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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2000

OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 0-31263

______________

VELOCITYHSI, INC.
(Exact name of registrant as specified in its charter)

Delaware 94-3360232
- ----------------------------------------- -------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

2175 N. California Blvd.
Suite 150
Walnut Creek, California 94596
- ----------------------------------------- -------------------------------------
(Address of principal executive offices) (Zip Code)

(925) 952-5600
---------------------------------------------------
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.01 par value
(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes X No_____
-------

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

At March 15, 2001, the aggregate market value of the registrant's shares of
common stock par value, $.01 per share, held by nonaffiliates of the registrant
was approximately $1,993,000. Shares of common stock held by each executive
officer and director and by each person who owns 5% or more of the outstanding
common stock have been excluded in that such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes. As of March 15, 2001, the
Registrant had 12,727,154 outstanding shares of common stock.

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DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the Annual Meeting of Shareholders of
VelocityHSI, Inc. to be filed within 120 days of December 31, 2000 (the "Proxy
Statement") are incorporated by reference in Part III of this report. In the
event that the Proxy Statement is not filed within the 120-day period, the Part
III information will be filed as an amendment to this Form 10-K no later than
the end of such 120-day period.

VELOCITYHSI, INC.

ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000

TABLE OF CONTENTS

Page No.
--------

Part I
Forward-Looking Statements 4
Preliminary Statement 4

ITEM 1: Business 6
ITEM 2: Properties 22
ITEM 3: Legal Proceedings 22
ITEM 4: Submission of Matters to a Vote of Security Holders 23

PART II
ITEM 5: Market for Registrant's Common Equity and Related
Shareholder Matters 24
ITEM 6: Selected Financial Data 26
ITEM 7: Management's Discussions and Analysis of Financial Condition
and Results of Operations 27
ITEM 7A: Quantitative and Qualitative Disclosures About Market Risk 32
ITEM 8: Financial Statements and Supplementary Data 32
ITEM 9: Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 32

PART III ITEM 10: Directors and Executive Officers of the Registrant 33
ITEM 11: Executive Compensation 33
ITEM 12: Security Ownership of Certain Beneficial Holders and Management 33
ITEM 13: Certain Relationships and Related Transactions 33

PART IV ITEM 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K 34

VELOCITYHSI, INC.

PART I

FORWARD-LOOKING STATEMENTS

This Form 10-K contains forward-looking statements that involve a number of
risks and uncertainties which may cause actual results to differ from those
expressed in such forward-looking statements. Forward-looking statements can be
identified by the use of forward-looking words such as "believes," "expects,"
"may," "will," "plan," "intends," "estimates," "could," "should," "would,"
"continue," "seeks," "pro forma" or "anticipates," or other similar words
(including their use in the negative), or by discussions of strategies, plans or
intentions. These statements include but are not limited to statements under
the captions "Additional Factors That May Affect Future Results" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" as well as other sections in this Form 10-K. A number of factors
could cause results to differ materially from those anticipated by the forward-
looking statements, including those discussed under "Preliminary Statement",
"Additional Factors That May Affect Future Results" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations." Our forward-
looking statements are dependent upon assumptions and estimates that may prove
to be incorrect. Although we believe that the assumptions and estimates
reflected in the forward-looking statements are reasonable, our plans,
intentions or expectations may not be achieved. The cautionary statements made
in this Form 10-K are intended to be applicable to all related forward-looking
statements wherever they may appear in this Form 10-K.

PRELIMINARY STATEMENT

VelocityHSI, Inc. ("we", "VelocityHSI" or the "Company"), a provider of
high-speed Internet access service to the multifamily industry, became a
publicly traded company when it was spun-off from BRE Properties, Inc., a real
estate investment trust ("BRE"), in August 2000. We commenced operations in
March 1999 with limited revenue generating activities conducted mainly on a
part-time basis by several employees of BRE. On January 1, 2000, BRE formed a
division with separate reporting and accounting from BRE's other activities. We
were formed as a Delaware corporation in April 2000. On August 7, 2000, BRE
entered into an agreement with VelocityHSI to provide up to $10 million in funds
through September 30, 2001 to finance our operating expenses and the costs of
installing equipment at properties not owned by BRE. BRE also agreed to provide
us with funds through September 30, 2001, without limitation on amount, to
finance the installation of our equipment at properties owned by BRE. We refer
to this credit commitment by BRE as the "BRE Line".

In December 2000, in response to adverse changes in the capital and credit
markets and our inability to obtain additional financing, we adopted a modified
business plan and as part of the plan, we laid off approximately 50% of our
workforce and announced the deferral of our efforts to expand service to other
apartment properties until such time as we were able to obtain additional
financing. In April 2001, we announced that we eliminated an additional eight
positions and that additional positions may be eliminated later in order to
further conserve capital.

As of December 31, 2000, BRE had extended $7,177,883, excluding accrued
interest of $92,493, under the BRE Line. BRE has included, as a reserve or a
deduction against available funds under the BRE Line, the future lease payments
of our corporate offices. In March 2001, BRE informed us that due to a possible
sublease for a significant portion of the office lease, the reserve for the
office lease would be reduced; however, BRE reserved additional amounts under
the BRE Line based on contracts entered into by BRE on behalf of VelocityHSI.
These contracts primarily consist of leases for equipment and office space
(other than the space subject to the possible sublease) and T-1 service
agreements. As a result of these new reserves, the remaining amount available
to us under the BRE Line as of March 15, 2001 was $695,372. BRE has indicated
that it does not intend to increase its level of committed funding beyond its
original commitment of the BRE Line. We currently have no external debt
facility or source of funds other than BRE. An analysis of the amount available
under the BRE Line follows (excludes accrued interest of $191,601, which accrues
separately from the BRE Line):

As of March 15,
2001
-------------

Basic amount $ 10,000,000
Additional amount available for cost
of installations at BRE owned communities 1,235,156
Reserve for BRE commitments (2,400,000)
Advances to March 15, 2001 (8,139,784)
-------------
Net available for future borrowing under the BRE
Line as of March 15, 2001 $ 695,372
=============

We have previously stated that in light of the available amount under the
BRE Line and our current lack of other funding sources, our cash will become
insufficient to permit continued operations beyond the second quarter of 2001
and possibly as early as May 1, 2001, although there can be no assurance in this
regard. In order to continue operations beyond that period, we will require an
additional, substantial capital infusion. The Company is also pursuing
negotiations with a third party that may result in a new investment in the
Company. If such investment is made, it would resolve issues in connection with
earlier arrangements between such party and the Company. Although the possible
funding arising from current negotiations would assist the Company to continue
operating while seeking strategic alternatives, the Company does not expect any
resulting funding to allow continued operations beyond the second quarter of
2001.

We are actively exploring strategic alternatives, which might include a
merger, asset sale, or another comparable transaction or a financial
restructuring. However, in the event we are unsuccessful in completing one of
these strategic alternatives, we will be required to cease operations during the
second quarter of 2001, and possibly as early as May 1, 2001. In that case, our
common stock is expected to have no value. In addition, potential investors in
our securities should consider the risk that, even if we are successful in
completing a strategic transaction as described above, our common stock may
nonetheless have no value. In addition, if we are able to complete a financing
through the issuance of equity, equity-linked or debt securities, those
securities may have rights, preferences or privileges senior to those of the
rights of our common stock and our stockholders will likely experience
significant dilution.

The accompanying financial statements have been prepared assuming that
VelocityHSI will continue as a going concern. However, the accompanying Report
of Independent Auditors states that we have experienced recurring losses from
operations and have a working capital deficiency which have adversely affected
our liquidity and that these conditions raise substantial doubt about our
ability to continue as a going concern. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.

Any person considering an investment in our securities is urged to consider
both the risk that we will cease operations during the second quarter of 2001,
and possibly as early as May 1, 2001, and the risk that our securities will be
worthless even assuming completion of a strategic transaction. All of the
statements set forth in this report are qualified by reference to those facts.
Please see "Item 1. Business --Additional Factors That May Affect Future
Results" and "Item 7. -- Management's Discussion and Analysis of Financial
Condition and Results of Operations" for a discussion of these and other risk
factors relating to us and an investment in our securities.

Item 1. BUSINESS

Corporate Profile

VelocityHSI provides high-speed Internet installation and access to the
multifamily apartment industry. Our customers are multifamily apartment property
owners and managers and their apartment unit residents and we offer them
services to meet their high-speed Internet communication and information needs.
We develop and install high-speed Internet connection systems for multifamily
apartment property owners and managers. Our systems deliver Internet access over
existing copper telephone wires at T-1 speed, a signaling speed of 1.5 megabits
per second, and allow property owners and managers to offer their residents
subscriptions to very fast Internet access through existing telephone lines. Our
systems are "always on" which allow our subscribers continuous connection to the
Internet eliminating busy signals or the additional time required to
periodically reconnect to the Internet inherent with the use of traditional
dial-up modems. We provide portable email, Web site hosting and local-area
networks, or LANs, with our Internet service provider, or ISP, service offered
on a monthly subscription basis giving individual subscribers unlimited, always-
on, high-speed Internet service which may be accessed by personal computers. We
offer portable email services, host subscribers' personal Web sites and create
local-area networks allowing file and printer sharing between multiple personal
computers within each apartment unit. We generate revenues through monthly
subscriptions to our ISP service.

As of December 31, 2000, VelocityHSI was installed in 40 apartment
communities with 11,424 apartment units. BRE owns 30 of these apartment
communities and the remaining 10 apartment communities are owned by entities in
which BRE is a minority partner. As of December 31, 2000, VelocityHSI had
approximately 2,300 service activations, approximately 2,200 of which are
revenue-generating subscribers and the balance of which are for leasing office
and demonstration purposes.

VelocityHSI commenced operations in March 1999 with limited revenue
generating activities conducted mainly on a part-time basis by several employees
of BRE. On January 1, 2000, BRE formed a division with accounting and reporting
separate and discrete from all of BRE's other activities and referred to as
"Project Velocity." In April 2000, BRE formed a Delaware corporation,
VelocityHSI, Inc., which had no assets or liabilities until August 7, 2000. On
August 7, 2000, the operations and assets of Project Velocity were transferred
to VelocityHSI in exchange for stock. Some employees of BRE then joined
VelocityHSI. On August 15, 2000, BRE distributed a portion of the shares
received from VelocityHSI to BRE common shareholders and retained the balance.
In addition, the holders of stock options in BRE received options in VelocityHSI
as an anti-dilution mechanism. In related issuances of securities, VelocityHSI
sold shares of its common stock subject to vesting requirements and forfeiture
provisions to seven of its officers, issued without consideration shares of its
common stock subject to vesting requirements and forfeiture provisions to six
employees of BRE, and offered to sell to the holders of units in BRE Property
Investors LLC other than BRE, one share of VelocityHSI common stock for each
five shares of BRE common stock issuable to the unit holder upon exchange of the
units held by the unit holder. On August 7, 2000, BRE entered into an agreement
with VelocityHSI to provide up to $10 million in funds through September 30,
2001 to finance its operating expenses and the costs of installing equipment at
properties not owned by BRE. As part of the BRE Line, BRE also agreed to provide
us with funds through September 30, 2001, without limitation on amount, to
finance the installation of our equipment at properties owned by BRE.

On December 15, 2000, due to general capital market conditions and our
inability to obtain additional financing, we announced modifications in our
business plan to defer efforts to install VelocityHSI service in new
communities, focusing only on the existing installed communities. Further, we
reduced our staffing by approximately 50% in order to conserve capital. Based
on our subscribership level and the belief that the subscriber level would not
increase through new communities, we included the personnel creating the
Company's subscriber interface or portal in the staff reduction. The portal was
intended to "capture" subscribers and generate additional revenue to us from
advertisers paying for the right to advertise on the portal, commonly known as
"banner ads", and revenue sharing arrangements with Internet companies, or
"click-thru" revenues. Because we have determined that we will not move forward
with the use of the portal, no income will be generated from this source. In
addition, we determined that plans to include services such as specialized
information to particular regions or communities or video content would no
longer be pursued. Separately, we determined that our planned use of non-PC
access devices, where a device other than a personal computer is used to access
the Internet, to increase subscriber penetration rates was not cost effective
and we terminated these plans.

behalf of VelocityHSI. These contracts primarily consist of leases for equipment
and office space (other than the space subject to the possible sublease) and T-1
service agreements. As a result of these new reserves , the amount available to
us under the BRE Line as of March 15, 2001 was $695,372. BRE has indicated that
it does not intend to increase its level of committed funding beyond its
original commitment under the BRE Line.

We have previously stated that in light of the available amount under the
BRE Line, our cash will become insufficient to permit continued operations
beyond the second quarter of 2001 and possibly as early as May 1, 2001, although
there can be no assurance in this regard. In order to continue operations beyond
that period, we will require an additional, substantial capital infusion. The
Company is also pursuing negotiations with a third party that may result in a
new investment in the Company. If such investment is made, it would resolve
issues in connection with earlier arrangements between such party and the
Company. Although the possible funding arising from current negotiations would
assist the Company to continue operating while seeking strategic alternatives,
the Company does not expect any resulting funding to allow continued operations
beyond the second quarter of 2001.

We are actively exploring strategic alternatives, which might include a
merger, asset sale, or another comparable transaction or a financial
restructuring. However, in the event we are unsuccessful in completing one of
these strategic alternatives, we will be required to cease operations during the
second quarter of 2001 and possibly as early as May 1, 2001. In that case, our
common stock is expected to have no value. In addition, potential investors in
our securities should consider the risk that, even if we are successful in
completing a strategic transaction as described above, our common stock may
nonetheless have no value. In addition, if we are able to complete a financing
through the issuance of equity, equity-linked or debt securities, those
securities may have rights, preferences or privileges senior to those of the
rights of our common stock and our stockholders will likely experience
significant dilution. See our discussion under the section entitled
"Preliminary Statement."

Competition

Over the last few years, DSL technologies, cable modems, T-1-based systems
and fixed-wireless connections have emerged as alternative technologies for
high-speed Internet access. As a result, we operate in a highly competitive
environment for each of our Internet services, which may become increasingly
competitive in the future. There exist companies that offer or are capable of
offering some or all of the services we provide, and new companies may enter
these markets. Many of these competitors are larger and more established
companies with significantly greater financial, technical and marketing
resources and deeper customer relationships. In addition, if we do not find
additional sources of funding, we will not be able to compete in our target
markets.

We face several major groups of competitors in the business of providing
high-speed Internet connectivity and networking services. We face direct
competition from companies that are focused specifically on servicing multi-
tenant properties with high-speed Internet access and networking services
although some of these companies are no longer providing high-speed service.
These include companies focused on the multifamily apartment sector, such as
Brix Communications Corp., Ntegrity Telecontent Services Incorporated and
BroadbandNOW, Inc., as well as companies focused on office properties, such as
Allied Riser Communications Corporation, Cypress Communications, Inc. and
BroadBand Office, Inc., which could extend their offerings to include apartment
communities. Many of these competitors have been in existence much longer and
have already gained significant market share and visibility, and they may be in
a better position to drive acceptance of their services.

In addition, we face competition from several other major groups in the
business of providing high-speed Internet connectivity and networking services,
although some of these companies are no longer providing high-speed service.
One such group consists of providers of DSL services, including incumbent and
competitive local exchange carriers, or CLECs, such as Pacific Bell Telephone
Company and SBC Communications, Inc.; established inter-exchange carriers such
as AT&T Corp., Sprint Corporation and MCI WorldCom, Inc.; and DSL infrastructure
providers such as Covad Communication Group Inc. and Rhythms NetConnections Inc.
In addition, we experience competition from local, regional and national ISPs,
such as PSINet Inc., EarthLink, Inc. and Internet America, Inc. which either
offer DSL service on their own networks or resell these services from the
providers listed above. We also face competition from established and emerging
cable television providers which offer high-speed connectivity through cable
modem service, such as Excite@Home and Road Runner and their respective cable
partners. Some companies have also developed the technology to efficiently offer
high-speed connectivity through fixed wireless technology such as WinStar
Communications, Inc. and Teligent, Inc. Other companies intend to launch high-
speed satellite services within the next several years, such as Spaceway, Loral
Cyberstar, iSKY and Teledesic LLC.

Many ISPs have partnered directly with high-speed network providers. These
include Excite@Home, which offers some of its service through the @HomeNetwork,
and America Online, which has gained a cable affiliate through its merger with
Time Warner. Many of the DSL network providers also partner directly with ISPs,
often offering their services through a variety of ISP partners. The ISP market
is highly competitive, and we believe simple Internet access services will
become commoditized over time. As a result of our current financial condition
and reduced staffing, many of our competitors are in a better financial and
market position from which to drive acceptance of their product. Accordingly,
our ability to compete successfully in this market will depend on our ability to
find substantial additional funding sources in order to compete against
providers that offer value-added services along with high-speed Internet access,
including Internet long-distance telephone service and video delivery
technologies.

