The discussion and analysis below should be read in conjunction with the Interim Financial Statements of Diversified and Notes appearing elsewhere in this report and the Form 10-KSB for the year ended December 31, 1999 as filed with the Securities and Exchange Commission.

Overview

Diversified Senior Services, Inc. (“Diversified”) was formed in May 1996 as a wholly owned subsidiary of Taylor House Enterprises, Limited (“Taylor House”) and began operations in July 1996. Diversified manages apartments, primarily for seniors, and develops and manages assisted living properties and develops and independent living properties for seniors. All properties target low and moderate income residents.

In July 1996 Diversified acquired Residential Properties Management, Inc. (“RPM”), a wholly owned subsidiary of Taylor House. RPM was formed in March 1989 to manage government subsidized multi-family and elderly residential rental apartments. On January 14, 1998, Diversified completed its initial public offering. On February 16, 1998, Diversified formed a wholly-owned subsidiary, DSS Funding, Inc. (“DSSF”), a North Carolina corporation, for the purpose of securing permanent financing for the properties which Diversified develops or acquires for third party owners. On July 22, 1998, Diversified formed a wholly owned subsidiary, Diversified Senior Services of Virginia, Inc. (“DSSVA”), a Virginia corporation, for the purpose of developing and managing properties in Virginia.

Diversified, RPM and DSSF are incorporated in North Carolina, and DSSVA is incorporated in Virginia and, as C corporations, file federal income tax returns as part of a consolidated group. Diversified, RPM, DSSF and DSSVA file separate state returns since state income tax regulations do not permit filing consolidated returns.

Diversified began offering home care services in August 1996 at selected apartment locations. We sold the home care business effective June 1, 1999 to an independent home care provider to execute a strategy to expand the availability of services to its managed properties.

Diversified anticipates growth in income from a moderate increase in the number of residential units managed and from inflationary effects on rent and service fees. All personnel located at the residences are our employees. However, we are reimbursed for the services of site personnel. Diversified anticipates moderate growth in reimbursement income because of increases in salaries of site personnel and an increase in the number of complexes under management.

Diversified continues to develop 60-unit assisted living residences and 30-unit independent senior housing residences with services. As of May 5, 2000, Diversified has two assisted living properties stabilized at greater than 90% occupancy, one in final rent-up, one in initial rent-up, two nearing the completion of construction, and controls six additional sites approved under North Carolina's moratorium on new assisted living facilities. The construction process is estimated to be nine to twelve months for each 60-unit assisted living residence.

Our first two 60-unit assisted living facilities commenced operations in June and July, 1999. We also began managing an assisted living property for an affiliated owner in October 1998. The property, located in South Boston, Virginia, is licensed for up to 64 residents but currently configured for 43 residents. It was completed in April 1998. On March 1, 2000 Diversified began managing two 64 resident assisted living facilities located in Newport and Shelby, North Carolina.

We completed construction of our first 30-unit residence in March 2000, and we have another site scheduled for completion during the summer of 2000. There are two sites ready to begin construction and an additional site we control, all of which have positive feasibility. All sites are in North Carolina.

Upon completion of these 60-unit and 30-unit residences, we will begin to recognize management fee income from the properties. Our development and construction pace depends upon our success in obtaining construction and permanent financing. There can be no assurance that we will obtain financing on a regular or timely schedule. If alternative financing cannot be arranged on acceptable terms, we may not be able to produce a pipeline of developed properties on a regular basis. We believe that in the future the development and management of assisted living facilities and residences for the elderly will provide the vast majority of Diversified's revenues and profits.

Diversified develops properties for third party owners. Diversified recognizes development fee income on the percentage of completion basis. Development costs are paid by Diversified as incurred and are reimbursed by the purchaser when the property is sold. If a site is abandoned, all development costs associated with that property are written off.

Most of the operating expenses of Diversified are related to the personnel directly performing the management services and the corporate management staff. Between 75% and 85% of the expenses are for salaries, benefits and payroll taxes. The remaining expenses are primarily administrative expenses such as travel, rent, telephone and office expenses that support the activities of the personnel. Since Diversified's inception, the operating staff increases have been due to the addition of properties under management. However, the corporate staff has grown over that same period of time because of the need to have adequate personnel in place to support the development effort. We expect that expenses associated with operating personnel will continue to increase significantly as Diversified expands, but we do not expect to increase the corporate staff significantly during the next several years.

