ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                RESULTS OF OPERATIONS.

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. We manage apartments, primarily for seniors, and develops and manages assisted living properties and independent living properties for seniors. All properties target low and moderate income residents.

In July 1996 we 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, we completed our initial public offering. On February 16, 1998, we formed a wholly-owned subsidiary, DSS Funding, Inc. ("DSSF"), a North Carolina corporation, for the purpose of securing permanent financing for the properties which we develop or acquire for third party owners. On July 22, 1998, we 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.

We 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.

We anticipate 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. We anticipate moderate growth in reimbursement income because of increases in salaries of site personnel and an increase in the number of complexes under management.

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 50 residents. It was completed in April 1998. On March 1, 2000 we began managing two 64 resident assisted living facilities located in Newport and Shelby, North Carolina.

We continue to develop and manage 60-unit assisted living residences and 30-unit independent senior housing residences with services. As of August 1, 2000, we manage five assisted living properties stabilized at greater than 90% occupancy, and three developed facilities: two in initial rent-up and one awaiting final licensure. Additionally, we control six 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.

We completed construction of our first 30-unit residence in March 2000, and we have another site scheduled for completion during the fall 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 majority of our revenues and profits.

We develop properties for third party owners. We recognize development fee income on the percentage of completion basis. Development costs are paid by us 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 our operating expenses 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 our 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 we expand, but we do not expect to increase the corporate staff significantly during the next several years.

Results of Operations

Three and Six Months Ended June 30, 2000 As Compared to the Three and Six Months Ended June 30, 1999

Income

Total income increased $320,718 to $3,077,778 for the six months ended June 30, 2000 from $2,757,060 for the six months ended June 30, 1999. Total income increased $336,910 to $1,548,552 for the three months ended June 30, 2000 from $1,211,642 for the three months ended June 30, 1999. The increase was the net effect of increases in management fees and reimbursement income and a decrease in development fees and other income.

Management Fees. Management fees increased $117,738 to $538,193 for the six months ended June 30, 2000 from $420,455 for the six months ended June 30, 1999. For the three months ended June 30, 2000, management fees increased $53,142 to $284,439 compared to $231,297 for the three months ended June 30, 1999. The increase was due primarily to the recognition of management fees on the two 60-unit assisted living facilities we developed, which commenced operations during the third quarter of 1999 and the management, which began in March 1, 2000, of two 64 resident assisted living facilities located in Newport and Shelby, North Carolina. We expect growth in fee income as the developed assisted living and independent living properties are completed and rented.

Reimbursement Income. Reimbursement income increased $869,542, to $1,673,543 for the six months ended June 30, 2000 from $804,001 for the six months ended June 30, 1999. Reimbursement income was $998,334 and $435,694 for the three months ended June 30, 2000 and 1999, respectively. 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 us that began accepting residents in June and July of 1999 and the two new 64 resident assisted living facilities mentioned above. We expect continued increases in reimbursement income as the number of properties under management increases.

Development Fees. Development fees decreased $482,473 to $803,859 for the six months ended June 30, 2000 from $1,286,332 for the six months ended June 30, 1999. Development fees were $210,509 for the three months ended June 30, 2000 compared to $386,705 for the three months ended June 30, 1999. The change is due to decreased development activities during the first six months of 2000. 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 we are currently developing. We expect development fee income to be cyclical, depending on the availability of both construction and permanent financing at reasonable rates.

Other Income. Other income decreased $184,089 to $62,183 for the six months ended June 30, 2000 from $246,272 for the six months ended June 30, 1999. Other income was $55,270 and $157,946 for the three months ended June 30, 2000 and 1999, respectively. Other income includes DSSF consulting fees and, for the six months ended June 30, 1999, home care fees. The decrease is due to a decrease in home care fees. On June 1, 1999, we sold the home care business to an independent home care provider. We expect consulting fees earned by DSSF to be cyclical, depending on the availability of permanent financing at reasonable rates.

Operating Expenses

Operating expenses increased $811,474 to $2,950,024 for the six months ended June 30, 2000 from $2,138,550 for the six months ended June 30, 1999. For the three months ended June 30, 2000 and 1999, operating expenses were $1,659,723 and $1,096,429, respectively. The increase is due to personnel related expenses and administrative expenses.

Personnel Related Expense. Personnel expense increased $774,900 to $2,465,581 for the six months ended June 30, 2000 from $1,690,681 for the six months ended June 30, 1999. Personnel expense was $1,392,329 for the three months ended June 30, 2000 compared to $873,063 for the three months ended June 30, 1999. The increase was the net effect of an increase in site related personnel expense of $869,542, 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. We expect increases in personnel expense in future periods depending upon increases in management and development activity.

