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 in the state of Ohio. We currently manage sixteen facilities, comprised of six skilled nursing centers, seven assisted living residences and three independent living/senior housing facilities, totaling over 850 beds.

We have an ownership interest in eight of the facilities we manage, comprised of 100% ownership of two of the skilled nursing centers and one assisted living facility, 99% ownership in one independent living facility as well as a 50% ownership of four of the assisted living 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 is strategic in providing potential management opportunities to our core long-term care business. AdCare Health Systems, Inc.® and Hearth & Home® are registered trademarks. All of our properties are located within the State of Ohio.

Our business operates in two segments: (1) management and facility-based care and (2) home-based care. In our management and facility-based care segment, we derive revenues from three primary sources. We operate and have ownership interests in eight 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. We also manage assisted living facilities and nursing homes 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 facility-based care 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.

We have implemented changes at our skilled nursing centers to improve occupancy and revenue. We have recently completed renovations at all three facilities with additional renovations planned during 2008 and 2009. We continue to focus our attention towards providing care to more patients covered by Medicare where our profit margins are typically higher than those of Medicaid. For the quarter ended June 30, 2008, compared to the quarter ended June 30, 2007, overall occupancy in our skilled nursing centers increased 1.3% and occupancy in our assisted living centers increased 2.6%.

Our home health division has reduced and, in most cases, eliminated services to patients where our reimbursement provided very little profit margin. This has resulted in a lower number of patient visits and lower revenue. The majority of the reduced revenue has been offset by lower payroll and related expenses. The benefits of this change have been offset by overall lower visits than anticipated. We are in the process of utilizing our home health services in our assisted living and independent living properties creating cross selling opportunities which will further enhance our revenue. These needs had previously been satisfied by other home health agencies.

On May 15, 2008, we completed our acquisition of the New Lincoln Lodge. This acquisition was effective April 1, 2008. Consequently, many of the expense areas in our income statement have increased. The New Lincoln Lodge is a 49 unit retirement community located in Columbus, Ohio. For further information on this acquisition, please review our 8-K filed on May 19, 2008 and amended on July 29, 2008.

On June 26, 2008 we completed the refinancing of our three assisted living properties known as Community's Hearth & Home. This refinancing replaced our adjustable rate demand taxable notes, series 2002 Bonds in the original principal amount of $4,200,000 obtained 2002. Interest on the note was indexed at the LIBOR rate. We refinanced this debt with two HUD insured loans at a fixed interest rate of 6.65% with a 35 year amortization. The new financing consists of two loans, one for the two Springfield, Ohio properties and one for the Urbana, Ohio property. The loans are in the amount of $1,863,800 and $2,142,700, respectively, and total $4,006,500. As a result of this refinancing, in June 2008, we recognized the balance of the unamortized financing costs of approximately $106,000 from the 2002 Bond financing.
Additionally, Huntington National Bank released the balance of cash previously pledged to secure a letter of credit related to the 2002 financing.

                             Results of Operations


Three months ended June 30, 2008 as compared to three months ended June 30, 2007

Revenue

                                      June 30, 2008   June 30, 2007    Increase   %  Change
Patient care revenue                     $5,574,114      $5,457,475      $116,639      2.1%
Management, consulting and
development fee revenue                     442,422         414,902        27,520      6.6%
                                         $6,016,536      $5,872,377      $144,159      2.5%

For the periods compared, patient care revenue increased approximately $116,600 or 2.1%. Average occupancy levels in our skilled nursing centers and assisted living centers increased nearly 3%. Charges for privately paying residents at our assisted living and skilled nursing facilities were increased approximately 5% effective January 1, 2008. Home health revenue declined primarily as a result of reducing services provided to payers that are not profitable or only marginally profitable. Payroll and related payroll costs were reduced accordingly to offset the reduced revenue. Additionally, patient care revenue increased due to the acquisition of the New Lincoln Lodge effective April 1, 2008. Management, consulting and development fee revenue increased approximately $27,500 or 6.6% as a result of higher management fees on our managed properties.

Operating Expenses

                                                                                %
                                    June 30, 2008   June 30, 2007   Increase  Change
 Payroll and related payroll costs    $3,697,477      $3,653,871     $43,606    1.2%
 Other operating expenses              2,113,128       1,924,627     188,501    9.8%
 Depreciation and amortization           206,324         169,682      36,642   21.6%
                                      $6,016,929      $5,748,180    $268,749    4.7%

Operating expenses for the three months ended June 30, 2008 increased $268,749 or 4.7%. Payroll and related payroll costs for the three months ended June 30, 2008 increased $43,600 or 1.2%. The acquisition of New Lincoln Lodge contributed to the increase payroll and related costs. Increased administrative staff expense and higher payroll expense at our assisted living centers was partially offset by lower payroll expense at our home health agency and skilled nursing centers. Payroll expense at

our home health agency was lower as a result of discontinuing services provided to payers that are not profitable or only marginally profitable. These savings were partially offset by employee wages which have increased approximately 3% as a result of annual wage increases. Administrative staff has increased in the areas of management information systems and human resources in order to satisfy the increasing demands on these departments.