Customer Service and Technical Support

We believe that customer service and technical support are extremely
important in retaining subscribers. Service and technical support are available
to subscribers from 7:00 a.m. to 12:00 midnight, Monday through Friday and 10:00
a.m. to 7:00 p.m. on Saturdays and Sundays. Our trained Help Desk team has
access to a historical database of similar issues and resolutions, problem areas
and service histories and to the necessary in-house resources, training, and
inventory to resolve problems.

Sales and Marketing

We market our service to multifamily apartment property owners and managers
and apartment community residents. We provide Internet connectivity to the
apartment communities' management office. We train, support and utilize
management and leasing professionals in our connected communities to market our
service to new and existing residents, using sales commissions and other
incentive programs to encourage active and productive marketing. We also
advertise our services in kiosks and model apartments in some of the apartment
communities during the normal course of the leasing presentation. Additionally,
we provide flexible service options offered to subscribers.

As of December 31, 2000, all of our subscribers were residents of apartment
communities either owned by BRE or owned by entities in which BRE is a minority
partner. We anticipate that residents of BRE owned apartment communities will
continue to remain our largest source of revenues through 2001.

Intellectual Property

Our success is dependent in part on recognition of our name. We previously
filed applications for federal registration for "VelocityHSI" and other
trademarks of VelocityHSI. However, as a result of our modified business plan
and current financial condition, we are not currently pursuing such
applications. Accordingly, we do not have trademark or servicemark protection
for VelocityHSI, and we do not currently plan to pursue such protection We
cannot assure you that the use of our name, "VelocityHSI", will be free from
legal challenges or we will have sufficient funds to withstand such challenges
or claims, regardless of merit. If we are unable to protect our name, it could
seriously affect our ability to market our services. In addition, legal
challenges to our proprietary rights could lead to a substantial diversion of
our limited resources.

The acquisition and maintenance of Web domain names generally in the past
was regulated by governmental agencies and their designees. In October of 1998,
the Internet Corporation for Assignment Names and Numbers ("ICANN") was
established as a not-for-profit corporation to oversee the domain-name
registration system on a worldwide basis. Following the establishment of ICANN,
ICANN accredited new registrars to compete with Network Solutions, Inc. (now
part of VeriSign), which had been designated by the National Science Foundation
to serve as the exclusive registrar for the ".com", ".net" and ".org" generic
top-level domains. In November of 2000, ICANN selected seven new top-level
domain proposals (".biz", ".info", ".name", ".pro", ".aero", ".coop" and
".museum") for negotiations toward appropriate agreements between ICANN and the
proposing registry operators and sponsoring organizations. ICANN may in the
future establish additional top-level domains, appoint additional domain name
registrars or modify the requirements for holding domain names. The regulation
of domain names in the United States and in foreign countries is subject to
change in the future.

From time to time, we may receive notice of claims of infringement of other
parties' proprietary rights, including claims for infringement resulting from
the downloading of materials by the online or Internet services we operate or
facilitate. There can be no assurance that infringement or invalidity claims (or
claims for indemnification resulting from infringement claims) will not be
asserted or prosecuted against us or that any assertions or prosecutions will
not materially affect our business, operating results and financial condition.
Irrespective of the validity or the successful assertion of such claims, we
would incur significant costs and diversion of

resources with respect to the defense thereof, which could have a material
adverse effect on our business, operating results and financial condition. If
any claims or actions are asserted against us, we may seek to obtain a license
under a third party's rights. There can be no assurance, however, that under
such circumstances a license would be available on commercially reasonable
terms, or at all.

Regulatory Matters

At the present time, Internet Service Providers ("ISPs") like the Company
are not subject to direct regulation by the Federal Communications Commission
("FCC") even though they provide Internet access through transmission over
public telephone lines. However, as the growth of the Internet industry
continues, there has been considerable discussion and debate about whether the
industry should be subjected to regulation. This regulation could include
universal service subsidies for local telephone services and enhanced
communications systems for schools, libraries and certain health care providers.
Local telephone companies could be allowed to charge ISPs for the use of their
local telephone network to originate calls, similar to charges currently
assessed on long distance telecommunications companies. In addition, many state
and local government officials have asserted the right or indicated a
willingness to impose taxes on Internet-related services and commerce, including
sales, use and excise taxes.

Employees

As of December 31, 2000, we had approximately 49 employees, of which 29
were full-time. None of the employees are covered by collective bargaining
agreements. In April 2001, we announced that we eliminated an additional eight
positions and that additional positions may be eliminated later in order to
further conserve capital.

FACTORS THAT MAY AFFECT FUTURE RESULTS

The following risk factors and other information included in this Annual
Report on Form 10-K should be carefully considered and should be read in
conjunction with the preliminary statement and financial statements and notes
thereto appearing elsewhere in this Annual Report on Form 10-K. The risks and
uncertainties described below are not the only ones we face. Additional risks
and uncertainties not presently known to us or that we currently deem immaterial
also may impair our business operations. If any of the following risks actually
occur, our business, operating results, and financial condition could be
materially negatively affected. In this section, "we" or "us" refers to
VelocityHSI and "you" refers to our stockholders.

We estimate that we will cease operations during the second quarter of 2001 and
possibly as early as May 1, 2001 unless we are successful in pursuing strategic
alternatives.

In light of the available amount under the BRE Line and our current lack of
other funding sources, our cash will become insufficient to permit continued
operations beyond the second quarter of 2001 and possibly as early as May 1,
2001, although there can be no assurance in this regard. In order to continue
operations beyond that period, we will require an additional, substantial
capital infusion. The Company is also pursuing negotiations with a third party
that may result in a new investment in the Company. If such investment is made,
it would resolve issues in connection with earlier arrangements between such
party and the Company. Although the possible funding arising from current
negotiations would assist the Company to continue operating while seeking
strategic alternatives, the Company does not expect any resulting funding to
allow continued operations beyond the second quarter of 2001.

We are actively exploring strategic alternatives, which might include a
merger, asset sale, or another comparable transaction or a financial
restructuring. However, in the event we are unsuccessful in completing one of
these strategic alternatives, we will be required to cease operations during the
second quarter of 2001, and perhaps as early as May 1, 2001. In that case, our
common stock is expected to have no value. In addition, potential investors in
our securities should consider the risk that, even if we are successful in
completing a strategic transaction as described above, our common stock may
nonetheless have no value. In addition, if we are able to complete a financing
through the issuance of equity, equity-linked or debt securities, those
securities may have rights, preferences or privileges senior to those of the
rights of our common stock and our stockholders will likely experience
significant dilution.

Any person considering an investment in any of our securities is urged to
consider both the risk that we will cease operations during the second quarter
of 2001, and possibly as early as May 1, 2001, and the risk that our securities
will be worthless even assuming completion of a strategic transaction.

As a result of questions concerning our status as a going concern, our vendors
may decide not to do business with us

Due to concerns regarding our ability to continue operations, vendors are
likely to decide not to conduct business with us, or may conduct business with
us on terms that are less favorable than those customarily extended by them. In
that event, our costs may increase or we may not be able to provide service to
customers and our business will suffer significantly.

Because we have a limited operating history, it is difficult to evaluate our
business. Even if we receive a substantial capital infusion to permit our
continued operations beyond the second quarter of 2001, we face various risks,
expenses and difficulties associated with early stage companies and may not be
able to manage our business successfully or achieve profitability.

The business referred to as VelocityHSI commenced operations in March 1999
with limited revenue generating activities conducted mainly on a part-time basis
by several BRE employees. On January 1, 2000, BRE formed a division with
accounting and reporting separate and discrete from all of BRE's other
activities and referred to this division as "Project Velocity." We were formed
as a Delaware corporation in April 2000. Even if we receive the substantial
additional capital necessary to continue operations beyond the second quarter of
2001, our prospects for financial and operational success must be considered in
light of the risks and challenges frequently encountered by early stage
companies in the Internet services industry that provide services to owners,
managers and residents of multifamily apartment communities.

In the event that we are able to continue operations beyond the second
quarter of 2001, the material risks and uncertainties related to our limited
operating history include risks that we may be unable to:

. expand our property owner and manager customer base beyond BRE, whose
properties account for 94% of our revenues in fiscal year 2000, which
would impair our ability to successfully develop our business;

. attract and retain new subscribers for our services and retain
existing subscribers, which is critical to our ability to achieve
profitability in the future, and if we cannot retain subscribers our
results of operations and business will be materially and adversely
affected;

. create and maintain relationships with technology and content
providers, which would impair our ability to compete with the dominant
companies in the Internet services industry;

. compete in the highly competitive Internet services industry, which
would adversely affect our business and results of operations and
impair our ability to obtain additional capital;

. introduce new services, which would impair our ability to attract and
retain subscribers;

. upgrade our technologies, systems and infrastructure and enhance our
service features, which would impair our ability to satisfy the
evolving Internet service needs of our subscribers; and

. minimize potential Internet service interruptions, which interruptions
could cause our subscribers to switch to a competing Internet service
provider.

Even if we receive a substantial capital infusion to permit our continued
operations beyond the second quarter of 2001, we will need a significant amount
of additional capital to meet our repayment obligations and ongoing capital
requirements. If we cannot obtain additional capital, our business and results
of operations will be materially and adversely affected and your shares of
VelocityHSI common stock will likely become worthless. In addition, we may only
be able to raise capital on terms that are not favorable to us economically or-
that may significantly dilute existing shareholders.

Even if we receive the significant capital infusion necessary to continue
operations beyond the second quarter of 2001, we will require additional capital
to meet our repayment obligations and ongoing capital requirements. In
addition, we must repay, on or before September 30, 2001, all of the funds
advanced to us by BRE under the BRE Line, including advances we use to reimburse
BRE for administration services, together with accrued interest on unpaid
balances at the rate of 9% per year. We currently have no external debt facility
or source of funds other than BRE. Accordingly, even if we are able to obtain
sufficient amounts of capital to continue our operations beyond the second
quarter of 2001, our ongoing capital requirements during the next 12 months will
be substantial and vary depending upon a number of additional factors,
including:

. the number of new apartment property owner customers and subscribers
engaged during that period which will determine the amount required
for the acquisition and installation of capital equipment;

. the extent of the changes and developments that may occur during that
period in available technology and user requirements and preferences
that will affect the amount we will be required to spend to develop
and maintain a competitive position in the industry; and

. the cost of attracting new apartment property owner customers and
subscribers.

Although we cannot predict with precision the amount required to fund
future operating expenses and capital expenditures, even if we are able to
obtain additional funding sufficient to permit our continued operations beyond
the second quarter of 2001, the funding required to successfully develop our
business and repay the BRE line at September 30, 2001 will likely substantially
exceed the amount of such funds. Consequently, we will be required to obtain
financing from additional sources in order to fund our expected operations both
during the next 12 months and thereafter, including the repayment on or before
September 30, 2001 of advances made by BRE. If we are unable to obtain
sufficient additional capital to repay the BRE Line prior to September 30, 2001,
our business would be materially and adversely affected and we will be unable to
continue our operations after that date, assuming our operations do not cease
earlier, likely causing our common stock to become worthless. In addition, even
if we raise additional capital, any transaction is likely to be highly dilutive
to existing shareholders, and if we incur additional debt, the lender may
subject us to restrictions which will impair our ability to successfully develop
our business.

Our need to preserve working capital has required us to reduce our expenditures
which will impair our ability to develop our business as we believe will be
required in order to manage our business successfully or achieve profitability.

Because we have not been able to obtain additional capital, we have been
forced to reduce our expenditures in order to preserve our working capital. This
reduction in expenditures has limited our ability to:

. hire and retain the technical personnel necessary to develop services;

. hire and retain the marketing personnel necessary to expand our
property owner customer base beyond BRE and attract new subscribers;

. acquire the equipment necessary to expand or maintain our business;

. respond effectively to competitive services; and

. hire necessary management personnel.

Even if we raise additional capital, it may not be sufficient to allow us
to make the necessary expenditures to develop our business in the manner that we
believe will be required in order to manage our business successfully or achieve
profitability.

Our quarterly performance may be difficult to forecast and our actual
performance may fluctuate.

Our quarterly revenues and operating results are difficult to forecast even
in the short term. Many of our expenses, such as depreciation, overhead, payroll
and T-1 Internet service costs, are fixed costs. If revenue is below
expectations in any given quarter,

the adverse impact of the shortfall on our operating results may be magnified by
our inability to adjust spending to compensate for the shortfall.

Our actual operating results may fluctuate significantly due to a variety
of factors, many of which are outside our control. The material factors that may
affect our operating results include:

. the speed with which third parties are able to deliver local and
national telecommunications circuits should we install new apartment
communities;

. the condition of the copper telephone wiring within an apartment
community and our ability to upgrade or maintain that wiring system;

. our ability to install our equipment and wiring in an apartment
community;

. our effectiveness in marketing our services to apartment property
owners and subscribers;

. the rate at which customers subscribe to our Internet services and the
price the market will bear for these services;

. our ability to retain our current and obtain and retain future
subscribers; and

. the overall market demand for e-commerce and broadband content and
applications in general.

Loss of BRE as a customer would have a material adverse effect on our financial
condition and results of operations.

As of December 31, 2000, approximately 1,900 of our subscribers were
residents of apartment communities owned by BRE and approximately 400 were
residents of communities owned by entities in which BRE is a minority partner.
During the fiscal year 2000, monthly subscriber fees from residents of BRE
communities comprised 94% of our revenues. In December 2000, in response to
adverse changes in the capital and credit markets and our inability to obtain
additional financing, we adopted a modified business plan and as part of the
plan, we laid off approximately 50% of our workforce and announced the deferral
of our efforts to expand service to other apartment properties until such time
as we were able to obtain additional financing. We have entered into only one
agreement with a property owner unrelated to BRE and, even if we are able to
continue our operations beyond the second quarter of 2001, we cannot assure you
that we will enter into agreements with other property owners. We anticipate
that residents of apartment communities owned by BRE will remain our largest
source of revenues at least through the end of the year 2001. BRE may terminate
its service agreement with us by providing us with a 30-day termination notice
at any time. The loss of BRE as a customer would have a material adverse effect
on our business, financial condition and results of operations.

Retention of our current and future subscribers is critical to our ability to
achieve profitability in the future. Even if we are able to continue operations
beyond the second quarter of 2001, if we cannot retain our subscribers, our
revenues and therefore our business will be materially and adversely affected.

We believe that our long-term success depends on our ability to retain our
existing subscribers, while continuing to attract and retain new subscribers.
Our sales, marketing and other costs of obtaining and providing service for
subscribers, including depreciation on equipment at the apartment community,
overhead, payroll, the installation at the subscriber's apartment unit and the
T-1 line to access the Internet, are substantial relative to the basic $35
monthly fee derived from most of our subscribers. There can be no assurance that
these expenditures will improve subscriber retention or improve our ability to
attract and retain new subscribers. Because the high-speed Internet services
market is new and changing rapidly, and the variety of available services is not
well understood by new and potential customers, it is difficult, if not
impossible for us to predict our ability to attract and retain future
subscribers. Moreover, a number of new Internet users experience the Internet
only as a novelty and do not become consistent users of Internet services. These
factors may adversely effect our subscriber retention rates. Our subscribers pay
for our Internet services on a monthly basis. Either the subscriber or
VelocityHSI can terminate our service upon 30 days notice. Our subscribers are
not required to sign written agreements obligating them to pay for our services
for any minimum length of time. If we cannot retain our current

subscribers or attract and retain new subscribers, our revenues and therefore
our business and results of operations will be materially and adversely
affected.

Attracting and retaining property owners and managers as customers is important
for our revenues. If we cannot retain property owners and managers, our revenues
and therefore our business will be materially and adversely affected.

The multifamily apartment property owners and managers that we expect to
have as customers will provide us access to their apartment properties so that
we may install the equipment necessary to deliver our services to the residents
in these apartment properties. Our installation costs for new properties are
substantial relative to the monthly subscriber service fee that can be derived
from subscribers at those properties. We have not in the past and do not
anticipate in the foreseeable future charging the property owner or the
subscriber for installation costs. In order to offset these installation costs,
we charge monthly subscriber fees for the Internet services that we provide. The
subscriber service fees that we expect to receive per apartment unit for most
apartment units we service is approximately $35 per subscriber per month and we
recognize this revenue as we collect from the subscribers. Our agreements with
property owners and managers will be generally short-term, non-exclusive
contracts which can be terminated by the property owner or manager on 30 days'
notice. If the property owner or manager cancels the contract after the initial
30-day period, we cannot recover the substantial capital cost of installing our
equipment and systems at their property. If we enter into an agreement with a
property owner or manager and install our equipment at the property, there is no
assurance that property residents will subscribe to our services. Our contracts
do not guarantee a percentage of subscribers at each property. Our long-term
success is dependent on our continuing relationship with the property owners and
managers on whose properties we have installed the equipment necessary to
deliver our services. If we cannot enter into and maintain agreements with
property owners and managers, our revenues and therefore our business will be
materially and adversely affected.

