed by
three additional facilities on September 1, 2010.  All eight facilities are
leased facilities.  Since



26



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operations began, we have assembled a division team consisting of
operations management, sales and marketing, human resources, nurse professionals
and business services managers to oversee the transition and integration of the
facilities.



For
the three and nine months ended September 30, 2010, revenue in our skilled
nursing facilities in the Southeast Division was $6,628,000.  Net loss was
$516,000.  Our strategy to improve the facilities performance is the same
as our strategy in the Midwest Division.  We plan to increase facility
occupancy and to increase the number of patients covered by Medicare.  We
expect the division team lead by AdCares senior management to continue to
implement and refine strategies to achieve these goals.



Southeast Division-Assisted Living Facility



Our
assisted living facility in our Southeast Division began operations June 24,
2010.  For the three months ended September 30, 2010, revenue in our
assisted living segment was $449,000.  Net loss was $143,000.  This is
a result of low facility occupancy.  We have a number of initiatives in
place to help improve the occupancy but primarily we are focusing on improving
the interior aesthetics of the building and on improving the reputation of the
facility in the community.



Home Health Segment



For
the three months ended September 30, 2010, revenue in our home health segment
decreased approximately $234,000 as a result of services provided to fewer
patients as well as fewer Medicare patients overall. In addition, the home based
care segment experienced increased expenses from annual employee wage increases
of approximately 3%.  The decline in revenues and increases in expenses
resulted in a net loss of $29,000.



For the nine months ended September 30, 2010, revenue in our home
based care segment declined approximately $428,000 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 a net income of approximately $4,000.  The decrease in total
assets was primarily the result of depreciation.

Management, Development and Corporate Segment

Management consulting and development fee revenue has increased
$59,000 for the three months ended September 30, 2010 when compared to the three
months ended September 30, 2009.  Net loss was $928,000 due primarily to corporate overhead,
costs for acquisitions and non cash charges for compensation expense related to
warrants, restricted stock and employee stock options.

Management consulting and development fee revenue has increased
$170,000 for the nine months ended September 30, 2010 when compared to the nine
month ended September 30, 2009.  Net loss was $1,966,000 due primarily to
corporate overhead costs for acquisitions and non cash charges for compensation
expense related warrants, restricted stock and employee stock options.

Critical Accounting Policies and Use of Estimates



There have been no significant changes during the nine month
period ended September 30, 2010 to the items that we disclosed as our critical
accounting policies and use of estimates in our discussion and analysis of
financial condition and results of operation contained in our most recent Annual
Report on Form 10-K/A filed with the SEC on April 2, 2010.





27



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Consolidated Results of Operations

Three months ended September 30, 2010 and September 30,
2009

Revenue

|                                                   |                    |  |                    |  |            |           
|-------------------------------------------------- | ------------------ |  | ------------------ |  | ---------- | ----------
|                                                   | September 30, 2010 |  | September 30, 2009 |  | Increase   | %   Change
|Patient
care revenue                               | $12,741,701        |  | $6,434,186         |  | $6,307,515 | 98.0%     
|Management,
consulting and development fee revenue | 532,985            |  | 475,313            |  | 57,672     | 12.1%     
|                                                   | $13,274,686        |  | $6,909,499         |  | $6,365,187 | 92.1%     



For the periods compared, patient care revenue increased
approximately $6,308,000 or 98.0%.  Revenue increased $7,078,000 as a
result of our growth in the Southeast Division during the quarter.  This
increase was offset by a decrease in revenue in our Midwest Division and other
segments of approximately $770,000.  The average occupancy in our skilled
nursing centers in this Division declined 9.4% while the number of residents
covered by Medicare decreased to 12.1% for the three months ended September 30,
2010 compared to 14.6% for the three months ended September 30, 2009 resulting
in a decrease in revenue of approximately $503,000.  The average occupancy
in our assisted living facilities declined 5.9%; however, revenue in our
assisted living centers decreased approximately $8,000 as a result of an annual increase in rates charged to
privately paying residents.  Home health revenue declined approximately
$234,000 as a result of services provided to fewer patients as well as few
Medicare patients overall.  Management, consulting and development fee
revenue increased approximately $58,000 or 12.1% 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

|                                  |                    |  |                    |  |            |         
|--------------------------------- | ------------------ |  | ------------------ |  | ---------- | --------
|                                  | September 30, 2010 |  | September 30, 2009 |  | Increase   | % Change
|Payroll and
related payroll costs | $8,243,065         |  | $3,929,280         |  | $4,313,785 | 109.8%  
|Other
operating expenses          | 5,488,360          |  | 2,250,032          |  | 3,238,328  | 143.9%  
|Depreciation
and amortization     | 303,190            |  | 231,773            |  | 71,417     | 30.8%   
|                                  | $14,034,615        |  | $6,411,085         |  | $7,623,530 | 118.9%  



