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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------

                                   FORM 10-K
                            ------------------------

     [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

         FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .

                          COMMISSION FILE NO. 0-27877

                        NEXT LEVEL COMMUNICATIONS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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                  DELAWARE                                      95-3342408
       (STATE OR OTHER JURISDICTION OF                       (I.R.S. EMPLOYER
       INCORPORATION OR ORGANIZATION)                       IDENTIFICATION NO.)
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                             6085 STATE FARM DRIVE
                             ROHNERT PARK, CA 94928
                    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (707) 584-6820

          SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

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               TITLE OF CLASS                    NAME OF EACH EXCHANGE ON WHICH REGISTERED
<S>                                            <C>
        COMMON STOCK, PAR VALUE $0.01                     NASDAQ NATIONAL MARKET
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     Indicate by check mark whether 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.  [ ]

     The aggregate market value of the voting stock held by non-affiliates of
the registrant was $153,977,320 as of February 28, 2001.

     As of February 28, 2001, the registrant had 84,712,240 outstanding shares
of common stock.

                      DOCUMENTS INCORPORATED BY REFERENCE

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                    DOCUMENTS                                      FORM 10-K REFERENCES
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<S>                                                     <C>
Portions of our Definitive Proxy Statement for our      Items 10-13
upcoming Annual Meeting of Stockholders
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                               TABLE OF CONTENTS

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                                PART I
Item 1.   Business....................................................    1
Item 2.   Properties..................................................    9
Item 3.   Legal Proceedings...........................................    9
Item 4.   Submission of Matters to a Vote of Security Holders.........   10
                               PART II
Item 5.   Market for Registrant's Common Equity and Related
          Stockholder Matters.........................................   11
Item 6.   Selected Financial Data.....................................   12
Item 7.   Management's Discussion and Analysis of Financial Condition
          and Results of Operations...................................   14
Item 7A.  Quantitative and Qualitative Disclosures About Market
          Risk........................................................   27
Item 8.   Financial Statements and Supplementary Data.................   28
Item 9.   Changes in and Disagreements With Accountants on Accounting
          and Financial Disclosure....................................   45
                               PART III
Item 10.  Directors and Executive Officers of the Registrant..........   45
Item 11.  Executive Compensation......................................   45
Item 12.  Security Ownership of Certain Beneficial Owners and
          Management..................................................   45
Item 13.  Certain Relationships and Related Transactions..............   45
Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form
          8-K.........................................................   45
Exhibits..............................................................   45
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                                     PART I

ITEM 1. BUSINESS

     The statements in this report that are forward-looking are based on current
expectations and beliefs and involve numerous risks and uncertainties that could
cause actual results to differ materially. For a discussion of the factors that
could cause actual results to differ materially from the forward-looking
statements, see "Risk Factors" and such other risks and uncertainties as set
forth below in this report or detailed in our other Securities and Exchange
Commission reports and filings.

OVERVIEW

     We design and market broadband communications equipment that enables
telephone companies and other communications service providers to
cost-effectively deliver a full suite of voice, high-speed data and digital
video services over the existing copper telephone wire infrastructure. Service
providers who deploy our equipment can either offer voice, data and video
services in a single product offering or offer each service separately depending
on subscriber demand and the service provider's objectives. We believe that by
installing our equipment, telephone companies and other emerging communications
service providers will be able to capitalize on, and compete effectively in, the
emerging market for integrated voice, data and video services. Our products
consist of equipment located at the telephone company's central office or
exchange, in the field and at the subscriber's home or business.

     We commenced operations in July 1994 and recorded our first sale in
September 1997. From January 1998 until November 1999, we operated through Next
Level Communications L.P., which was formed as the result of the transfer of all
of the net assets, management and workforce of a wholly owned subsidiary of
General Instrument. In November 1999, the business and assets of that
partnership were merged into Next Level Communications, Inc. as part of our
recapitalization. In November 1999, we completed an initial public offering of
our common stock, raising approximately $177.0 million in net proceeds. In
January 2000, General Instrument was acquired by Motorola, Inc., making us an
indirect subsidiary of Motorola. As a result of the transactions that occurred
in connection with our recapitalization, Motorola, through General Instrument,
owns 64,103,724 shares of our common stock constituting approximately 76% of our
outstanding common stock on a fully diluted basis as of December 31, 2000. Kevin
Kimberlin Partners, LP (an affiliate of our former General Partner, Spencer
Trask) and its affiliates own, including shares issuable upon exercise of
outstanding warrants, 7,221,892 shares of common stock in the aggregate,
constituting approximately 8% of our outstanding common stock on a fully diluted
basis as of December 31, 2000.

     Our equipment is designed to provide the following key benefits:

     Flexible, Integrated Products. Our products are designed with the
flexibility to allow our customers to deliver voice, data and video services in
a single packaged offering or to offer them individually. This flexibility
allows telephone companies to immediately serve the varying needs of their
diverse end-user base, including residential, corporate and telecommuter
customers. As a result, telephone companies can generate significant incremental
revenue from their existing networks by using our system. By offering the
flexibility inherent in an integrated system, our products enable telephone
companies to effectively time their network equipment expenditures and rapidly
introduce new services as demand warrants.

     Cost Effective Product Deployment. Our product design reduces the cost and
complexity often associated with deploying multiple services to end users.
Because telephone companies often use separate equipment for each communications
service, they require multiple equipment purchases, installations, training
procedures, maintenance procedures and network management packages. In contrast,
our products deliver all services from a single system. By integrating many
traditionally separate functions, our products allow telephone companies to
incrementally add services by simply installing new modules into our existing
equipment, rather than purchasing entirely new infrastructure equipment.
Additionally, our products installed in the house or office deliver video and
data services from a single networked set-top box, thus eliminating the need for
set-top boxes or modems for different services or separately located TVs and
PCs. We believe our products provide cost savings, reduce trouble calls and ease
installation compared to other equipment that

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often consists of separate systems, each of which corresponds to one service and
which may not operate effectively together.

     Complete Solution For Delivery of Voice, Data and Video. By supplying
equipment for the telephone company central office, the field and the
subscriber's home or office, we offer a single integrated system for the
delivery of voice, data and video services. With our products, telephone
companies initially deploying voice service can subsequently activate data
and/or video service with a simple addition and installation of equipment at the
subscriber's home or office. We believe the flexibility found in our products
cannot currently be accomplished by attempting to integrate multiple systems
from multiple vendors.

     Reliable and Compatible Technology. Because our products provide multiple
services, including voice, they are engineered to comply with rigorous industry
standards for reliability and safety. We have also designed our products to
operate with existing telephone company switches and billing systems, thereby
minimizing the cost of using our products.

     Security. We believe that our products produce greater security compared to
cable systems that are based on shared network design in which data is broadcast
to all users simultaneously. Security has always been important to individuals
and businesses in voice transmission and is becoming increasingly important as
e-commerce applications and video-on-demand services become more prevalent.

PRODUCTS

     Our products include equipment located at a telephone company's central
office, in the field and at a subscriber's home or business.

     Broadband Digital Terminal. The Broadband Digital Terminal is the central
element of our product suite, providing centralized access to both broadband and
narrowband core networks and related voice, data and video services. The
Broadband Digital Terminal is typically located in a telephone company's central
office, or at a remote building basement or hut where it connects with central
office equipment including voice and data switches and billing systems. On the
subscriber side, the Broadband Digital Terminal provides high-speed connections
to remote Universal Service Access Multiplexers or Broadband Network Units that
can support several thousand telephone subscribers or combinations thereof. The
Broadband Digital Terminal has the capacity for broadband applications such as
video-on-demand and high definition television. Also, because the Broadband
Digital Terminal supports different remote terminals, changes to network layouts
or transmission media, copper or fiber, do not require different Broadband
Digital Terminals.

     Universal Service Access Multiplexer. We designed the Universal Service
Access Multiplexer to use existing copper wire to connect to a customer's home
or office. This product can be connected with fiber optic cable to the Broadband
Digital Terminal. Each Universal Service Access Multiplexer can support up to 32
video and/or data subscribers via Very High Bit Rate Digital Subscriber Line of
Asymmetric Digital Subscriber Line technology or up to 96 voice subscribers. By
using modular components, a single Universal Service Access Multiplexer enables
multiple voice, data and video services. The Universal Service Access
Multiplexer can be deployed in the telephone company's central office or
remotely. Because the Universal Service Access Multiplexer is flexible in terms
of where it can be located in the network, as well as the services it can
support, its use can reduce both the costs and the complexity of deploying new
high-speed data and video services.

     Broadband Network Unit. The Broadband Network Unit is used with Fiber to
the Curb installations where fiber optic cable is deployed up to a location
relatively close to the customer's home or office. The Broadband Network Unit
supports voice, data and video services, and can be mounted on a telephone pole,
a pedestal or a wall. The Broadband Network Unit provides voice, high-speed data
and video service for clusters of up to 16 video and/or data and up to 36 voice
subscribers. Our Broadband Network Unit is particularly suited to situations
where a new network is being built, or where existing copper wire is being
upgraded by the installation of fiber optic cable as the transmission medium for
residences or larger apartment buildings or offices. The advanced design and
environmentally secure housing of the Broadband Network Unit helps to reduce
in-field trouble calls.

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     N(3) Residential Gateway. Our N(3) Residential Gateway product is a single
set-top box that delivers integrated data and video services. One N(3)
Residential Gateway enables multiple televisions and PCs to be served from the
same copper line coming into the customer's home or office. Traditionally, the
high cost of customer home or office equipment for broadband services has been a
limiting factor in the deployment of broadband services to multiple televisions
or personal computers. Historically, a customer would have to obtain multiple
modems or set-top boxes to support services to multiple televisions or personal
computers. In contrast, our N(3) Residential Gateway simultaneously provides
three independent high quality digital video streams that can be distributed
throughout a home or office using standard coaxial cable. The N(3) Residential
Gateway also supports enhanced telephone services, such as an indicator on the
television that a message is waiting on the customer's answering machine or
service as well as on-screen caller ID. The data port in our N(3) Residential
Gateway supports high-speed connectivity to the Internet or remote work-at-home
access.

     N(3) ETHERset. Our N(3) ETHERset is a data-only, desktop device that
provides a powerful, low-cost solution for delivering high-speed Internet or
data services to subscribers in residences, small businesses, branch offices and
the like. Individual or multiple PCs can be connected to a single N(3) ETHERset.

     Element Management Systems. Our products can be managed remotely by our
N(3)View-1 Element Management System and our N(3) View-2 Service Manager. The
View-1 Element Management System enables service providers to manage our
equipment and their other systems and products. The View-2 Service Manager
enables service providers to manage delivery of voice, data and video services
to their customers.

CUSTOMERS

     We market and sell our products through our direct sales force to service
providers. For the year ended December 31, 2000, approximately 56% of our sales
were to Qwest. Additionally, we have increased our sales to the local,
independent and international telephone companies in the current year. During
the year ended December 31, 2000, we had 62 customers that purchased at least
$100,000 of our products.

     Qwest: In August 1997, we entered into an agreement with Qwest (formerly US
WEST) through which Qwest may purchase, without obligation to do so, up to
450,000 N(3) Residential Gateways and associated central office and field
equipment, in eight of the 14 states in which Qwest currently operates over a
five-year period. We recorded our first sale to Qwest in September 1997 for
deployment of video and data service to Qwest's customers in Phoenix, Arizona.
In October 1998, Qwest selected our product to provide voice applications in six
of the 14 states that Qwest serves. Sales to Qwest represented 56% of our
revenues in 2000, 67% in 1999 and 68% in 1998. As a result of the merger between
U S WEST and Qwest, Qwest slowed its purchases of our equipment while it
re-evaluates its plans regarding the deployment of VDSL across its network.
Sales to Qwest in the future are dependent upon their decision regarding the
deployment of our product.

     Others: Our customers also include Hutchinson Telephone, Paul Bunyan Rural
Telephone, Chibardun Telephone, Horizon, New ULM, Washington, Wood County,
Hickory Tech, Clearlake, Cablevision, Bell Canada, All West and Northstar
Telephone.

TECHNOLOGY

     We believe the following key technologies have been instrumental in our
ability to provide what we believe is the world's only integrated, complete
solution for the delivery of integrated voice, high-speed data and digital video
services over the existing telephone copper wires.

     Advanced Application Specific Circuits Architecture. Applications Specific
Circuits are custom-designed silicon circuits that are optimized for a specific
task or set of tasks. These circuits are critical because they are
performance-optimized to minimize gate counts, packaging size, power dissipation
and cost. In addition, one of these circuits may be the only way to provide a
new or novel function that is not available in an off-the-shelf circuit. Our
engineers have substantial experience in the design of these circuits and have
developed a portfolio of over 15 of these circuits, which enables flexible
delivery of voice, data and video from a single system. We

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will continue to pursue additional service and system level Application Specific
Circuits as a mechanism for protecting our intellectual property and to achieve
ongoing cost reductions.

     System Design and Integration Expertise. We employ a team of experienced
system design and integration engineers in our research and development group.
These individuals provide research, design and development resources and ensure
that our products can be integrated by our customers. System integration by our
customers is required on our specific access products, equipment at the
consumer's home or business, and management systems, as well as the integration
of our products into our customers' networks. System integration expertise is
critical to the successful deployment of new advanced full service
telecommunications systems and services by our customers.

     Wavelength Division Multiplexing Technology. Our system uses a technology
known as wavelength division multiplexing. This technology allows multiple
optical signals to be carried on the same optical fiber. In particular, this
technology is used to communicate two-way voice, data and video over a single
optical fiber. This enables our customers to save fiber costs and increase
bandwidth.

     Software and Protocol Stacks. Most of the system software in our products
has been developed internally using modern design principles and processes.
Where appropriate, various third-party software packages have been integrated
into the access system. Some examples include the real time operating system and
various protocol stack software packages.

     Standards-based Architecture. We support multiple industry standards to
minimize interoperability issues and leverage industry hardware and software
capabilities, and improve time to market. On the customer side of the network,
we are working with industry standards for asynchronous digital subscriber line
and very high-speed digital subscriber line standards to support various
equipment at the customer's home or business.

RESEARCH AND DEVELOPMENT

     As of February 28, 2001, we had 242 full time employees and four
independent contractors engaged in research and development. We believe that our
future success depends on our ability:

     - to adapt to the rapidly changing telecommunications environment;

     - to maintain our expertise in core technologies; and

     - to continue meeting and anticipating the evolving needs of telephone
       companies.

     We continually review and evaluate technological changes affecting the
telecommunications market and invest substantially in applications-based
research and development. We are committed to an ongoing program of new product
development that combines internal development efforts with strategic
relationships and licensing or marketing arrangements relating to new products
and technologies from outside sources.

     We have focused our research and development expenditures for the past
several years on creating a complete solution for the delivery of voice, data
and video services using the existing infrastructure of telephone companies. We
have also concentrated on developing the associated customer premises equipment,
including our N(3) Residential Gateway, and on developing our N(3) View-1
Element Management Systems. In 2000, 1999 and 1998, research and development
expenses were $55.8 million, $48.5 million and $47.1 million. We believe that
our extensive experience in designing and implementing high-quality network
components has enabled us to develop integrated systems solutions. We seek to
constantly improve our existing products, including developing additional home
and office products and higher speed interfaces for our products.

SALES AND MARKETING

     We primarily market and sell our products through a direct sales force
located in North America that consisted of 73 people as of February 28, 2001. To
date, sales activities have been focused primarily on the regional Bell
operating companies. More recently, we have focused on emerging opportunities
within the local, independent and international telephone markets. We are
currently expanding our sales organization to focus on these emerging customer
opportunities. As of February 28, 2001, 22 sales people were focused solely on

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sales to local telephone companies. Because of the potential importance of our
products to our customers' networks, we focus our selling efforts at many levels
within each customer's organization.

     We have a variety of marketing programs and initiatives to support the sale
and distribution of our products. As of February 28, 2001, we had 12 full time
employees engaged in marketing activities focusing on reaching technical experts
within telephone companies and creating product awareness and credibility for
our systems among telephone companies. A key factor to building brand awareness
for our products is promoting the success of our customers deploying our
products. We seek to educate telephone companies regarding the benefits of
deploying broadband-ready equipment across a diverse subscriber base. We also
build our brand name through continued publicity and referral efforts in both
media and industry-centered activities, including editorial presence in various
trade magazines, press releases, public speaking opportunities, national and
regional trade show participation, advertising, Internet-based communication and
promotion, media sponsorships and participation in industry standards
activities.