Our Internet service agreements with property owners or managers do not require
them to ensure specific subscriber levels, and their residents may choose not to
subscribe to our services. As a result we may be unable to derive revenues from
our agreements.

Property owners and managers do not provide a direct source of revenue to
us because our Internet service agreements with them do not require them to
ensure specific subscription levels for their residents. Therefore, even if we
enter into Internet service agreements with property owners or managers, we
cannot assure you that we will obtain revenues because the property residents
may choose not to subscribe to our Internet services. If we are unable to
attract and retain resident subscribers, currently our primary source of
revenue, our business and results of operations would suffer materially.

Even if we receive a significant capital infusion, our failure to manage the
necessary growth of our operations could harm our business.

Even if we obtain additional sources of funding sufficient to permit our
continued operations beyond the second quarter of 2001, our future performance
depends, in part, on the ability of our senior management to manage our growth
effectively. We anticipate that significant expansion of installation,
technical support, customer service and administrative personnel will be
required to increase our subscriber base to the extent necessary to achieve
profitability. We may not be able to implement management information and
control systems in an efficient and timely manner, and our current or planned
personnel, systems, procedures and controls may not be adequate to support
expanded operations. To manage the required growth of our operations and
personnel, we will be required to:

. train, motivate and manage our sales and marketing, technical and
customer support employees to develop and sell new services and
provide acceptable levels of customer service to attract and retain
subscribers, which is critical to our ability to achieve profitability
and improve our results of operations;

. improve existing and implement new operational, financial and
management controls, reporting systems and procedures; and

. install new management information systems, which are necessary for
our senior management to monitor our existing business while
attempting to expand our operations and personnel.

Consequently, even if we obtain significant amounts of additional funding,
if we are unable to manage growth effectively, our business and results of
operations will suffer.

The Internet service provider and consumer Web site markets are very
competitive. If we are unable to compete successfully, your shares may lose
value and may become worthless.

The Internet services market in which we operate is extremely competitive.
Although several of our competitors have stopped providing service during 2000
and the first quarter of 2001, our current and prospective competitors include
many large companies with substantially greater market presence and access to
capital and financial, technical, marketing and other resources than we have.

We do and will compete directly and indirectly with these dominant
companies in the following categories:

. local exchange carriers, or LECs, such as Pacific Bell Telephone
Company and SBC Communications, Inc.;

. inter-exchange carriers such as AT&T Corp., Sprint Corporation and MCI
WorldCom, Inc.;

. digital subscriber line infrastructure providers such as Covad
Communications Group Inc. and Rhythms NetConnections Inc.;

. local, regional and national Internet service providers which provide
DSL service, such as PSINet Inc., EarthLink, Inc. and Internet
America, Inc.;

. cable television providers which offer high-speed connectivity such as
Excite@Home and Road Runner, and their respective cable partners;

. fixed wireless and satellite companies such as WinStar Communications,
Inc., Teligent, Inc., Spaceway, Loral Cyberstar, iSKY, Inc. and
Teledesic LLC;

. Internet access and networking service providers focused primarily on
multifamily apartment properties and office properties, such as Brix
Communications Corp., Ntegrity Telecontent Services Incorporated,
BroadBandNOW, Inc., Allied Riser Communications Corporation, Cypress
Communications, Inc. and BroadBand Office, Inc.

We compete with these companies primarily on the basis of:

. operating performance and reliability;

. speed of Internet service;

. broadband capacity;

. scalability of our services; and

. price.

These competitors pose a risk to VelocityHSI because they have resources
that may allow them advantages based on their ability to:

. build high-speed Internet infrastructure more rapidly than we can;

. market to existing and future customers more readily than we can; and

. gain acceptance by property owners and individual subscribers more
readily than we can through the provision of related services (e.g.
telephone, cable, Internet service provider or portal services).

Competitors with substantial financial resources, established brands and
substantial marketing resources may offer content and services that are more
popular than the content and services we offer. Also, recent advances in
technology have lowered the barriers to entry for emerging participants.
Specifically, the ability to deliver high-speed Internet access over existing
copper telephone wires has allowed more entrants to compete directly with larger
digital subscriber line and cable modem providers. Even if we are able to obtain
the substantial additional funding that we need to continue operations beyond
the second quarter of 2001, we cannot assure you that we will have the financial
resources, technical expertise or marketing and support capabilities to compete
successfully with these competitors. If we are unable to do so, our business and
results of operations will be materially and adversely affected.

If we do not respond effectively and on a timely basis to rapid technological
change in our industry, we will not be able to sell our services and our revenue
will materially decline.

The Internet service provider industry is characterized by rapid change.
The speed of both the technological change and user requirements and preferences
creates rapid change in industry standards. These changing standards could
render our existing services and systems obsolete. Even if we are able to obtain
the substantial additional funding that we need to continue operations beyond
the second quarter of 2001, we must continually improve the performance,
features and reliability of our services, particularly in response to
competitive offerings in order to manage our business successfully.

Even if we are able to continue operations beyond the second quarter of
2001, over the long-term, our success will depend , in part, on our ability to
enhance our existing email and Internet services and to develop new services,
functionality and technology that address the increasingly sophisticated and
varied needs of our prospective subscribers. If we do not properly identify the
future preferences of prospective subscribers, or if we fail to deliver features
or content which meet the standards of these prospective customers, our ability
to market our services successfully and to increase our revenues could be
impaired.

The development and implementation of technology and necessary service
enhancements can entail significant technical and business risks and require
substantial expenditures and lead-time. As discussed in the section "Preliminary
Statement" we may not be able to continue operations without a significant
infusion of capital. If we do not locate a significant source of additional
funding, we will not be able to keep pace with the latest technological
developments. Even if we do obtain additional funds, we may not be able to use
new technologies effectively or adapt our services to customer requirements or
emerging industry standards. If we cannot adapt or respond in a cost-effective
and timely manner to changing market conditions or customer requirements, our
business and results of operations will be materially and adversely affected.

The future success of our business (should we be able to continue operations
beyond the second quarter of 2001) depends largely on the continued growth in
use of the Internet and the development of demand for our email and Web hosting
services. If the Internet does not continue to grow or demand for our email and
Web hosting services does not develop, our business would be materially and
adversely affected.

In the event that we are able to continue operations beyond the second
quarter of 2001, our future long-term success is substantially dependent on
continued growth in the use of the Internet by residents of multifamily
apartment communities. Rapid growth in the use of, and interest in, the Internet
is a recent phenomenon. There can be no assurance that Internet usage will
become more widespread by residents of multifamily apartment communities, that
extensive Internet content will continue to be developed or accessible at no or
nominal cost, or that there will be a demand for high-speed, always-on Internet
access. There can be no assurance that demand will develop for current or
possible expanded services.

The Internet may not prove to be viable for a number of reasons, including
potentially inadequate development of the necessary infrastructure or
performance improvements. If use of the Internet does not continue to grow, our
business and results of operations would be materially and adversely affected.
Conversely, to the extent that the Internet continues to experience significant
growth in the number of users and level of use, the Internet infrastructure may
not be able to support the demands placed on it by that growth and it may not
function properly or adequately thereby also materially and adversely affecting
the growth or use of the Internet.

If consumer oriented Web-based businesses are unable to raise adequate capital
or if these businesses implement cutbacks in expenditures, our business and
results of operations may be materially and adversely affected.

In the event that we are able to continue operations beyond the second
quarter of 2001, our future long-term success depends in part on the growth and
success of consumer-oriented Web-based businesses that provide varying forms of
content and electronic commerce. Many of these businesses have recently
experienced difficulties in implementing their business plans. As a result, the
private and public capital markets have become less willing to finance these
types of businesses. Recently some of these businesses have experienced
significant layoffs and, in some cases, the termination of operations. The
inability of these companies to successfully implement and finance their
business plans could impact the commercial development of the Internet, and
therefore materially and adversely affect our business.

We need to upgrade our systems and infrastructure continually to accommodate
increases in email and Internet traffic. If we fail to upgrade these services,
our business and results of operations could be materially and adversely
affected.

Even if we are able to continue operations beyond the second quarter of
2001 , we may need to expand and adapt our network infrastructure as the number
of users and the amount of information they wish to transmit over the Internet
increases and as their requirements change. We believe our network
infrastructure can support the existing subscriber base and foreseeable
increases in that base without significant capital expenditures. As of December
31, 2000, we had installed our equipment in 40 multifamily apartment communities
with 11,424 apartment units, of which approximately 2,300 units had been
activated for service. Our service includes approximately 150 non-revenue
leasing office and demonstration activations and approximately 2,200 revenue
generating subscriptions. However, if it becomes necessary, the expansion and
adaptation of our network infrastructure will require substantial financial,
operational and management resources. Even if we are able to continue operations
beyond the second quarter of 2001, unless we obtain significant sources of
additional funding, we will not able to expand our network and make the
necessary upgrades and our operations will be materially and adversely affected.
Due to the limited deployment of our services to date, the ability of our
network to connect and manage a substantially larger number of customers at high
transmission speeds is unknown. We face risks related to the network's ability
to operate with higher customer levels while maintaining expected performance.

As the frequency, size and complexity of email transmission and Web hosting
requirements increase, we will need to make additional and costly investments in
our infrastructure. In addition, we may not be able to project accurately the
rate or timing of email and Internet traffic increases or upgrade our systems
and infrastructure to accommodate future traffic levels. We may also not be able
to achieve or maintain a sufficient capacity of data transmission as customer
usage increases. Subscriber demand for our services could be greatly reduced if
we fail to maintain high capacity data transmission. High capacity data
transmission is generally regarded to include Internet connection equipment
which allows transmission through the Internet of audio, video, graphic and text
data in content densities which are greater than those readily transmitted
through the Internet by traditional dial-up modems. In addition, as we upgrade
our network infrastructure to increase capacity available to our subscribers, we
are likely to encounter equipment or software incompatibility which may cause
delays in implementations. We may not be able to expand or adapt our network
infrastructure to meet additional demand or our subscribers' changing
requirements in a timely manner or at all. If we fail to do so, our business and
results of operations could be materially and adversely affected.

Security breaches and viruses could hurt our business.

Our network and services may be vulnerable to unauthorized access, computer
viruses and other disruptive problems. Internet service providers and online
service providers have in the past experienced, and may in the future
experience, interruptions in service as a result of the accidental or
intentional actions of Internet users, current or former employees or others.
Unauthorized access may also jeopardize the security of confidential information
stored in our computer systems or those of our subscribers, which might result
in liability to our subscribers, the loss of our current subscribers and the
possible deterrence of potential subscribers. Although we have adopted industry-
standard security measures and intend to continue to implement industry standard
security measures in the future, those measures have been circumvented in the
past at other companies, and there is no assurance that measures we implement
will not be circumvented in the future. Eliminating computer viruses and
alleviating other security problems may require interruptions, expenses, delays
or cessation of service to our subscribers, which could have a material adverse
effect on our business, operating results and financial condition. Any
imposition of liability that is not covered by insurance or is in excess of our
insurance coverage could have a material adverse effect on our business,
operating results and financial condition. We are currently covered under a

general liability and umbrella liability insurance policy. We may not be able
to obtain adequate insurance at a reasonable cost, if at all, in the future.

We depend on the development and acceptance of high-quality, high-speed
broadband Internet content and applications. If the content and applications are
not available, our business could be adversely affected.

We believe that, in addition to providing high-speed, high-performance
Internet access, we must also promote the development and aggregation of high-
quality multimedia Internet content and applications. Our ability to provide and
aggregate the content and applications, and our ability to charge a premium for
our service, is dependent on the capability of content and applications
providers to create and support high-quality, high-speed multimedia Internet
content and applications and our ability to aggregate content and applications
offerings in a manner that subscribers find useful. Our ability to accomplish
this will depend on our ability and that of our competitors to develop a
subscriber base sufficiently large to justify investments in the development of
high-quality, high-speed multimedia Internet content and applications by others.
There is no assurance that we will be successful in these endeavors. In
addition, the market for high-quality, high-speed multimedia Internet content
and applications is at an early stage of development and is rapidly evolving,
and there is significant competition among Internet service providers and online
service providers for aggregating content and applications. If the market fails
to develop as expected or competition increases or our content and applications
offerings do not achieve or sustain market acceptance, our business, operating
results and financial condition will be materially and adversely affected.

We may not be able to use our name, "VelocityHSI", which could hamper our
ability to market our services.

Our success is dependent in part on recognition of our name. We previously
filed applications for federal registration for "VelocityHSI" and other
trademarks of VelocityHSI. However, as a result of our current financial
condition, we are not currently expending resources to further these
registrations applications. Accordingly, we do not have trademark or servicemark
protection for VelocityHSI and we do not intend to pursue such protections at
this time We cannot assure you that the use of our name, "VelocityHSI", will be
free from legal challenges or we will have sufficient funds to withstand such
challenges or claims, regardless of merit. If we are unable to protect our name,
it could seriously affect our ability to market our services. In addition, legal
challenges to our proprietary rights could lead to a substantial diversion of
our limited resources.

Uncertain federal and state tax and other surcharges on our services may
increase our payment obligations.

The tax treatment of the Internet and e-commerce is currently unsettled. A
number of proposals have been made at the federal, state and local level that
could impose taxes on the sale of goods and services ordered through the
Internet. A recently passed federal law has placed a three-year moratorium on
types of taxation on Internet commerce. However, this moratorium may not
continue and we cannot predict the effect of any current or future attempts to
tax or regulate commerce over the Internet. Any legislation that substantially
impairs the growth of e-commerce could harm our business.

Proposed federal and state legislation with respect to Internet privacy-related
issues may adversely impact our business.

Federal and state legislators are currently studying online privacy-related
issues. In particular, they are examining Internet sites' use of identifiers
that enable sites, including advertisers, to track usage patterns by compiling
data and to deliver customized content to users. The Federal Trade Commission
and certain states' attorneys general are investigating these activities as
potentially unfair and deceptive practices. In addition, other Internet privacy
concerns, such as protecting the confidentiality of medical records, personal
finances and credit card numbers, are also being reviewed. We have industry-
standard security measures in place to maintain the confidentiality of certain
subscriber information; however, our security measures may not prevent security
breaches by people who intend to steal or misuse personal or confidential
information of or about our subscribers. In addition, our own internal use of
subscriber information, which we may use to personalize and customize service
offerings to individuals and customer groups, could be the subject of government
investigation or regulation in the future. We cannot predict the effect of or
our liability under any legislation designed to safeguard privacy on the
Internet. Any legislation that substantially impairs the growth of e-commerce
could cause our sales to decline and have a material adverse effect on our
business.

We may have liability for Internet content and we may not have adequate
liability insurance. If we are subject to any claim that is not covered
adequately by insurance, we may be liable for damages that could materially and
adversely affect our financial condition.

As a provider of email and Web hosting services, we face potential
liability for defamation, negligence, copyright, patent or trademark
infringement and other claims based on the nature and content of the materials
transmitted through email, posted on the Web and downloaded from the Web by our
subscribers. We do not and cannot screen all of the content generated by our
users, and we could be exposed to liability with respect to this content. In
addition, Congress has attempted to regulate the dissemination of obscene or
indecent materials over the Internet. The constitutionality of those provisions
has been debated in ongoing litigation and has been subject to further
litigation. We may be subject to liability for the content distributed by our
subscribers.

We have general liability and umbrella liability insurance. However, this
insurance may not cover claims of these types or may not be adequate to
indemnify us for all liability that may be imposed. There is also a risk that a
single claim or multiple claims, if successfully asserted against us, could
exceed the total of our coverage limits. Should either of these risks occur, we
may not have sufficient capital to cover the claims. Any imposition of
liability, particularly liability that is not covered by insurance or is in
excess of insurance coverage, could have a material adverse effect on our
reputation and our business and results of operations, or could result in the
imposition of criminal penalties.

We do not have an agreement concerning the occupancy of our executive offices
and our occupancy could be terminated at any time.

Our executive offices, located at 2175 North California Blvd., Suite 150,
Walnut Creek, California 94596, are leased by BRE on our behalf pursuant to a
lease between BRE and Metropolitan Life Insurance Company. However, there is no
agreement between VelocityHSI and BRE concerning this lease agreement and BRE
could terminate our occupancy of the property at any time. Although BRE has not
given us any indication that it intends to terminate our tenancy under the
lease, if our tenancy is terminated, we may not be able to find additional
office space at all or on reasonable terms and moving our executive offices
would divert significant management resources from our daily operations. As a
result, our business and results of operations would be materially and adversely
affected.

We must retain our directors and senior management to sustain our business. If
we are unable to retain these individuals, our business would suffer and the
value of your shares would be adversely affected.

