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 approximately 850 beds.

We have an ownership interest in eight of the facilities we manage, comprised of 100% ownership of two skilled nursing facilities and two assisted living facilities, 99% ownership in one independent living facility as well as a 50% ownership in three assisted living facilities. We lease one additional skilled nursing facility. 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.

We focus on two primary indicators in evaluating the financial performance of our business. Those indicators are facility occupancy and staffing. Facility occupancy is important as higher occupancy generally leads to higher revenue.
According to the Ohio Health Care Association, average nursing home occupancy within Ohio was 88.6% for 2007. Over the past 10 years, occupancy has averaged 87.8% statewide according to the State of Ohio. Our nursing homes averaged 84.9% for 2008 and assisted living averaged 90.3%. For 2007 our nursing facilities averaged 84.4% and assisted living averaged 90.7%. Statewide averages are not published for assisted living facilities.

In recent years, we observed the trend that more seniors were staying in their homes for a longer period of time prior to moving into a long-term care setting.
We have also observed that more seniors are using nursing and assisted living facilities for short rehabilitation stays and then moving back to their homes.
We have taken advantage of this opportunity and expanded our operations to provide personal care and health care services in the home. Accordingly, in January, 2005, we acquired Assured Health Care, a home health care service provider located in Dayton, Ohio. Assured has been providing home health care services in the greater Dayton area for nearly 15 years.

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 51 unit senior living facility located in Columbus, Ohio.

During 2008, we completed refinancing three of our assisted living facilities and one skilled nursing facility. The new financings are long-term fixed interest rate non-recourse HUD insured loans.

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 skilled nursing facilities 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.

Management and Facility Based Care Segment

We have implemented changes at our skilled nursing facilities to improve occupancy and revenue. We have recently completed renovations at two facilities we own and one facility we lease with additional renovations planned during 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 year ended December 31, 2008, compared to the year ended December 31, 2007, overall occupancy in our skilled nursing centers increased .5% and occupancy in our assisted living centers decreased .4%.

Revenue in our management and facility based care segment increased approximately $1,657,000 or 7.5% as result of the acquisition of the New Lincoln Lodge along with increases in rates charged to our privately paying residents.
Net loss declined as result of the higher rates charged as well increases in Medicare covered residents. Total assets increased primarily as a result of the acquisition of the New Lincoln Lodge.

Home Based Care Segment

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 but increased profit margins. 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 have previously been satisfied by other home health agencies.

Revenue in our home based care segment decreased approximately $414,000 or 13%.
This is primarily the result of eliminating services to low margin payer sources. Net profit increased approximately $2,000 or 1% due to increasing services to primarily Medicare and commercial insurance covered patients offset by accrued expenses for income tax payable.

The table below shows the net income (loss) from both our management and facility-based care operation and our home based care operation for the years ended December 31, 2008 and 2007.

                                               (Amounts in 000s)
                        Manage-
                        ment and    Home              Discon-
                        Facility   Based     Total     tinued       Cor-
                       Based Care   Care   Segments  operations    porate         Total

 Year ended December 31, 2008:
   Net Revenue            23,782    2,804    26,586          -        (1,793)       24,793
   Net Profit (Loss)      (1,252)     176    (1,076)         -             -        (1,076)
   Total Assets           24,280    2,545    26,825          -             -        26,825
   Capital Spending          468        9       477          -             -           477

 Year ended December 31, 2007:
   Net Revenue            22,125   3,218    25,343                    -    (1,675)  23,668
   Net Profit (Loss)        (980)    174      (806)                 587         -     (219)
   Total Assets           22,134   2,357    24,491                    -         -   24,491
   Capital Spending        1,374       6     1,380                    -         -    1,380

               Year Ended December 31, 2008 and December 31, 2007

Revenue

Approximately 93% of our revenue is derived from patient care services provided
by our skilled nursing facilities, assisted living facilities and home health
agency.  The following table compares revenue for the years ended December 31,
2008 and 2007:

                                       December      December                 %  Change
                                       31, 2008      31, 2007      Increase
Patient care revenue                  $23,008,754   $21,928,808    $1,079,946      4.9%
Management, consulting and
development fee revenue                 1,784,540     1,738,948        45,592      2.6%
                                      $24,793,294   $23,667,756    $1,125,538      4.8%