Other operating expenses increased approximately $188,500 or 9.8%.
Approximately $85,000 of the increase is the result of the acquisition of the New Lincoln Lodge. The increase is also due to increased supply usage as a result of higher occupancy in our assisted living facilities, inflationary increases in supply costs, therapy services and pharmacy supplies provided to residents of our skilled nursing centers. These increases are somewhat offset by increased patient care revenue. Monthly expenses for our financial advisors also contributed to the increase.

Depreciation and amortization expense increased $36,642 or 21.6% due primarily to additional assets placed into service and their related depreciation expense.

Income (Loss) from Continuing Operations

Loss from continuing operations for the three months ended June 30, 2008 was $393. Compared to the three months ended June 30, 2007 income of $124,196, this represents a decrease of $124,589. This is primarily due to the consolidation of the New Lincoln Lodge and higher Other Operating Expenses.

Other Income and Expense

For the three months ended June 30, 2008 compared to the three months ended June 30, 2007, interest income decreased $11,600 as a result of less interest earned on bank accounts. Interest expense for the three months ended June 30, 2008 compared to the three months ended June 30, 2007, increased $103,982 or 35.9% as a result of New Lincoln Lodge's interest expense somewhat offset by lower interest expense on our variable rate loans as well as the recognition of the balance of the unamortized financing costs associated with our 2002 financing of Community's Hearth of $106,000 which was a result of refinancing the related debt.

Summary

Income from continuing operations before income taxes for the three months ended June 30, 2008 was $33,605 compared to a net loss of $202,309 for the three months ended June 30, 2007, an increase of approximately $235,900 or 116.6%.
This is primarily the result of the gain we recognized upon our acquisition of the New Lincoln Lodge of approximately $414,000 partially offset by other losses of approximately $380,000. The loss is due to increased supply usage as a result of higher occupancy in our assisted living facilities, inflationary increases in supply costs, therapy services, pharmacy supplies provided to residents of our skilled nursing centers, and monthly expenses for our financial advisors. Additionally, the losses were the result of the recognition of unamortized financing costs associated with our 2002 financing of Community's Hearth & Home of approximately $106,000. Increased revenue was not enough to offset the increased expenses.

Income tax expense of $10,642 recognized for three months ended June 30, 2008 is related to the amortization of purchased goodwill under Internal Revenue Code section 197.

Net income for the three months ended June 30, 2008, was $22,963 compared to a net loss for the three months ended June 30, 2007, of $212,880.

Six months ended June 30, 2008 as compared to six months ended June 30, 2007

Revenue

                                                                       Increase/  %  Change
                                      June 30, 2008   June 30, 2007   (Decrease)
Patient care revenue                    $11,142,175     $10,824,117      $318,058      2.9%
Management, consulting and
development fee revenue                     866,903         872,609       (5,706)    (0.7)%
                                        $12,009,078     $11,696,726      $312,352      2.7%

For the period ended June 30, 2008, patient care revenue increased approximately $318,000 or 2.9%. Average occupancy levels in our skilled nursing centers declined by 1.8% while our assisted living centers increased 3.4%. Charges for privately paying residents at our assisted living and skilled nursing facilities were increased approximately 5% effective January 1, 2008. Home health revenue declined $385,000 as a result of reducing services provided to payers that are not profitable or only marginally profitable. Payroll and related payroll costs were reduced accordingly to offset the reduced revenue. This decline in revenue was more than offset by higher overall revenue in our assisted living and skilled nursing centers. Additionally, patient care revenue increased due to the acquisition of the New Lincoln Lodge effective April 1, 2008. Management, consulting and development fee revenue decreased approximately $5,700 or .7% as a result of higher management fees on our managed properties offset by lower development fees.