The development of our business depends on the skills, experience and
performance of our directors and senior management. William Vinck, our chief
operations officer has resigned effective April 13, 2001. Stephen E. Carlson,
our president and chief executive officer, has taken over Mr. Vinck's duties.
Christine Garvey, one of our independent directors, has notified us that she
will be relocating to London in connection with her primary employment and will
not be able to continue serving on our board after May 15, 2001. In addition,
Morgan Guenther, the other independent director on our board, submitted his
resignation to the Board of Directors on April 6, 2001, citing time constraints
based on his other business obligations. The remaining members of the board are
seeking replacements for Ms. Garvey and Mr. Guenther. The loss of the services
of any of our other directors, or certain members of our senior management
including Mr. Carlson and Charles P. Wingard, our senior vice president, chief
financial officer could materially and adversely affect our business. We do not
have "key person" life insurance on any of our employees.

We must retain our sales, marketing and technical personnel. If we are unable to
retain a sufficient number of these personnel, our business and results of
operations would be adversely affected.

We may not be able to successfully retain and motivate qualified personnel
needed in order to maintain our current operations. In December 2000, we reduced
our staffing by approximately 50%. In April 2001, we announced that we
eliminated an additional eight positions and that additional positions may be
eliminated later in order to further conserve capital. Under our modified
business plan, we currently have no intention of increasing our staff from the
current level. However, given the lower staffing level, retaining our existing
sales, marketing and technical personnel becomes critical to maintain customer
service levels. If we are unable to retain necessary personnel, our business and
our ability to develop new services and to provide acceptable levels of customer
service would suffer.

Governmental regulation and legal uncertainties could impair the growth of the
Internet and decrease demand for our services or increase our cost of doing
business. Future government regulation could make it easier for our competitors
to have access to our customers. If legislation is enacted that makes
competition easier, our business and results of operations could be materially
and adversely affected.

Although there are currently few U.S. laws and regulations that
specifically regulate communications or commerce over the Internet, we may
become subject to burdensome government regulation which could increase our
costs of doing business or subject us to liability. New and existing laws may be
interpreted to cover issues which include:

. content;

. distribution;

. antitrust matters;

. user privacy;

. pricing controls;

. consumer protection;

. libel and defamation;

. copyright and trademark protection;

. characteristics and quality of services;

. sales and other taxes; and

. other claims based on the nature and control of Internet materials.

The applicability to the Internet of new or existing laws in various
jurisdictions governing these issues or issues such as property ownership, sales
and other taxes, libel and personal privacy is uncertain and may take years to
resolve. Further, the growth and development of the market for high-speed home
Internet service may prompt calls for more stringent consumer protection laws
that may impose additional burdens on those companies conducting business
online. We face risks due to possible changes in the way our competitors are
regulated which could have an adverse effect on our business. For example, the
Federal Communications Commission is considering measures that could stimulate
the development of high-speed telecommunications facilities and make it easier
for operators of these facilities to obtain access to customers. Favorable
regulatory measures could enhance the viability of our competitors in the
Internet access marketplace. In addition, changes in the regulatory environment
may provide competing Internet service providers the right of access to the
cable systems of local franchised cable operators. If legislation is enacted
that increases competition, our business and results of operations could be
materially and adversely affected.

Directors, officers and significant stockholders have substantial influence over
VelocityHSI, which could prevent or delay a change in control.

As of December 31, 2000, our executive officers, directors and significant
stockholders collectively owned approximately 23% of the outstanding shares of
VelocityHSI common stock. If these stockholders choose to act or vote together,
they will have the power to influence matters requiring stockholder approval,
including the election of our directors, amendments to our charter and approval
of significant corporate transactions, including mergers or asset sales. This
concentration of ownership may have the effect of discouraging others from
making a tender offer or bid to acquire VelocityHSI at a price per share that is
above the then-current market price.

The ongoing relationship between VelocityHSI and BRE may present conflict-of-
interest situations for directors of VelocityHSI.

VelocityHSI and BRE intend to pursue separate and distinct business
strategies to minimize potential conflicts of interest between the two
companies. Nonetheless, the ongoing relationship between VelocityHSI and BRE may
present conflict-of-interest situations for directors of VelocityHSI. The Board
of Directors has created an executive committee comprised of non-BRE directors,
and may or may not continue such arrangements, depending on the composition of
the Board from time to time. In any event, it is anticipated that Messrs.
McDowell and Carlson will abstain from voting on any matter submitted to a vote
of the VelocityHSI board of directors involving a conflict of interest with BRE.
Although the directors of VelocityHSI intend to act in a manner consistent with
their fiduciary duties to VelocityHSI shareholders, there is a risk that common
membership on the boards of directors or in management of VelocityHSI and BRE
will lead to conflicts of interest in connection with transactions between the
two companies, including matters arising under the administrative services and
reimbursement agreement between VelocityHSI and BRE.

We rely on a continuous power supply to conduct our operations and California's
current energy crisis could disrupt our operations and increase our expenses.

California is in the midst of an energy crisis that could disrupt our
operations and increase our expenses. In the event of an acute power shortage,
California has on some occasions implemented, and may in the future continue to
implement, rolling blackouts throughout California. We currently do not have
backup generators or alternate sources of power in the event of a blackout, and
our current insurance does not provide coverage for any damages we or our
customers may suffer as a result of any interruption in our power supply. If
blackouts interrupt our power supply, we would be temporarily unable to continue
operations at our facilities. Any such interruption in our ability to continue
operations at our facilities could damage our reputation, harm our ability to
retain existing customers and to obtain new customers, and could result in lost
revenue, any of which could substantially harm our business and results of
operations.

Our stock price has fluctuated and may continue to fluctuate widely.

The price at which our common stock has been quoted on the National Association
of Securities Dealers Over-The-Counter Bulletin Board System has been volatile
and has fluctuated substantially. The price may continue to be volatile due to
factors such as:

. actual or anticipated fluctuations in our results of operations;

. announcements of technological innovations;

. introduction of new services by us or our competitors;

. the trading price of equity securities of our competitors;

. developments with respect to intellectual property rights;

. conditions and trends in the Internet and other technology industries;
and

. general market conditions, including the depth and liquidity of the
market for VelocityHSI common stock.

In addition, the National Association of Securities Dealers Over-The-
Counter Bulletin Board System has from time to time experienced significant
price quotation fluctuations. These broad market price fluctuations may result
in a material decline in the market price of our common stock. If the market
price for our common stock declines for a prolonged period of time, we may not
be able to obtain sufficient capital to implement our current business plan and
attract and retain qualified employees. These results would have a material and
adverse effect on our business, liquidity and financial condition.

Our common stock is deemed to be a "penny stock." Transactions in penny stocks
require broker-dealers to implement additional procedures before selling a penny
stock to a particular investor. These additional procedures may materially and
adversely affect the trading market of our common stock.

Our common stock is deemed to be "penny stock" as that term is defined in
Rule 3a51-1 promulgated under the Securities Exchange Act of 1934. Generally,
penny stocks are stocks that trade at a price of less than five dollars per
share and:

. are not registered on a recognized national securities exchange; or

. are not issued by an issuer with net tangible assets in excess of
$2,000,000, if the issuer has been in continuous operation for at
least three years, or $5,000,000, if the issuer has been in continuous
operation for less than three years, or an issuer with average annual
revenues of at least $6,000,000 for the last three years.

Section 15(g) of the Securities Exchange Act of 1934 and Rule 15g-2
promulgated under the Securities Exchange Act of 1934 require broker-dealers
dealing in penny stocks to provide potential investors with a document
disclosing the risks of penny stocks and to obtain a manually signed and dated
written receipt of the document before effecting any transaction in a penny
stock for the investor's account.

In addition, Rule 15g-9 promulgated under the Securities Exchange Act of
1934 requires broker-dealers in penny stocks to approve the account of any
investor for transactions in penny stocks before selling any penny stock to that
investor. This procedure requires the broker-dealer to:

. obtain from the investor information concerning his or her financial
situation, investment experience and investment objectives;

. reasonably determine, based on that information, that transactions in
penny stocks are suitable for the investor and that the investor has
sufficient knowledge and experience as to be reasonably capable of
evaluating the risks of penny stock transactions;

. provide the investor with a written statement setting forth the basis
on which the broker-dealer made the determination that the investor
has sufficient knowledge and experience to be reasonably capable of
evaluating the risks of penny stock transactions; and

. receive a signed and dated copy of this statement from the investor,
confirming that it accurately reflects the investor's financial
situation, investment experience and investment objectives.

Compliance with these requirements may make it more difficult for investors
in our common stock to resell their shares to third parties or to otherwise
dispose of these shares which may materially and adversely affect the trading
market of our common stock.

Future sales of our securities may cause our stock price to decline.

The market price of our common stock could decline as a result of sales of
substantial amounts of our common stock in the public market, or the perception
that such sales could occur. As of December 31, 2000, 9,915,100 shares of common
stock were held by non-affiliates and 2,812,054 shares were held by affiliates.
Of these shares, approximately 9,658,252 are currently available for resale in
the public market without registration, subject to compliance with Rule 144
under the Securities Act. The remaining 3,068,902 shares will become available
for resale in the public market without registration, subject to compliance with
Rule 144 under the Securities Act, periodically over the next five years.
Moreover, as of December 31, 2000, certain holders of our stock had rights to
require us to register up to 1,363,678 shares of common stock under the
Securities Act in certain circumstances. In addition, holders of warrants to
purchase 750,000 shares have rights to requires us, under certain conditions, to
register those shares under the Securities Act under certain circumstances
should they choose to exercise their warrants into our shares. These resales of
common stock, or the perception that they may occur, could cause our stock price
to decline. These events may also make it more difficult for us to raise funds
through future offerings of common stock.

The anti-takeover provisions of Delaware's general corporation law and our
certificate of incorporation and bylaws contain provisions which could delay or
prevent a change in control. This could have the effect of materially and
adversely affecting the value of your shares because it may discourage an
acquisition or take-over.

Our certificate of incorporation and bylaws contain the following provisions
that could delay or prevent a change in control of VelocityHSI or could limit
the price that investors might be willing to pay in the future for shares of our
common stock:

. establishing a staggered board of directors, which prevents a third
party from being able to remove all or a majority of our directors at
once;

. requiring the affirmative vote of holders of at least 66 2/3% of the
outstanding voting stock to remove a director for cause, which could
make it more difficult for a third party to remove our directors;

. authorizing the issuance of preferred stock which can be created and
issued by the board of directors without prior stockholder approval,
commonly referred to as "blank check" preferred stock, with rights
senior to those of our common stock, which could make it more
difficult or expensive for a third party to obtain voting control;

. prohibiting stockholder action by written consent, which requires a
third party to execute the proper procedures to convene a meeting of
the stockholders which could delay a third party from acquiring us;

. requiring the affirmative vote of holders of at least 66 2/3% of the
outstanding voting stock to amend any provision in our certificate of
incorporation or bylaws and to approve certain business combinations,
which could make it more difficult for a third party to remove the
provisions we have included to prevent or delay a change of control;
and

. reserving to our board of directors the exclusive right to change the
number of directors and fill vacancies on our board of directors,
which could make it more difficult for a third party to obtain control
of our board of directors.

These provisions, along with Section 203 of the Delaware General Corporation
Law, could delay or prevent a third party from acquiring us even if this change
of control would benefit our stockholders.

Item 2. PROPERTIES

General

VelocityHSI does not maintain any material physical properties or plants.
All fixed assets relating to the infrastructure of the Company's product are
located at various apartment complexes. These apartment complexes are owned
and operated by third-parties and the VelocityHSI equipment is maintained at the
properties in accordance with ownership agreements between VelocityHSI and the
owner of the property.

Headquarters

Our executive offices are located at 2175 North California Blvd., Suite
150, Walnut Creek, California 94596 and are leased by BRE. The lease, as
amended, between BRE and Metropolitan Life Insurance Company covers (i) 10,544
rentable square feet for a 5-year term at annual per square foot rents which
began at $30.00 in 2000 and rise to $32.40 in the fifth year of the lease; and
(ii) 3,154 rentable square feet for a 3-year term at annual per square foot
rents which began at $30.00 in 2000 and rise to $32.40 in the third year of the
lease. Our executive offices currently occupy 3,154 rentable square feet of the
total space covered under the lease. BRE intends to sublease the remaining
portion of the space to a third party. The lease term for the space occupied by
VelocityHSI ends on October 31, 2003; however, there is no agreement between
VelocityHSI and BRE concerning the lease agreement and BRE may terminate our
occupancy at any time.

Item 3. LEGAL PROCEEDINGS

In March 2001, VelocityHSI received notice that Nancye Miller had submitted
a request for arbitration of a claim against VelocityHSI for breach of contract.
Ms. Miller was terminated by VelocityHSI for cause in January, 2001. She claims
that she was terminated without cause and that she is entitled to damages in the
amount of approximately $345,000. To date, no date has been set for the
arbitration. We believe that the claims asserted by Ms. Miller are without
merit, and we intend to vigorously defend against the

claim. While it is not feasible to predict or determine the ultimate outcome of
this matter, in the opinion of management, this action will not have a material
adverse effect on the Company.

At December 31, 2000, amounts invoiced (and included as a liability in the
accompanying financial statements) by Tut Systems, Inc. ("Tut"), a vendor
primarily associated with the infrastructure equipment, totaled approximately
$2,900,000. VelocityHSI has been actively engaged in discussions with Tut
concerning warranty returns. On March 23, 2001, Tut filed a complaint against
VelocityHSI in the Superior Court of Contra Costa County, California, alleging
breach of contract for non-payment and damages of no less than $2,487,736.62
plus costs and interest. We intend to vigorously defend this action.

We believe that we will increasingly become subject to claims, lawsuits and
other comparable collection procedures such as those described above due to the
fact that our cash will become insufficient to permit continued operations
beyond the second quarter of 2001 and possibly as early as May 1, 2001. After
such period, we would be required to cease operations unless we are able to
consummate a strategic transaction or financial restructuring. In addition,
unless we are able to obtain a substantial capital infusion, we expect that we
will be unable to pay our vendors' invoices as they become due. While it is not
feasible to predict or determine the ultimate outcome of any claims such as
those discussed above, these and other similar actions would likely have a
material adverse effect on the Company.

The Company is also pursuing negotiations with a third party that may
result in a new investment in the Company. If such investment is made, it would
resolve issues in connection with earlier arrangements between such party and
the Company. Although the possible funding arising from current negotiations
would assist the Company to continue operating while seeking strategic
alternatives, the Company does not expect any resulting funding to allow
continued operations beyond the second quarter of 2001.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

PART II

Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

Our common stock is traded on the National Association of Securities
Dealers Over-The-Counter Bulletin Board System under the symbol ''VHSI''. As of
March 15, 2001, there were approximately 4,400 recordholders of BRE's common
stock and the last reported sales price on the OTCBB was $0.2031. The number of
holders does not include shares held of record by a broker or clearing agency,
but does include each such broker or clearing agency as one recordholder. As of
March 15, 2001, there were approximately 27,200 beneficial holders of
VelocityHSI's common stock.

The following table shows the high and low sales prices of the common stock
reported on the National Association of Securities Dealers Over-The-Counter
Bulletin Board System and the dividends we paid for each common share. Our
common stock began trading on August 16, 2000.

Year ended December 31, 2000
----------------------------
Stock Price
-----------
High Low
---- ---
August 16, 2000................ $4.000 $2.0000
Third Quarter.................. $4.625 $1.8125
Fourth Quarter................. $2.625 $0.0156

The payment of distributions by the Company is at the discretion of the
Board of Directors and depends on numerous factors, including the cash flow,
financial condition, capital requirements, and other factors. We have not
declared or paid cash dividends on our common stock and do not plan to pay cash
dividends in the foreseeable future.

Recent Sales of Unregistered Securities

1. On August 7, 2000, VelocityHSI issued options to purchase
approximately 694,992 shares of VelocityHSI common stock to holders of options
to purchase common stock of BRE Properties, Inc. ("BRE"). The offer and sale of
such securities was made pursuant to the exemption from registration under Rule
701 as promulgated by the Securities and Exchange Commission under the
Securities Act of 1933, as amended. The exercise price of each VelocityHSI
option was established using the ratio of the holder's BRE option exercise price
to the underlying BRE market value per share immediately before the distribution
and took into account the five to one exchange ratio for BRE to VelocityHSI.
This ratio was then applied to the VelocityHSI value per share at the time of
the distribution to establish the exercise price of the VelocityHSI option. The
exercise price of the existing BRE option after the distribution was calculated
by applying the same ratio to the BRE market value per share immediately after
the distribution. The market value of BRE common stock immediately before the
distribution was based on the market capitalization of BRE on the date three
days prior to the distribution record date. The VelocityHSI value was based on
$1.20 per share, the amount determined by the board of directors of BRE, after
consideration of an analysis prepared by an independent valuation and consulting
firm, to represent the fair value of a share of VelocityHSI common stock at the
time of the distribution. As of December 31, 2000, VelocityHSI issued 570,364
shares of common stock upon exercise of these options. As of December 31, 2000,
6,580 shares were cancelled, 242,818 of these shares were fully vested and
320,966 of these shares were held as restricted shares pursuant to early
exercises of these options.