For the periods compared, patient care revenue increased $1,079,946 or 4.9%.
Average occupancy in our skilled nursing facilities and assisted living facilities was nearly unchanged from 2007 to 2008. Charges for private paying residents at our assisted living and skilled nursing facilities increased approximately 5% beginning January 1, 2008. Additionally, the number of residents covered by Medicare in our skilled nursing facilities have increased approximately 23% from 2007 to 2008 contributing significantly to our increased revenue. Home health revenue declined primarily as a result of reducing services provided to payers that are not profitable or only marginally profitable as well as overall lower visits being provided to other payers.
Payroll and related payroll costs were reduced accordingly to partially offset the reduced revenue. Additionally, patient care revenue increased due to the acquisition of the New Lincoln Lodge effective April 1, 2008 which resulted in an additional $466,000 in revenue for 2008. Management, consulting and development fee revenue increased $45,592 or 2.6% as a result of higher management fees charged to our managed only properties as a result of negotiated increases.

Operating Expenses

                                       December 31, 2008   December 31, 2007                   %
                                                                                Increase    Change
Payroll and related payroll costs           $15,649,862         $14,762,090      $887,772       6.0%
Other operating expenses                      8,248,157           7,746,505       501,652       6.5%
Depreciation and amortization                   882,900             847,440        35,460       4.2%
                                            $24,780,919         $23,356,035    $1,424,884       6.1%

Operating expenses for the year ended December 31, 2008 increased by approximately $1,425,000 or 6.1%. Payroll and related payroll costs for the year ended December 31, 2008 increased by approximately $888,000 or 6.0%. The acquisition of New Lincoln Lodge contributed approximately $175,000 to the increased 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. Additionally, we accrued approximately $162,000 in payroll expense related to the retirement benefits of our previous Chief Operating Officer who retired on September 30, 2008. Additionally, we incurred approximately $640,000 in non-cash expenses primarily related to the warrants approved by shareholders at our August 15, 2008, shareholder meeting and other share based compensation.

Other operating expenses increased approximately $500,000 or 6.5%. A number of factors contributed to this increase including approximately $105,000 in non-cash expenses related to warrants granted to our investment banker, approximately $161,000 due to inflationary increases in supplies at our assisted living centers, an increase in expenses at our skilled nursing facilities of approximately $36,000 as a result of the increased number of Medicare residents offset by lower supplies usage in our home health division of approximately $(27,000) as a result of fewer visits being provided and nearly $225,000 in expenses related to New Lincoln Lodge which was acquired in April, 2008.

Depreciation and amortization increased approximately $35,000 or 4.2% primarily due to depreciation expense related to the acquisition of the New Lincoln Lodge and related depreciation as well as the addition of other depreciable assets during the year.

Income from Operations

Income from continuing operations for the year ended December 31, 2008 was approximately $12,000 compared to approximately $312,000 for the year ended December 31, 2007, an decrease of approximately $300,000 or 96%. Total revenue grew by 4.8% from 2007 to 2008 ahead of growth in operating expenses of 4.2%.
Approximately $640,000 of operating expenses in 2008 was related to non-cash expenses for warrants with an additional $162,000 related to a one time charge for retirement expenses for our Chief Operating Officer.

Other Income and Expense

                                       December 31, 2008   December 31, 2007   (Decrease)/     %
                                                                                Increase    Change
Interest income                                 $23,287             $59,300      $(36,014)   (60.7)%
Interest expense, others                     (1,265,622)           (978,731)     (286,891)     29.3%
Interest expense, related parties               (36,446)            (66,432)       29,986    (45.1)%
Minority interest in earnings of
consolidated entities                           (57,919)            (94,811)       38,892    (38.9)%
Other income (expense)                            4,200             (37,014)       41,214   (111.3)%
                                            $(1,332,500)        $(1,117,688)    $(212,813)     19.0%

Interest income decreased approximately $36,000 or 60.7% for the year ended December 31, 2008, as a result of less interest earned on certificates of deposit. Interest expense for the year ended December 31, 2008 increased approximately $287,000 or 29.3%. Approximately $210,000 of this increase is due to the recognition of the balance of the unamortized financing costs associated with our Community's Hearth & Home properties and Hearth & Care of Greenfield.
Additionally, the acquisition of the New Lincoln Lodge in April, 2008, caused interest expense to increase approximately $100,000. These increases were partially offset by lower interest expense of approximately $35,000 on our variable rate loans.