Administrative and Other Expenses. Administrative and other expenses increased $48,942 to $457,088 for the six months ended June 30, 2000 from $408,146 for the six months ended June 30, 1999. For the three months ended June 30, 2000 and 1999, administrative and other expenses were $253,355 and $203,400, respectively. The increase was due to additional fees paid to professionals for corporate business. We expect 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.

Other Income and Expenses. We earned $236,766 and $28,227 in interest income during the six months ended June 30, 2000 and 1999, respectively and $115,678 compared to zero for the quarters ended June 30, 2000 and 1999. 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. We expect interest income in future periods from funds loaned to the owners of properties currently being developed to increase. Interest and other expenses was $24,039 for the six months ended June 30, 2000 compared to $3,548 for the same period of 1999. Interest expense will increase since we obtained a three year loan from a bank in April of 2000.

Net Income (Loss) before cumulative effect of change in accounting for development related costs. The net income (loss) before the cumulative effect decreased $302,708 to $340,481 for the six months ended June 30, 2000 from $643,189 for the six months ended June 30, 1999. For the three months ended June 30, 2000 and 1999, net income (loss) before cumulative effect of change in accounting for development related costs was a loss of $11,099 and income of $111,665, respectively. 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 (Loss). The net income increased $25,858 to $340,481 for the six months ended June 30, 2000 from $314,623 for the six months ended June 30, 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. For the three months ended June 30, 2000 and 1999, the net loss was $11,099 and net income was $111,665, respectively.

Preferred Stock Dividends. During 1999, we 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 $207,300 for the six months ended June 30, 2000 compared to $57,205 for the six months ended June 30, 1999.

Net Income (Loss) Available to Common Shareholders. The net income available to common shareholders decreased $124,237 ($.04 per share) to $133,181 ($.04 per share) for the six months ended June 30, 2000 from $257,418 ($.08 per share) for the six months ended June 30, 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. For the three months ended June 30, 2000, the net loss available to common shareholders was $115,033 ($.03 per share) compared to net income of $54,460 ($.02 per share) for the three months ended June 30, 1999. We expect to operate near break even until properties currently being developed are completed and reach stabilized occupancy.

Financial Condition

June 30, 2000 As Compared to December 31, 1999

We had current assets of $1,195,789 on June 30, 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 increased to $137,923 at June 30, 2000 compared to $86,893 at December 31, 1999 due primarily to the increase of DSSF income during the second quarter of 2000. We expect receivables to increase as we increase management of apartment units and assisted living residences. Prepaid expenses and other increased from $120,109 at December 31, 1999 to $156,675 at June 30, 2000 due primarily to the payment of certain operating expenses during the six months ended June 30, 2000 that will be charged to expense as the related services are performed.

Development costs decreased to $449,694 at June 30, 2000 from $606,911 at December 31, 1999. The decrease is due to reimbursements of development costs previously advanced by us. During the initial stages of development, we advance funds for, and capitalize 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 $4,317,404 at June 30, 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 us 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.

We 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 June 30, 2000, accounts receivables from properties were $1,114,270 as compared to $687,159 at December 31, 1999 and notes receivable-properties increased to $2,758,335 at June 30, 2000 from $1,760,115 at December 31, 1999.

Accounts receivable-affiliates increased to $712,379 at June 30, 2000 from $669,507 at December 31, 1999. The increase is due primarily to our advances made to an affiliate for operations at the Virginia facility.

Accounts payable-affiliates decreased to $601,446 at June 30, 2000 from $760,246 at December 31, 1999 due to our repayments to Taylor House for advances associated with properties currently being developed.

Total liabilities increased $891,254 to $2,432,700 at June 30, 2000 from $1,541,446 at December 31, 1999 due primarily to the bank loan we obtained in May, 2000 offset by the decrease in accounts payable-affiliates, as mentioned above. 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 $8,794,357 at June 30, 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 $207,300 and the decrease in accumulated deficit due to the net income of $340,481. As discussed previously, during the first quarter of 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, we operate, and expect to continue to operate, on a negative cash flow from operations due to start-up expenses and lengths of the development cycles. Currently, our 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.

During the second quarter of 2000, we obtained 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. We anticipate 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. We currently have several sources of potential funding and do not anticipate that liquidity demands will not be met. However, there can be no assurance that we will be able to obtain financing on a favorable or timely basis. The type, timing and terms of financing selected by us will depend on its cash needs, the availability of other financing sources and the prevailing conditions in the financial markets.

We are the guarantor on the construction loans for two 30-unit properties, one under construction and one in rent-up. Both are owned by Taylor House.

Inflation and Interest Rates

Inflation has had minimal impact on our daily operations. 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, we expect the reimbursement to keep pace with inflation.

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

Year 2000

All computer programs currently in use by us 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. We adopted our Stock Incentive Plan effective January 1, 1997. During 1998, we 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 June 30, 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 our 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 we do not undertake any responsibility to update any of these statements in the future.