Well, it is certainly not the amount of files on your empeg. (I have a little bit more, ok a lot, and DSv1.1 worked for me)
Just to be clear, you are running player image version 1.03 developer, and DisplayServer 2b2 ??
I am having a funny feeling that DS2 was built for the 2.x series of empeg images, Frank can tell us more, but he seems to have returned to his homeworld for a while, so he is unavailable for comment. Perhaps try displayserver v1.1 ?? I know for a fact that it works, the install is relativly simple, and it works. The custom html stuff doesnt work, as that is a DS2 implementation. But for simple m3u streaming, use DS1.1

For the record, I did use Empeg Dev Image 1.03 and DSv1.1 ever since Dec/Jan 2000/2001, and have only recently upped to the 2.07Beta, hence losing DSv1.1
I have tried DS2, but well, we all know that emplode will not accept a mock *.mp3 file anymore, and untarring the archive reveals far too many files to upload (SecureCRT will do this nicely however). So I am still using DSv1.1 with the 2.07 Beta, which for me seems to be rock solid, so hopefully we will be going gold soon.

Oops, after re-reading the whole thread, I think what is happening is that DS is trying to generate the html pages, and is sort of puking at its size. This did happen to me, and I am going to list a few things that I checked and fixed to resolve this.
#1 Chache size, seems like you have already done this
#2 Check to make sure that DS put the drives back in ro, and check the init script to make sure it is trying to mount the proper partitions, there was an issue with this when Frank first published DS, he only had a single drive empeg, ad others with dual drives were having all sorts of funky issues, spreading across every conceivable problem. Turns out, Frank's mount/init script didnt have the proper partitions mounted for dual drives, so that caused a lot of grief. Also he estimated the numerical convention of partition names/numbers into his mount/init script, and empeg didnt follow natural convention (or did and we didnt, whatever)
#3 See it DS is launching it's process on every reboot, not a big deal since it hardly uses much memory (we would all like it to use more, but the greedy player likes ram, perhaps mlord and his hijack tweak can help Frank with the memory issues)
But it seems that if its in the startup script, it has a better chance of grabbing memory before the player software does. And if ds pukes, simply reboot the player.

This one isnt much of a fix, but in the root/parent playlist folder, I have about 5-8 choices; Artist, Genre, Mood, Party, etc. Then below that level it goes crazy, especially in the Artists playlist as all artists are in there, rather than in Segmented sections, A-D, E-H, etc.
However, even when I pop into the artists playlist, it does take a whole while to display the whole html page, and displayserver usually does output some sort of puke on the serial line.
But I usually dont give it much notice, as even if ds really does die, it seems that fids still fall out the ethernet port.

My thoughts, not yours. Please excuse the incoherent ramblings of an overworked man.