Operating Expenses

                                                                       Increase/      %
                                       June 30, 2008   June 30, 2007   (Decrease)  Change
Payroll and related payroll costs      $  7,284,874    $  7,342,447    $(57,573)     (.08)%
Other operating expenses                  4,136,385       3,704,381      432,004      11.7%
Depreciation and amortization               433,018         340,087       92,931      27.3%
                                        $11,854,277     $11,386,915     $467,362       4.1%

Operating expenses for the six months ended June 30, 2008 increased $467,362 or 4.1%. Payroll and related payroll costs for the six months ended June 30, 2008 decreased $57,573 or .8%. Payroll expense at our home health agency was lower as a result of discontinuing services provided to payers that are not profitable or only marginally profitable. These reduced costs were somewhat offset by employee wages which have increased approximately 3% as a result of annual wage increases, increased administrative staff expense and the acquisition of New Lincoln Lodge. Administrative staff has increased in the areas of management information systems and human resources in order to satisfy the increasing demands on these departments. Additionally, we recognized approximately $12,000 in stock option compensation expense as a result of our May 2007 stock option awards that we did not have as of June 30, 2007.

Other operating expenses increased $432,004 or 11.7%. Approximately $85,000 of the increase is the result of the acquisition of the New Lincoln Lodge. The increase is also due to increased supply usage as a result of higher occupancy in our assisted living facilities, inflationary increases in supply costs, therapy services and pharmacy supplies provided to residents of our skilled nursing centers. These increases are somewhat offset by increased patient care revenue. Monthly expenses for our financial advisors and public relations consultants also contributed to the increase by approximately $47,000 as a result of non cash warrant compensation expense.

Depreciation and amortization expense increased $92,931 or 27.3% due primarily to additional assets placed into service and their related depreciation expense.

Income (Loss) from Continuing Operations

Income from continuing operations for the six months ended June 30, 2008 was $154,801. Compared to the six months ended June 30, 2007 income of $309,811, this represents a decrease of $155,010. This is primarily due to the consolidation of the New Lincoln Lodge and higher Other Operating Expenses..

Other Income and Expense

For the six months ended June 30, 2008 compared to the six months ended June 30, 2007, interest income decreased $19,080 as a result of less interest earned on bank accounts due to lower balances. Interest expense for the six months ended June 30, 2008 compared to the six months ended June 30, 2007, increased $49,764 or 8.7% as a result of lower interest paid on our variable rate loans partially offset by New Lincoln Lodge's interest expense and the recognition of the balance of the unamortized financing costs associated with our 2002 financing of Community's Hearth of $106,000 which was a result of refinancing the related debt.

As a result of our acquisition of the New Lincoln Lodge, we recognized a gain of approximately $414,000 in June, 2008.

Summary

Loss from continuing operations before income taxes for the six months ended June 30, 2008 was $95,223 compared to a net loss of $326,517 for the six months ended June 30, 2007, a decrease of $231,294 or 71%. This is primarily the result of the gain we recognized upon our acquisition of the New Lincoln Lodge of approximately $414,000 partially offset by losses of approximately $509,000.
The loss is due to increased supply usage as a result of higher occupancy in our assisted living facilities, inflationary increases in supply costs, therapy services, pharmacy supplies provided to residents of our skilled nursing centers and monthly expenses for our financial advisors. Additionally, the losses were the result of the recognition of unamortized financing costs associated with our 2002 financing of Community's Hearth & Home of approximately $106,000. Increased revenue was not enough to offset the increased expenses.

Income tax expense of $21,284 recognized for six months ended June 30, 2008 is related to the amortization of purchased goodwill under Internal Revenue Code section 197.

Net loss for the six months ended June 30, 2008, was $116,507 compared to a net loss for the six months ended June 30, 2007, of $347,657.

As a newer public company, we have incurred legal, accounting and other expenses that we did not incur as a private company related to the Securities Exchange Commission's reporting requirements under the Securities Exchange Act of 1934, as amended, and compliance with the various provisions of the Sarbanes-Oxley Act of 2002. In addition, there are increased expenses for investor relations, legal and board activities that we did not have before becoming a public company.

We have obtained directors and officer's liability insurance and key man life insurance which we did not have in the past and as a result we have incurred additional costs. We expect to fund these additional costs using cash flows from expanded operations and financing activities and additional indebtedness such as a new line of credit.

Overview

We had negative net working capital as of June 30, 2008 of approximately $899,000 as compared to negative net working capital of approximately $1,167,000 for the year ended December 31, 2007, an improvement of approximately $268,000.
Our negative net working capital is the result of our forward purchase contract which matures in October, 2008.

We have a forward purchase contract to acquire the outstanding limited liability company interest in Hearth & Home of Van Wert by October 2008. The fair value of this contract is $900,000 as of December 31, 2007. If the partners of the subsidiary accept the offer, we plan to satisfy this contract with proceeds from refinancing our Hearth & Care of Greenfield property which will return cash to the Company that was invested to complete the construction and remodel project.
On July 29, 2008, the refinance of the Hearth & Care of Greenfield property was completed and consequently the company received approximately $800,000 in cash.