MANUFACTURING

     We seek to deliver our products on time and defect-free by capitalizing on
the experience and expertise of strategic contract manufacturers. Based on their
quality assurance and strengths in the volume manufacture of our products, we
have established our primary contract manufacturing relationships with SCI
Systems and ACT Manufacturing. SCI Systems is responsible for manufacturing a
majority of our circuit board plug-in assemblies. ACT Manufacturing is
responsible for manufacturing our N3 Residential Gateway product. Using contract
manufacturers allows us to reduce the costly investment in manufacturing
capital, achieve economies of scale in purchasing selected components and reduce
inventory warehousing.

     We maintain only a limited in-house manufacturing capability for final
assembly, testing and integration of our products. Our internal manufacturing
expertise is focused on product design for testability, design for
manufacturability and the transfer of products from development to
manufacturing. Each contract manufacturer typically assembles an account team of
personnel representing all the essential functions to deliver products from
prototype through volume production. This team works with our design, test and
manufacturing engineers, and our quality, materials, logistics and program
management teams. All of our major contract manufacturers are certified under
international quality standards. Although our contract manufacturers manage
material procurement for the majority of the components that are incorporated in
our products, we continue to manage the evaluation and selection of certain key
components.

     Our engineering team designs circuits and tests these designs using
computer simulations. When the fundamental design is stable, our outsourced
manufacturers make the circuits for testing. Upon completion of these tests,
vendors such as Oki Semiconductor, Broadcom, STMicroelectronics, VLSI (Philips)
and Motorola manufacture the circuit in volume. Warranty and repair support is
performed off-site by our contract manufacturers and by us at our Rohnert Park,
California facility.

CUSTOMER SERVICE AND SUPPORT

     We believe that successful long-term relations with our customers require a
service organization committed to customer satisfaction. As of February 28,
2001, we had 39 technical support employees at our headquarters or in the field.
We also offer a five-day training course for all new customers prior to
receiving and installing a system. To date, revenues from customer service and
support have been immaterial.

     We provide direct support by telephone or at a customer's office or other
location at any time. To monitor service activities, we maintain a customer call
tracking system. We also maintain a dial-up analog modem connection or an
Internet-based management interface to our equipment to assist with diagnostics.

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COMPETITION

     The market for providing equipment for local telecommunications networks is
extremely competitive. The principal competitive factors in this market include,
or are likely to include:

     - product performance and price;

     - features and reliability;

     - technical support and service;

     - relationships with phone companies and systems integrators;

     - compliance with industry standards;

     - compatibility with the products of other suppliers;

     - sales and distribution capabilities;

     - strength of brand name;

     - long-term cost of ownership to communications providers; and

     - general industry and economic conditions.

     Many of our current and potential competitors have longer operating
histories and greater name recognition and resources than we do. These
competitors may undertake more extensive marketing campaigns than we do. In
addition, these competitors may adopt more aggressive pricing policies than we
do. Also, these competitors may devote substantially more resources to
developing new products than we do. Many of our competitors have recently been
acquired and now have even greater resources to compete with us.

     Our significant current and potential competitors include Advanced Fibre
Communications, Alcatel, Cisco Systems, Efficient Networks, Ericsson, Lucent
Technologies, Nokia, Nortel Networks, RELTEC Corporation (acquired by BAE
Systems, CNI Division, formerly GEC Marconi), Scientific Atlanta, Siemens and
our largest stockholder, General Instrument/Motorola. Some of these competitors
have existing relationships with our current and prospective customers, which
could give them a competitive advantage over us as a preferred provider. In
addition, we anticipate that other large companies, such as Matsushita Electric
Industrial, which markets products under the Panasonic brand name, Microsoft,
Network Computer, Philips, Sony Corp., STMicroelectronics and Toshiba America,
will likely introduce products that compete with our N(3) Residential Gateway
product in the future.

     In addition, we are likely to face increasing competition from alternative
technologies. In particular, cable operators are currently deploying products
that deliver voice, high-speed data and video services over cable. Cable service
providers that offer these packaged services will give subscribers the
alternative of purchasing all communications services from a single service
provider. If these services are implemented successfully, they will compete
directly with the services offered by telephone companies using our products.

     Consolidation in the telecommunications equipment industry may strengthen
our competitors' position in our market. Consolidation of our competitors has
occurred, and we expect it to continue to occur in the foreseeable future. For
example, Alcatel acquired DSC Communications, Lucent acquired Ascend
Communications, and GEC Marconi acquired RELTEC Corporation. Acquisitions such
as these further strengthen our competitors' financial, technical and marketing
resources and provide access to regional Bell operating company customers. As a
result, these competitors are able to devote greater resources to the
development, promotion, sale and support of their products. This consolidation
may allow some of our competitors to penetrate new markets that we have
targeted, such as the domestic local, independent and international telephone
markets. If our competitors are successful in these markets, we will be harmed.

INTELLECTUAL PROPERTY

     We rely on a combination of patent, copyright and trademark laws, and on
trade secrets, confidentiality provisions and other contractual provisions to
protect our intellectual property. These measures afford only

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limited protection. As of February 28, 2001, we had 24 issued patents in the
United States and 26 issued patents in foreign countries. We have 35 pending
U.S. patent applications and 99 pending international patent applications. We
market our products primarily under our own name and mark. We consider our
trademarks to be valuable assets. We rely on patent, trademark, trade secret and
copyright laws both to protect our proprietary technology and to protect us
against claims from others. We believe that we have direct intellectual property
rights or rights under cross-licensing arrangements covering substantially all
of our material technologies. Given the technological complexity of our systems
and products, however, we cannot assure that claims of infringement will not be
asserted against us or against our customers in connection with their use of our
systems and products, nor can we assure the outcome of any such claims.

SOURCES AND AVAILABILITY OF MATERIALS

     We contract for the manufacture of all of our products and have limited
in-house manufacturing capabilities. We rely primarily on two large contract
manufacturers: SCI Systems and ACT Manufacturing. For a detailed discussion of
these relationships and the risks associated with our dependence upon
third-party manufacturers, see "Business -- Manufacturing" and "Risk Factors."

     Some parts, components and equipment used in our products are obtained from
sole sources of supply. If our sole source suppliers or we fail to obtain
components in sufficient quantities when required, delivery of our products
could be delayed. Additional sole-sourced components may be incorporated into
our equipment in the future. We do not have any long-term supply contracts to
ensure sources of supply. In addition, our suppliers may enter into exclusive
arrangements with our competitors, stop selling their products or components to
us at commercially reasonable prices or refuse to sell their products or
components to us at any price, which could harm our operating results.

ENVIRONMENTAL MATTERS

     Our research and development operations are subject to certain federal,
state, local and foreign environmental protection laws and regulations. These
laws and regulations relate to the use, handling, storage, discharge and
disposal of certain hazardous materials and wastes, the pre-treatment and
discharge of process waste waters and the control of process air pollutants. We
believe that we are in compliance in all material respects with applicable
environmental regulations. If those laws and regulations become more stringent
over time, we may not be able to comply in a timely manner, or comply at all.
Compliance with new laws and regulations could create significant compliance
expenses, result in production suspension and delay, restrictions on expansion
at present locations and require the acquisition of costly equipment.
Non-compliance with laws and regulations could result in penalties and
suspension of operations.

REGULATION OF CUSTOMERS

     Although our products are not now directly subject to significant
regulation by the Federal Communications Commission, or FCC, or any other
federal or state communications regulatory agency, our customers and their
networks, into which our products are incorporated, are subject to government
regulation. Accordingly, the effects of regulation on our customers may, in
turn, harm us. FCC regulatory policies affecting either the willingness or the
ability of cable operators or telephone companies to offer certain services and
to permit the allocation of our products on their premises, or the terms on
which these companies offer the services and conduct their businesses, may
impede sales of our products.

     Several FCC regulatory policies may affect the degree to which or way in
which incumbent local exchange carriers, which we refer to as incumbent
carriers, principally the regional Bell operating companies, can or choose to
make integrated voice, data and video offerings available. For example, the
Telecommunications Act of 1996 requires incumbent carriers to offer their
competitors cost-based access to certain parts of their networks to enable these
competitors to provide telecommunications services. In response to a decision by
the Supreme Court overturning the FCC's rule identifying the specific network
elements that incumbent carriers must offer to their competitors, the FCC
announced that, except in limited circumstances, it will not require incumbent
carriers to offer their competitors access to the facilities and equipment used
to provide

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high-speed data services. However, the FCC has stated that it will reexamine
this decision every three years and judicial appeals of the decision may follow.
The 1996 Telecommunications Act also requires incumbent carriers to offer for
resale, at wholesale rates, any telecommunications services that incumbent
carriers offer to customers. The FCC has determined that high-speed data
services are "telecommunications services," and thus incumbent carriers must
offer high-speed data services for resale by competitors. The FCC also requires
incumbent carriers to permit competitive carriers to collocate their equipment
with the local switching equipment of the incumbents. The U.S. Court of Appeals
for the D.C. Circuit recently overturned some of the FCC's collocation rules
that required incumbents to permit the collocation of equipment that provides
functionalities in addition to interconnection and access to unbundled network
elements and the FCC is currently in the process of revising its rules.

     The uncertainties caused by pending regulatory proceedings or appeals could
cause potential customers to delay purchasing decisions. In addition, the
outcomes of the various regulatory proceedings may cause potential customers to
not deploy all of the services for which our products are designed or to delay
the widespread introduction of one or more of these services. Certain members of
Congress have also expressed an interest in reducing the regulation of incumbent
carriers' provision of video and high-speed data services, but again there is no
way to predict whether this legislation will be adopted.

     The FCC also has proposed allowing incumbent carriers to offer high-speed
data and video services through a structurally separate subsidiary that is not
subject to the unbundling and resale requirements. Our equipment is designed to
allow carriers to provide video, high-speed data, and digital voice on an
integrated basis. If incumbent carriers choose to offer video or data services
through a separate affiliate, incumbent carriers may prefer vendors whose
equipment does not provide for integration of service offerings. A separate
affiliate may choose to purchase less sophisticated equipment because it might
not be able to utilize fully our equipment's integrated features. We will not
know for certain the FCC's position on the proposed separate affiliate
requirement until the FCC issues an order. In a separate proceeding, the FCC
released an order requiring two large incumbent carriers, SBC and Ameritech, to
provide high-speed data services through a separate subsidiary as a condition to
the FCC's approval of their merger. Under the terms of the order, this condition
terminates when the two incumbent carriers satisfy certain requirements, but no
sooner than 42 months after the merger's closing. Recently, however, the U.S.
Court of Appeals for the D.C. Circuit vacated, in part, the FCC's order and held
that the FCC may not permit an incumbent carrier to avoid its regulatory
obligations by setting up an affiliate to offer such services.

     The FCC's rules prohibit incumbent carriers from providing voice or data
services along with customer premises equipment, such as our N(3) Residential
Gateway, as a package offering at a single price. The FCC also currently
regulates the offering of enhanced services by certain carriers, including
incumbent carriers. The FCC restricts these carriers from offering, for example,
Internet access services bundled with local exchange voice services. These
bundling restrictions may limit the ability of incumbent carriers using our
equipment to attract customers. The FCC is considering amending or repealing
these bundling restrictions, but we cannot assure that rule changes will take
place.

     Distribution of our N3 Residential Gateway could be adversely affected by
the FCC's "navigation devices" rules. Those rules require video program
distributors, including those who use our system to deliver video, to allow
set-top boxes and other navigation devices owned by customers or manufactured by
third parties to be connected to the video program distributor's system. The
rules require video program distributors to disclose technical details of their
interfaces so as to permit third parties to manufacture the navigation devices
and retail customers to connect them. We believe these rules are not readily
applicable to our system because our N3 Residential Gateway is in many ways
different from a cable set-top box, and currently there is little likelihood of
an independent market for our N3 Residential Gateway separate from our entire
system. However, if these rules could be applied to our N3 Residential Gateway
or other parts of our system, our customers might be required to disclose
proprietary technical information including patented data about our technology,
to allow competing vendors to access the system.

                                        8
<PAGE>   11

EMPLOYEES

     As of February 28, 2001, we had a total of 476 full-time employees and 14
independent contractors. Of the total number of employees, 242 were in research
and development, 20 in marketing, 53 in operations, 92 in sales and sales
support and 69 in administration. Of the total number of contractors, four were
in research and development, two were in operations, two were in administration
and six were in sales and sales support. Our employees are not represented by
any collective bargaining agreement with respect to their employment, and we
have never experienced an organized work stoppage. Satisfactory relations have
generally prevailed between our employees and us. Our future success is heavily
dependent upon our ability to hire and retain qualified technical, marketing and
management personnel. The competition for personnel is intense, particularly for
engineering personnel.

ITEM 2. PROPERTIES

     Our principal corporate offices, which include two main buildings, are
located in Rohnert Park, California. We lease one of the buildings and own the
other. We also lease five sales offices, in Denver, Colorado, San Diego,
California, Des Moines, Iowa, Heerenveen, Netherlands, and Ngee Ann City,
Singapore. In addition, we lease two facilities for our technology department in
Parsippany, New Jersey and Ho Chi Minh City, Vietnam. We also lease one office
in Phoenix, Arizona for our customer service department. We believe our current
facilities are suitable and adequate and have sufficient productive capacity to
meet our current needs.

ITEM 3. LEGAL PROCEEDINGS

     We are currently not a party to any material legal proceeding.

     In April 1995, DSC Communications and DSC Technologies filed an action
against us and our founders, who are former DSC employees, in the United States
District Court for the Eastern District of Texas alleging breach of contract,
usurpation of corporation opportunity and misappropriation of trade secrets. The
complaint alleged that certain telecommunications technology known as switched
digital video was misappropriated by the defendants. Following a March 1996
trial on the merits, the jury found against the defendants on all three
theories, and the court awarded DSC $136.7 million in damages based on future
lost profits. Following several post-trial proceedings and an appeal of a
federal district court's denial of injunctive relief, on February 28, 1997, the
United States Court of Appeals for the Fifth Circuit ruled that DSC was not
entitled to permanent injunctive relief, since the lost profits damage award was
based on the assumption that we developed a competing switched digital video
system. Subsequently, we satisfied the judgment of the Texas litigation,
including interest, by paying DSC $141.0 million in November 1997.

     In March 1998, DSC filed an action against Next Level Communications L.P.,
Spencer Trask Investors LLC, General Instrument and Spencer Trask & Co., Inc.,
the parent of the general partner, in the Superior Court of the State of
Delaware in and for New Castle County. In that action, DSC alleged that in
connection with the formation of Next Level Communications L.P. and the transfer
to it of the switched digital video technology, Next Level Communications L.P.
and Spencer Trask Investors LLC misappropriated DSC's trade secrets; that
General Instrument improperly disclosed trade secrets when it conveyed this
technology to the partnership; and that Spencer Trask & Co. conspired to
misappropriate DSC's trade secrets. The trade secrets at issue were the
same-switched digital video technology trade secrets at issue in the Texas
litigation. DSC sought actual damages for the defendants' purported unjust
enrichment, disgorgement of consideration, exemplary damages and attorney's
fees, all in unspecified amounts. In April 1998, the defendants filed an action
in the United States District Court for the Eastern District of Texas,
requesting that the federal court preliminarily and permanently enjoin DSC from
prosecuting the Delaware action because by pursuing the action, DSC effectively
was trying to circumvent and relitigate the Texas action, in which we had paid
$141.0 million. In May 1998, the Texas court granted a preliminary injunction
preventing DSC from proceeding with the Delaware action. That injunction order
was appealed to the United States Court of Appeals for the Fifth Circuit. In
June 1999, the Fifth Circuit affirmed the grant of the preliminary injunction.
On July 15, 1999, the Texas federal court granted the Delaware defendants'
motion for summary judgment

                                        9
<PAGE>   12

and issued its final judgment, permanently enjoining DSC from prosecuting and
continuing the Delaware action.

     In May 1998, actions by BroadBand Technologies, Inc. against General
Instrument and by Next Level Communications against BroadBand Technologies,
pending in the United States District Court for the Eastern District of North
Carolina, were dismissed with prejudice. The action brought by BroadBand related
to fiber optic communications systems for delivering television signals and a
patent held by BroadBand. The action brought by Next Level Communications
involved contentions that BroadBand infringed two patents held by Next Level
Communications relating to video compression and signal processing and that
BroadBand had violated antitrust laws. These dismissals were entered pursuant to
a settlement agreement under which, among other things, Next Level
Communications L.P. paid BroadBand Technologies $5.0 million, which was expensed
in 1998, and BroadBand Technologies and Next Level Communications L.P. have
entered into a perpetual cross-license of patents applied for or issued
currently or through May 2003.