2. On August 7, 2000, VelocityHSI sold, at a price of $0.50 per share,
1,721,816 shares of VelocityHSI common stock, to officers and employees of
VelocityHSI and gave an aggregate of 395,000 shares of VelocityHSI common stock
without compensation to employees of BRE, subject to certain vesting and
repurchase rights. The offer, sale and gift of such securities was made pursuant
to an exemption from registration under the Securities Act in reliance on
Section 4(2) of such Act as transactions by an issuer not involving any public
offering. As of December 31, 2000, 619,854 shares were cancelled, 160,704 shares
had vested and 1,336,258 shares remained restricted.

3. In August, 2000, VelocityHSI sold, at a price of $1.20 per share,
181,347 shares of VelocityHSI common stock to holders of units in BRE Property
Investors LLC. The offer and sale of such securities was made pursuant to an
exemption from registration under the Securities Act in reliance on Section 4(2)
of such Act as transactions by an issuer not involving any public offering.

4. On August 15, 2000, Banc of America Mortgage Capital Corporation
("BAMCC") purchased warrants of VelocityHSI, Inc. for a price of $112,500,
giving BAMCC the right to purchase 450,000 shares of common stock of
VelocityHSI. These warrants may be exercised on or before August 15, 2005 and
the exercise price for these warrants is $1.20 per share which equaled the fair
market value of our common stock as of the date of grant. The offer and sale of
such securities was made pursuant to an exemption from registration under the
Securities Act in reliance on Section 4(2) of such Act as transactions by an
issuer not involving any public offering.

5. On August 11, 2000, a director of the Company early exercised options
for 55,000 shares of common stock. As of December 31, 2000, no shares had
vested. The offer and sale of such securities was made pursuant to an exemption
from registration under the Securities Act in reliance on Section 4(2) of such
Act as transactions by an issuer not involving any public offering.

6. On October 12, 2000, BAMCC purchased warrants of VelocityHSI, Inc. for
a price of $75,000, giving BAMCC the right to purchase 300,000 shares of common
stock of VelocityHSI. These warrants may be exercised on or before October 12,
2005, and the exercise price for these warrants is $1.20 per share which equaled
the common stock fair market value at date of grant. The offer and sale of such
securities was made pursuant to an exemption from registration under the
Securities Act in reliance on Section 4(2) of such Act as transactions by an
issuer not involving any public offering.

Item 6. SELECTED FINANCIAL DATA

The selected financial data below should be read in conjunction with
''Management's Discussion and Analysis of Financial Condition and Results of
Operations'' and the financial statements and notes. Due to the fact that there
were no operations before March 1, 1999, financial data prior to this
commencement date has not been included.

Period from March 1, 1999
(commencement of operations)
Year ended December 31, 2000 through December 31, 1999
---------------------------- -------------------------

Operating Results
Revenues..................................................... $ 473,897 $ 138,125

Less:
Cost of services............................................ 3,826,591 287,779
Sales and marketing......................................... 2,165,547 53,396
Product development......................................... 2,146,565 -
General and administrative.................................. 4,315,640 4,861
Impairment loss on on-site equipment........................ 5,060,367 -
Loss on inventory of equipment.............................. 3,481,579 -
Amortization of deferred compensation and other stock
compensation expense...................................... 671,994 -
------------- -----------
Operating loss............................................... (21,194,386) (207,911)
------------- -----------
Transaction costs........................................... 3,006,279 -
Interest.................................................... 92,493 -
------------- -----------
Net loss..................................................... $ (24,293,158) $ (207,911)
============= ===========
Balance sheet information
Cash......................................................... $ 556,410 -
Total current assets......................................... 1,909,507 -
On-site equipment............................................ 1,109,845 $ 857,350
Total assets................................................. 4,164,938 887,000
Advances from BRE Properties, Inc............................ 7,270,376 -
Total liabilities............................................ 13,857,308 -
Shareholders' (deficit) equity............................... (9,692,370) 887,000
Cash flow information and other data
Net cash flows used in operating activities.................. $ (12,405,555) $ (102,842)
Net cash flows used in investing activities.................. (8,097,973) (992,069)
Net cash flows from financing activities..................... 21,059,938 1,094,911
Dividends to common shareholders............................. - -
Weighted average pro forma common shares used in
computing basic and diluted pro forma net loss per share.... 6,200,185 N/A

Shares outstanding at end of period.......................... 12,727,154 N/A

Basic and diluted pro forma net loss per share............... $ (3.92) N/A

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Overview

VelocityHSI commenced operations in March 1999 with limited revenue
generating activities conducted mainly on a part-time basis by several BRE
employees. On January 1, 2000, BRE formed a division with accounting and
reporting separate and discrete from all of BRE's other activities and referred
to as "Project Velocity." In April 2000, BRE formed a Delaware corporation,
VelocityHSI, Inc., which had no assets or liabilities until August 7, 2000, when
the operations and assets of Project Velocity were transferred to VelocityHSI,
Inc. in exchange for 10,430,061 shares of common stock of VelocityHSI
transferred to BRE. A number of employees of BRE then joined VelocityHSI. On
August 15, 2000, BRE distributed a portion of the shares received from
VelocityHSI to BRE common shareholders and retained the balance. In addition,
the holders of stock options in BRE received options in VelocityHSI as an anti-
dilution mechanism. In related issuances of securities, VelocityHSI sold shares
of its common stock subject to vesting requirements and forfeiture provisions to
seven of its officers, issued without consideration shares of its common stock
subject to vesting requirements and forfeiture provisions to six employees of
BRE, and offered to sell to the holders of units in BRE Property Investors LLC
other than BRE, one share of VelocityHSI common stock for each five shares of
BRE common stock issuable to the unit holder upon exchange of the units held by
the unit holder. On August 7, 2000, BRE entered into an agreement with
VelocityHSI to provide up to $10 million in funds through September 30, 2001 to
finance its operating expenses and the costs of installing equipment at
properties not owned by BRE. BRE also agreed to provide us with funds through
September 30, 2001, without limitation on amount, to finance the installation of
our equipment at properties owned by BRE. We refer to this credit commitment by
BRE as the "BRE Line."

Monthly subscriber fees comprised 100% of revenues for the year ended
December 31, 2000 and the period ended December 31, 1999. As of December 31,
2000, all of our subscribers were residents of apartment communities either
owned by BRE or owned by entities in which BRE is a minority partner.

Subscribers pay our subscription fees for our Internet services on a
monthly basis. The subscriber can terminate our service upon 30 days notice. Our
subscribers are not required to sign written contracts to pay for our
subscription fees for any minimum length of time. These subscription fees are
recognized as income is earned. As part of our marketing plan, we may reduce the
charges to potential subscribers as part of special promotions. As of December
31, 2000, we had approximately 2,300 subscribers in 40 apartment communities.

Recent Developments

As of December 31, 2000, BRE had extended $7,177,883, excluding accrued
interest of $92,493, under the BRE Line. BRE has included, as a reserve or a
deduction against available funds under the BRE Line, the future lease payments
of our corporate offices. In March 2001, BRE informed us that due to a possible
sublease for a significant portion of the office lease, the reserve for the
office lease would be reduced; however, BRE reserved additional amounts under
the BRE Line based on contracts entered into by BRE on behalf of VelocityHSI.
These contracts primarily consist of leases for equipment and office space
(other than the space subject to the possible sublease) and T-1 service
agreements. As a result of these new reserves, the amount available to us under
the BRE Line as of March 15, 2001 was $695,372. BRE has indicated that it does
not intend to increase its level of committed funding beyond its original
commitment of the BRE Line. We currently have no external debt facility or
source of funds other than BRE. An analysis of the amount available under the
BRE Line follows (excludes accrued interest of $191,601, which accrues
separately from the BRE Line):

As of March 15,
2001
------------
Basic amount $ 10,000,000
Additional amount available for cost of 1,235,156
installations at BRE owned communities
Reserve for BRE commitments (2,400,000)
Advances to March 15, 2001 (8,139,784)
------------
Net available for future borrowing under the BRE
Line as of March 15, 2001 $ 695,372
============

We have previously stated that in light of the available amount under the
BRE Line and our current lack of other funding sources, we expect that our cash
will become insufficient to permit continued operations beyond the second
quarter of 2001 and possibly as early as May 1, 2001, although there can be no
assurance in this regard. In order to continue operations beyond that period, we
will require an additional, substantial capital infusion. The Company is also
pursuing negotiations with a third party that may result in a new investment in
the Company. If such investment is made, it would resolve issues in connection
with earlier arrangements between such party and the Company. Although the
possible funding arising from current negotiations would assist the Company to
continue operating while seeking strategic alternatives, the Company does not
expect any resulting funding to allow continued operations beyond the second
quarter of 2001.

The accompanying financial statements have been prepared assuming that
VelocityHSI will continue as a going concern. However, the accompanying Report
of Independent Auditors states that we have experienced recurring losses from
operations and has a working capital deficiency which have adversely affected
our liquidity and that these conditions raise substantial doubt about our
ability to continue as a going concern. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty. See our
discussion under the section entitled "Preliminary Statement."

RESULTS OF OPERATIONS
Comparison of the year ended December 31, 2000 and the period from March 1, 1999
(commencement of operations) through December 31, 1999.

Revenues totaled $473,897 for the year ended December 31, 2000 and $138,125
for the period from March 1, 1999 (commencement of operations) through December
31, 1999. This increase was due to an increased number of subscribers over the
year ended December 31, 2000. Revenues consist solely of subscription fees from
subscribers to our monthly Internet access service. Subscription fees vary in
amount based on the level of service a subscriber chooses.

Cost of services totaled $3,826,591 for the year ended December 31, 2000,
as compared to $287,779 for the period from March 1, 1999 (commencement of
operations) through December 31, 1999. The increase of $3,538,812 in cost of
services resulted from the addition of new apartment communities as customers
and the addition of more subscribers during the year ended December 31, 2000 in
addition to related increases in depreciation of capitalized equipment
installation costs. The costs, excluding depreciation, for the year ended
December 31, 2000 consisted of $1,478,790 in charges for wiring, setup and
installation of apartment infrastructures performed by an independent
contractor, T-1 access charges of $662,295 and, to a lesser extent, commissions
to on-site personnel for new subscriptions. For the period ended December 31,
1999, costs, excluding depreciation, consisted primarily of $93,670 in charges

for wiring, setup and installation of apartment infrastructures performed by an
independent contractor and T-1 access charges of $69,590.

Included in costs of services is depreciation expense totaling $1,315,938
for the year ended December 31, 2000 compared to $105,069 for the period from
March 1, 1999 (commencement of operations) through December 31, 1999. The
increase of $1,210,869 is directly related to the increase in equipment placed
in service in 2000 and is calculated on a straight-line basis over three years.

Sales and marketing expenses totaled $2,165,547 for the year ended December
31, 2000. For the period from March 1, 1999 (commencement of operations) through
December 31, 1999, sales and marketing expenses totaled $53,396. The increase in
sales and marketing expenses of $2,112,151 related primarily to salaries,
promotional materials and site assessment surveys for new communities, many of
which did not receive VelocityHSI service during 2000 and, in line with our
modified business plan, we have no current intention to provide VelocityHSI
service to these communities.

Product development expenses totaled $2,146,565 for the year ended December
31, 2000. No such costs were incurred for the period from March 1, 1999
(commencement of operations) through December 31, 1999. This increase resulted
primarily from the costs associated with the development and testing of a
customer user interface that we determined was not economical to operate.

General and administrative expenses totaled $4,315,640 for the year ended
December 31, 2000, an increase of $4,310,779 over the $4,861 expense for the
period from March 1, 1999 (commencement of operations) through December 31,
1999. The increase resulted from direct and indirect personnel costs of
executive and administrative officers and support personnel, facility costs and
expenses for travel, printing, and office supplies incurred in connection with
the development of the VelocityHSI business.

Impairment loss on on-site equipment totaled $5,060,367 for the year ended
December 31, 2000. No such costs were incurred for the period from March 1, 1999
(commencement of operations) through December 31, 1999. Impairment of on-site
equipment which was installed at certain properties for which a negative future
undiscounted cash flow over the remaining life of the asset was written down to
a zero carrying value. In addition, the loss on inventory of equipment, totaling
$3,481,579, results from the write-down of equipment from invoiced amounts due
primarily from our decision to stop installations in new communities and what we
consider inadequate performance of the equipment. We are pursuing warranty
claims with the vendor; however there can be no assurance we will be successful.
Accordingly, the value of inventory of equipment was reduced to its estimated
resale value.

Amortization of deferred compensation and other stock compensation expense
totaled $671,994 for the year ended December 31, 2000. No such costs were
incurred for the period from March 1, 1999 (commencement of operations) through
December 31, 1999. This amortization is primarily associated with the issuance
of shares of restricted common stock to certain employees of VelocityHSI and BRE
during August 2000. Of this total expense, $409,180 relates to general and
administrative personnel, $119,808 relates to an employee in the sales and
marketing department, $118,167 relates to employees associated with product
development, and $24,839 relates to non-employees and other expenses.

Operating loss of $21,194,386 for the year ended December 31, 2000
increased $20,986,475 compared to $207,911 for the period March 1, 1999
(commencement of operations) through December 31, 1999 primarily due to a
significant increase in our operations impairment loss on on-site equipment and
loss on inventory of equipment.

Transaction costs related to the spin-off of VelocityHSI from BRE were
$3,006,279 for the year ended December 31, 2000. These costs consist of legal
and professional fees, financial printing fees, stock service fees and other
costs incurred prior to the August 7, 2000 spin-off of VelocityHSI from BRE. No
such costs were incurred in the period from March 1, 1999 (commencement of
operations) through December 31, 1999.

Net loss of $24,293,158 and $207,911 for the year ended December 31, 2000
and the period from March 1, 1999 (commencement of operations) through December
31, 1999, respectively, resulted from the costs of services, sales and marketing
costs, depreciation, general and administrative costs and transaction costs
exceeding revenues generated from subscriber service fees.

Liquidity and Capital Resources

Cash used in operating activities, primarily for the payment of operating
expenses, was $12,405,555 and $102,842 for the year ended December 31, 2000 and
the period from March 1, 1999 (commencement of operations) through December 31,
1999, respectively. In the event that we are able to obtain additional capital
to continue operations beyond May 1, 2001, we expect to experience substantial
negative cash flow from operating activities for the foreseeable future. Our
future cash requirements as well as our revenues, assuming we commence
installations of VelocityHSI service at new apartment communities, will depend
on a number of factors including: the number of multifamily apartment properties
with which we contract to provide services; the terms of contracts with the
multifamily apartment property owners; subscriber penetration within the
multifamily apartment property; monthly subscription rates; variable
installation and setup costs at each multifamily apartment property and
marketing costs.

We incur both infrastructure deployment costs (i.e. system installation
costs to place equipment in service at each property) and incremental
installation costs to set up each new subscriber with VelocityHSI service. Since
we have not charged the property owner or subscribers for these installation
costs (and have no intention to start charging for installation), and the
monthly subscriber fees generated from VelocityHSI service are earned over a
period of time, we experience negative cash flows initially upon installation.

Net cash used in investing activities was $8,097,973 and $992,069 for the
year ended December 31, 2000 and the period from March 1, 1999 (commencement of
operations) through December 31, 1999, respectively. The infrastructure
deployment technology solution and cost required to provide VelocityHSI service
to apartment communities varies. In apartments where all of the individual
units' telephone lines terminate in a single, central location ("central
communities"), the technology solution may be different than apartment
communities where the individual apartment units' telephone lines do not
terminate in a single location ("non-central communities"). We estimate that
over one-half of the apartment communities which are in our target market are
non-central communities. The cost of infrastructure deployment in non-central
communities may be higher than central communities and we have been pursuing
technology solutions which are cost effective for both types of apartment
communities. However, no assurance can be given that we will be successful in
identifying cost effective technology solutions to all communities. As further
discussed below, we have no current intention to deploy VelocityHSI service to
any additional communities.