Other expense for the year ended December 31, 2007 was approximately $37,000.
This is the result of recognizing as expense, costs that had been capitalized that were associated with the contemplated merger with Family Home Health Services. When the merger agreement was discontinued, the accumulated costs were immediately recognized as expense. For the year ended December 31, 2008, other income was $4,200 and was due to the lease of commercial space at the New Lincoln Lodge.

Summary

The loss from continuing operations for the year ended December 31, 2008 was approximately $1,076,000 compared to a loss from continuing operations of approximately $628,000 for the year ended December 31, 2007. The loss during 2008 was partially offset by recognizing a gain of approximately $414,000 related to our acquisition of the New Lincoln Lodge.

Income tax expense for the year ended December 31, 2008, of approximately $170,000 is related to the amortization of purchased goodwill under Internal Revenue Code section 197.

Income from discontinued operations was approximately $409,000 for the year ended December 31, 2007, as the result of recognizing a gain on the sale of assets in our discontinued operations during 2007.

Net loss for the years ended December 31, 2008 and 2007, was approximately $1,076,000 and $219,000 respectively.

                            Changes in Balance Sheet

The following table contains certain balance sheet items and their respective
change from 2007 to 2008.  For a complete balance sheet, please refer to page 29
of this 10-K.

                                                                           Increase/
                                      December 31, 2008 December 31, 2007  (Decrease)  % Change
Cash and cash equivalents                    $1,266,315          $926,625     $339,690    36.7%
Certificate of deposit, restricted                   $-          $209,637   $(209,637) (100.0)%
Advances and receivables from
affiliates, current                             $17,635           $27,558     $(9,923)  (36.0)%
Long-term care resident receivables,
net                                          $2,008,847        $2,115,364   $(106,517)   (5.0)%
Restricted cash                              $1,155,596          $973,975     $181,621    18.6%
Property and equipment                      $16,772,660       $14,425,868   $2,346,792    16.3%
Note receivable, net                                 $-          $221,413   $(221,413) (100.0)%
Accounts payable                             $1,009,002        $1,416,313   $(407,311)  (28.8)%
Accrued expenses                             $2,838,407        $2,060,222     $778,185    37.8%
Forward purchase contract                            $-          $900,000   $(900,000) (100.0)%

current portion                                 $34,626          $810,084   $(775,458)  (95.7)%
Other liabilities                              $299,314          $559,509   $(260,195)  (46.5)%
Income tax payable                             $170,007                $-     $170,007   100.0%

Cash increased approximately $340,000 primarily due to cash generated by operations. Please refer to the Cash Flow section of the Liquidity and Capital Resources section of this management discussion and analysis for a thorough discussion of cash.

Certificate of deposit, restricted, was eliminated in 2008 as a result of refinancing the loan for Hearth & Care of Greenfield. Once the loan was refinanced, the certificate of deposit was liquidated and the proceeds used to retire other debt.

Advances and receivables from affiliates, current, decreased approximately $9,900 due to an account receivable being written off against bad debt reserved for collection of the account. The account had been previously fully reserved for potential bad debt.

Long term care resident receivables decreased approximately $107,000 or 5% as a result of increased collections.

Restricted cash increased approximately $182,000 due to additional deposits made as a result of refinancing four of our properties with HUD during 2008 as well as interest earned and additional deposits to HUD reserves for replacements.

Property and equipment increased by approximately $2,347,000 primarily as a result of the acquisition of the New Lincoln Lodge.

Note receivable, net, decreased approximately $221,000 as a result of the acquisition of the New Lincoln Lodge. This note receivable was forgiven as partial consideration in the acquisition of the assets.

Accounts payable decreased by approximately $407,000 primarily as a result of improved cash flow at some of the properties and therefore improved ability to satisfy accounts payable requirements.