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

     No matters were submitted to a vote of our stockholders during the quarter
ended December 31, 2000.

                                        10
<PAGE>   13

                                    PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS

     During November 1999, we completed our initial public offering in which we
sold 9,775,000 shares of our common stock at a price of $20.00 per share. Our
common stock is listed on The Nasdaq Stock Market's National Market under the
symbol "NXTV." The following table sets forth the high and low prices or our
common stock for the periods indicated as reported on The Nasdaq National
Market.

<TABLE>
<CAPTION>
                          YEAR                              HIGH        LOW
                          ----                            --------    -------
<S>                                                       <C>         <C>
2000
Fourth Quarter..........................................  $ 71.500    $10.375
Third Quarter...........................................  $125.563    $40.625
Second Quarter..........................................  $128.125    $50.000
First Quarter...........................................  $195.750    $60.750
1999
Fourth Quarter..........................................  $ 74.875    $47.875
</TABLE>

     On February 28, 2001, the last reported sale price for our common stock on
the Nasdaq National Market was $8.781 per share. At February 28, 2001, the
number of record holders of our common stock was 158.

     We have never declared or paid any cash dividends on our common stock and
do not anticipate paying any cash dividends in the foreseeable future. We intend
to retain all available funds and any future earnings for use in the operation
of our business.

     In November 1999, we completed our initial public offering through an
underwritten public offering pursuant to a Registration Statement on Form S-1
(File No. 333-85999). These funds have been the principal source of liquidity
for us during the year ended December 31, 2000 and were used to fund operating
losses and make capital expenditures as described in the financial statements
included with this report.

                                        11
<PAGE>   14

ITEM 6. SELECTED FINANCIAL DATA

     The selected financial data set forth below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the historical consolidated financial statements and notes
included in this report.

<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31,
                                  -------------------------------------------------------------------
                                     2000          1999          1998          1997          1996
                                  -----------   -----------   -----------   -----------   -----------
                                                            (IN THOUSANDS)
<S>                               <C>           <C>           <C>           <C>           <C>
STATEMENT OF OPERATIONS DATA:
Revenues
  Equipment.....................  $   146,314   $    54,301   $    39,243   $     6,045   $        --
  Software......................        3,777         3,296         4,587         2,266            --
                                  -----------   -----------   -----------   -----------   -----------
          Total revenues........      150,091        57,597        43,830         8,311            --
Cost of revenues
  Equipment.....................      116,090        51,265        37,372        10,954            --
  Software......................          141           292           261           306            --
  Inventory charge..............        9,000            --         5,800            --            --
                                  -----------   -----------   -----------   -----------   -----------
          Total cost of
            revenues............      125,231        51,557        43,433        11,260            --
Gross profit (loss).............       24,860         6,040           397        (2,949)           --
Operating Expenses:
  Research and development......       55,834        48,454        47,086        37,064        17,102
  Selling, general and
     administrative.............       46,907        30,511        26,248        26,414        15,850
  Litigation....................           --            --         5,000            --       141,000
  Non-cash compensation
     charge.....................        2,384       128,284            --            --            --
                                  -----------   -----------   -----------   -----------   -----------
          Total operating
            expenses............      105,125       207,249        78,334        63,478       173,952
Operating loss..................      (80,265)     (201,209)      (77,937)      (66,427)     (173,952)
Interest income (expense),
  net...........................        5,575        (3,564)       (3,776)           --            --
Other income (expense), net.....         (148)         (299)          (18)           (2)           48
                                  -----------   -----------   -----------   -----------   -----------
Net loss........................  $   (74,838)  $  (205,072)  $   (81,731)  $   (66,429)  $  (173,904)
                                  ===========   ===========   ===========   ===========   ===========
Basic and diluted net loss per
  share (pro forma in 1999,
  1998, 1997 and 1996)..........  $     (0.91)  $     (2.78)  $     (1.08)  $     (0.95)  $     (2.49)
Shares used to compute basic and
  diluted net loss per share
  (pro forma in 1999, 1998, 1997
  and 1996).....................   81,929,663    71,597,834    69,967,053    69,967,053    69,967,053
</TABLE>

<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                             -----------------------------------------------------
                                               2000       1999       1998       1997       1996
                                             --------   --------   --------   --------   ---------
                                                                (IN THOUSANDS)
<S>                                          <C>        <C>        <C>        <C>        <C>
BALANCE SHEET DATA:
Cash and cash equivalents..................  $ 35,863   $128,752   $ 28,983   $    377   $      --
Working capital (deficit)..................    70,265    147,948     38,564    (29,571)   (143,001)
Total assets...............................   275,716    267,811     97,771     52,689      17,393
Long-term obligations, net of current
  portion..................................        --     25,199     81,275         --          --
Total partners' deficit/stockholders'
  equity (deficit).........................   158,749    206,228    (14,769)    (3,702)   (172,029)
</TABLE>

                                        12
<PAGE>   15

     The following table sets forth unaudited statement of operations data for
our eight most recent quarters ended December 31, 2000. This unaudited
information has been prepared on the same basis as the annual financial
statements and includes all adjustments, consisting of normal recurring items
except for the noncash compensation charges in the three months ended December
31, 1999 and March 31, 2000 and the inventory charge in the three months ended
December 31, 2000, that management considers necessary for a fair presentation
of the financial information for the periods presented.
<TABLE>
<CAPTION>
                                                                        THREE MONTHS ENDED
                                        ----------------------------------------------------------------------------------
                                        DECEMBER 31,   SEPTEMBER 30,   JUNE 30,   MARCH 31,   DECEMBER 31,   SEPTEMBER 30,
                                            2000           2000          2000       2000          1999           1999
                                        ------------   -------------   --------   ---------   ------------   -------------
                                                                          (IN THOUSANDS)
<S>                                     <C>            <C>             <C>        <C>         <C>            <C>
Revenues
  Equipment...........................    $ 30,159       $ 47,126      $ 39,340   $ 29,689     $  24,453       $ 13,419
  Software............................       1,007          1,144           836        790           714            821
                                          --------       --------      --------   --------     ---------       --------
        Total revenues................      31,166         48,270        40,176     30,479        25,167         14,240
Cost of revenues
  Equipment...........................      22,991         36,132        32,076     24,891        21,524         12,759
  Software............................          52              7            25         57            64             70
  Inventory charge....................       9,000             --            --         --            --             --
                                          --------       --------      --------   --------     ---------       --------
        Total cost of revenues........      32,043         36,139        32,101     24,948        21,588         12,829
                                          --------       --------      --------   --------     ---------       --------
Gross profit (loss)...................        (877)        12,131         8,075      5,531         3,579          1,411
Operating expenses:
  Research and development............      15,285         13,053        13,652     13,844        12,593         12,810
  Selling, general and
    administrative....................      12,671         13,705        10,966      9,565         8,291          7,836
  Noncash compensation charge.........           0              0             0      2,384       128,284              0
                                          --------       --------      --------   --------     ---------       --------
        Total operating expenses......      27,956         26,758        24,618     25,793       149,168         20,646
                                          --------       --------      --------   --------     ---------       --------
Operating loss........................     (28,833)       (14,627)      (16,543)   (20,262)     (145,589)       (19,235)
Other income (expense), net...........         (67)           (30)          (46)        (5)          (35)           (17)
Interest income (expense), net........         518          1,264         1,956      1,837           500         (1,499)
                                          --------       --------      --------   --------     ---------       --------
Net loss..............................    $(28,382)      $(13,393)     $(14,633)  $(18,430)    $(145,124)      $(20,751)
                                          ========       ========      ========   ========     =========       ========

<CAPTION>
                                         THREE MONTHS ENDED
                                        --------------------
                                        JUNE 30,   MARCH 31,
                                          1999       1999
                                        --------   ---------
                                           (IN THOUSANDS)
<S>                                     <C>        <C>
Revenues
  Equipment...........................  $  8,482   $  7,947
  Software............................       931        830
                                        --------   --------
        Total revenues................     9,413      8,777
Cost of revenues
  Equipment...........................     8,651      8,331
  Software............................        84         74
  Inventory charge....................        --         --
                                        --------   --------
        Total cost of revenues........     8,735      8,405
                                        --------   --------
Gross profit (loss)...................       678        372
Operating expenses:
  Research and development............    11,798     11,253
  Selling, general and
    administrative....................     7,593      6,791
  Noncash compensation charge.........         0          0
                                        --------   --------
        Total operating expenses......    19,391     18,044
                                        --------   --------
Operating loss........................   (18,713)   (17,672)
Other income (expense), net...........       (17)      (230)
Interest income (expense), net........    (1,210)    (1,355)
                                        --------   --------
Net loss..............................  $(19,940)  $(19,257)
                                        ========   ========
</TABLE>

                                        13
<PAGE>   16

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

     You should read the following discussion and analysis along with selected
financial data, our consolidated financial statements and the related notes
included elsewhere in this report.

     Some of the statements in the following discussion and elsewhere in this
Form 10-K constitute forward-looking statements. These statements relate to
future events or our future financial performance. In some cases, you can
identify forward-looking statements by terminology such as "may," "will,"
"should," "expect," "plan," "anticipate," "believe," "estimate," "predict,"
"potential" or "continue" or the negative of such terms or other comparable
terminology. These statements involve known and unknown risks, uncertainties,
and other factors that may cause our or our industry's actual results, levels of
activity, performance, or achievements to be materially different from any
future results, levels of activity, performance or achievements expressed or
implied by such forward-looking statements. These factors include, among other
things, those listed under "Risk Factors" and elsewhere in this Form 10-K.

     Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance, or achievements.

OVERVIEW

     We design and market broadband communications equipment that enables
telephone companies and other communications service providers to
cost-effectively deliver a full suite of voice, data and video services over the
existing copper wire telephone infrastructure. We commenced operations in July
1994 and recorded our first sale in September 1997. From January 1998 until
November 1999, we operated through Next Level Communications L.P., which was
formed as the result of the transfer of all of the net assets, management and
workforce of a wholly owned subsidiary of General Instrument. In November 1999,
the business and assets of that partnership were merged into Next Level
Communications, Inc. as part of our recapitalization. In January 2000, General
Instrument was acquired by Motorola, Inc., making us an indirect subsidiary of
Motorola.

     We generate our revenue primarily from sales of our equipment. One customer
has accounted for a large part of our revenues to date, and we expect this
concentration to continue in the future. Qwest, formerly U S WEST, accounted for
56%, 67% and 68% of total revenues in 2000, 1999 and 1998, respectively. As a
result of the merger between U S WEST and Qwest, Qwest has slowed its purchases
of our equipment while it re-evaluates its plans regarding the deployment of
VDSL across its network. Sales to Qwest in the future are dependent upon their
decision regarding the deployment of our product. Our agreements with our
largest customers are cancelable by these customers on short notice and without
penalty, and do not obligate the customers to purchase any products. In
addition, our significant customer agreements generally contain fixed-price
provisions. As a result, our ability to generate a profit on these contracts
depends upon our ability to produce and market our products at costs lower than
these fixed prices.

     The timing of our revenue is difficult to predict because of the length and
variability of the sales cycle for our products. Customers view the purchase of
our products as a significant and strategic decision. As a result, customers
typically undertake significant evaluation, testing and trial of our products
before deploying them. This evaluation process frequently results in a lengthy
sales cycle, typically ranging from six months to more than a year. While our
customers are evaluating our products and before they place an order, if at all,
we may incur substantial sales and marketing expenses and expend significant
management efforts.

     Revenues. Our revenues consist primarily of sales of equipment and sales of
data communications software. We recognize revenue from equipment sales when
contractual obligations have been satisfied, title and risk of loss have been
transferred to the customer and collection of the resulting receivable is
reasonably assured. We accrue a provision for estimated sales returns and other
allowances as a reduction of revenue at the time of revenue recognition. Amounts
received in excess of revenue recognized are recorded as deferred revenue.
Software revenue consists of sales to original equipment manufacturers that
supply communications software and hardware to distributors. Software license
revenue is recognized when a noncancelable license agreement has been signed,
delivery has occurred, the fees are fixed and determinable and collection is

                                        14
<PAGE>   17

probable. The portion of revenues from new software license agreements that
relate to our obligation to provide customer support are deferred based on the
price charged for customer support when it is sold separately, and recognized
ratably over the maintenance period. Revenue from the renewal of customer
support contracts is recognized ratably over the term of the agreement.

     Cost of revenues. Cost of equipment revenue includes direct material and
labor, depreciation and amortization expense on property and equipment, warranty
expenses, license fees and manufacturing and service overhead.

     Research and development. Research and development expense consists
principally of salaries and related personnel expenses, consultant fees,
prototype component expenses and development contracts related to the design,
development, testing and enhancement of our products. All research and
development costs are expensed as incurred.

     Selling, general and administrative. Selling, general and administrative
expense consists primarily of salaries and related expenses for personnel
engaged in direct marketing and field service support functions, executive,
accounting and administrative personnel, recruiting expenses, professional fees
and other general corporate expenses.

RESULTS OF OPERATIONS

  Comparison of 2000 to 1999

     Revenues. Total revenues in 2000 increased to $150.1 million from $57.6
million in 1999. The increase was primarily due to an increase in equipment
sales. Total revenues for the period included $146.3 million of equipment sales,
compared to $54.3 million in 1999. Qwest accounted for $83.4 million of
equipment revenue in 2000 as compared to $38.5 million in 1999. This increase
was primarily attributable to Qwest's increased deployment in the first three
quarters of 2000. As a result of the merger between U S WEST and Qwest, Qwest
slowed its purchases of our equipment while it re-evaluates its plans regarding
the deployment of VDSL across its network. Sales to Qwest in the future are
dependent upon their decision regarding the deployment of our product. We expect
to continue to derive substantially all of our revenues from sales of equipment
to Qwest and local, foreign and independent telephone companies for the
foreseeable future. The growth in equipment revenue in future quarters will
depend upon whether and how quickly our existing customers roll out broadband
services in their coverage areas and whether and how quickly we obtain new
customers.

     Software revenue remained comparable in both years increasing in 2000 to
$3.8 million from $3.3 million in 1999. We expect demand for our software to
remain relatively flat in the near term because the market for these products is
mature.

     Cost of Revenues. Total cost of revenues increased to $125.2 million in
2000 from $51.6 million in 1999. Included in current year cost of sales is a
$9.0 million charge to inventory that was primarily related to a lower of cost
or market adjustment to certain residential gateway products due to decreases in
our sales price per unit and other obsolescence provisions. Our gross margin
percentage including the inventory charge increased to 17% in 2000 from 10% in
1999. Excluding the inventory charge, our gross margin percentage increased to
23% in 2000 from 10% in 1999. The increase in our gross margin percentage was
primarily the result of higher unit volumes, leading to greater efficiencies,
including lower fixed costs per unit. We expect gross margin improvements in the
latter part of 2001 as we increase sales of our higher margin products, and
continue implementing cost reductions. In the future, cost of sales as a percent
of sales may fluctuate due to a wide variety of factors, including: the customer
mix, the product mix, the timing and size of orders which are received, the
availability of adequate supplies of key components and assemblies, our ability
to introduce new products and technologies on a timely basis, the timing of new
product introductions or announcements by us or our competitors, price
competition and unit volume.

     Research and development. Research and development expenses increased to
$55.8 million in 2000 from $48.5 million in 1999. The increase was primarily due
to an increase in research and development personnel. We believe that continued
investment in research and development is critical to attaining our strategic
product

                                        15
<PAGE>   18

development and cost reduction objectives and, as a result, expect these
expenses to increase in absolute dollars. We expense all of our research and
development costs as incurred.

     Selling, general and administrative. Selling, general and administrative
expenses increased to $46.9 million in 2000 from $30.5 million in 1999. The
increase is primarily attributable to the increase in the scale of our
operations including additional personnel in our operations, administration,
sales and marketing organizations, promotional expenses and other administrative
expenses. We have generated higher sales expenses by hiring new sales
representatives in order to increase the number and size of our customer
accounts. We expect selling, general and administrative expenses to increase as
required to support future revenue growth.

     Non-cash compensation charge. Substantially all of our employees had been
granted contingently exercisable stock options that became options to purchase
our common stock upon our recapitalization in 1999. In addition, tandem stock
options were granted in January 1997 to some of our employees. As a result,
non-cash compensation expense was recognized upon the completion of our initial
public offering based on the difference between the exercise price of these
options and the initial public offering price of our common stock. The non-cash
compensation expense related to these option grants was $2.4 million in 2000 and
$128.3 million in 1999.