Our expenses and capital expenditures prior to August 7, 2000 were financed
with funds advanced from BRE as part of the intracompany equity account. Of the
total $11,937,483 in advances for the year ended December 31, 2000, $2,747,750
relate to transaction costs, $3,983,986 relate to operating expenses and
$5,205,747 relate to purchases of fixed assets. These funds are not part of the
BRE Line described below. On August 7, 2000, we entered into an agreement with
BRE pursuant to which BRE has agreed to provide us with up to $10,000,000 in
additional funds through September 30, 2001 to finance our operating expenses
and the costs of installing equipment at properties which are not owned by BRE.
We refer to this financing arrangement as the "BRE Line". The BRE Line also
covers funds advanced through September 30, 2001 to finance the installation of
our equipment at properties owned by BRE. As of December 31, 2000, the costs of
installations of BRE owned properties was $1,233,258; this amount is included in
the total amount available to borrow on the BRE Line. In addition, BRE has
entered into contracts prior to August 7, 2000, including the lease for our
corporate offices, which are included as a reserve, or deduction against
available funds on the BRE Line. At December 31, 2000, after advances and
reserves, a total of $2,325,856 was available under the BRE Line. At March 15,
2001, after advances and reserves, a total of $695,372 was available under the
BRE Line. An analysis of the BRE Line follows:

As of As of
December 31, March 15,
2000 2001
------------ ------------

Basic amount $ 10,000,000 $ 10,000,000
Cost of installations at BRE owned communities 1,233,258 1,235,156
Reserve for BRE commitments (1,729,519) (2,400,000)
------------ ------------
Subtotal 9,503,739 8,835,156
------------ ------------
Advances to December 31, 2000 and
March 15, 2001, respectively (7,177,883) (8,139,784)
------------ ------------
Net available for future borrowing $ 2,325,856 $ 695,372
============ ============

The cost of installation at BRE owned properties may increase due to
additional capital expenditures at such communities. The reserve for BRE
commitments may increase or decrease depending on whether such obligations are
paid, additional charges assessed

or discharged. The above advances exclude accrued interest of $92,493 and
$191,601 at December 31, 2000 and March 15, 2001, respectively.

We must repay, on or before September 30, 2001, all of the funds advanced to
us by BRE under the agreement, together with accrued interest on unpaid balances
at the rate of 9% per year ($92,493 at December 31, 2000). BRE advanced a total
of $7,177,883 to us through December 31, 2000, and $2,325,856 was available to
us under the BRE Line, subject to changes, if any, in amounts reserved by BRE.
We currently have no external debt facility or source of funds other than BRE
and BRE has not committed to provide us with funds in addition to the BRE Line
or make any change in the due date of September 30, 2001.

In December 2000, in response to adverse changes in the capital and credit
markets and our inability to fund by an anticipated lender, we adopted a
modified business plan and as part of the plan, we laid off approximately 50% of
our workforce and announced the deferral of our efforts to expand service to
other apartment properties until such time as we were able to obtain additional
financing. We also entered into discussions with vendors to reduce invoiced
amounts. The invoiced amounts of certain other vendors are under dispute or we
have proposed the return of the equipment (due to warranty or other reasons) for
credit against the invoiced amount. At December 31, 2000, amounts owed to a
vendor primarily associated with the infrastructure equipment totaled
approximately $2,900,000. Currently, we are actively engaged in discussions with
this vendor concerning warranty returns and the vendor has filed an action
against us in the Superior Court of Contra Costa County, California. There can
be no assurance that we will be successful in negotiating a settlement or other
reduction of the invoiced amounts or defending against this or other lawsuits
(see Item 3, "Legal Proceedings"). Accordingly, the invoiced amounts for all of
our vendors have been recorded without reduction as liabilities at December 31,
2000. The liabilities we have recorded (in accordance with a policy of recording
invoiced amounts as a liability, regardless of potential claims or offsets) at
December 31, 2000 are well in excess of funding available under the BRE Line. In
addition, even after our reductions in staffing, we believe that we will
continue to experience significant negative cash flow from our operations in
2001. Accordingly, unless we are able to obtain significant amounts of
additional capital, we are not currently able to pay the full amount, if any, of
liabilities.

We have previously stated that in light of the available amount under the BRE
Line and our current lack of other funding sources, we expect that our cash will
become insufficient to permit continued operations beyond the second quarter of
2001 and possibly as early as May 1, 2001, although there can be no assurance in
this regard. In order to continue operations beyond that period, we will require
an additional, substantial capital infusion. The company is also pursuing
negotiations with a third party that may result in a new investment in the
company. If such investment is made, it would resolve issues in connection with
earlier arrangements between such party and the company. Although the possible
funding arising from current negotiations would assist the company to continue
operating while seeking strategic alternatives, the company does not expect any
resulting funding to allow continued operations beyond the second quarter of
2001.

The accompanying financial statements have been prepared assuming that
VelocityHSI will continue as a going concern. However, the accompanying
Independent Auditors' Report states that we have experienced recurring losses
from operations which have adversely affected our liquidity and that these
conditions raise substantial doubt about our ability to continue as a going
concern. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty. See our discussion under the
section entitled "Preliminary Statement."

See the discussion in the section entitled "Preliminary Statement" and the
"Recent Developments" section of Management's Discussion and Analysis.

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of December 31, 2000, the Company's debt structure only included short-
term, fixed rate debt. Although the Company did not have any long-term debt
outstanding at December 31, 2000, the Company is still exposed to indirect
market risk for changes in interest rates. However, the Company does not expect
any material loss attributable to these risks or significant changes in its
business prospects.

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See the Index to Financial Statements. Such Financial Statements and
Schedules are incorporated herein by reference.

Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by Item 10 as to directors and executive officers is
incorporated by reference from the Sections entitled "Directors and Executive
Officers of the Registrant" and "Compliance with the Reporting Requirements of
Section 16(a)" in the Company's Proxy Statement for the Company's 2001 Annual
Meeting of Shareholders to be filed with the Securities and Exchange Commission
within 120 days of the end of the Company's fiscal year. In the event that the
Proxy Statement is not filed within the 120-day period, the information required
by Item 10 will be filed as an amendment to this Form 10-K no later than the end
of such 120-day period.

Item 11. EXECUTIVE COMPENSATION

The information required by Item 11 is incorporated by reference from the
Sections entitled "Executive Compensation" in the Company's Proxy Statement for
the Company's 2001 Annual Meeting of Shareholders to be filed with the
Securities and Exchange Commission within 120 days of the end of the Company's
fiscal year. In the event that the Proxy Statement is not filed within the 120-
day period, the information required by Item 11 will be filed as an amendment to
this Form 10-K no later than the end of such 120-day period.

Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL HOLDERS AND MANAGEMENT

The information required by Item 12 is incorporated by reference from the
Sections entitled "Security Ownership of Certain Beneficial Holders and
Management" in the Company's Proxy Statement for the Company's 2001 Annual
Meeting of Shareholders to be filed with the Securities and Exchange Commission
within 120 days of the end of the Company's fiscal year. In the event that the
Proxy Statement is not filed within the 120-day period, the information required
by Item 12 will be filed as an amendment to this Form 10-K no later than the end
of such 120-day period.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by Item 13 is incorporated by reference from the
Sections entitled "Certain Relationships and Related Transactions" in the
Company's Proxy Statement for the Company's 2001 Annual Meeting of Shareholders
to be filed with the Securities and Exchange Commission within 120 days of the
end of the Company's fiscal year. In the event that the Proxy Statement is not
filed within the 120-day period, the information required by Item 13 will be
filed as an amendment to this Form 10-K no later than the end of such 120-day
period.

PART IV

Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) Financial Statements

1. Financial Statements:

Report of Independent Auditors

Balance Sheets at December 31, 2000 and 1999

Statements of Operations for the year ended December 31, 2000 and the
period from March 1, 1999 (commencement of operations) through
December 31, 1999

Statements of Shareholders' Equity (Deficit) for the years ended
December 31, 2000 and the period from March 1, 1999 (commencement of
operations) through December 31, 1999

Statements of Cash Flows for the year ended December 31, 2000 and the
period from March 1, 1999 (commencement of operations) through
December 31, 1999

Notes to Financial Statements

2. Financial Statement Schedule:

Schedule II - Valuation and qualifying accounts

All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable, and,
therefore, have been omitted.

3. See Index to Exhibits immediately following the Financial Statements.
Each of the exhibits listed is incorporated herein by reference.

(b) Reports on Form 8-K:

None.

See Index to Exhibits.

(d) Financial Statement Schedules

See Financial Statements and Financial Statement Schedule above.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

VelocityHSI, Inc.

By /s/ Stephen E. Carlson
---------------------------------------------
Stephen E. Carlson
President, Chief Executive Officer and Director

Dated: April 13, 2001
--------------

POWER OF ATTORNEY

KNOWN ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Stephen E. Carlson and Charles P. Wingard, each
of whom may act without joinder of the other, as his or her true and lawful
attorneys-in-fact and agents, each with full power of substitution and
resubstitution, for him or her and in his or her name, place and stead, in any
and all capacities, to sign any and all amendments to this Annual Report on Form
10-K, and to file the same, with all exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorneys-in-fact and agents full power and authority to do and perform
each and every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he or she might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or their substitutes, may lawfully do or cause to be done by virtue
hereof.

Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:

Signature Title Dated
--------- ----- -----

/s/ Stephen E. Carlson President, Chief Executive Officer and April 13, 2001
- ------------------------- ------------------------------
Stephen E. Carlson Director
(Principal Executive Officer)

/s/ Charles P. Wingard Senior Vice President, April 13, 2001
- ------------------------- ------------------------------
Charles P. Wingard Chief Financial Officer, Secretary and
Treasurer
(Principal Financial and
Accounting Officer)

/s/ LeRoy E. Carlson Director, Chairman of the Board April 13, 2001
- ------------------------- ------------------------------
LeRoy E. Carlson

/s/ Christine Garvey Director April 13, 2001
- ------------------------- ------------------------------
Christine Garvey

/s/ Frank C. McDowell Director April 13, 2001
- ------------------------- ------------------------------
Frank C. McDowell

REPORT OF INDEPENDENT AUDITORS

To the Shareholders and Directors of
VelocityHSI, Inc.:

We have audited the accompanying balance sheets of VelocityHSI, Inc. (the
Company) as of December 31, 2000 and 1999, and the related statements of
operations, shareholders' equity (deficit) and cash flows for the year ended
December 31, 2000 and the period from March 1, 1999 (commencement of operations)
through December 31, 1999. Our audits also included the financial statement
schedule listed in the Index at Item 14(a). These financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule based on our
audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of VelocityHSI, Inc. at December
31, 2000 and 1999, and the results of its operations and its cash flows for the
year ended December 31, 2000 and the period from March 1, 1999 (commencement of
operations) through December 31, 1999, in conformity with accounting principles
generally accepted in the United States. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As more fully described in Note 2,
the Company has incurred recurring operating losses and has a working capital
deficiency. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 2. The financial statements do not include
any adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.

/s/ Ernst & Young LLP
San Francisco, California
February 23, 2001

VELOCITYHSI, INC.

BALANCE SHEETS

December 31, December 31,
2000 1999
-------------- ------------

ASSETS

Current assets:
Cash $ 556,410 $ -
Inventory of equipment 417,680 -
Other current assets 935,417 -
------------ -----------
Total current assets 1,909,507 -
------------ -----------

On-site equipment 1,430,262 962,419
Office equipment 1,022,884 -
------------ -----------
2,453,146 962,419
Less accumulated depreciation (421,539) (105,069)
------------ -----------
2,031,607 857,350

Software 95,164 29,650
Other assets 128,660 -
------------ -----------

TOTAL ASSETS $ 4,164,938 $ 887,000
============ ===========

LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)

Current liabilities:
Accounts payable and accrued expenses $ 6,586,932 $ -
Advances from BRE Properties, Inc. (note 11) 7,270,376 -
------------ -----------
Total current liabilities 13,857,308 -
------------ -----------

Shareholders' equity (deficit):
Intracompany account - 1,094,911
Preferred stock, $0.01 par value; 50,000,000 shares authorized. No
shares issued or outstanding at December 31, 2000 and 1999,
respectively - -
Common stock, $0.01 par value; 100,000,000 shares authorized. Shares
issued and outstanding: 12,727,154 at December 31, 2000; no shares
issued at December 31, 1999 127,271 -
Additional paid in capital 15,279,083 -
Deferred compensation (597,655) -
Accumulated deficit (24,501,069) (207,911)
------------ -----------
Total shareholders' equity (deficit) (9,692,370) 887,000
------------ -----------

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) $ 4,164,938 $ 887,000
============ ===========

See Report of Independent Auditors and Notes to Financial Statements

VELOCITYHSI, INC.

STATEMENTS OF OPERATIONS

Period from March 1,
Year ended 1999 (commencement of
December 31, operations) through
2000 December 31, 1999
------------- ---------------------

Revenues
Subscription fees $ 473,897 $ 138,125
------------- -----------------

Operating expenses
Cost of services (including depreciation of $1,315,938
and $105,069 respectively) 3,826,591 287,779
Sales and marketing 2,165,547 53,396
Product development 2,146,565 -
General and administrative (including $151,478 and
$0 of depreciation, respectively) 4,315,640 4,861
Impairment loss on on-site equipment 5,060,367 -
Loss on inventory of equipment 3,481,579 -
Amortization of deferred compensation and other
stock compensation expense 671,994 -
------------- -----------------
Total operating expenses 21,668,283 346,036

------------- -----------------

Operating loss (21,194,386) (207,911)

Other expenses:
Transaction costs related to spin-off 3,006,279 -
Interest to BRE Properties, Inc. 92,493 -
------------- -----------------
Net loss $(24,293,158) $ (207,911)
============= =================

Basic and diluted pro forma net loss per share $ (3.92) $ N/A
============= =================
Weighted average pro forma common shares used in
computing basic and diluted pro forma net loss per share 6,200,185 N/A
============= =================

See Report of Independent Auditors and Notes to Financial Statements

VELOCITYHSI, INC.

STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)

Additional
Number Intra- Common Paid in Deferred Accumulated
of Shares company Stock Capital Compensation Deficit Total
----------- ------------- -------- ----------- ------------ ------------- ------------

Advances from BRE $ 1,094,911 $ 1,094,911
Net loss and comprehensive loss $ (207,911) (207,911)
------------- ------------- ------------
Balance at December 31, 1999 1,094,911 (207,911) 887,000
------------- ------------- ------------

Additional advances from BRE 11,937,483 11,937,483
Net loss and comprehensive loss (2,214,263) (2,214,263)
------------- ------------- ------------
Balance at August 7, 2000 13,032,394 (2,422,174) 10,610,220
------------- ------------- ------------

Issuance of common stock:
BRE 10,430,061 $ (13,032,394) $104,301 $12,928,093 $ -
VelocityHSI and BRE Employees 2,116,816 21,168 2,051,667 $(1,211,927) 860,908
Cancellation of VelocityHSI Employees (619,854) (6,199) (736,189) 403,096 (339,292)
Exercise of mirrored stock options
by BRE optionees 570,364 5,704 566,888 572,592
Other cancellations (6,580) (66) (129) (195)
Exercise of stock options 55,000 550 65,450 66,000
BRE Properties Investors, LLC 181,347 1,813 215,803 217,616
Issuance of warrants 187,500 187,500

Amortization of deferred
compensation expense and other 211,176
Net loss and comprehensive loss 211,176 $(22,078,895) (22,078,895)
----------- ------------- -------- ----------- ----------- ------------- ------------
Balance at December 31, 2000 12,727,154 $ - $127,271 $15,279,083 $ (597,655) $(24,501,069) $ (9,692,370)
=========== ============= ======== =========== =========== ============= ============

See Report of Independent Auditors and Notes to Financial Statements

VELOCITYHSI, INC.
STATEMENTS OF CASH FLOWS

Period from
March 1, 1999
(commencement
of operations)
Year ended through
December 31, December 31,
2000 1999
------------- --------------

Operating Activities: $ (24,293,158) $ (207,911)
Net loss
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation expense 1,467,415 105,069
Amortization and other non-cash expenses 836,995 -
Impairment loss on on-site equipment 5,060,367 -
Loss on inventory of equipment 3,481,579 -
Changes in operating assets and liabilities:
(Increase) in other assets (1,976,845) -
Increase in accounts payable and accrued expenses 3,018,092 -
------------- --------------
Net Cash Used in Operating Activities: (12,405,555) (102,842)
------------- --------------

Investing Activities:
Purchases of on-site equipment (6,628,800) (962,419)
Purchases of inventory of equipment and software costs (1,469,173) (29,650)
------------- --------------
Net Cash Used in Investing Activities: (8,097,973) (992,069)
------------- --------------
Financing Activities:
Increase in advances from BRE post spin-off 7,270,376 -
Issuance of common stock for cash:
Pre spin-off advances from BRE converted to equity 11,937,483 1,094,911
VelocityHSI employees, net of repurchases 860,908 -
Exercise of stock options and other 803,671 -
Issuance of warrants for cash proceeds 187,500 -
------------- --------------
Net Cash Provided by Financing Activities: 21,059,938 1,094,911
------------- --------------

Net increase in cash 556,410 -
Cash at beginning of period - -
------------- --------------
Cash at end of period $ 556,410 $ -
============= ==============

Supplemental disclosure of non-cash investing and financing transactions:
Issuance of shares to BRE for conversion of advances to equity $ 13,032,394 $ -
============= ==============

Deferred compensation:
Issuance of shares, subject to vesting, to certain employees of BRE for services $ 6,656 $ -
============= ==============
Issuance of shares, subject to vesting, to certain employees of VelocityHSI for
services $ 802,175 $ -
============= ==============

See Report of Independent Auditors and Notes to Financial Statements

VELOCITYHSI, INC.