Operating expenses for the three months ended September
30, 2010 increased by approximately $7,623,530 or 118.9%.  Payroll and
related payroll costs increased by approximately $4,314,000 or 109.8%.
 Payroll and related payroll costs increased $4,079,000 as a result of
growth in our Southeast Division during the quarter.  The remaining
increase of $234,000 is due primarily to $213,000 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 in the Southeast
Division.  These increases were partially offset by reductions in staff as
a result of lower occupancy in our skilled nursing facilities and the need for
fewer care givers in our home health division as a result of fewer patients
being cared for.



Other operating expenses increased approximately $3,238,000 or
143.9%.  Approximately $3,015,000 was as a result of growth in our
Southeast Division during the quarter.  Approximately $223,000 of the
increase was due primarily to increased expenses related to Board activities,
higher legal fees and consulting fees for investment bankers and investor
relations.



Depreciation and amortization expense increased by approximately
$71,000 or 30.8% primarily due to depreciation of the assets of Riverchase
Village assisted living and routine additions of fixed assets and their related
depreciation expense.

(Loss)
Income from Operations

Loss from operations for the three months ended September 30, 2010
was approximately $760,000.  When compared to the three months ended
September 30, 2009 income from operations of approximately $498,000, this
represents a decrease of approximately $1,258,000.  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.



28



---

Other Income and Expense

For
the three months ended September 30, 2010 compared to the three months ended
September 30, 2009, interest expense increased approximately $134,000 primarily
due to interest expense on additional debt incurred as a result of the
acquisition of Riverchase Village assisted living.  Other expense increased
approximately $450,000 primarily as a result of acquisitions costs incurred in
leasing the facilities in Georgia and purchasing facilities in Alabama.



Summary

Loss before income taxes for the three months ended September 30,
2010 was approximately $1,633,000 compared to a net income of approximately
$204,000 for the three months ended September 30, 2009, a decrease of
approximately $1,837,000.

Income tax expense of approximately $10,600 for three months ended
September 30, 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 three
months ended September 30, 2010, was approximately $1,500,000 compared to a net
income for the three months ended September 30, 2009, of approximately $200,000,
a decrease of approximately $1,700,000 as a result of the items described
above.

Consolidated Results of Operations

Nine months ended September 30, 2010 and September 30,
2009

Revenue

|                                                   |                    |  |                    |  |            |           
|-------------------------------------------------- | ------------------ |  | ------------------ |  | ---------- | ----------
|                                                   | September 30, 2010 |  | September 30, 2009 |  | Increase   | %   Change
|Patient
care revenue                               | $24,308,760        |  | $18,513,767        |  | $5,794,993 | 31.3%     
|Management,
consulting and development fee revenue | 1,564,657          |  | 1,393,748          |  | 170,909    | 12.3%     
|                                                   | $25,873,417        |  | $19,907,515        |  | $5,965,902 | 30.0%     



For the periods compared, patient care revenue increased
approximately $5,795,000 or 31.3%.  Revenue increased $7,078,000 as a
result of our growth in the Southeast Division during 2010.  This increase
was offset by a decrease in revenue in our Midwest Division and other segments
of approximately $1,283,000.  The average occupancy in our skilled nursing
centers declined 7.9% while the number of residents covered by Medicare
decreased to 11.8% for the nine months ended September 30, 2010 compared to 15%
for the nine months ended September 30, 2009 resulting in a decrease in revenue
of approximately $945,000.  The average occupancy in our assisted living
facilities declined 2.7%; however, revenue in our assisted living centers
increased approximately $91,000 as a result of an annual increase in rates
charged to privately paying residents.  Home health revenue declined
approximately $429,000 as a result of services provided to fewer patients as
well as few Medicare patients overall.  Management, consulting and
development fee revenue increased approximately $171,000 or 12.3% 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

|                                  |                    |  |                    |  |            |         
|--------------------------------- | ------------------ |  | ------------------ |  | ---------- | --------
|                                  | September 30, 2010 |  | September 30, 2009 |  | Increase   | % Change
|Payroll and
related payroll costs | $16,269,039        |  | $11,376,737        |  | $4,892,302 | 43.0%   
|Other
operating expenses          | 9,969,524          |  | 6,418,118          |  | 3,551,406  | 55.3%   
|Depreciation
and amortization     | 779,164            |  | 682,959            |  | 96,205     | 14.1%   
|                                  | $27,017,727        |  | $18,477,814        |  | $8,539,193 | 46.2%   