     Interest income (expense), net. Interest income, net in 2000 was $5.6
million, and represents interest income earned on proceeds from our initial
public offering. In 1999, interest expense, net was $3.6 million, and related to
interest on a $75.0 million note and accrued interest thereon payable to General
Instrument that General Instrument contributed to us in exchange for shares of
our common stock immediately prior to our initial public offering.

  Comparison of 1999 to 1998

     Revenues. Revenues in 1999 increased to $57.6 from $43.8 million in 1998.
The increase was primarily due to an increase in equipment sales. Total revenues
for 1999 included $54.3 million of equipment sales, compared to $39.2 million
for 1998. Qwest accounted for $38.5 equipment revenue in 1999 as compared to
$29.9 in 1998. Bell Atlantic accounted for $5.4 million of equipment revenue in
1999 as compared to $8.6 million in 1998. Sales to Bell Atlantic decreased in
1999 due to the Bell Atlantic merger with NYNEX and the new company's shift in
focus from network rehabilitation to the entry into the long distance market.

     Software revenue in 1999 decreased to $3.3 million in 1999 as compared to
$4.6 million in 1998. The decrease was primarily due to a shift in demand from
1999 to 1998.

     Cost of Revenues. Total cost of revenues increased to $51.6 million in 1999
from $43.4 million in 1998. Cost of revenues in 1998 included a $5.8 million
inventory charge to establish reserves primarily for obsolescence. Our gross
margin percentage increased to 10% in 1999 from 1% in 1998. The increase in our
gross margin percentage was primarily the result of higher unit volumes, leading
to greater efficiencies, including lower fixed costs per unit.

     Research and development. Research and development expenses increased to
$48.5 million in 1999 from $47.1 million in 1998. The increase was primarily due
to an increase in research and development personnel. Included in research and
development expenses in 1998 were expenses related to spending on third party
testing, development of the Residential Gateway product, and the completion of
our products for voice applications.

     Selling, general and administrative. Selling, general and administrative
expenses were $30.5 million in 1999 compared to $26.2 million in 1998.
Approximately $3.9 million of compensation expense relating to the Telenetworks
acquisition is included in the amount for 1998. There was no Telenetworks
compensation expense during 1999. The decrease in compensation expense was
offset by an increase in other selling, general and administrative expenses due
to the increase in scale of our operations including additional personnel in the
sales and marketing organizations, promotional expenses and other administrative
expenses.

     Non-cash compensation charge. Substantially all of our employees had been
granted contingently exercisable stock options that became options to purchase
our common stock upon our recapitalization in

                                        16
<PAGE>   19

November 1999. In addition, tandem stock options were granted in January 1997 to
some of our employees. As a result, non-cash compensation expense was recognized
upon the completion of our initial public offering based on the difference
between the exercise price of the options and the initial public offering price
of our common stock. The non-cash compensation expense related to these option
grants was $128.3 million in 1999.

     Litigation. Litigation expenses of $5.0 million for 1998 related to the
settlement cost of litigation with Broad Band Technologies. For a detailed
discussion of this litigation matter, see "Legal Proceedings." Litigation
expenses in 1999 were not significant and are included in selling, general and
administrative expenses.

     Interest expense, net. Interest expense, net was $3.6 million in 1999
remaining relatively unchanged from a net expense of $3.8 million in 1998. The
net interest expense in these periods was primarily attributable to interest on
a $75 million note and accrued interest thereon payable to General Instrument
that General Instrument contributed to us in exchange for shares of our common
stock immediately prior to our initial public offering. Interest income was $2.2
million in both 1999 and 1998 and was attributable to interest income earned on
cash and cash equivalents.

LIQUIDITY AND CAPITAL RESOURCES

     We have financed our operations primarily by our initial public offering of
our stock and through cash contributions and borrowings from General Instrument.

     Net cash used in operating activities was $88.3 million in 2000, $56.6
million in 1999 and $66.6 million in 1998. In each case, the use of cash in
operating activities was primarily due to our net losses. The increase in cash
used in 2000 was primarily attributable to increases in inventories and
receivable balances, partially offset by an increase in liabilities. In 1999,
net losses were partially offset by $128.3 million in non-cash compensation
charges.

     Net cash used in investing activities of $12.5 million in 2000, $78.7
million in 1999 and $9.3 million in 1998 was primarily attributable to capital
expenditures to support our engineering and testing activities. Our capital
expenditures increased in 1999 due to the fact that we completed a significant
portion of our build-out in that year. In 2000, net cash used in investing
activities also included investments in Expanse Networks, Inc., OutReach
Communications L.L.C., and Virtual Access totaling approximately $15 million,
offset by the sale of $18.0 million in marketable securities. Net cash used in
1999 also included purchases of $45.2 million of marketable securities with the
proceeds from our initial public offering. As we increase the scope of our
operations, we expect that our capital expenditures will increase.

     Net cash provided by financing activities was $7.9 million in 2000, $235.0
million in 1999 and $104.6 million in 1998. Net cash provided by financing
activities in 2000 was primarily attributable to the issuance of common stock.
Net cash provided by financing activities in 1999 included $177.0 million net
proceeds from our initial public offering, $34.0 million contributed by General
Instrument and borrowings of $24.9 million. Net cash provided by financing
activities of $104.6 million in 1998 consisted of a $75.0 million loan from
General Instrument, a $19.6 million capital contribution from General Instrument
and a $10.0 million capital contribution from the general partner.

     At December 31, 2000, we had $35.9 million of cash and cash equivalents and
$70.3 million of working capital.

     We have commitments with suppliers to purchase a total of approximately
$75.0 million of components in 2001.

     In December 1999, we entered into a revolving bank line of credit under
which we have the ability to borrow up to the lesser of $50 million or the value
of pledged collateral. At December 31, 2000, the balance outstanding was $25.0
million and the line was secured by $25.0 million of marketable securities.

     We anticipate that operating expenses, as well as planned capital
expenditures, will constitute a material use of our cash resources. In addition,
we may use cash resources to fund acquisitions or investments in complementary
businesses, technologies or product lines. Our long-term operating and capital
lease obliga-

                                        17
<PAGE>   20

tions are generally less than $3.0 million per year. Other than capital lease
commitments, we have no material commitments for capital expenditures. As we
increase the scope of our operations, we expect that our capital expenditures
will increase.

     We believe that our cash on hand will be sufficient to meet our working
capital and capital expenditure requirements for at least the next 12 months.
However, it may still be necessary to obtain additional equity or debt financing
either during or after the next 12 months if we are not able to generate
sufficient cash from operating activities to meet our capital expenditure and
working capital needs. In the event additional financing is required, we may not
be able to raise it on acceptable terms, or at all.

RECENTLY ISSUED ACCOUNTING STANDARDS

     SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,
as amended, is effective for us beginning January 1, 2001. SFAS No. 133 requires
that all derivative instruments be measured at fair value and recognized in the
balance sheet as either assets or liabilities. Management has determined that
the initial adoption of SFAS No. 133 will not have a material effect on our
financial statements.

RISK FACTORS

     You should carefully consider the risk factors set forth below.

     WE HAVE INCURRED NET LOSSES AND NEGATIVE CASH FLOW FOR OUR ENTIRE HISTORY,
     WE EXPECT TO INCUR FUTURE LOSSES AND NEGATIVE CASH FLOW, AND WE MAY NEVER
     ACHIEVE PROFITABILITY

     We incurred net losses of $74.8 million in 2000, $205.1 million in 1999,
and $81.7 million in 1998. Our ability to achieve profitability on a continuing
basis will depend on the successful design, development, testing, introduction,
marketing and broad commercial distribution of our broadband equipment products.

     We expect to continue to incur significant product development, sales and
marketing, and administrative expenses. In addition, we depend in part on cost
reductions to improve gross profit margins because the fixed-price nature of
most of our long-term customer agreements prevents us from increasing prices. As
a result, we will need to generate significant revenues and improve gross profit
margins to achieve and maintain profitability. We may not be successful in
reducing our costs or in selling our products in sufficient volumes to realize
cost benefits from our manufacturers. We cannot be certain that we can achieve
sufficient revenues or gross profit margin improvements to generate
profitability.

     OUR LIMITED OPERATING HISTORY MAKES IT DIFFICULT FOR YOU TO EVALUATE OUR
     BUSINESS AND PROSPECTS.

     We recorded our first sale in September 1997. As a result, we have only a
limited operating history upon which you may evaluate our business and
prospects. You should consider our prospects in light of the heightened risks
and unexpected expenses and difficulties frequently encountered by companies in
an early stage of development. These risks, expenses and difficulties, which are
described further below, apply particularly to us because the market for
equipment for delivering voice, data and video services is new and rapidly
evolving. Due to our limited operating history, it will be difficult for you to
evaluate whether we will successfully address these risks.

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<PAGE>   21

     WE EXPECT OUR QUARTERLY REVENUES AND OPERATING RESULTS TO FLUCTUATE, AND
     THESE FLUCTUATIONS MAY MAKE OUR STOCK PRICE VOLATILE.

     Our quarterly revenues and operating results have fluctuated in the past
and are likely to fluctuate significantly in the future. As a result, we believe
that quarter-to-quarter comparisons of our operating results may not be
meaningful. Fluctuations in our quarterly revenues or operating results may
cause volatility in the price of our stock. It is likely that in some future
quarter our operating results may be below the expectations of public market
analysts and investors, which may cause the price of our stock to fall. Factors
likely to cause variations in our quarterly revenues and operating results
include:

     - delays or cancellations of any orders by Qwest, which accounted for
       approximately 56% of our revenues in 2000, or by any other customer
       accounting for a significant portion of our revenues;

     - variations in the timing, mix and size of orders and shipments of our
       products throughout a quarter or year;

     - new product introductions by us or by our competitors;

     - the timing of upgrades of telephone companies' infrastructure;

     - variations in capital spending budgets of telephone companies; and

     - increased expenses, whether related to sales and marketing, product
       development or administration.

     The amount and timing of our operating expenses generally will vary from
quarter to quarter depending on the level of actual and anticipated business
activity. Because most of our operating expenses are fixed in the short term, we
may not be able to quickly reduce spending if our revenues are lower than we had
projected and our results of operations could be harmed.

     OUR CUSTOMER BASE OF TELEPHONE COMPANIES IS EXTREMELY CONCENTRATED AND THE
     LOSS OF OR REDUCTION IN BUSINESS FROM EVEN ONE OF OUR CUSTOMERS,
     PARTICULARLY QWEST, COULD CAUSE OUR SALES TO FALL SIGNIFICANTLY.

     A small number of customers have accounted for a large part of our revenues
to date. We expect this concentration to continue in the future. If we lose one
of our significant customers, our revenues could be significantly reduced. Qwest
accounted for 56%, 67% and 68% of total revenues in 2000, 1999 and 1998. Our
agreements with our customers are cancelable by these customers on short notice,
without penalty, do not obligate the customers to purchase any products and are
not exclusive. Accordingly, we may lose revenues from our significant customers
at any time, which could have a material adverse effect on us. As a result of
the merger between U S WEST and Qwest, Qwest slowed its purchases of our
equipment while it re-evaluates its plans regarding the deployment of VDSL
across its network. Sales to Qwest in the future are dependent upon their
decision regarding the deployment of our product. A significant reduction in
purchases of our equipment by Qwest could have a material effect on us.

     CONSOLIDATION AMONG TELEPHONE COMPANIES MAY REDUCE OUR SALES.

     Consolidation in the telecommunications industry may cause delays in the
purchase of our products and cause a reexamination of strategic and purchasing
decisions by our customers. In addition, we may lose relationships with key
personnel within a customer's organization due to budget cuts, layoffs, or other
disruptions following a consolidation. For example, our sales to NYNEX,
previously one of our largest clients, have decreased significantly as a result
of a shift in focus resulting from its merger with Bell Atlantic. In addition,
as a result of the merger between US WEST and Qwest, Qwest has slowed its
purcahses of our equipment while it re-evaluates its plans regarding the
deployment of VDSL across its network.

     BECAUSE OUR SALES CYCLE IS LENGTHY AND VARIABLE, THE TIMING OF OUR REVENUE
     IS DIFFICULT TO PREDICT, AND WE MAY INCUR SALES AND MARKETING EXPENSES WITH
     NO GUARANTEE OF A FUTURE SALE.

     Customers view the purchase of our products as a significant and strategic
decision. As a result, customers typically undertake significant evaluation,
testing and trial of our products before deployment. This

                                        19
<PAGE>   22

evaluation process frequently results in a lengthy sales cycle, typically
ranging from nine months to more than a year. Before a customer places an order,
we may incur substantial sales and marketing expenses and expend significant
management efforts. In addition, product purchases are frequently subject to
unexpected administrative, processing and other delays on the part of our
customers. This is particularly true for customers for whom our products
represent a very small percentage of their overall purchasing activities. As a
result, sales forecasted to be made to a specific customer for a particular
quarter may not be realized in that quarter; and this could result in lower than
expected revenues.

     WE MAY NOT BE ABLE TO OBTAIN SUFFICIENT FINANCING TO FUND OUR BUSINESS AND,
     AS A RESULT, WE MAY NOT BE ABLE TO GROW AND COMPETE EFFECTIVELY.

     We may need to raise additional funds if our estimates of revenues or
capital requirements change or prove inaccurate. If we cannot raise these funds,
we may not be able to grow our business. We may need additional capital if we
need to respond to unforeseen technological or marketing hurdles or if we desire
to take advantage of unanticipated opportunities. In addition, we expect to
review potential acquisitions that would complement our existing product
offerings or enhance our technical capabilities that could require potentially
significant amounts of capital. Funds may not be available at the time or times
needed on terms acceptable to us, if at all. If adequate funds are not
available, or are not available on acceptable terms, we may not be able to take
advantage of market opportunities, to make acquisitions, to develop new products
or to otherwise respond to competitive pressures effectively.

     A SIGNIFICANT MARKET FOR OUR PRODUCTS MAY NOT DEVELOP IF TELEPHONE
     COMPANIES DO NOT SUCCESSFULLY DEPLOY BROADBAND SERVICES SUCH AS HIGH-SPEED
     DATA AND VIDEO.

     Telephone companies have just recently begun offering high-speed data
services, and most telephone companies have not offered video services at all.
Unless telephone companies make the strategic decision to enter the market for
providing broadband services, a significant market for our products may not
develop. Sales of our products largely depend on the increased use and
widespread adoption of broadband services and the ability of our customers to
market and sell broadband services, including video services, to their
customers. Certain critical issues concerning use of broadband services are
unresolved and will likely affect their use. These issues include security,
reliability, speed and volume, cost, government regulation and the ability to
operate with existing and new equipment.

     Even if telephone companies decide to deploy broadband services, this
deployment may not be successful. Our customers have delayed deployments in the
past and may delay deployments in the future. Factors that could cause telephone
companies not to deploy, to delay deployment of, or to fail to deploy
successfully the services for which our products are designed include the
following:

     - industry consolidation;

     - regulatory uncertainties and delays affecting telephone companies;

     - varying quality of telephone companies' network infrastructure and cost
       of infrastructure upgrades and maintenance;

     - inexperience of telephone companies in obtaining access to video
       programming content from third party providers;

     - inexperience of telephone companies in providing broadband services and
       the lack of sufficient technical expertise and personnel to install
       products and implement services effectively;

     - uncertain subscriber demand for broadband services; and

     - inability of telephone companies to predict return on their investment in
       broadband capable infrastructure and equipment.

     Unless our products are successfully deployed and marketed by telephone
companies, we will not be able to achieve our business objectives and increase
our revenues.

                                        20
<PAGE>   23

     GOVERNMENT REGULATION OF OUR CUSTOMERS AND RELATED UNCERTAINTY COULD CAUSE
     OUR CUSTOMERS TO DELAY THE PURCHASE OF OUR PRODUCTS.