NOTES TO FINANCIAL STATEMENTS

1. Company

VelocityHSI, Inc. ("we", "VelocityHSI" or "the Company") provides high-
speed Internet access to the multifamily apartment industry.

The business referred to as VelocityHSI commenced operations as "Project
Velocity" in March 1999 by several BRE employees of BRE Properties, Inc. ("BRE")
on a part-time basis. In 2000, BRE formed a division with separate reporting
and accounting from BRE's other activities. For convenience in these financial
statements, both the division known as Project Velocity and its legal successor,
VelocityHSI, Inc., are referred to herein as VelocityHSI. In April 2000, BRE
formed a Delaware corporation, VelocityHSI, Inc., which had no assets or
liabilities until August 7, 2000. On August 7, 2000, the operations and assets
of the Project Velocity were transferred from BRE to VelocityHSI, Inc. in
exchange for VelocityHSI stock. Some employees of BRE then joined VelocityHSI.
On August 15, 2000, BRE distributed approximately 87% of the shares received
from VelocityHSI to BRE common shareholders and retained the balance. In
addition, the holders of stock options in BRE received options in VelocityHSI as
an anti-dilution mechanism. In related issuances of securities, VelocityHSI sold
shares of its common stock subject to vesting requirements and forfeiture
provisions to seven of its officers, issued, without consideration, shares of
its common stock subject to vesting requirements and forfeiture provisions to
six employees of BRE, and offered to sell to the holders of units in BRE
Property Investors LLC other than BRE, one share of VelocityHSI common stock for
each five shares of BRE common stock issuable to the unit holder upon exchange
of the units held by the unit holder. The table below summarizes the shares of
VelocityHSI common stock issued during this transaction:

Shares
------------

Shares issued to BRE common shareholders in the distribution.......................... 9,066,383
Shares retained by BRE................................................................ 1,363,678
-----------
10,430,061
-----------
Shares issued in related transactions to:
BRE option holders............................................................... 570,364
Unit holders in BRE Property Investors LLC....................................... 181,347
VelocityHSI and BRE employees (subject to forfeiture)............................ 2,116,816
-----------
2,868,527
-----------
Total VelocityHSI shares outstanding as a result of the spin-off...................... 13,298,588
===========

BRE funded the costs associated with this distribution, including legal,
accounting and other professional fees, in the form of intracompany advances,
which were converted into an equity contribution on August 7, 2000, the date of
BRE's contribution of net assets to VelocityHSI.

VelocityHSI accounted for the net assets transferred to it in connection
with BRE's contribution as a non-reciprocal transfer to owners in accordance
with Accounting Principles Board Opinion No. 29, "Accounting for Nonmonetary
Transactions." Accordingly, the net assets have been carried over to the balance
sheet of VelocityHSI at the same basis as they appeared on the balance sheet of
BRE immediately prior to the transfer.

Through December 31, 2000, revenues of VelocityHSI were generated from
residents located in communities owned by BRE or communities owned by entities
in which BRE is a minority partner. Revenues generated from BRE communities
consisted of 94% of the total revenues. The loss of residents of apartments
owned by BRE as a source of revenues would have a material adverse effect on
VelocityHSI's financial condition and results of operations.

In December 2000, in response to adverse changes in the capital and credit
markets and the failure to obtain additional financing, the Company adopted a
modified business plan and as part of the plan, the Company laid off
approximately 50% of its workforce and announced the deferral of its efforts to
expand service to other apartment properties until such time as the Company was
able to

obtain additional financing. In April 2001, we announced that we eliminated an
additional eight positions and that additional positions may be eliminated later
in order to further conserve capital.

As of December 31, 2000, BRE had advanced $7,177,883 of the BRE Line. In
addition, we owe BRE $92,493 of accrued interest. BRE has included, as a reserve
or a deduction against available funds on the BRE Line, the future lease
payments of our corporate offices as BRE is obligated to make these payments.
BRE has indicated that it does not intend to increase its level of committed
funding beyond its original commitment of the BRE Line. An analysis of the BRE
Line follows (excludes accrued interest of $92,493):

As of
December 31, 2000
-----------------
Basic amount $ 10,000,000
Cost of installations at BRE owned communities 1,233,258
Reserve for BRE commitments (1,729,519)
-----------------
Subtotal 9,503,739
Advances to December 31, 2000 (7,177,883)
-----------------
Net available for future borrowing $ 2,325,856
=================

In light of the available amount under the BRE Line and the Company's
current lack of other funding sources, the Company expects that its cash will
become insufficient to permit continued operations beyond the second quarter of
2001 and possibly as early as May 1, 2001, although there can be no assurance in
this regard. In order to continue operations beyond that period, the Company
will require an additional, substantial capital infusion. The Company is also
pursuing negotiations with a third party that may result in a new investment in
the Company. If such investment is made, it would resolve issues in connection
with earlier arrangements between such party and the Company. Although the
possible funding arising from current negotiations would assist the Company to
continue operating while seeking strategic alternatives, the Company does not
expect any resulting funding to allow continued operations beyond the second
quarter of 2001.

The Company is actively exploring strategic alternatives, which might
include a merger, asset sale, or another comparable transaction or a financial
restructuring. However, in the event the Company is unsuccessful in completing
one of these strategic alternatives, the Company will be required to cease
operations during the second quarter of 2001, and possibly as early as May 1,
2001. In that case, the Company's common stock is expected to have no value. In
addition, potential investors in the Company's securities should consider the
risk that, even if the Company is successful in completing a strategic
transaction as described above, the Company's common stock may nonetheless have
no value. In addition, if the Company is able to complete a financing through
the issuance of equity, equity-linked or debt securities, those securities may
have rights, preferences or privileges senior to those of the rights of the
Company's common stock and the Company's stockholders will likely experience
significant dilution. In addition, see note 13.

2. Summary of Significant Accounting Policies

Basis of Presentation

The financial statements of VelocityHSI, prior to August 7, 2000, reflect
an activity of a division of BRE prepared on a stand-alone basis. Included
herein, for that period, are charges by BRE to the activity or division for
direct and indirect costs which, in the opinion of management, reflect all costs
of VelocityHSI doing business on such basis.

The accompanying financial statements are presented on the basis that the
Company is a going concern. The Company has incurred significant operating
losses of $24,501,069 since inception and has negative working capital of
$11,947,801 as of December 31, 2000. This condition raises substantial doubt
about the Company's ability to continue as a going concern. The Company plans to
finance its continuing operations with a combination of debt and/or equity
financing. However, there can be no assurance that such financing will be
available on terms acceptable by the Company, if at all. The accompanying
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts
and classification of liabilities that may result from the outcome of this
uncertainty.

Use of Estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

Inventory of Equipment

VelocityHSI maintained an inventory of equipment available to be installed
at properties of $417,680. The Company has no current intention to install this
equipment at apartment communities. Once this equipment is installed at a
specific property, depreciation associated with the equipment will commence.

At December 31, 2000, a reserve for loss on equipment was established
relating to equipment of $3,481,579. The reserve was created as the Company has
no current intention to install the equipment at apartment communities due to
the Company's decision to defer further installations and what the Company
contends is the unsatisfactory performance of the equipment. The Company is
actively pursuing warranty remedies; however, there can be no assurance that the
Company will be successful. The equipment was purchased primarily from one
vendor and at December 31, 2000, the total amount payable to this vendor was
approximately $2,900,000 and this amount is included in full as a liability at
December 31, 2000.

On-Site Equipment

VelocityHSI's on-site equipment is stated at the lower of cost, less
accumulated depreciation or fair market value after impairment adjustment, if
any. System installation costs incurred in order to place the equipment in
service at a property are capitalized as on-site equipment. Costs to install the
service for individual new subscribers are expensed as incurred and included as
cost of services. Depreciation is calculated using the straight-line method over
the estimated useful lives of the assets, which is three years. In the event
that a community cancels the Company's service prior to the respective
equipment's full depreciation, any equipment not able to be redeployed and any
other unamortized costs will be written off at the cancellation date.

Office Equipment

VelocityHSI's office equipment is stated at cost, less accumulated
depreciation. Depreciation is calculated using the straight-line method over the
estimated useful lives of the assets, which is three years. Leasehold
improvements are amortized over the shorter of the lease term or the estimated
useful life.

Software

Software is capitalized or expensed in accordance with Statement of
Position No. 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use" and Emerging Issues Task Force Issue No. 00-2,
"Accounting for Website Development Costs". Amounts incurred during the planning
and operation stages are expensed as incurred, while amounts incurred during the
product development, Web application and infrastructure development, and
graphics development stages are capitalized. Software costs which are subject to
continual and substantial change are expensed as incurred. Capitalized amounts
are stated at cost less accumulated amortization. Amortization will be
calculated using the straight-line method over periods not to exceed three
years, beginning at the time assets are placed in service. No amortization
expense was recorded for the year ended December 31, 2000 and the period ended
December 31, 1999. However, the Company recorded a loss for the development of
software of $1,735,166 included in product development expense for the year
ended December 31, 2000.

Impairment of Long-Lived Assets

VelocityHSI records impairment losses on long-lived assets used in
operations when events and circumstances indicate that the assets might be
impaired and the undiscounted cash flows estimated to be generated by those
assets are less than the carrying amounts of those assets. Impairment losses, if
any, would be determined based on the present value of the cash flows using
discount rates that reflect the inherent risk of the underlying business.

For the year ended December 31, 2000, the Company recorded expense of
$5,060,367 (net of accumulated depreciation of $1,102,338) related to the write-
down of on-site equipment. The circumstances giving rise to the write-down
include, but are not limited to, limited market penetration, operating
performance of specific properties, reorganization of Company personnel, lack of

funding and issues concerning the recoverability of tangible assets associated
with the de-emphasis of certain technology. The carrying amount of on-site
equipment was determined from estimated future cash flows to be generated,
discounted at a market rate of interest.

Liabilities

VelocityHSI records liabilities at their full invoiced amount without
regard to possible offsets for returns or negotiated settlements unless such
reduction has been finalized.

Transaction Costs

Costs, primarily legal and accounting paid to third parties, directly
related to the performance of services in connection with the distribution of
VelocityHSI shares to BRE common shareholders (discussed in note 1) were
required to be expensed at the time of the distribution. The total amount of
transaction costs which were expensed totaled $3,006,279 and is included in
other expenses in the Statement of Operations.

Revenue Recognition

VelocityHSI records monthly subscriber service fees due from apartment
residents as revenue as the services are provided. For the year ended December
31, 2000 and the period ended December 31, 1999, there were no advertising
revenues; however, should there be any advertising revenues in the future, they
will be recognized provided that no significant VelocityHSI obligations remain
at the end of a contract period and collection of the resulting receivable is
probable. VelocityHSI obligations may include guarantees of minimum amounts of
advertising display times. To the extent minimum guaranteed display times are
not met, VelocityHSI will defer recognition of the corresponding revenues until
the remaining guaranteed display levels are achieved.

Cost of Services

Cost of services includes depreciation of capitalized equipment and related
system installation costs incurred in order to place the equipment in service at
a property. Cost of services also includes charges for wiring, setup and
installation of Internet services performed by an independent contractor and T-1
access charges related to the monthly service for individual new subscribers
which are expensed as incurred. Additionally, cost of services includes amounts
owed to property owners under the service agreements which provide access to the
residents. As of December 31, 2000, VelocityHSI had two service agreements
(including the service agreement with BRE). The service agreement with BRE is
the only such agreement which generated revenue for the year ended December 31,
2000 and VelocityHSI accrued $21,627 in commission revenue on BRE's behalf for
the period of August 7 to December 31, 2000.

Income Taxes

Income taxes are computed using the asset and liability method, under which
deferred income tax assets and liabilities are determined based on the
differences between the financial reporting and tax bases of assets and
liabilities and are measured using the currently enacted tax rates and laws. A
valuation allowance is provided for the amount of deferred tax assets that,
based on available evidence, are not expected to be realized.

Stock-based Compensation and Consideration

VelocityHSI accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees" (APB No. 25) and Financial
Accounting Standards Board Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation," an interpretation of APB No. 25, and
complies with the disclosure provisions of Statement of Financial Accounting
Standards ("SFAS") No. 123,

"Accounting for Stock-Based Compensation" (SFAS 123). Under APB No. 25,
compensation expense is based on the difference, if any, on the date of the
grant, between the estimated fair market value of VelocityHSI stock and the
exercise price.

VelocityHSI accounts for stock issued to non-employees in accordance with
the provisions of SFAS No. 123 and the Emerging Issues Task Force Consensus in
Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services." This statement requires that the calculated fair market value of the
option be expensed over the vesting period of the option.

Segment Information

Financial Accounting Standards Board issued SFAS No. 131, "Disclosures
About Segments of an Enterprise and Related Information" ("SFAS 131"),
establishes standards for the way that public business enterprises report
financial and descriptive information about reportable operating segments in
annual financial statements and interim reporting to shareholders. In adopting
the provisions of SFAS 131, VelocityHSI has determined that it has only one
operating and reportable segment; therefore, separate quarterly segment
disclosure has not been provided.

3. Stock Option Plans

The 2000 Equity Incentive Plan ("Plan") provides for the issuance of
Incentive Stock Options, Non-Qualified Stock Options, restricted shares and
other grants. The maximum number of shares that may be issued under the Plan is
3,694,992. The option price may not be less than the fair market value of a
share on the date the option is granted and the option generally vests over four
years for employees and consultants and one year for directors. The exercise
price of options granted during the year ended December 31, 2000 was equal to
the market price on the date of grant.

As a result of BRE's spin-off of VelocityHSI, holders of stock options in
BRE stock option plans received options in VelocityHSI. The number of
VelocityHSI options reflect the common stock spin-off distribution ratio of one
share of VelocityHSI common stock for every five shares of BRE common stock. The
terms of VelocityHSI options received by the BRE option holders are identical to
the BRE options held by the BRE option holders. The exercise price of each
VelocityHSI option was established using the ratio of the holder's BRE option
exercise price to the underlying BRE market value per share immediately before
the distribution. This ratio was then applied to the VelocityHSI value per share
at the time of the distribution to establish the exercise price of the
VelocityHSI option. The VelocityHSI common stock market value was based on $1.20
per share, the amount determined by the board of directors of BRE, after
consideration of an analysis prepared by an independent valuation and consulting
firm, to represent the fair value of a share of VelocityHSI common stock at the
time of the distribution.

Changes in options outstanding during the year ended December 31, 2000 were
as follows:

Weighted
Shares average
under Range of exercise
option exercise price price
----------- --------------- -----------

Balance at January 1, 2000................................ - - $ -
Granted to BRE option holders on August 7, 2000........... 694,992 $0.51-$1.18 $ 0.91
Granted to VelocityHSI employees and directors............ 972,370 $0.81-$4.00 $ 1.67
Exercised................................................. (618,784) $0.51-$1.18 $ 0.94
Cancelled................................................. (229,974) $0.69-$3.69 $ 1.21
----------- ---------
Balance at end of year.................................. 818,604 $ 1.71
=========== =========

Exercisable............................................... 51,605 $ 1.76
=========== =========
Shares available for granting future options.............. 2,257,604
===========

At December 31, 2000, the exercise price of shares granted under options
ranged from $0.51 to $4.00, with a weighted average exercise price of $1.34. At
December 31, 2000, there were 375,966 restricted shares issued pursuant to early
exercise of unvested options outstanding under the Plan. These restricted shares
are subject to repurchase by VelocityHSI, at the Company's option, should such
option holders service with VelocityHSI or BRE terminate prior to vesting at the
lower of the exercise price or the then current market value.

The following table summarizes information concerning options outstanding
at December 31, 2000:

Weighted average Number of
Number of remaining options Weighted
options Weighted average contractual life in exercisable average exercise
Exercise price outstanding exercise price years upon issuance price
-----------------------------------------------------------------------------------------------------------------------

$0.51 - $1.10 93,554 $0.87 8.46 10,355 $0.94
$1.20 175,000 $1.20 9.61 - -
$1.97 541,250 $1.97 9.75 41,250 $1.97
$2.75- $4.00 8,800 $3.38 9.67 - -
-----------------------------------------------------------------------------------------------
818,604 $1.71 9.57 51,605 $1.76
===============================================================================================

Pro forma information regarding the net loss and net loss per share is
required by SFAS 123. This information is required to be determined as if the
Company had accounted for its employee stock option grants under the fair value
method of that statement. The Company calculated the minimum fair value of each
option grant on the date of the grant using the Black-Scholes option pricing
model. The following weighted average assumptions were used:

December 31, 2000
-------------------------------------

Risk-free interest rate........................................... 6.00%
Dividend yield.................................................... 0.00%
Volatility........................................................ 4.66
Weighted average option life...................................... 3 years as to BRE option holders and
5 years as to VelocityHSI employees

Had compensation cost for the Company's stock option plan been determined
consistent with the fair value method as required by SFAS 123, the Company's net
loss and net loss per share would have been as indicated below:

For the year ended
December 31, 2000
------------------

Net loss:
As reported $(24,293,158)
Pro forma $(24,479,434)
Basic and diluted net loss per share:
As reported $ (3.92)
Pro forma $ (3.95)

VelocityHSI has accounted for 107,100 stock options granted to non-
employees during the period from August 7, 2000 to December 31, 2000, of which
87,300 were cancelled during that period, under the fair value method of SFAS
123, "Accounting for Stock Compensation" and Emerging Issues Task Force Issue
No. 96-18, "Accounting for Equity Instruments with Variable Terms that are
Issued for Consideration other than Employee Services under FASB Statement No.
123" which include recording the options at fair value. The fair value for these
options was estimated as of the date of grant using a Black-Scholes option
pricing model, with the same weighted average assumptions for the period ended
December 31, 2000 as defined in the above table. The total expense

recognized relating to these shares for the year ended December 31, 2000 was
$14,578. In addition, at the beginning of December 2000, each of the non-
employees who were granted stock options became employees.