Results of Operations

Three Months Ended March 31, 2000 As Compared to the Three Months Ended March 31, 1999

Income

Total income decreased $16,192 to $1,529,226 for the three months ended March 31, 2000 from $1,545,418 for the three months ended March 31, 1999. The slight decrease was the net effect of a decrease in development fees and increases in management fees and reimbursement income.

Management Fees.   Management fees increased $64,596 to $253,754 for the three months ended March 31, 2000 from $189,158 for the three months ended March 31, 1999. The increase was due primarily to the recognition of management fees on the two 60-unit assisted living facilities developed by Diversified, which commenced operations during the third quarter of 1999, and beginning March 1, 2000, the management of two 64 resident assisted living facilities located in Newport and Shelby, North Carolina. Diversified expects growth in fee income as the developed assisted living and independent living properties are completed and rented.

Reimbursement Income.   Reimbursement income increased $306,902, to $675,209 for the three months ended March 31, 2000 from $368,307 for the three months ended March 31, 1999. The increase was the result of income received from the properties for personnel hired to manage the two 60-unit assisted living facilities developed by Diversified that began accepting residents in June and July of 1999 and the two new 64 resident assisted living facilities mentioned above. Diversified expects continued increases in reimbursement income as the number of properties under management increases.

Development Fees.   Development fees decreased $306,277 to $593,350 for the three months ended March 31, 2000 from $899,627 for the three months ended March 31, 1999 as a result of decreased development activities during the first quarter of 2000. Since development fee income is recognized on a percentage of completion basis on the 60-unit assisted living facilities and the 30-unit independent senior housing residences currently being developed by Diversified. Diversified expects development fee income to be cyclical, depending on the availability of both construction and permanent financing at reasonable rates.

Other Income.   Other income decreased $81,413 to $6,913 for the three months ended March 31, 2000 from $88,326 for the three months ended March 31, 1999. Other income includes DSSF consulting fees and, for the three months ended March 31, 1999, home care fees. The decrease is due to a decrease in home care fees. On June 1, 1999, Diversified sold the home care business to an independent home care provider. Diversified expects consulting fees earned by DSSF to be cyclical, just as development fee income mentioned above.

Operating Expenses

Operating expenses increased $248,180 to $1,290,301 for the three months ended March 31, 2000 from $1,042,121 for the three months ended March 31, 1999. The increase is due to personnel related expenses.

Personnel Related Expense.   Personnel expense increased $255,634 to $1,073,252 for the three months ended March 31, 2000 from $817,618 for the three months ended March 31, 1999. The increase was the net effect of an increase in site related personnel expense of $306,902, as mentioned above in reimbursement income, offset by a decrease in personnel expense related to the home care business which was sold on June 1, 1999. Diversified expects increases in personnel expense in future periods depending upon increases in management and development activity.

Administrative and Other Expenses.   Administrative and other expenses decreased $1,013 to $203,733 for the three months ended March 31, 2000 from $204,746 for the three months ended March 31, 1999. Diversified expects increases in administrative expenses as the number of assisted living and independent senior housing properties managed increases for support of direct management of the properties, but only minor increases attributable to corporate management of Diversified.

Other Income and Expenses.   Diversified earned $121,088 and $28,227 in interest income from the investment of cash and cash equivalents and interest on funds loaned to the owners of properties being developed during the three months ended March 31, 2000 and 1999, respectively. The increase is the net effect of an increase in interest on funds loaned to properties and a decrease in the amount of funds held for development at March 31, 2000 as compared to March 31, 1999. Diversified expects interest income in future periods from funds loaned to the owners of properties currently being developed.

Net Income before cumulative effect of change in accounting for development related costs.   The net income before the cumulative effect decreased $179,944 to $351,580 for the three months ended March 31, 2000 from $531,524 for the three months ended March 31, 1999. The decrease was the net effect of a decrease in operating income and an increase in interest income.

Cumulative effect of change in accounting for development related costs. The change in accounting policy resulted in the write off of salaries and administrative and other expenses in the amount of $328,566 capitalized in development costs at January 1, 1999.

Net Income.   The net income increased $148,622 to $351,580 for the three months ended March 31, 2000 from $202,958 for the three months ended March 31, 1999. The increase was due to the net effect of a decrease in operating income, an increase in interest income and the cumulative effect of change in accounting for development related costs at January 1, 1999.