     The Telecommunications Act requires telephone companies, such as the
regional Bell operating companies, to offer their competitors cost-based access
to some elements of their networks, including facilities and equipment used to
provide high-speed data and video services. These telephone companies may not
wish to make expenditures for infrastructure and equipment required to provide
broadband services if they will be forced to allow competitors access to this
infrastructure and equipment. The Federal Communications Commission, or FCC,
announced that, except in limited circumstances, it will not require incumbent
carriers to offer their competitors access to the facilities and equipment used
to provide high-speed data services. Nevertheless, other regulatory and judicial
proceedings relating to telephone companies' obligations to provide elements of
their network to competitors are pending. The FCC also requires incumbent
carriers to permit competitive carriers to collocate their equipment with the
local switching equipment of the incumbents. The FCC's collocation rules
recently have been vacated in part and continue to be subject to regulatory and
judicial proceedings. The uncertainties caused by these regulatory proceedings
may cause these telephone companies to delay purchasing decisions at least until
the proceedings and any related judicial appeals are completed. The outcomes of
these regulatory proceedings, as well as other FCC regulation, may cause these
telephone companies not to deploy services for which our products are designed
or to further delay deployment. Additionally, telephone companies' deployment of
broadband services may be slowed down or stopped because of the need for
telephone companies to obtain permits from city, state or federal authorities to
implement infrastructure.

     OUR CUSTOMERS AND POTENTIAL CUSTOMERS WILL NOT PURCHASE OUR PRODUCTS IF
     THEY DO NOT HAVE THE INFRASTRUCTURE NECESSARY TO USE OUR PRODUCTS.

     The copper wire infrastructures over which telephone companies may deliver
voice, data and video services using our products vary in quality and
reliability. As a result, some of these telephone companies may not be able to
deliver a full set of voice, data and video services to their customers, despite
their intention to do so, and this could harm our sales. Even after installation
of our products, we remain highly dependent on telephone companies to continue
to maintain their infrastructure so that our products will operate at a
consistently high performance level. Infrastructure upgrades and maintenance may
be costly, and telephone companies may not have the necessary financial
resources. This may be particularly true for our smaller customers and potential
customers such as independent telephone companies and domestic local telephone
companies. If our current and potential customers' infrastructure is inadequate,
we may not be able to generate anticipated revenues from them.

     IF COMPETING TECHNOLOGIES THAT OFFER ALTERNATIVE SOLUTIONS TO OUR PRODUCTS
     ACHIEVE WIDESPREAD ACCEPTANCE, THE DEMAND FOR OUR PRODUCTS MAY NOT DEVELOP.

     Technologies that compete with our products include other
telecommunications-related wireline technologies, cable-based technologies,
fixed wireless technologies and satellite technologies. If these alternative
technologies are chosen by our existing and potential customers, our business,
financial condition and results of operations could be harmed. In particular,
cable operators are currently deploying products that will be capable of
delivering voice, high-speed data and video services over cable, including
products from General Instrument, our principal stockholder, and Motorola, its
parent. Our technology may not be able to compete effectively against these
technologies on price, performance or reliability.

     Our customers or potential customers that also offer cable-based services
may choose to purchase cable-based technologies. Cable service providers that
offer not only data and video but also telephony over cable systems will give
subscribers the alternative of purchasing all communications services from a
single communications service provider, allowing the potential for more
favorable pricing and a single point of contact for bill payment and customer
service. If these services are implemented successfully over cable connections,
they will compete directly with the services offered by telephone companies
using our products. In addition, several telephone companies have commenced the
marketing of video services over direct broadcast satellite while continuing to
provide voice and data services over their existing copper wire

                                        21
<PAGE>   24

infrastructure. If any of these services are accepted by consumers, the demand
for our products may not develop and our ability to generate revenues will be
harmed.

     WE FACE INTENSE COMPETITION IN PROVIDING EQUIPMENT FOR TELECOMMUNICATIONS
     NETWORKS FROM LARGER AND MORE WELL-ESTABLISHED COMPANIES, AND WE MAY NOT BE
     ABLE TO COMPETE EFFECTIVELY WITH THESE COMPANIES.

     Many of our current and potential competitors have longer operating
histories, greater name recognition and significantly greater financial,
technical, marketing and distribution resources than we do. These competitors
may undertake more extensive marketing campaigns, adopt more aggressive pricing
policies and devote substantially more resources to developing new products than
we are able to, which could result in the loss of current customers and impair
our ability to attract potential customers.

     Our significant current competitors include Advanced Fibre Communications,
Alcatel, Cisco Systems, Efficient Networks, Ericsson, Lucent Technologies,
Nokia, Nortel Networks, RELTEC (acquired by BAE Systems, CNI Division, formerly
GEC Marconi), Scientific Atlanta, Siemens and our largest stockholder, General
Instrument/Motorola, as well as emerging companies that are developing new
technologies. Some of these competitors have existing relationships with our
current and prospective customers. In addition, we anticipate that other large
companies, such as Matsushita Electric Industrial which markets products under
the Panasonic brand name, Microsoft, Network Computer, Philips, Sony,
STMicroelectronics and Toshiba America, will likely introduce products that
compete with our N(3) Residential Gateway product in the future. Our customer
base may be attracted by the name and resources of these large, well-known
companies and may prefer to purchase products from them instead of us.

     CONSOLIDATION OF OUR COMPETITORS MAY CAUSE US TO LOSE CUSTOMERS AND
     NEGATIVELY AFFECT OUR SALES.

     Consolidation in the telecommunications equipment industry may strengthen
our competitors' positions in our market, cause us to lose customers and hurt
our sales. For example, as a result of the merger between US WEST and Qwest,
Qwest has slowed its purchases of our equipment while it re-evaluates its plans
regarding the deployment of VDSL across its network. In addition, Alcatel
acquired DSC Communications, Lucent acquired Ascend Communications and BAE
Systems, CNI Division, formerly GEC Marconi, acquired RELTEC. Acquisitions such
as these may strengthen our competitors' financial, technical and marketing
resources and provide them access to regional Bell operating companies and other
potential customers. Consolidation may also allow some of our competitors to
penetrate new markets that we have targeted, such as domestic local, independent
and international telephone companies. This consolidation may negatively affect
our ability to increase revenues.

     IF WE DO NOT RESPOND QUICKLY TO CHANGING CUSTOMER NEEDS AND FREQUENT NEW
     PRODUCT INTRODUCTIONS BY OUR COMPETITORS, OUR PRODUCTS MAY BECOME OBSOLETE.

     Our position in existing markets or potential markets could be eroded
rapidly by product advances. The life cycles of our products are difficult to
estimate. Our growth and future financial performance will depend in part upon
our ability to enhance existing products and develop and introduce new products
that keep pace with:

     - the increasing use of the Internet;

     - the growth in remote access by telecommuters;

     - the increasingly diverse distribution sources for high quality digital
       video; and

     - other industry and technological trends.

We expect that our product development efforts will continue to require
substantial investments. We may not have sufficient resources to make the
necessary investments. If we fail to timely and cost-effectively develop new
products that respond to new technologies and customer needs, the demand for our
products may fall and we could lose revenues.

                                        22
<PAGE>   25

     OUR EXECUTIVE OFFICERS AND CERTAIN KEY PERSONNEL ARE CRITICAL TO OUR
     BUSINESS AND THE LOSS OF THEIR SERVICES COULD DISRUPT OUR OPERATIONS AND
     OUR CUSTOMER RELATIONSHIPS.

     None of our executive officers or key employees is bound by an employment
agreement. Many of these employees have a significant number of options to
purchase our common stock. Many of these options are currently vested and some
of our key employees may leave us once they have exercised their options. In
addition, our engineering and product development teams are critical in
developing our products and have developed important relationships with our
regional Bell operating company customers and their technical staffs. The loss
of any of these key personnel could harm our operations and customer
relationships.

     COMPETITION FOR QUALIFIED PERSONNEL IN THE TELECOMMUNICATIONS EQUIPMENT
     INDUSTRY IS INTENSE, AND IF WE ARE NOT SUCCESSFUL IN ATTRACTING AND
     RETAINING THESE PERSONNEL, OUR ABILITY TO GROW OUR BUSINESS MAY BE HARMED.

     Competition for qualified personnel in the telecommunications equipment
industry, specifically in the Rohnert Park, California area, is intense, and we
may not be successful in attracting and retaining such personnel. Failure to
attract qualified personnel could harm the growth of our business.

     We are actively searching for research and development engineers and sales
and marketing personnel who are in short supply. Competitors and others have in
the past and may in the future attempt to recruit our employees. In addition,
companies in the telecommunications industry whose employees accept positions
with competitors frequently claim that the competitors have engaged in unfair
hiring practices. We may receive such notices in the future as we seek to hire
qualified personnel and such notices may result in material litigation and
related disruption to our operations.

     OUR OPERATIONS AND CUSTOMER RELATIONSHIPS MAY BECOME STRAINED DUE TO RAPID
     EXPANSION.

     We have expanded our operations rapidly since inception. We intend to
continue to expand in the foreseeable future to pursue existing and potential
market opportunities both inside and outside the United States. This rapid
growth places a significant demand on management and operational resources. Our
management, personnel, systems, procedures, controls and customer service may be
inadequate to support our future operations. To manage expansion effectively, we
must implement and improve our operational systems, procedures, controls and
customer service on a timely basis. We expect significant strain on our order
and fulfillment process and our quality control systems if significant expansion
of business activity occurs. If we are unable to properly manage this growth,
our operating results, reputation and customer relationships could be harmed.

     OUR LIMITED ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY MAY AFFECT OUR
     ABILITY TO COMPETE, AND WE COULD LOSE CUSTOMERS.

     We rely on a combination of patent, copyright and trademark laws, and on
trade secrets and confidentiality provisions and other contractual provisions to
protect our intellectual property. There is no guarantee that these safeguards
will protect our intellectual property and other valuable confidential
information. If our methods of protecting our intellectual property in the
United States or abroad are not adequate, our competitors may copy our
technology or independently develop similar technologies and we could lose
customers. In addition, the laws of some foreign countries do not protect our
proprietary rights as fully as do the laws of the United States. If we fail to
adequately protect our intellectual property, it would be easier for our
competitors to sell competing products, which could harm our business.

     THIRD-PARTY CLAIMS REGARDING INTELLECTUAL PROPERTY MATTERS COULD CAUSE US
     TO STOP SELLING OUR PRODUCTS, LICENSE ADDITIONAL TECHNOLOGY OR PAY MONETARY
     DAMAGES.

     From time to time, third parties, including our competitors and customers,
have asserted patent, copyright and other intellectual property rights to
technologies that are important to us. We expect that we will increasingly be
subject to infringement claims as the number of products and competitors in our
market grows and the functionality of products overlaps, and our products may
currently infringe on one or more United

                                        23
<PAGE>   26

States or international patents. The results of any litigation are inherently
uncertain. In the event of an adverse result in any litigation with third
parties that could arise in the future, we could be required:

     - to pay substantial damages, including paying treble damages if we are
       held to have willfully infringed;

     - to halt the manufacture, use and sale of infringing products;

     - to expend significant resources to develop non-infringing technology;
       and/or

     - to obtain licenses to the infringing technology.

     Licenses may not be available from any third party that asserts
intellectual property claims against us, on commercially reasonable terms, or at
all. In addition, litigation frequently involves substantial expenditures and
can require significant management attention, even if we ultimately prevail. In
addition, we indemnify our customers for patent infringement claims, and we may
be required to obtain licenses on their behalf, which could subject us to
significant additional costs.

     WE DEPEND ON THIRD-PARTY MANUFACTURERS AND ANY DISRUPTION IN THEIR
     MANUFACTURE OF OUR PRODUCTS WOULD HARM OUR OPERATING RESULTS.

     We contract for the manufacture of all of our products and have limited
in-house manufacturing capabilities. We rely primarily on two large contract
manufacturers: SCI Systems and ACT Manufacturing. The efficient operation of our
business will depend, in large part, on our ability to have these and other
companies manufacture our products in a timely manner, cost-effectively and in
sufficient volumes while maintaining consistent quality. As our business grows,
these manufacturers may not have the capacity to keep up with the increased
demand. Any manufacturing disruption could impair our ability to fulfill orders
and could cause us to lose customers.

     WE HAVE NO LONG-TERM CONTRACTS WITH OUR MANUFACTURERS, AND WE MAY NOT BE
     ABLE TO DELIVER OUR PRODUCTS ON TIME IF ANY OF THESE MANUFACTURERS STOP
     MAKING OUR PRODUCTS.

     We have no long-term contracts or arrangements with any of our contract
manufacturers that guarantee product availability, the continuation of
particular payment terms or the extension of credit limits. If our manufacturers
are unable or unwilling to continue manufacturing our products in required
volumes, we will have to identify acceptable alternative manufacturers, which
could take in excess of three months. It is possible that a source may not be
available to us when needed or be in a position to satisfy our production
requirements at acceptable prices and on a timely basis. If we cannot find
alternative sources for the manufacture of our products, we will not be able to
meet existing demand. As a result, we may lose existing customers, and our
ability to gain new customers may be significantly constrained.

     OUR INABILITY TO PRODUCE SUFFICIENT QUANTITIES OF OUR PRODUCTS BECAUSE OF
     OUR DEPENDENCE ON COMPONENTS FROM KEY SOLE SUPPLIERS COULD RESULT IN DELAYS
     IN THE DELIVERY OF OUR PRODUCTS AND COULD HARM OUR REVENUES.

     Some parts, components and equipment used in our products are obtained from
sole sources of supply. If our sole source suppliers or we fail to obtain
components in sufficient quantities when required, delivery of our products
could be delayed resulting in decreased revenues. Additional sole-sourced
components may be incorporated into our equipment in the future. We do not have
any long-term supply contracts to ensure sources of supply. In addition, our
suppliers may enter into exclusive arrangements with our competitors, stop
selling their products or components to us at commercially reasonable prices or
refuse to sell their products or components to us at any price, which could harm
our operating results.

     THE OCCURRENCE OF ANY DEFECTS, ERRORS OR FAILURES IN OUR PRODUCTS COULD
     RESULT IN DELAYS IN INSTALLATION, PRODUCT RETURNS AND OTHER LOSSES TO US OR
     TO OUR CUSTOMERS OR END USERS.

     Our products are complex and may contain undetected defects, errors or
failures. These problems have occurred in our products in the past and
additional problems may occur in our products in the future and could result in
the loss of or delay in market acceptance of our products. In addition, we have
limited experience

                                        24
<PAGE>   27

with commercial deployment and we expect additional defects, errors and failures
as our business expands from trials to commercial deployment at certain
customers. We will have limited experience with the problems that could arise
with any new products that we introduce. Further, our customer agreements
generally include a longer warranty for defects than our manufacturing
agreements. These defects could result in a loss of sales and additional costs
and liabilities to us as well as damage to our reputation and the loss of our
customers.

     WE DO NOT HAVE SIGNIFICANT EXPERIENCE IN INTERNATIONAL MARKETS AND MAY HAVE
     UNEXPECTED COSTS AND DIFFICULTIES IN DEVELOPING INTERNATIONAL REVENUES.

     We plan to extend the marketing and sales of our products internationally.
International operations are generally subject to inherent risks and challenges
that could harm our operating results, including:

     - unexpected changes in telecommunications regulatory requirements;

     - limited number of telephone companies operating internationally;

     - expenses associated with developing and customizing our products for
       foreign countries;

     - tariffs, quotas and other import restrictions on telecommunications
       equipment;

     - longer sales cycles for our products; and

     - compliance with international standards that differ from domestic
       standards.

     To the extent that we generate international sales in the future, any
negative effects on our international business could harm our business,
operating results and financial condition. In particular, fluctuating exchange
rates may contribute to fluctuations in our results of operations.

     MOTOROLA MAY EXERCISE SIGNIFICANT INFLUENCE OVER OUR BUSINESS AND AFFAIRS
     AND OUR STOCKHOLDER VOTES AND, FOR ITS OWN REASONS, COULD PREVENT
     TRANSACTIONS WHICH OUR OTHER STOCKHOLDERS MAY VIEW AS FAVORABLE.

     Motorola beneficially owns approximately 76% of the outstanding shares of
our common stock as of December 31, 2000. Motorola will be able to exercise
significant influence over all matters relating to our business and affairs,
including approval of significant corporate transactions, which could delay or
prevent someone from acquiring or merging with us and could prevent you from
receiving a premium for your shares.

     We do not know whether Motorola's plans for our business and affairs will
be different than our existing plans and whether any changes that may be
implemented under Motorola's control will be beneficial or detrimental to our
other stockholders.

     OUR PRINCIPAL STOCKHOLDER AND ITS PARENT MAY HAVE INTERESTS THAT CONFLICT
     WITH THE BEST INTERESTS OF OUR OTHER STOCKHOLDERS AND US AND MAY CAUSE US
     TO FORGO OPPORTUNITIES OR TAKE ACTIONS THAT DISPROPORTIONATELY BENEFIT OUR
     PRINCIPAL STOCKHOLDER.