During the fourth quarter 2006, the Company terminated the contract of a construction firm that had been engaged to complete renovations on its nursing facility, Hearth & Care of Greenfield. Subsequently, the contractor filed a claim against the Company alleging damages of approximately $376,000. The claims filed by the contractor and some of the subcontractors have been released with the exception of two subcontractors with claims of approximately $27,000.
We believe the claims are without merit and intend to continue to vigorously defend our position and, in our opinion, the likelihood of a material adverse outcome is remote. Accordingly, adjustments, if any that might result from the resolution of this matter, have not been reflected in the financial statements.
Other subcontractors and materialmen may assert similar claims but have not yet done so, also the contractor has contractually assumed responsibility for any additional claims as yet unasserted.

We currently do not have a line of credit available from any banks to assist with cash flow. We are currently working with lenders to secure a line of credit but we have not received firm commitments in this regard. We anticipate that our cash flow from our subsidiaries will continue to be sufficient to fund their operating cash needs. We have established a $150,000 line of credit using funds from our non-qualified deferred compensation plan. Members of this plan, which is only available to a select group of senior management, authorized the transfer of funds to establish the line of credit with interest accruing at 8%.
As of June 30, 2008, all $150,000 was available for use by the Company.

We plan to 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 GCC Capital Group and Prospect Financial Advisors to assist the Company in identifying, evaluating and securing alternative capital, financing and investment sources to fund the Company's strategic business plan.

Notes Payable and Other Debt

Our debt instruments contain various financial covenants and other restrictions including requirements for the following: minimum income and cash flow, debt service coverage, tangible net worth and working capital requirements. Many of these debt instruments also contain cross default provisions and limitations on the amount of additional debt we can raise. We were not in compliance with loan covenants on the following loans at December 31, 2007:

In connection with the financing and loan agreement used to re-finance two assisted living properties located in Springfield, Ohio and one in Urbana, Ohio, the properties are required on an annual basis to maintain a minimum tangible net worth which shall be increased each year by the cumulative net earnings of the properties and maintain a debt service coverage ratio of at least 1.4. On June 26, 2008, this loan agreement was refinanced.

Cash Flow

Our cash requirements are satisfied primarily with cash generated from operating activities and financing activities such as equity offerings and additional indebtedness. Our cash flow is dependent on our ability to collect accounts receivable in a timely manner. Accounts receivable collections in the health care industry can be very complex processes. 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 be long. On average, accounts receivable were outstanding nearly 35 days before collection as of June 30, 2008 and nearly 37 days as of December 31, 2007. The status of accounts receivable collections is monitored very closely by our senior management.

Net cash provided by operating activities for the six months ended June 30, 2008 was $57,803 consisting primarily of decreases in accounts receivable and prepaid expenses offset by reductions in accounts payable and accrued expenses and other liabilities.

Net cash used in investing activities for the six months ended June 30, 2008 was $223,660. This is a result of purchases of additional equipment.

Net cash provided by financing activities was $292,564 for the six months ended June 30, 2008. This is the result of cash released by our bank from restricted cash. On November 20, 2006, we entered into an agreement for the extension of the letter of credit for Community's Hearth & Home. The letter of credit was to expire on December 15, 2006. As an inducement to WesBanco to secure the extension, we were required to put on deposit with WesBanco $500,000 in an interest bearing account. The funds were held by WesBanco until a replacement letter of credit was secured. In September 2007, a replacement letter of credit was secured with The Huntington National Bank. Huntington also required a deposit to secure the letter of credit and increased the required deposit by $125,000 to $625,000. The terms of the letter of credit with Huntington required Huntington to release the deposit in increments of $125,000 once the properties achieve certain performance benchmarks. In March, 2008, The Huntington National Bank released $250,000. Their decision to release funds was based on the financial performance of Community's Hearth & Home and compliance with certain loan covenants. In June 2008, Huntington released the balance of the restricted cash held as security as a result of refinancing the Community's Hearth & Home note. This is somewhat offset by routine repayments on notes payable partially offset by prepaid financing as a result of the new loan for Community's Hearth & Home.

Six months ended June 30, 2007

For the six months ended June 30, 2007, cash flow used in operating activities consisted primarily of net operating losses. A decrease in accounts payable and accrued expenses was compounded by an increase in accounts receivable, prepaid expenses offset by non-cash expenses for depreciation and amortization and minority interest.

Cash used in investing activities was $569,895 for the six months ended June 30, 2007. This was the result of property and equipment additions.

Net cash used in financing activities was $54,726 for the six months ended June 30, 2007. This was primarily the result of routine repayments on notes payable offset by the amortization of bond issuance costs, proceeds from notes payable for additional equipment purchases and by cash received upon exercise of warrants.