Preferred Stock Dividends.   During 1999, Diversified issued 2,225 shares of 12% Series B Cumulative Convertible Preferred Stock with no par value per share and a stated value of $2,000 per share. The Stock pays a 12% dividend semiannually and has a liquidation preference superior to all stock, common or preferred, currently issued and outstanding. During the first quarter of 2000, 497 shares were converted to 442,222 shares of common stock. Preferred stock dividends were $103,366 for the three months ended March 31, 2000.

Net Income Available to Common Shareholders.   The net income available to common shareholders increased $45,256 ($.01 per share) to $248,214 ($.07 per share) for the three months ended March 31, 2000 from $202,958 ($.06 per share) for the three months ended March 31, 1999. The increase was due to the net effect of a decrease in operating income and an increase in interest income, offset by the cumulative effect of the change in accounting policy and the preferred stock dividends. Diversified expects to break even until properties currently being developed are completed and reach stabilized occupancy.

Financial Condition

March 31, 2000 As Compared to December 31, 1999

     Diversified had current assets of $714,059 on March 31, 2000 and $1,941,355 on December 31, 1999. The primary current asset on December 31, 1999 was development fees and costs due from affiliates of $1,235,650. This amount was collected during the first quarter of 2000. Accounts receivable-trade decreased to $79,462 at March 31, 2000 compared to $86,893 at December 31, 1999 due primarily to the termination of the home care business in 1999. Diversified expects receivables to increase as Diversified increases management of apartment units and assisted living residences. Prepaid expenses and other increased from $120,109 at December 31, 1999 to $163,794 at March 31, 2000 due primarily to the payment of certain operating expenses during the three months ended March 31, 2000 that will be charged to expense as the related services are performed.

Development costs decreased to $440,024 at March 31, 2000 from $606,911 at December 31, 1999. The decrease is due to reimbursements of development costs previously advanced by Diversified. During the initial stages of development, Diversified advances funds for, and capitalizes certain development costs. When development fee income is recognized on a certain property, that property's associated development costs become receivable from either Taylor House, on a temporary basis, or from the permanent owner. Development costs are either recouped with the successful completion of a property or written off if a site is abandoned.

Development fees and costs due from properties currently held by Taylor House increased to $4,145,445 at March 31, 2000 from $3,917,140 at December 31, 1999. The increase reflects the ongoing development of properties and the related recognition of development fees by Diversified as the properties near completion. Development fees and costs are collected at permanent financing or from operations of the property after stabilized occupancy depending upon the type and amount of permanent financing.

The Company completed the permanent financing on four 60-unit facilities in June and July of 1999 and one 60-unit facility in February of 2000. As part of the transactions, the ownership of those facilities transferred from Taylor House to a third party, not-for-profit organization. As a result of the transfers of properties from Taylor House to third parties, receivables previously recorded in development fees and costs due from properties are reclassified to accounts receivable-properties and/or notes receivable-properties, as appropriate. At March 31, 2000, accounts receivables from properties were $786,100 as compared to $687,159 at December 31, 1999 and notes receivable-properties increased to $2,758,335 at March 31, 2000 from $1,760,115 at December 31, 1999.

Accounts receivable-affiliates increased to $712,826 at March 31, 2000 from $669,507 at December 31, 1999. The increase is due primarily to Diversified's advances made to an affiliate for operations at the Virginia facility.

Accounts payable-affiliates decreased to $596,194 at March 31, 2000 from $760,246 at December 31, 1999 due to Diversified's repayments to Taylor House for advances associated with properties currently being developed.

Total liabilities decreased $250,743 to $1,290,703 at March 31, 2000 from $1,541,446 at December 31, 1999 due primarily to the decrease in accounts payable-affiliates, as mentioned above and the payment of preferred dividends accrued at December 31, 1999. The deferred salaries of $191,823 are payable at the discretion of the employees and more than likely will not be paid from cash.

Shareholder's equity increased to $8,909,390 at March 31, 2000 from $8,661,176 at December 31, 1999. The increase was the net effect of a decrease due to the accrual of preferred dividends of $103,366 and the decrease in accumulated deficit due to the net income of $351,580. As discussed previously, during the three months ended March 31, 2000, 497 shares of Series B Cumulative Convertible Preferred Stock were converted to 442,222 shares of common stock. The conversion resulted in a decrease of $897,992 in preferred stock and an increase of $897,992 in common stock.