The Black-Scholes option pricing model was developed for use in estimating
the fair market value of traded options that have no vesting restrictions and
are fully transferable. In addition, option valuation models require the input
of highly subjective assumptions, including the expected stock price volatility.

Because the above stock option plans have characteristics significantly
different from those of traded options, and because, in management's opinion,
changes in the subjective input assumptions can materially affect the fair value
estimate, the existing models do not necessarily provide a reliable single
measure of the fair value of the above stock option plans.

4. Issuance of Restricted Shares

On August 7, 2000, VelocityHSI issued an aggregate of 1,721,816 shares of
VelocityHSI common stock to seven officers of VelocityHSI who were instrumental
in the development of the business of VelocityHSI. These seven employees paid
$0.50 per share for these shares. The shares vest in installments over a period
ranging from six to 36 months, from the date of the employment agreement, and
will be forfeited if the person to whom the shares are issued ceases to be
employed by VelocityHSI prior to the date of vesting. The Company originally
recorded $1,205,271 of deferred compensation expense for the shares of common
stock. Of this total deferred compensation amount, $403,096 was written-off
related to 619,854 forfeited restricted shares during the year ended December
31, 2000. The remaining balance of the deferred compensation of $591,923 at
December 31, 2000 will be amortized over the vesting period of the restricted
shares. During the year ended December 31, 2000, $210,252 of amortization
expense has been recognized. At December 31, 2000, 160,704 shares had vested
and 941,258 shares remained restricted.

On August 7, 2000, VelocityHSI issued an aggregate of 395,000 shares of
VelocityHSI common stock to six employees of BRE who were instrumental in the
development of the business of VelocityHSI. These six employees of BRE were not
required to pay for these shares. The shares vest in installments over a period
of 36 months and will be forfeited if the person to whom the shares are issued
ceases to be employed by BRE prior to the date of vesting. The Company has
recorded deferred compensation expense for the 395,000 shares of common stock
totaling $6,656 at December 31, 2000 and will amortize this deferred
compensation over the 36-month vesting period, based on the market value of the
shares at period end. As of December 31, 2000, $924 of amortization expense has
been recognized. At December 31, 2000, no shares had vested or cancelled and
395,000 shares remained.

5. Results of Operations Per Share

Historical per share data for the periods ended December 31, 1999 has not
been presented as no common shares were outstanding until August 7, 2000. Prior
to August 7, 2000, the Company operated as a division of BRE. The calculation
of the weighted average number of shares of common stock outstanding for
December 31, 2000 includes a pro forma adjustment to reflect the number of
shares that would have been outstanding as if the shares issued on August 7,
2000 had been issued on January 1, 2000, as adjusted for cash advances converted
to equity on a pro forma basis for these periods. For the year ended December
31, 2000, the following table sets forth the computation of basic and diluted
net loss per share with respect to results of operations from continuing
operations:

Period from
March 1, 1999
Year ended (commencement of
December 31, operations) through
2000 December 31, 1999
------------ -------------------

Numerator for basic and diluted net loss per share..................... $(24,293,158) N/A
============ ==============
Denominator
Denominator for basic and diluted net loss per share adjusted for
weighted average shares and assumed conversion..................... 6,200,185 N/A
============ ==============
Effect of dilutive securities:
Warrants........................................................... 24,835 N/A
Stock options...................................................... 514 N/A
------------ --------------
Dilutive potential common shares..................................... 25,349 N/A
============ ==============

Basic and diluted net loss per share................................. $ (3.92) N/A
============ ==============

The Company has excluded all warrants and outstanding stock options from
the calculations of diluted net loss per common share because their inclusion
would be anti-dilutive. The total number of shares of common stock subject to
these warrants and stock options excluded from the calculations of diluted net
loss per common share is 2,187,388 for the year ended December 31, 2000. Such
securities, had they been dilutive, would have been included in the computations
of diluted net loss per share. In addition, restricted shares, totaling
1,712,224 have been excluded from the loss per share denominator because their
inclusion would be antidilutive.

6. Issuance of Warrants

On August 15, 2000, Banc of America Mortgage Capital Corporation ("BAMCC")
purchased warrants of VelocityHSI for a total consideration of $112,500, giving
BAMCC the right to purchase 450,000 shares of common stock of VelocityHSI.
These warrants may be exercised on or before August 15, 2005 and the exercise
price for these warrants is $1.20 per share which equaled the common stock fair
market value at date of grant.

On October 12, 2000, BAMCC purchased warrants of VelocityHSI for a price of
$75,000, giving BAMCC the right to purchase 300,000 shares of common stock of
VelocityHSI. These warrants may be exercised on or before October 12, 2005 and
the exercise price for these warrants is $1.20.

7. Retirement Plan

The Company maintains, through a co-adoption of the BRE Retirement Plan, a
defined contribution 401(k) plan under which its full-time employees are
eligible to participate. Participants may make, within certain limitations,
voluntary contributions based upon a percentage of their compensation. The
Company may make voluntary contributions to the Plan. Participants are fully
vested in the Company's contributions after a specified number of years of
service, as defined under the plan. During the year ended December 31, 2000,
the Company contributed $8,552 to the plan; there were no contributions for the
period ended December 31, 1999.

8. Commitments and Contingencies

Lease Obligations

On behalf of VelocityHSI, BRE has entered into several lease agreements for
the rental of office space and office furniture and equipment. For the year
ended December 31, 2000 and the period from March 1, 1999 (commencement of
operations) through

December 31, 1999, total rent expense incurred related to these leases amounted
to $211,266 and $0, respectively. See footnote 11 for a further explanation of
the obligation agreement.

Other Obligations

BRE has entered into agreements on behalf of VelocityHSI with the for T-1
service. In accordance with these agreements, the service providers will
provide T-1 services to the Company through October of 2001.

Legal Proceedings

The Company is involved in a number of legal proceedings, including
employment and vendor related claims. After accounting for amounts recorded as
liabilities as of December 31, 2000, the Company does not believe that such
legal proceedings will have, individually or in the aggregate, any additional
material adverse effect on its financial condition or operating results as of
and for the year ended December 31, 2000. However, the Company may encounter
additional legal proceedings in light of its cash flow, liquidity and operating
constraints as further discussed in note 1.

9. Income Taxes

For the period January 1 through August 7, 2000, VelocityHSI's tax basis
income or loss will be included in the federal and state income or franchise tax
returns of BRE. For preparation of these financial statements, income taxes are
accounted for on a separate return basis for the period subsequent to the spin-
off using the liability method. Accordingly, deferred tax assets and liabilities
are determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates expected to
be in effect when the differences are expected to reverse.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets are as follows:

December 31, December 31,
2000 1999
------------ ------------

Deferred tax assets:
Net operating losses $ 7,017,494 $ -
Other 1,814,064 -
------------ ------------
Total deferred tax assets 8,831,558 -
------------ ------------

Valuation allowance (8,831,558) -
------------ ------------
Net deferred tax assets $ - $ -
============ ============

Realization of deferred tax assets is dependent upon future earnings, if
any, the timing and amount of which are uncertain. Accordingly, the net deferred
tax assets have been fully offset by a valuation allowance.

As of December 31, 2000, the Company had net operating loss carryforwards
for federal income tax purposes of approximately $18,000,000 which expire in the
years 2010 through 2020.

Utilization of the Company's net operating loss may be subject to
substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code and similar state provisions. Such an annual
limitation could result in the expiration of the net operating loss before
utilization.

BRE has elected to be taxed as a Real Estate Investment Trust under the
Internal Revenue Code of 1986, as amended. As a result, BRE is not subject to
taxation at the corporate level. Accordingly, no income tax benefit has been
provided in connection with VelocityHSI's tax basis loss for the period prior to
August 7, 2000.

10. Supplemental Information on Operations

The following table represents the pre- and post-spin-off balances of
VelocityHSI:

January 1 - August 8 -
August 7, December 31,
2000 2000 Total
----------- ------------ ------------

Revenues $ 227,803 $ 246,094 $ 473,897
----------- ------------ ------------

Cost of services 1,154,192 2,672,399 3,826,591
Sales and marketing 224,400 1,941,147 2,165,547
Product development - 2,146,565 2,146,565
General and administrative 1,063,474 3,252,166 4,315,640
Impairment loss on on-site equipment - 5,060,367 5,060,367
Loss on inventory of equipment - 3,481,579 3,481,579
Amortization of deferred compensation and
other stock compensation expense - 671,994 671,994
----------- ------------ ------------
Total operating expenses 2,442,066 19,226,217 21,668,283

Other expenses - 3,098,772 3,098,772
----------- ------------ ------------

Net loss $(2,214,263) $(22,078,895) $(24,293,158)
=========== ============ ============

11. Related Party Transactions

BRE incurred direct and indirect costs and expenses on behalf of
VelocityHSI. These costs and expenses, attributable to VelocityHSI operations,
including payroll costs, have been included in these financial statements
through August 7, 2000. Where appropriate, costs and expenses were allocated to
VelocityHSI by BRE based on BRE's cost, which reflects management's estimate of
what the expenses would have been on a stand-alone basis. In the opinion of
management, the allocation method is reasonable and appropriate.

Effective August 7, 2000 and under an Internet Services Agreement,
VelocityHSI is required to pay or accrue to BRE 10% of revenues generated from
services provided to residents of communities owned by BRE. For the year ended
December 31, 2000 and related to the period of August 7 to December 31, 2000,
the amount expensed relating to BRE's share of revenue was $21,627.

The intracompany account was comprised of amounts earned and incurred by
BRE on behalf of VelocityHSI. This account was converted into VelocityHSI common
stock on August 7, 2000.

On behalf of VelocityHSI, BRE entered into a lease agreement on April 24,
2000 for the rental of office space in Walnut Creek, California. The term of the
lease is through July 1, 2005 and all monthly lease payments are required to be
made by VelocityHSI. The monthly base rent payments for the lease range between
$26,112 and $28,201. An amendment to this office lease was entered into by BRE
on October 31, 2000, providing for additional office space. The term of the
lease is through November 1, 2003 and monthly base rent payments range between
$7,885 and $8,516. BRE has also entered into agreements for the lease of office
furniture and equipment for VelocityHSI use, with lease terms through December
2003 and monthly base rent payments totaling approximately $8,000. Thereafter,
monthly base rent payments of $3,533 continue through July 2005. The future
obligations have been included in the reserve, reducing funds available on the
BRE Line as of December 31, 2000 (see note 1).

Administrative Services and Reimbursement Agreement

VelocityHSI has entered into an Administrative Services and Reimbursement
Agreement with BRE pursuant to which BRE will provide VelocityHSI with office
space and administrative services in connection with the business operations as
reasonably required of VelocityHSI. BRE has also agreed to provide VelocityHSI
with up to $10 million in funds through September 30, 2001, to finance operating
expenses and the costs of installing equipment at properties which are not owned
by BRE. BRE has further agreed to provide VelocityHSI with funds through
September 30, 2001 to finance the installation of equipment at properties owned
by BRE. Funds advanced by BRE to VelocityHSI subsequent to BRE's contribution of
net assets to VelocityHSI on August 7, 2000, must be repaid by VelocityHSI on or
before September 30, 2001 together with interest on periodic unpaid balances at
the rate of 9% per year (see note 1). For the year ended December 31, 2000, we
incurred interest expense on the BRE Line of $92,493; pursuant to the terms of
the BRE Line, this amount was accrued and not paid.

12. Supplemental Financial Data (Unaudited)

Quarterly financial information (unaudited) follows.

Year ended December 31, 2000
-----------------------------------------------------------------------
Quarter ended Quarter ended Quarter ended Quarter ended
March 31 June 30 September 30 December 31
------------- ------------- ------------- -------------

Revenues............................ $ 77,441 $ 104,937 $ 118,367 $ 173,152
Net loss............................ $(508,003) $(1,102,048) $(6,947,876) $(15,735,231)
Basic and diluted net loss per
outstanding common share............ N/A N/A $ (0.79) $ (1.58)

Period ended December 31, 1999
-----------------------------------------------------------------------
Month ended Quarter ended Quarter ended Quarter ended
March 31 June 30 September 30 December 31
------------- ------------- ------------- -------------

Revenues............................ $ 6,948 $ 20,843 $ 42,070 $ 68,265
Net loss............................ $ (18,650) $ (55,951) $ (7,833) $ (125,477)
Basic and diluted net loss per
outstanding common share............ N/A N/A N/A N/A

13. Events Subsequent to Date of Auditors' Report (Unaudited)

On March 23, 2001, Tut Systems, Inc., a supplier of infrastructure
equipment filed a complaint against VelocityHSI in the Superior Court of Contra
Costa County, California, alleging breach of contract for non-payment and
damages of no less than $2,487,736.62 plus costs and interest. As of December
31, 2000, we had recorded a liability of approximately $2,900,000 related to
invoices received from Tut Systems, Inc. We intend to vigorously defend this
action.

In March 2001, BRE informed us that due to the possible sublease for a
significant portion of the office lease, the reserve for the office lease would
be reduced; however, BRE reserved additional amounts under the BRE Line based on
contracts entered into by BRE on behalf of VelocityHSI. These contracts
primarily consist of leases for equipment and office space (other than the space
subject to the possible sublease) and T-1 service agreements. As a result of the
reserves, BRE has reserved approximately $2,400,000 of the total funding
available on the BRE Line as of March 15, 2001. This represents a decrease in
the amount that would otherwise be available to borrow from December 31, 2000 of
approximately $700,000.

VELOCITYHSI, INC.

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
DECEMBER 31, 2000

Column A Column B Column C Column D Column E
Additions
------------------------------------
(1) (2)
Balance at Charged to Charged to Balance at
Description January 1, 2000 costs and expenses other accounts Deductions December 31, 2000
- ------------------------- --------------- ------------------ -------------- ---------- -----------------

Inventory of equipment $ - $ 3,481,579 $ - $ - $ 3,481,579

--------------- ------------------ -------------- ---------- -----------------

Total $ - $ 3,481,579 $ - $ - $ 3,481,579
=============== ================== ============== ========== =================

INDEX TO EXHIBITS

Exhibit
Number Description of Exhibit
- ------ ----------------------

3.1 Amended and Restated Certificate of Incorporation of VelocityHSI,
Inc.*

3.2 Amended and Restated Bylaws of VelocityHSI, Inc.**

3.3 Form of Common Stock Certificate of VelocityHSI, Inc.*

10.1 Contribution and Distribution Agreement dated as of August 7, 2000
between VelocityHSI, Inc. and BRE Properties, Inc.**

10.2 Administrative Services and Reimbursement Agreement dated as of August
7, 2000 between VelocityHSI, Inc. and BRE Properties, Inc.**

10.3 VelocityHSI, Inc. 2000 Equity Incentive Plan**

10.4 Service Agreement dated as of August 7, 2000 between VelocityHSI, Inc.
and BRE Properties, Inc.**

10.5 Registration Rights Agreement dated as of August 7, 2000 between
VelocityHSI, Inc. and BRE Properties, Inc.**

10.6 Tax Allocation Agreement dated as of August 7, 2000 between
VelocityHSI, Inc. and BRE Properties, Inc.**

10.7 Employment Agreement of Stephen E. Carlson*

10.8 Employment Agreement of William C. Vinck**

10.9 Warrant Agreement between VelocityHSI, Inc. and Banc of America
Mortgage Capital Corporation dated August 15, 2000**

10.10 Form of Indemnification Agreement

10.11 Office Lease dated as of April 24, 2000 between Metropolitan Life
Insurance Company and BRE Properties, Inc.

10.12 First Amendment to Office Lease dated as of October 31, 2000 between
Metropolitan Life Insurance Company and BRE Properties, Inc.

10.13 Warrant Agreement between VelocityHSI, Inc. and Banc of America
Mortgage Capital Corporation dated October 12, 2000

* Incorporated herein by reference from the Company's Registration Statement
on Form S-1 (File No. 333-36162).
** Incorporated herein by reference from the Company's Quarterly Report on Form
10-Q for the quarter ended December 31, 2000.