Accrued expenses increased approximately $778,000 or 37.8% primarily due to increased accruals at year end for invoices not yet received and due to the accrual of retirement benefits for our retiring Chief Operating Officer.

The Forward Purchase Contract was satisfied in November 2008 when we acquired the remaining partners interests in Hearth & Home of Van Wert giving us 100% ownership of the property.

Notes payable and other debt, net of current portion, increased approximately $4,160,000. The increase is due primarily to the acquisition of the New Lincoln Lodge. Additionally, increases are due to additional debt incurred in relation to the refinancing of four of our properties with HUD during 2008 as well as refinancing our notes payable, stockholder.

Notes payable, stockholder, net of current portion, decreased approximately $775,000 as a result of refinancing the majority of the debt with a traditional bank loan.

Other liabilities decreased approximately $260,000 primarily as a result of changes in market value associated with invested deferred compensation.

Income tax payable increased approximately $170,000 during 2008 in relation to the amortization of purchased goodwill under Internal Revenue Code section 197.

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. As of December 31, 2008, we have incurred increased expenses with respect to Sarbanes-Oxley Section 404 compliance. In addition, there are increased expenses for investor relations, legal, auditing 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 December 31, 2008 of approximately $540,000 as compared to negative net working capital of approximately $1,167,000 for the year ended December 31, 2007, a decrease of $627,000. The majority of the decrease in negative net working capital was the result of satisfying our commitment under the forward purchase contract, which matured in October, 2008, partially offset by increases in accrued expenses.

On November 14, 2008, we established a $100,000 line of credit with Huntington National Bank to assist with cash flow. As of December 31, 2008, approximately $97,000 was being used in operations of the Company.

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 senior management, authorized the transfer of funds to establish the line of credit with interest accruing at 8%. We withdrew $150,000 from a deferred employee compensation plan (see note 17 to the consolidated financial statements). We deposited the funds into an interest bearing savings account.
We intend to use the savings to fund temporary cash short falls. We repaid the withdrawn funds to the plan at the end of 2008 with interest that accrued at 8%.
In January, 2009, we reestablished the line of credit from the non-qualified deferred compensation plan with same terms as 2008. The funds are presently used in the operations of 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 GCC 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.

We discontinued the operations of Hearth & Home of Marion, a wholly owned subsidiary, in November, 2003, and entered a land installment contract in January, 2004, to sell the assets of Hearth & Home of Marion for $1,600,000. In early 2007, we agreed to reduce the price to $1,300,000. On September 6, 2007, we completed the disposition of assets held by Hearth & Home of Marion. The buyer was Concerned Citizens Against Violence Against Women, Inc., DBA Turning Point, a non-profit organization providing shelter and services to abused women.
The transaction resulted in recognizing a gain on the sale of approximately $619,000.

In November 2008, we completed the acquisition of Hearth & Home of Van Wert as required by our forward purchase contract to acquire the outstanding partnership interest in Hearth & Home of Van Wert by October 2008. The cost of acquiring the partners' interest was approximately $950,000 and was primarily satisfied with cash received at the closing of financing for Hearth & Care of Greenfield and with a note payable to the sellers of approximately $28,500 bearing interest of 5% due in November, 2010 a note payable to a seller of $112,500 that bears no interest but for which interest has been imputed at 5% resulting in a discount of approximately $8,400. Total notes payable to sellers is approximately $141,000.

Notes Payable and Other Debt

For the year ended December 31, 2008 and the year ended December 31, 2007, we had notes payable and other debt outstanding of $17,688,111 and $13,586,616, respectively with weighted average interest rates of 6.6% and 6.8%, respectively. Approximately 13% of our debt is now at a variable interest rate compared to approximately 50% in 2007 as a result of refinancing loans that were previously at a variable interest rate to fixed interest rate loans. We project a change of 1% in interest rates could result in a change in interest expense of approximately $23,000.

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 loan at December 31, 2007:

In connection with the financing and loan agreement used to re-finance an assisted living property located in Van Wert, Ohio, the property is required on an annual basis to maintain a minimum tangible net worth and such net worth shall not be less than 10% of total assets. As of December 31, 2007, the minimum requirement was $308,846 and the actual tangible net worth was $252,491.
Also, 10% of the total assets was $335,338 as compared to the actual tangible . . .