Liquidity and Capital Resources

Generally, Diversified has operated, and expects to continue to operate, on a negative cash flow from operations basis due to start-up expenses and lengths of the development cycles. Currently, Diversified's primary cash requirements include funding operating deficits and development expenses related to the development, construction and fill-up of 60 unit assisted living residences and 30 unit independent senior housing residences with services.

The net proceeds of the January 14, 1998 initial public offering were used to pay off the outstanding balance under the bank line of credit, to provide $3.5 million in development working capital for the assisted living and independent living projects and for general corporate purposes. The proceeds from the initial public offering designated for development were fully invested in assisted living and in dependent living properties by the end of the first quarter of 1999. The proceeds from the issuance of preferred stock during the second, third and fourth quarters of 1999 provided additional development working capital. Diversified has arranged for a $1 million, three year term loan from a bank that will be repaid primarily from the collection of notes receivable properties over the life of the loan. Diversified anticipates that the proceeds from the term loan, the collection of development fees and costs receivable, together with construction funds available for each facility, will be sufficient to complete the current development pipeline. Future development will require additional debt or equity financing. Diversified currently has several sources of potential funding and does not anticipate that liquidity demands will not be met. However, there can be no assurance that Diversified will be able to obtain financing on a favorable or timely basis. The type, timing and terms of financing selected by Diversified will depend on its cash needs, the availability of other financing sources and the prevailing conditions in the financial markets.

Diversified is the guarantor on the construction loans for the 30-unit properties currently under construction owned by Taylor House.

Inflation and Interest Rates

Inflation has had minimal impact on the daily operations of Diversified. Increases in salaries and administrative expenses have been offset by increases in management fees that are computed as a percentage of rent and resident service fees. Increases in resident service fees may lag behind inflation since the amount of the fee is based on a cost reimbursement by public sources. Except for the lag time, however, Diversified expects the reimbursement to keep pace with inflation.

Diversified's primary concern regarding inflation is interest rate fluctuations. High interest rates would increase the cost of building new facilities and could slow down Diversified's development plans.

Year 2000

All computer programs currently in use by Diversified have been upgraded to be Year 2000 compliant as part of normal updating expense. We have experienced minor problems with the software for filing Medicaid claims but the dollar amounts involved have not been material.

Certain Accounting Considerations

SFAS No. 123

In October 1995, FASB issued SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). SFAS No. 123 establishes financial accounting and reporting standards for stock-based employee compensation plans. Those plans include all arrangements by which employees receive shares of stock or other equity instruments of the employer or the employer incurs liabilities to employees in amounts based on the price of the employer's stock. Examples are stock purchase plans, stock options, restricted stock awards, and stock appreciation rights. This statement also applies to transactions in which an entity issues its equity instruments to acquire goods or services from non-employees. Those transactions must be accounted for, or at least disclosed in the case of stock options, based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. The accounting requirements of SFAS No. 123 are effective for financial statements for fiscal years beginning after December 15, 1995, or for an earlier fiscal year for which SFAS No. 123 is initially adopted for recognizing compensation cost. The statement permits a company to choose either a new fair value-based method or the current APB Opinion No. 25 intrinsic value-based method of accounting for its stock-based compensation arrangements. Diversified adopted its Stock Incentive Plan effective January 1, 1997. During 1998, Diversified granted 47,000 stock options at an exercise price ranging from $4.75 to $5.225, the market value of the shares at the date of grant. The stock options are 100% vested and have a five-year term. Warrants for 45,000 shares were issued with a four-year term, a one-year vesting schedule and exercise prices ranging from $6.00 to $9.00 per share. Warrants for 50,000 shares have a four-year term, one year vesting schedule and an exercise price of $6.75 per share. At March 31, 2000, a total of 142,000 stock options and warrants are outstanding, 1,400 common shares have been issued and 356,600 shares are available for granting.

Information Concerning Forward Looking Statements

With the exception of historical information (information relating to Diversifed's financial condition and results of operations at historical dates or for historical periods), the matters discussed herein contain “forward-looking statements” within the meaning of the Private Securities Litigation Act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “intend,” “project,” “will be,” “will likely continue,” “will result,” or words or phrases of similar meaning. Forward-looking statements involve risks and uncertainties, which may cause actual results to differ materially from the forward-looking statements. These forward-looking statements are based on management's expectations as of the date hereof, and Diversified does not undertake any responsibility to update any of these statements in the future.