Operating expenses for the nine months ended September
30, 2010 increased by approximately $8,539,000 or 46.2%.  Payroll and
related payroll costs for the nine months ended September 30, 2010 increased by
approximately $4,892,000 or 43%.  Payroll and related payroll costs
increased $4,091,000 as a result of growth in our Southeast Division during
2010.  The



29



---

remaining increase of $801,000 is due primarily to $647,000 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 in the Southeast Division.  These increases were partially offset by
reductions in staff as a result of lower occupancy in our skilled nursing
facilities and the need for fewer care givers in our home health division as a
result of fewer patients being cared for.



Other operating expenses increased approximately $3,551,000 or
55.3%.  Approximately $3,021,000 was as a result of growth in our Southeast
Division during 2010.  Approximately $477,000 of the remainder of the
increase was due primarily to increased expenses related to Board activities,
higher legal fees and consulting fees for investment bankers and investor
relations.



Depreciation and amortization expense increased by approximately
$96,000 or 14.1% primarily due to depreciation of the assets of Riverchase
Village assisted living and routine additions of fixed assets and their related
depreciation expense.

(Loss)
Income from Operations

Loss from operations for the nine months ended September 30, 2010
was approximately $1,144,000.  When compared to the nine months ended
September 30, 2009 income from operations of approximately $1,430,000, this
represents a decrease of approximately $2,574,000.  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

For
the nine months ended September 30, 2010 compared to the nine months ended
September 30, 2009, interest expense increased approximately $132,000 primarily
due to interest expense on additional debt incurred as a result of the
acquisition of Riverchase Village assisted living.  Other expense increased
approximately $607,000 primarily as a result of acquisitions costs incurred in
acquiring the facilities in Georgia and Alabama.



Gain on Acquisitions



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 $980,000.  Refer to Note 8 in the consolidated financial
statements for additional information regarding the acquisition.



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.  Refer to Note 8 in the consolidated
financial statements for additional information regarding the acquisition.



Gain on acquisitions was approximately $1,806,000 for the nine
months ended September 30, 2010.



Summary

Loss before income taxes for the nine months ended September 30,
2010 was approximately $1,003,000 compared to a net income of approximately
$494,000 for the nine months ended September 30, 2009, an decrease of
approximately $1,497,000 primarily as a result of the gains on acquisition
offset partially by increases in operating expenses and reduced revenue.

Income tax expense of approximately $32,000 for nine months ended
September 30, 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.



30



---

Net loss attributable to AdCare Health Systems for the nine months
ended September 30, 2010, was approximately $1,700,000 compared to a net income
for the nine months ended September 30, 2009, of approximately $443,000, a
decrease of approximately $2,143,000 as a result of the items described
above.

Liquidity and Capital Resources

Overview

We had net working capital as of September 30, 2010 of
approximately $4,608,000 as compared to net working capital of approximately
$2,658,000 for the year ended December 31, 2009, an increase of approximately
$1,950,000.  This increase is primarily the result of increased accounts
receivable as a result of our growth in the Southeast Division and increased
cash from our acquisition financing 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 September 30,
2010, approximately $87,000 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%.  We withdrew
$191,000 from the deferred employee compensation plan and deposited the funds
into an interest bearing savings account.  We intend to use the savings to
fund temporary operating cash short falls.  We repaid the withdrawn funds
to the plan at the end of 2009 with interest that accrued at 8%.  In
January 2010, we reestablished the line of credit from the non-qualified
deferred compensation plan with same terms as 2009.  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 $5,455,000, there was approximately $660,000 of cash that was
subject to these requirements representing approximately 12% of our unrestricted
cash balance as of September 30, 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
will be 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.  Conditions of the



31



---

Agreement require the Borrowers to pay interest on a minimum
balance of $1,000,000.  Consequently, the Borrowers drew $1,000,000 at
closing and we have retained the proceeds for use as working capital in the
operations of our facilities.



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 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 26 days before
collection as of September 30, 2010 and 27 days as of December 31, 2009.
 The status of accounts receivable collections is monitored very closely by
our senior management.

Nine months ended September 30, 2010

Net cash used in operating activities for the nine months ended
September 30, 2010 was approximately $1,088,000 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 nine months ended
September 30, 2010 was approximately $7,000,000.  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 partially offset by an increase from restricted cash due
to certain released amounts.