     It is possible that Motorola could be in a position involving a conflict of
interest with us. In addition, individuals who are officers or directors of
Motorola and of us may have fiduciary duties to both companies. For example, a
conflict may arise if our principal stockholder were to engage in activities or
pursue corporate opportunities that may overlap with our business. These
conflicts could harm our business and operating results. Our certificate of
incorporation contains provisions intended to protect our principal stockholder
and these individuals in these situations. These provisions limit your legal
remedies.

                                        25
<PAGE>   28

     THE PRICE OF OUR COMMON STOCK HAS BEEN AND MAY CONTINUE TO BE HIGHLY
     VOLATILE.

     The stock markets have in general, and with respect to high technology
companies, including us, in particular, recently experienced extreme stock price
and volume volatility, often unrelated to the financial performance of
particular companies. The price at which our common stock will trade in the
future is likely to also be highly volatile and may fluctuate substantially due
to factors such as:

     - actual or anticipated fluctuations in our operating results;

     - changes in or our failure to meet securities analysts' expectations;

     - announcements of technological innovations by us or our competitors;

     - introduction of new products and services by us or our competitors;

     - limited public float of our common stock;

     - conditions and trends in the telecommunications and other technology
       industries; and

     - general economic and market conditions.

     SALES OF SHARES OF OUR COMMON STOCK BY EXISTING STOCKHOLDERS COULD CAUSE
     THE MARKET PRICE OF OUR COMMON STOCK TO DROP SIGNIFICANTLY.

     As of February 28, 2001, Motorola owned 64,103,724 shares of our common
stock and Kevin Kimberlin Partners, LP and its affiliates owned 2,933,128 shares
of our common stock and its affiliates held warrants to purchase an additional
4,288,764 shares of our common stock. If Motorola, Kevin Kimberlin Partners, LP
and its affiliates or any of our other stockholders sell substantial amounts of
common stock, including shares issued upon exercise of outstanding options and
warrants, in the public market, the market price of the common stock could fall.
In addition, any distribution of shares of our common stock by Motorola to its
stockholders could also have an adverse effect on the market price.

     Motorola and Kevin Kimberlin Partners, LP and its related persons and their
transferees will be entitled to registration rights pursuant to which they may
require that we register their shares under the Securities Act.

     In addition, as of December 31, 2000, there were outstanding options to
purchase 20,177,197 shares of our common stock. Subject to vesting provisions
and, in the case of our affiliates, volume and manner of sale restrictions, the
shares of common stock issuable upon the exercise of our outstanding employee
options will be eligible for sale into the public market at various times.

     ANTI-TAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW COULD
     PREVENT OR DELAY A CHANGE IN CONTROL OF OUR COMPANY THAT A STOCKHOLDER MAY
     CONSIDER FAVORABLE.

     Several provisions of our certificate of incorporation and by-laws and
Delaware law may discourage, delay or prevent a merger or acquisition that a
stockholder may consider favorable. These provisions include:

     - authorizing the issuance of preferred stock without stockholder approval;

     - providing for a classified board of directors with staggered, three-year
       terms;

     - prohibiting cumulative voting in the election of directors;

     - restricting business combinations with interested stockholders;

     - limiting the persons who may call special meetings of stockholders;

     - prohibiting stockholder action by written consent;

     - establishing advance notice requirements for nominations for election to
       the board of directors or for proposing matters that can be acted on by
       stockholders at stockholder meetings; and

     - requiring super-majority voting to effect amendments to our certificate
       of incorporation and by-laws.

                                        26
<PAGE>   29

     Some of these provisions do not currently apply to Motorola and its
affiliates.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Our exposure to market risk is limited to interest rate fluctuation. We do
not engage in any hedging activities and we do not use derivatives or equity
investments for cash investment purposes. The marketable securities portfolio is
classified as available for sale and recorded at fair value on the balance
sheet. Our portfolio consists solely of corporate bonds, commercial paper and
government securities, and therefore, our market risk is deemed relatively low.
At December 31, 2000, we had utilized $25.0 million of our $50.0 million line of
credit.

                                        27
<PAGE>   30

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
Independent Auditors' Report................................   29
Consolidated Statements of Operations -- Years ended
  December 31, 2000, 1999, 1998.............................   30
Consolidated Balance Sheets -- December 31, 2000 and 1999...   31
Consolidated Statements of Stockholders' Equity/Partners'
  Deficit-- Years ended December 31, 2000, 1999, 1998.......   32
Consolidated Statements of Cash Flows -- Years ended
  December 31, 2000, 1999, 1998.............................   33
Notes to Consolidated Financial Statements..................   34
</TABLE>

                                        28
<PAGE>   31

                          INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of Next Level Communications, Inc.:

     We have audited the accompanying consolidated balance sheets of Next Level
Communications, Inc. and subsidiary as of December 31, 2000 and 1999 and the
related consolidated statements of operations, stockholders' equity/partners'
deficit and cash flows for each of the three years in the period ended December
31, 2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

     We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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, such consolidated financial statements present fairly, in
all material respects, the financial position of Next Level Communications, Inc.
and subsidiary as of December 31, 2000 and 1999 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000 in conformity with accounting principles generally accepted in
the United States of America.

Deloitte & Touche LLP

San Francisco, California
February 19, 2001

                                        29
<PAGE>   32

                        NEXT LEVEL COMMUNICATIONS, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                   YEARS ENDED DECEMBER 31, 2000, 1999, 1998
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                         2000           1999           1998
                                                      -----------    -----------    -----------
<S>                                                   <C>            <C>            <C>
REVENUES
  Equipment.........................................  $   146,314    $    54,301    $    39,243
  Software..........................................        3,777          3,296          4,587
                                                      -----------    -----------    -----------
          Total revenues............................      150,091         57,597         43,830
                                                      -----------    -----------    -----------
COST OF REVENUES
  Equipment.........................................      116,090         51,265         37,372
  Software..........................................          141            292            261
  Inventory charge..................................        9,000             --          5,800
                                                      -----------    -----------    -----------
          Total cost of revenues....................      125,231         51,557         43,433
                                                      -----------    -----------    -----------
Gross profit........................................       24,860          6,040            397
OPERATING EXPENSES:
  Research and development..........................       55,834         48,454         47,086
  Selling, general and administrative...............       46,907         30,511         26,248
  Non-cash compensation charge......................        2,384        128,284             --
  Litigation........................................           --             --          5,000
                                                      -----------    -----------    -----------
          Total operating expenses..................      105,125        207,249         78,334
                                                      -----------    -----------    -----------
Operating loss......................................      (80,265)      (201,209)       (77,937)
Interest income (expense), net......................        5,575         (3,564)        (3,776)
Other income (expense), net.........................         (148)          (299)           (18)
                                                      -----------    -----------    -----------
Net loss............................................  $   (74,838)   $  (205,072)   $   (81,731)
                                                      ===========    ===========    ===========
Basic and diluted net loss per share (pro forma in
  1999 and 1998)....................................  $     (0.91)   $     (2.78)   $     (1.08)
                                                      ===========    ===========    ===========
Shares used to compute basic and diluted net loss
  per share (pro forma in 1999 and 1998)............   81,929,663     71,597,834     69,967,053
                                                      ===========    ===========    ===========
</TABLE>

                See notes to consolidated financial statements.

                                        30
<PAGE>   33

                        NEXT LEVEL COMMUNICATIONS, INC.

                          CONSOLIDATED BALANCE SHEETS
                           DECEMBER 31, 2000 AND 1999
                       (IN THOUSANDS, EXCEPT SHARE DATA)

                                     ASSETS

<TABLE>
<CAPTION>
                                                                2000        1999
                                                              --------    --------
<S>                                                           <C>         <C>
Current Assets:
  Cash and cash equivalents.................................  $ 35,863    $128,752
  Marketable securities.....................................        --      14,971
  Restricted marketable securities..........................    25,000          --
  Trade receivables, less allowance for doubtful accounts of
     $1,332 and $1,337, respectively........................    34,646      13,879
  Other receivables.........................................     2,836       2,385
  Inventories, net..........................................    86,764      22,553
  Prepaid expenses and other................................     2,123       1,792
                                                              --------    --------
          Total current assets..............................   187,232     184,332
Restricted marketable securities............................        --      30,151
Property and equipment, net.................................    53,593      48,263
Long-term investments.......................................    15,000          --
Goodwill, less accumulated amortization of $6,883 and
  $3,141, respectively......................................    17,813       5,065
Other assets................................................     2,078          --
                                                              --------    --------
          Total Assets......................................  $275,716    $267,811
                                                              ========    ========

                       LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
  Accounts payable..........................................  $ 53,367    $ 13,261
  Accrued liabilities.......................................    32,609      11,375
  Notes payable.............................................    25,000          --
  Deferred revenue..........................................     5,661      11,148
  Current portion of capital lease obligations..............       330         600
                                                              --------    --------
          Total current liabilities.........................   116,967      36,384
Long-term debt and capital lease obligations................        --      25,199
Commitments and Contingencies
Stockholders' Equity:
  Common stock -- $.01 par value, 400,000,000 shares
     authorized, 84,443,000 and 79,752,000 shares issued and
     outstanding, respectively..............................       776         754
  Additional paid-in-capital................................   438,123     412,930
  Accumulated deficit.......................................  (279,910)   (205,072)
  Unearned compensation.....................................      (240)     (2,384)
                                                              --------    --------
          Total Stockholders' Equity........................   158,749     206,228
                                                              --------    --------
          Total Liabilities and Stockholders' Equity........  $275,716    $267,811
                                                              ========    ========
</TABLE>

                See notes to consolidated financial statements.

                                        31
<PAGE>   34

                        NEXT LEVEL COMMUNICATIONS, INC.

       CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY/PARTNERS' DEFICIT
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                  GENERAL     LIMITED
                                  PARTNER     PARTNER       COMMON STOCK      ADDITIONAL
                                  CAPITAL     CAPITAL    ------------------    PAID-IN       UNEARNED     ACCUMULATED
                                 (DEFICIT)   (DEFICIT)   SHARES    AMOUNT      CAPITAL     COMPENSATION     DEFICIT       TOTAL
                                 ---------   ---------   ------   ---------   ----------   ------------   -----------   ---------
<S>                              <C>         <C>         <C>      <C>         <C>          <C>            <C>           <C>
BALANCE, DECEMBER 1, 1998......                                   $ 379,876                                $(383,578)   $  (3,702)
Conversion of note payable into
  corporation into
  partnership..................              $ (3,702)             (379,876)                                 383,578
Partner capital
  contributions................   $10,000      60,664                                                                      70,664
Net loss.......................    (8,990)    (72,741)                                                                    (81,731)
                                  -------    --------    ------   ---------    --------      -------       ---------    ---------
BALANCE, DECEMBER 31, 1998.....     1,010     (15,779)       --          --          --           --              --      (14,769)
Partner capital
  contributions................                34,000                                                                      34,000
Recapitalization:
  Conversion of note payable
    into common stock..........                           4,338          43    $ 86,710                                    86,753
  Conversion of general partner
    interest into common
    stock......................    (1,010)                5,863          59         951                                        --
  Conversion of limited partner
    interest into common
    stock......................               (18,221)   55,366         554      17,667                                        --
  Dividend to General
    Instrument.................                           4,400
Initial public offering
  proceeds.....................                           9,775          98     176,918                                   177,016
Issuance of common stock under
  stock option plan............                              10                      16                                        16
Stock-based compensation.......                                                 130,668      $(2,384)                     128,284
Net loss.......................                                                                             (205,072)    (205,072)
                                  -------    --------    ------   ---------    --------      -------       ---------    ---------
BALANCE, DECEMBER 31, 1999.....        --          --    79,752         754     412,930       (2,384)       (205,072)     206,228
Issuance of common stock in
  connection with:
  Exercise of stock options and
    employee stock purchase
    plan.......................                           2,183          21       9,230                                     9,251
  Exercise of warrants.........                           2,369
  Acquisition of SoftProse.....                             139           1      16,861         (365)                      16,497
Additional initial public
  offering expenses............                                                    (898)                                     (898)
Amortization of unearned
  compensation.................                                                                2,509                        2,509
Net loss.......................                                                                              (74,838)     (74,838)
                                  -------    --------    ------   ---------    --------      -------       ---------    ---------
BALANCE, DECEMBER 31, 2000.....        --          --    84,443   $     776    $438,123      $  (240)      $(279,910)   $ 158,749
                                  =======    ========    ======   =========    ========      =======       =========    =========
</TABLE>

                See notes to consolidated financial statements.
                                        32
<PAGE>   35

                        NEXT LEVEL COMMUNICATIONS, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                              2000        1999         1998
                                                            --------    ---------    --------
<S>                                                         <C>         <C>          <C>
OPERATING ACTIVITIES:
  Net loss................................................  $(74,838)   $(205,072)   $(81,731)
  Adjustments to reconcile net loss to net cash used in
     operating activities:
     Noncash compensation charge..........................     2,509      128,284          --
     Depreciation and amortization........................    13,813        8,857      10,733
     Loss on disposal of assets...........................       115          338       1,162
     Inventory charge.....................................     9,000           --       5,800
     Changes in assets and liabilities:
       Trade receivables..................................   (20,558)      (2,811)     (6,323)
       Inventories........................................   (73,211)      (1,883)    (13,086)
       Other assets.......................................      (782)       4,993      (5,468)
       Accrued interest payable to General Instrument.....        --        5,813       5,940
       Accounts payable...................................    40,106       (3,206)      7,926
       Accrued liabilities and deferred revenue...........    15,532        8,120       8,414
                                                            --------    ---------    --------
          Net cash used in operating activities...........   (88,314)     (56,567)    (66,633)
INVESTING ACTIVITIES:
  Purchases of property and equipment.....................   (15,515)     (33,585)     (9,612)
  Sales (purchases) of marketable securities, net.........    18,044      (45,121)         --
  Long-term investments...................................   (14,988)          --          --
  Proceeds from notes receivable..........................        --           56         264
                                                            --------    ---------    --------
          Net cash used in investing activities...........   (12,459)     (78,650)     (9,348)
FINANCING ACTIVITIES:
  Initial public offering proceeds (expenses), net........      (898)     177,016          --
  Issuance of common stock................................     9,251           16          --
  Proceeds from borrowings................................       148       24,853      75,000
  Repayment of capital lease obligations..................      (617)        (899)         --
  Limited Partner capital contribution....................        --       34,000      19,587
  General Partner capital contribution....................        --           --      10,000
                                                            --------    ---------    --------
          Net cash provided by financing activities.......     7,884      234,986     104,587
                                                            --------    ---------    --------
Net (Decrease)/Increase in Cash and Cash Equivalents......   (92,889)      99,769      28,606
Cash and Cash Equivalents, Beginning of Period............   128,752       28,983         377
                                                            --------    ---------    --------
Cash and Cash Equivalents, End of Period..................  $ 35,863    $ 128,752    $ 28,983
                                                            ========    =========    ========
NONCASH INVESTING AND FINANCING ACTIVITIES:
  Equipment acquired under capital lease and notes
     payable..............................................        --    $     899    $    930
  Acquisition of SoftProse:
     Issuance of common stock.............................    16,862           --          --
     Liabilities assumed, net.............................        91           --          --
Conversion of note payable to General Instrument into
  common stock............................................        --       86,753      41,077
Conversion of stockholders' net deficit into partnership
  deficit.................................................        --           --      (3,702)
Conversion of general partner interest into common
  stock...................................................        --        1,010          --
Conversion of limited partner interest into common
  stock...................................................        --       18,221          --
Common stock dividend (see Note 1)........................        --           --          --
SUPPLEMENTAL CASH FLOW INFORMATION:
  Cash paid for interest..................................       630          226          95
  Cash paid for taxes.....................................        43            1          --
</TABLE>

                See notes to consolidated financial statements.

                                        33
<PAGE>   36

                        NEXT LEVEL COMMUNICATIONS, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

 1. ORGANIZATION AND BUSINESS

     Next Level Communications, Inc. (the "Company") is a leading provider of
broad-band communications systems that enable telephone companies and other
emerging communications service providers to cost-effectively deliver voice,
data and video services over the existing copper wire telephone infrastructure.

     Next Level Communications ("NLC" or the "Limited Partner") was incorporated
as a California corporation on June 22, 1994 and commenced operations in July
1994. In September 1995, NLC was acquired by General Instrument Corporation
("General Instrument").

     In January 1998, NLC transferred its net assets, management and workforce
to a newly formed limited partnership, Next Level Communications L.P. (the
"Partnership"), in exchange for an 89% limited partnership interest. The
Partnership recorded the net assets transferred at their historical cost. At the
same time, Spencer Trask (the "General Partner") acquired an 11% general partner
interest in the Partnership in exchange for a $10.0 million cash contribution.

     On August 24, 1999 the Partnership formed the Company as a wholly owned
subsidiary. Management of NLC effected a 1-for-3 reverse stock split on October
14, 1999. All share amounts in the accompanying financial statements have been
restated to give effect to the reverse stock split.

     On November 9, 1999, the Company issued 9,775,000 shares of common stock at
$20.00 per share for net proceeds of $177,016,000 in an initial public offering
(the "Offering"). Prior to the completion of the offering, the following
recapitalization transactions (the "Recapitalization") occurred:

     - A note payable and accrued interest to General Instrument of $86.8
       million was converted into 4,337,633 shares of the Company's common
       stock.

     - The Partnership and NLC (a wholly owned subsidiary of General Instrument)
       were merged into the Company. As part of this merger, the General Partner
       received 5,863,329 shares of the Company's common stock and General
       Instrument received 55,366,091 shares of the Company's common stock in
       exchange for their respective partnership interests.

     - The Company issued a common stock dividend of 4,400,000 shares to General
       Instrument to reflect the additional value, $88 million, which will be
       received by the Company upon exercise of the warrants described below. In
       accordance with the Partnership agreement NLC was entitled to receive the
       $88 million exercise price. As a result of the Recapitalization, such
       amounts are to be received by the Company as these warrants are
       exercised. Accordingly, General Instrument received $88 million of common
       stock (4,400,000 shares) because it would have received that amount under
       the Partnership agreement.

     - The General Partner's option and the Partnership agreement to acquire up
       to 11% of NLC upon an initial public offering was converted into warrants
       to acquire 8,480,102 shares of the Company's common stock at $10.38 per
       share. In June 2000, warrants to purchase 2,070,000 shares of common
       stock were exercised. The exercise price of these warrants was paid
       through the surrender of additional warrants to purchase 423,493 shares
       of common stock. In addition, in October 2000, warrants to purchase
       299,000 shares of common stock were exercised. The exercise price of
       these warrants was paid through the surrender of additional warrants to
       purchase 96,000 shares of common stock. The Company did not receive any
       cash proceeds from either of these transactions. At December 31, 2000,
       warrants to acquire 5,591,609 shares of common stock were outstanding.

     - Options granted to employees of the Partnership to purchase shares of NLC
       were converted on a one-for-one basis into options to purchase a total of
       6,964,904 shares of the Company's common stock.

                                        34
<PAGE>   37
                        NEXT LEVEL COMMUNICATIONS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

     The Recapitalization was accounted for at historical cost. The accompanying
financial statements represent those of the Company from November 10, 1999, and
those of the Partnership from January 1, 1998 to November 9, 1999. In January
2000, General Instrument was acquired by Motorola, Inc.

 2. SIGNIFICANT ACCOUNTING POLICIES

     Principles of Consolidation -- These consolidated financial statements
include the accounts of the Company and its wholly owned subsidiary, SoftProse,
Inc. All significant intercompany transaction and balances have been eliminated.

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

     Revenue Recognition -- The Company recognizes revenue from equipment sales
when delivery has occurred, contractual obligations have been satisfied, title
and risk of loss have been transferred to the customer and collection of the
resulting receivable is reasonably assured. The Company accrues a provision for
estimated sales returns and other allowances as a reduction of revenue at the
time of revenue recognition. Amounts received in excess of revenue recognized
are recorded as deferred revenue. As of December 31, 2000 and 1999, deferred
revenue primarily relates to advance payments received on equipment sales.
Service revenue is recognized upon completion of the related contract.

     In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin ("SAB") No. 101 Revenue Recognition in Financial Statements.
SAB No. 101 provides guidance on the recognition, presentation and disclosure of
revenue in financial statements. The accounting and disclosures prescribed by
SAB No. 101 were effective for the Company in the fourth quarter of the year
ending December 31, 2000. The Company believes that it complies with the
provisions of SAB No. 101 and there was no material effect on the Company's
results of operations or financial position as a result of implementing SAB No.
101.

     Software license revenues are recognized when software revenue recognition
criteria have been met, pursuant to Statement of Position ("SOP") 97-2, Software
Revenue Recognition, as revised. License revenue is recognized when a
noncancelable license agreement has been signed, delivery has occurred, the fees
are fixed and determinable and collection is probable. The portion of revenues
from new license agreements which relate to the Company's obligations to provide
customer support are deferred, based upon the price charged for customer support
when it is sold separately, and recognized ratably over the maintenance period.
Revenue from the renewal of customer support contracts is recognized ratably
over the term of the agreement.

     Product Warranty -- The Company provides for the estimated costs to fulfill
customer warranty obligations upon the recognition of the related equipment
revenue. Actual warranty costs incurred are charged against the accrual when
paid.

     Cash Equivalents -- The Company considers all highly liquid debt
instruments with a maturity of three months or less at the date of purchase to
be cash equivalents.

     Marketable Securities -- The Company classifies its investments as
"available-for-sale" securities based on their intended use. Gains and losses on
sales of investments are determined on a specific identification basis. At
December 31, 2000 and 1999, marketable securities consisted of corporate bonds
and government agency securities. The difference between amortized cost and fair
value representing unrealized holding gains and losses are recorded as a
component of stockholders' equity as comprehensive accumulated other income

                                        35
<PAGE>   38
                        NEXT LEVEL COMMUNICATIONS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

(loss). At December 31, 2000 and 1999 there was no significant difference
between the fair market value and the underlying cost of these investments.

     Inventories -- Inventories are stated at the lower of cost, determined on a
first-in, first-out basis, or market.

     Property and Equipment -- Property and equipment are stated at cost.
Provisions for depreciation are based on estimated useful lives of the assets
using the straight-line method. Useful lives range from 20 years for buildings,
the shorter of five to ten years or the lease term for leasehold improvements
and two to seven years for machinery and equipment.

     Long-term investments -- Long-term investments represent preferred stock
and other strategic equity holdings in nonpublic companies (see Note 4).

     Goodwill -- Goodwill is being amortized on a straight-line basis over three
to seven years. Statement of Financial Accounting Standards ("SFAS") No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of, requires the Company to periodically review for possible
impairments of its long-lived assets, whenever events and circumstances indicate
that the carrying value may not be recoverable. If the undiscounted future cash
flows are less than the carrying amount, the carrying amount is reduced to fair
value and an impairment loss is recognized. The Company follows a similar policy
to evaluate goodwill for potential impairment.

     On February 14, 2001 the Financial Accounting Standards Board (the "Board")
issued a revised exposure draft, Business Combinations and Intangible
Assets -- Accounting for Goodwill. The proposed Statement would require that
goodwill no longer be amortized and that a goodwill impairment loss be
recognized if the implied fair value of a reporting unit's goodwill is less than
its carrying amount. The provisions in the proposed Statement would be effective
for fiscal quarters beginning after issuance of a final Statement. The Board has
announced that it plans to issue a final Statement in June 2001. The Company is
currently evaluating what impact this proposed Statement may have on its
financial statements.

     Income taxes -- Income taxes are accounted for under the asset and
liability method. Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and amounts used for income tax purposes. For the period from
January 6, 2000 to May 17, 2000 the Company's results of operations were
included in the consolidated federal income tax return of Motorola. Federal
income taxes for that period of time are provided in accordance with an
intercompany tax sharing agreement, whereby income taxes or credits for the
Company are reported as if the Company filed a separate federal income tax
return (see Note 15).

     Net Loss Per Share -- Basic net loss per share excludes dilution and is
computed by dividing net loss by the weighted average number of common shares
outstanding for the period. Diluted net loss per share is computed based on the
weighted average number of common shares outstanding plus the dilutive effect of
outstanding stock options and warrants. Diluted net loss per common share was
the same as basic net loss per common share for all periods presented since the
effect of any potentially dilutive common stock equivalents is excluded, as they
are anti-dilutive because of the Company's losses. As a result, in 2000 25.8
million shares of common stock equivalents were not included in the calculation
of diluted net loss per share because they were antidilutive. Pro forma basic
and diluted net loss per share for 1999 and 1998 has been computed using the
methods described in Note 13.

     Fair Value of Financial Instruments -- The carrying amounts of cash and
cash equivalents, accounts receivable and accounts payable approximate fair
value because of the short-term nature of these instruments. The fair value of
marketable securities, notes payable and other debt is based upon current
interest rates for debt instruments with comparable maturities and
characteristics.

                                        36
<PAGE>   39
                        NEXT LEVEL COMMUNICATIONS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

     Comprehensive Income (Loss) -- SFAS No. 130, Reporting Comprehensive
Income, requires that all items recognized under accounting standards as
components of comprehensive income be reported in an annual financial statement
that is displayed with the same prominence as other annual financial statements.
Other comprehensive income (loss) consists of unrealized gains and losses on
available-for-sale securities. Comprehensive loss was the same as net loss for
all periods presented.

     Certain Significant Risks and Uncertainties -- One customer comprised 56%,
67% and 68% of the Company's total revenues in 2000, 1999 and 1998,
respectively. At December 31, 2000 and 1999, 25% and 79%, respectively, of the
Company's trade accounts receivable were derived from this customer. The loss of
this customer or any substantial reduction in orders by this customer could have
a material adverse affect on the Company's operating results. Additionally, the
Company relies on certain contract manufacturers to perform substantially all of
its manufacturing activities. The inability of its contract manufacturers to
fulfill their obligations to the Company could adversely impact future results.

     The Company performs ongoing credit evaluations of its customers and
generally does not require collateral from its customers. The Company maintains
allowances for potential losses, and has not incurred any significant losses to
date. Allowance for doubtful accounts activity consists of (in thousands):

<TABLE>
<CAPTION>
                                          BALANCE AT    ADDITIONS                   BALANCE AT
                                          BEGINNING      CHARGED                       END
                                           OF YEAR      TO EXPENSE    DEDUCTIONS     OF YEAR
                                          ----------    ----------    ----------    ----------
<S>                                       <C>           <C>           <C>           <C>
Year ended December 31:
     1998...............................    $  170         $320          $ --         $  490
     1999...............................       490          896           (49)         1,337
     2000...............................     1,337           11           (16)         1,332
</TABLE>

     New Accounting Pronouncements -- SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended, is effective for the Company
beginning January 1, 2001. SFAS No. 133 requires that all derivative instruments
be measured at fair value and recognized in the balance sheet as either assets
or liabilities. Management has determined that the initial adoption of SFAS No.
133 will not have a material effect on the Company's financial statements.

     Reclassifications -- Certain prior year amounts have been reclassified to
conform to the current year presentation.

 3. ACQUISITIONS

     In 1997, General Instrument acquired all of the outstanding capital stock
of Telenetworks, a specialized data protocol communications software company for
$7.0 million in cash. The acquisition was accounted for using the purchase
method of accounting and, accordingly, the assets acquired and liabilities
assumed were recorded at their estimated fair values as of the date of
acquisition. The $6.9 million excess of the purchase price over the net
identifiable assets acquired was allocated to goodwill and is being amortized
over seven years. In January 1998, in conjunction with the formation of the
Partnership, the Limited Partner contributed the assets and liabilities of
Telenetworks to the Partnership at its cost. For financial statement purposes,
Telenetworks' assets, liabilities and results of operations have been included
in the accompanying consolidated financial statements for all periods presented.

     In July 2000, the Company acquired SoftProse, a company that provides
products and development services for consumer electronics, embedded systems,
real-time systems and communications systems. The purchase price of $16.9
million was comprised of the issuance of 144,781 shares of the Company's common
stock. The acquisition was accounted for using the purchase method of accounting
and accordingly, the assets

                                        37
<PAGE>   40
                        NEXT LEVEL COMMUNICATIONS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

acquired and liabilities assumed were recorded at their estimated fair values as
of the date of acquisition. Goodwill of $16.5 million arising from the
acquisition is being amortized over three years.

 4. LONG-TERM INVESTMENTS

     In July 2000, the Company invested in OutReach Communications, L.L.C.
("OutReach") which provides integrated broadband service to independent local
exchange companies. The Company contributed $7.0 million in cash in exchange for
an ownership interest of approximately 18% and warrants to acquire an additional
7% interest in OutReach, exercisable only upon either of the following: the
conversion of OutReach into a C Corporation and completion of an initial public
offering or the sale of substantially all of OutReach's assets. The Company and
OutReach have entered into a preferred vendor arrangement under which the
Company provides its products to OutReach's customers. Revenue from such sales
is deferred by the Company until the end user receives the products. At December
31, 2000 the Company had recorded $1.2 million of deferred revenue from
OutReach.

     In September 2000, the Company made an investment in Expanse Networks Inc.,
a developer of addressable television advertising delivery systems and software
for broadband networks. The Company contributed $3.0 million in cash in exchange
for an ownership interest of approximately 14%.

     In November 2000, the Company made a $5.0 million cash investment in
Virtual Access PLC, a network access company. The agreement requires additional
investments of $10 million by the Company provided that certain development
milestones are reached by Virtual Access. The Company currently holds
approximately a 3% ownership interest and its potential ownership interest under
the agreement is less than 20%.

 5. INVENTORIES

     Inventories at December 31 consist of (in thousands):

<TABLE>
<CAPTION>
                                                            2000       1999
                                                           -------    -------
<S>                                                        <C>        <C>
Raw materials............................................  $29,525    $11,746
Work-in-process..........................................    1,935      1,542
Finished goods...........................................   68,101     13,839
                                                           -------    -------
          Total..........................................   99,561     27,127
Less reserves and allowances.............................  (12,797)    (4,574)
                                                           -------    -------
Inventories, net.........................................  $86,764    $22,553
                                                           =======    =======
</TABLE>

     During the fourth quarter of 2000 the Company recorded a $9,000,000
inventory charge primarily related to a lower of cost or market adjustment to
certain residential gateway products and other obsolescence provisions. In 1998,
the Company recorded a charge of $5,800,000 primarily related to inventory
obsolescence.

                                        38
<PAGE>   41
                        NEXT LEVEL COMMUNICATIONS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

 6. PROPERTY AND EQUIPMENT

     Property and equipment at December 31 consist of (in thousands):

<TABLE>
<CAPTION>
                                                           2000        1999
                                                         --------    --------
<S>                                                      <C>         <C>
Land...................................................  $  1,889    $  1,889
Building...............................................    22,906      22,906
Machinery and equipment................................    50,515      35,938
Leasehold improvements.................................     6,511       5,930
                                                         --------    --------
          Total........................................    81,821      66,663
Less accumulated depreciation and amortization.........   (28,228)    (18,400)
                                                         --------    --------
Property and equipment, net............................  $ 53,593    $ 48,263
                                                         ========    ========
</TABLE>

     Machinery and equipment includes assets acquired under capital leases of
$1,549,000 and $1,801,000 and related accumulated depreciation and amortization
of $1,258,000 and $858,000 at December 31, 2000 and 1999, respectively.

 7. OTHER ACCRUED LIABILITIES

     Other accrued liabilities at December 31 consist of (in thousands):

<TABLE>
<CAPTION>
                                                              2000      1999
                                                             -------   -------
<S>                                                          <C>       <C>
Accrued payroll and related expenses.......................  $ 8,812   $ 4,764
Warranty reserve...........................................    5,645     2,841
Other accrued expenses.....................................    3,152     3,770
Due to Motorola (see Note 12)..............................   15,000        --
                                                             -------   -------
          Total............................................  $32,609   $11,375
                                                             =======   =======
</TABLE>

 8. NOTES PAYABLE

     In December 1999, the Company entered into a revolving bank line of credit
("Line") under which the Company may borrow up to the lesser of $50 million or
the value of pledged collateral. At December 31, 2000 and 1999, the balance
outstanding was $25,000,000 and $24,853,000, respectively. Interest on the Line
was 9.5% at December 31, 2000. The Line matures on October 1, 2001. The Line is
secured by $25,000,000 of marketable securities held by a custodian and recorded
as restricted marketable securities on the consolidated financial statements.

 9. STOCK OPTION PLANS

  NLC Stock Option Plans

     Certain employees of the Partnership were granted contingently exercisable
stock options (included in the table which follows) in NLC which vest over a
period ranging from two to three years and which expire in ten years. Such
options were exercisable only in the event of an initial public offering or a
change in control of NLC (the "Event").