Net
cash provided by financing activities was approximately $9,061,000 for the nine
months ended September 30, 2010.  This is primarily the result of proceeds
from the debt with detachable warrants issued in September, 2010, and proceeds
from the sale of stock.



Nine months ended September 30, 2009

Net cash provided by operating activities for the nine months
ended September 30, 2009 was approximately $1,562,000 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 nine months ended
September 30, 2009 was approximately $295,000.  This is primarily the
result of purchases of additional equipment and an increase from restricted cash
due certain released amounts.

Net
cash used in financing activities was approximately $502,000 for the nine months
ended September 30, 2009, primarily as a result of routine principal payments on
existing loans.



32



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Item 4T.  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.



There has been no change in our internal control over financial
reporting during our most recent fiscal quarter that has materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting.



Part II.  Other Information

Item 1.
 Legal Proceedings



There are no material pending legal proceedings to which AdCare
Health Systems, Inc and Subsidiaries is a party or to which any property is
subject.



Item 6.
 Exhibits and Reports on Form 8-K



a.

The
following Exhibits are attached:

|               |                                                                       
|-------------- | ----------------------------------------------------------------------
|Exhibit Number | Description                                                           
|31.1           | Certification
of CEO pursuant to Section 302 of the Sarbanes-Oxley Act
|31.2           | Certification
of CFO pursuant to Section 302 of the Sarbanes-Oxley Act
|32.1           | Certification
of CEO pursuant to Section 906 of the Sarbanes-Oxley Act
|32.2           | Certification
of CFO pursuant to Section 906 of the Sarbanes-Oxley
Act



b.

The
Company filed the following Reports on Form 8-K during the three months ended
September 30, 2010:



|                  |                                                       
|----------------- | ------------------------------------------------------
|Date              | Description                                           
|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                 



The
Company filed the following Reports on Form 8-K subsequent to September 30,
2010:



|                  |                                                                        
|----------------- | -----------------------------------------------------------------------
|Date              | Description                                                            
|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.



33



---

SIGNATURES



In accordance
with the requirements of the Exchange Act, the registrant has duly caused the
report to be signed on its behalf by the undersigned, thereunto duly
authorized.



AdCare
Health Systems, Inc.

(Registrant)



Date:
 November 15, 2010

/s/Gary
L. Wade

Chief
Executive Officer



Date:
 November 15, 2010

/s/Scott
Cunningham

Chief
Financial Officer





34



---

Exhibit 31.1

CERTIFICATIONS

I, Gary L. Wade certify that:

1.

I have reviewed this quarterly report on Form 10-Q 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
registrant as of, and for, the periods presented in this report;

4.

The registrant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 registrant 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 registrant, 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 registrant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 registrants internal
control over financial reporting that occurred during the registrants most
recent fiscal quarter (the registrants fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the registrants internal control over financial
reporting.

5.

The registrants other certifying officer and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrants auditors and the audit committee of the
registrant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 registrant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 registrants internal control
over financial reporting.



|                         |    |                                      
|------------------------ | -- | -------------------------------------
|Date:
 November 15, 2010 | By | /s/Gary L.
Wade                      
|                         |    | President
and Chief Executive Officer





35



---

Exhibit 31.2

CERTIFICATIONS

I, Scott Cunningham, certify that:

1.

I have reviewed this quarterly report on Form 10-Q 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
registrant as of, and for, the periods presented in this report;

4.

The registrant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 registrant 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 registrant, 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 registrant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 registrants internal
control over financial reporting that occurred during the registrants most
recent fiscal quarter (the registrants fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the registrants internal control over financial
reporting.

5.

The registrants other certifying officer and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrants auditors and the audit committee of the
registrant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 registrant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 registrants internal control
over financial reporting.







|                         |    |                        
|------------------------ | -- | -----------------------
|Date:
 November 15, 2010 | By | /s/Scott
Cunningham    
|                         |    | Chief
Financial Officer





36



---

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 Quarterly Report of AdCare Health Systems,
Inc. (the Company) on Form 10-Q for the period ended September 30, 2010 as
filed with the Securities and Exchange Commission (the Report), I, Gary L.
Wade, 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:
 November 15, 2010 |  | By: |  | /s/Gary
L. Wade                      
|                         |  |     |  | Gary L.
Wade, Chief Executive Officer





37



---

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 Quarterly Report of AdCare Health Systems,
Inc. (the Company) on Form 10-Q for the period ended September 30, 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:
November 15, 2010 |  | By: |  | /s/Scott
Cunningham                      
|                        |  |     |  | Scott
Cunningham, Chief Financial Officer







38