     In November 1999, in conjunction with the Recapitalization (see Note 1),
the outstanding options granted under the NLC stock plan were converted into
options to purchase 6,964,904 shares of the Company's common stock with
equivalent terms and exercise prices. As a result of the initial public offering
of the Company, compensation expense of $96,864,000 was recognized in 1999
related to the contingently exercisable stock options. The compensation expense
was determined based on the difference between the

                                        39
<PAGE>   42
                        NEXT LEVEL COMMUNICATIONS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

exercise price of the vested portion of such options and the initial offering
price for the Company's common stock. The Company recorded compensation expense
of $2,384,000 in 2000 related to the remaining vesting of these options, as a
result of the Motorola acquisition.

     In addition, in 1997, as part of a tandem stock option grant, certain
employees of NLC were granted options at $1.11 per share for a total of 1.9
million shares of common stock of NLC, or options at $15.75 per share for a
total of 1.5 million shares of General Instrument common stock (the "GI
Options"). The NLC options were exercisable only upon an Event. The options have
a ten-year life and vest over three years. At December 31, 1999, it was
determined that the NLC options granted as part of the tandem stock grant were
more likely to be exercised than the related GI options. As a result, the
Company recorded $31,420,000 in compensation expense in 1999 related to the
tandem stock grant. The compensation expense was calculated based on the
difference between the exercise price of the vested portion of the NLC options
and the initial offering price of the Company's common stock.

  1999 Stock Plan

     The Company adopted its 1999 Stock Plan effective October 1, 1999. Options
to purchase 5,388,476 shares of common stock were granted under the 1999 Stock
Plan. These options vest over either a three or four year period with a pro rata
portion vesting after one year of service and the remaining shares vesting in
equal monthly installments over the remaining months of service and expire not
later than 10 years after the date of grant. No future awards under the 1999
Stock Plan will be made.

  1999 Equity Incentive Plan

     On October 10, 1999, the Company adopted the 1999 Equity Incentive Plan.
Options to purchase 7,900,000 shares of common stock are available for grant
under the plan. Depending on the grant, shares vest over either a three or four
year period with a pro rata portion vesting after one year of service and the
remaining shares vesting in equal monthly installments over the remaining months
of service. Options expire not later than 10 years after the date of grant.

     The following table summarizes activity relating to the NLC Stock Plan
(including those granted as part of the tandem stock option grant) and the 1999
Stock Plan and 1999 Equity Incentive Plan (the "Plans"):

<TABLE>
<CAPTION>
                                                                           WEIGHTED AVERAGE
                                                             SHARES         EXERCISE PRICE
                                                         --------------    ----------------
                                                         (IN THOUSANDS)
<S>                                                      <C>               <C>
Balance at December 31, 1997 (none exercisable)........       6,914             $ 0.98
  Granted..............................................         179               5.74
  Canceled.............................................          (4)              1.11
                                                             ------
Balance at December 31, 1998 (none exercisable)........       7,089               1.10
  Granted (fair value of $14.98).......................       8,109              29.29
  Canceled.............................................        (281)              1.28
  Exercised............................................         (10)              1.61
                                                             ------
Balance at December 31, 1999 (6,799 exercisable).......      14,907              16.43
  Granted (fair value of $47.04).......................       8,735              64.20
  Canceled.............................................      (1,600)             60.05
  Exercised............................................      (1,865)              2.04
                                                             ------
Balance at December 31, 2000 (7,297 exercisable).......      20,177              34.98
                                                             ======
</TABLE>

                                        40
<PAGE>   43
                        NEXT LEVEL COMMUNICATIONS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

     In January 2001, the Company granted an additional 3,670,000 options at an
exercise price of $8.63 per share.

     The following table summarizes information about options granted under the
Plans and outstanding at December 31, 2000:

<TABLE>
<CAPTION>
                                   OUTSTANDING
                  ---------------------------------------------          EXERCISABLE
                                        WEIGHTED                  --------------------------
                      NUMBER            AVERAGE        WEIGHTED       NUMBER        WEIGHTED
                  OUTSTANDING AT       REMAINING       AVERAGE    EXERCISABLE AT    AVERAGE
    EXERCISE       DECEMBER 31,     CONTRACTUAL LIFE   EXERCISE    DECEMBER 31,     EXERCISE
     PRICES            2000            (IN YEARS)       PRICE          2000          PRICE
----------------  ---------------   ----------------   --------   ---------------   --------
                  (IN THOUSANDS)                                  (IN THOUSANDS)
<S>               <C>               <C>                <C>        <C>               <C>
$ 0.85 - $  9.66       5,186              6.6           $ 1.23         5,186         $1.24
$11.00 - $ 15.06       5,432              8.9            11.26         1,439            11
$18.00 - $ 76.07       7,228              9.2            60.52           671         65.43
$80.56 - $161.25       2,331              9.3            86.15             1           130
                      ------                                           -----
$ 0.85 - $161.25      20,177              8.5            34.98         7,297          9.08
                      ======                                           =====
</TABLE>

  1999 Employee Stock Purchase Plan

     On October 10, 1999, the Company adopted the 1999 Employee Stock Purchase
Plan (the "Purchase Plan") under which 1,000,000 shares of our common stock were
reserved for issuance.

     All employees are eligible to participate. Eligible employees may begin
participating in the 1999 Employee Stock Purchase Plan at the start of any
offering period each of which lasts 24 months. Overlapping offering periods
start on May 1 and November 1 of each year. However, the first offering period
was started on the effective date of the initial public offering of November 10,
1999 and will end on October 31, 2001. Under the Purchase Plan eligible
employees may purchase the Company's common stock at a price that is the lower
of 85% of either the fair market value at the beginning of the offering period
or the fair market value at the end of the period.

     During the year ended December 31, 2000, 318,208 shares of common stock
were issued under the Purchase Plan.

  Additional Stock Plan Information

     The Company accounts for its stock-based awards using the intrinsic value
method in accordance with APB No. 25.

     SFAS No. 123, Accounting for Stock-Based Compensation, requires the
disclosure of pro forma net income (loss) and net income (loss) per share had
the Company adopted the fair value method. Under SFAS No. 123, the fair value of
stock-based awards to employees is calculated through the use of option pricing
models which were developed to estimate the fair value of freely tradable, fully
transferable options without vesting restrictions. Such options differ
significantly from the Company' stock-based awards. These models require
subjective assumptions, including future stock price volatility and expected
time to exercise, which greatly affect the calculated values. The Company's
calculations for options granted after the offering were made using the
Black-Scholes option pricing model.

     The estimated fair value of an option grant is based, in part, on the
estimated term of the option. Prior to the Company's initial public offering,
NLC options granted under the NLC Stock Plan were not exercisable. As a result,
it is not practicable to determine the expected term of NLC options and
therefore it is not possible

                                        41
<PAGE>   44
                        NEXT LEVEL COMMUNICATIONS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

to estimate the fair value of such options. As a result, disclosure of the
estimated grant date fair value of such options and the related pro forma
compensation expense for such options is not possible.

     The following weighted average assumptions are included in the estimated
fair value calculations of 2000 and 1999 grants for the stock option and stock
purchase programs:

<TABLE>
<CAPTION>
                                                              2000     1999
                                                              -----    ----
<S>                                                           <C>      <C>
Expected dividend yields....................................      0%      0%
Expected stock price volatility.............................  103.0%   70.0%
Risk fee interest rate......................................    6.1%    5.9%
Expected term (years).......................................    4.0     4.8
</TABLE>

     Under SFAS No. 123, had the Company recorded compensation expense based on
the estimated grant date fair value for awards based on grants under the Plans
and the tandem stock grant, the Company's net loss and net loss per share would
have changed. The amounts below represent the pro forma amounts for fiscal 2000,
1999, and 1998 (in thousands, except for per share amounts):

<TABLE>
<CAPTION>
                                                     2000         1999         1998
                                                   ---------    ---------    --------
<S>                                                <C>          <C>          <C>
Net loss as reported.............................  $ (74,838)   $(205,072)   $(81,731)
Pro forma net loss, as adjusted..................  $(237,363)   $(213,108)   $(84,494)
Diluted net loss per share (pro forma in
  1999 and 1998).................................  $   (0.91)   $   (2.78)   $  (1.08)
Pro forma diluted loss per share, as adjusted....  $   (2.90)   $   (2.98)   $  (1.21)
</TABLE>

10. EMPLOYEE BENEFIT PLANS

     In January 2000, the Company adopted the Next Level Communications 401(k)
Plan ("NLC Plan") to which employees could contribute up to 12% of the
employees' salary subject to the legal maximum. The Company contributes an
amount equal to 100% of the first 5% of the employee's salary that the employee
contributes. The Company's expense related to the NLC Plan was $1,421,000 in
2000. The Company's expense related to the General Instrument 401(k) Plan was
$589,000 and $513,000 for 1999 and 1998, respectively.

11. COMMITMENTS AND CONTINGENCIES

     The Company leases certain of its facilities and equipment under operating
leases. Leases expire at various dates from 2001 to 2006 and certain facility
leases have renewal options.

     Future minimum lease payments at December 31, 2000 under operating leases
are as follows:

<TABLE>
<S>                                                   <C>
2001................................................  $2,202
2002................................................   1,887
2003................................................   1,586
2004................................................     945
2005................................................     870
Thereafter..........................................     650
                                                      ------
          Total.....................................  $8,140
                                                      ======
</TABLE>

     Additionally, the Company leases equipment under capital leases. These
leases all expire in 2001 and all contain purchase options.

                                        42
<PAGE>   45
                        NEXT LEVEL COMMUNICATIONS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

     Future minimum lease payments at December 31, 2000 are as follows (in
thousands):

<TABLE>
<S>                                                           <C>
Total payments under capital leases.........................  $349
Less amounts representing interest..........................   (19)
                                                              ----
Present value of net minimum lease payments.................  $330
                                                              ====
</TABLE>

     Rent expense was $1.7 million, $4.3 million and $3.8 million in 2000, 1999
and 1998, respectively.

     We have commitments with suppliers to purchase a total of approximately
$75.0 million of components in 2001.

     In May 1998, actions by Broad-Band Technologies, Inc. against General
Instrument and by Next Level Communications against Broad-Band Technologies,
pending in the United States District Court for the Eastern District of North
Carolina, were dismissed with prejudice. These dismissals were entered pursuant
to a settlement agreement under which, among other things, Next Level
Communications, Inc. paid Broad-Band Technologies $5.0 million, which was
expensed in 1998.

12. INCOME TAXES

     For the period from January 1, 1998 through November 9, 1999, the Company
was a limited partnership entity. For federal and state tax purposes, limited
partnership entities pass all items of income and expense through to the
respective partners of the entity. Consequently, all items of income and expense
attributable to the period in which the Company was a limited partnership were
allocated directly to the respective partners.

     For the period from November 10, 1999 through January 5, 2000, the Company
was a corporation filing its tax returns on a stand-alone basis. As a result of
the acquisition by Motorola of General Instrument, from January 6, 2000 through
May 17, 2000, the Company's taxable loss will be included in the consolidated
federal tax return of Motorola. Subsequent to May 17, 2000, due to the exercise
of various warrants and stock options, Motorola's ownership interest in the
Company declined below 80% and the Company was no longer eligible to be included
in Motorola's consolidated federal tax return. For the period May 18, 2000 to
December 31, 2000 the Company will file its federal income tax return on a
stand-alone basis.

     Significant components of the Company's deferred tax assets and liabilities
at December 31 were as follows (in thousands):

<TABLE>
<CAPTION>
                                                          2000         1999
                                                        ---------    --------
<S>                                                     <C>          <C>
Deferred tax assets:
  Net operating loss carryforwards....................  $  69,131    $  4,326
  Capitalized research and development................     31,744      28,865
  Stock option compensation...........................      1,021          --
  Basis difference in property and equipment..........      4,111      (2,127)
  Inventory reserves..................................      5,483       1,822
  Other...............................................     10,719       8,899
                                                        ---------    --------
          Total.......................................    122,209      41,785
Valuation allowance...................................   (122,209)    (41,785)
                                                        ---------    --------
  Net deferred tax assets.............................  $      --    $     --
                                                        =========    ========
</TABLE>

     No tax benefit has been recorded through December 31, 2000 because of the
net operating losses incurred and full valuation allowance provided. A valuation
allowance is provided when it is more likely than not that some portion of the
deferred tax assets will not be realized. The Company established a 100%
valuation

                                        43
<PAGE>   46
                        NEXT LEVEL COMMUNICATIONS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                  YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

allowance at December 31, 2000 and 1999 due to the uncertainty of realizing
future tax benefits from its net operating loss carryforwards and other deferred
tax assets.

     At December 31, 2000, for tax purposes, the Company had approximately
$168,000,000 in federal net operating loss carryforwards, approximately
$150,000,000 in state net operating loss carryforwards, and approximately
$1,600,000 in research and development credit carryforwards. The Company's
federal net operating loss carryforwards expire beginning in fiscal 2017. The
Company's other net operating loss and tax credit carryforwards have various
expiration dates beginning in fiscal year 2002.

     Provisions of the Internal Revenue Code place a limitation (the "Section
382 Limitation") on the amount of taxable income which can be offset by net
operating loss ("NOL") carryforwards after a change in control (generally a
greater than 50% change in ownership). The Company's indirect acquisition by
Motorola on January 5, 2000 resulted in an ownership change. The Company's
federal and state NOLs on the date of the ownership change were approximately
$18,000,000 and $14,000,000, respectively. Management believes that the Section
382 Limitation will not affect its ability to use its NOLs.

     In December 2000, the Company received a $15 million advance from Motorola
related to a tax sharing and allocation agreement. The Company received an
additional $17.3 million in January 2001 and the tax agreement was finalized in
February 2001. The amount advanced to the Company is based on an estimate of the
present value of income tax benefits to Motorola from the inclusion of the
Company's operating losses for the period from January 6, 2000 to May 17, 2000.
To the extent Motorola does not achieve the expected tax benefits by September
30, 2006, the Company must repay any difference. In addition, should the Company
obtain certain specified levels of financing from independent third parties, it
must repay all or a portion of the advance.

13. PRO FORMA NET LOSS PER SHARE

     Basic and diluted net loss per share for 1999 and 1998 is computed by
dividing the pro forma net loss by the pro forma shares outstanding for the
period giving effect to the Recapitalization as if it had occurred on January 1,
1997.

     Pro forma basic and diluted net loss per share give effect to the
contribution of the note and accrued interest thereon payable to General
Instrument and the related elimination of interest expense of $5.8 million and
$5.9 million for 1999 and 1998 respectively. The pro forma shares outstanding
exclude warrants held by affiliates of the General Partner to purchase 8,480,102
shares of common stock and employee stock options to purchase 14,907,000 shares
of common stock. Shares under these options and warrants were not included in
the computation of pro forma diluted net loss per common share since the
inclusion of these shares would be antidilutive.

     The following is a reconciliation of the components of the pro forma basic
and diluted net loss per share (in thousands except per share amounts):

<TABLE>
<CAPTION>
                                                          1999         1998
                                                        ---------    --------
<S>                                                     <C>          <C>
Net loss..............................................  $(205,072)   $(81,731)
Less: Interest expense for converted GI note
  payable.............................................      5,813       5,940
                                                        ---------    --------
Pro forma basic and diluted net loss..................  $(199,259)   $(75,791)
                                                        =========    ========
Pro forma weighted average shares outstanding.........     71,598      69,967
                                                        =========    ========
Pro forma net loss, basic and diluted.................  $   (2.78)   $  (1.08)
                                                        =========    ========
</TABLE>

                                        44
<PAGE>   47

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

OFFICERS AND DIRECTORS

     Information concerning this item will be in our definitive proxy statement
to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934
for our 2001 annual meeting of stockholders and is incorporated herein by
reference.

ITEM 11. EXECUTIVE COMPENSATION

     Information concerning this item will be in our definitive proxy statement
to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934
for our 2001 annual meeting of stockholders and is incorporated herein by
reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     Information concerning this item will be in our definitive proxy statement
to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934
for our 2001 annual meeting of stockholders and is incorporated herein by
reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Information concerning this item will be in our definitive proxy statement
to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934
for our 2001 annual meeting of stockholders and is incorporated herein by
reference.

                                    PART IV

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

FINANCIAL STATEMENTS AND SCHEDULES

     The Financial Statements which are filed with this Form 10-K are set forth
in the Index to Financial Statements at page 26, which immediately precedes such
financial statements. No schedules are required under the applicable
instructions or are inapplicable and have therefore been omitted.

EXHIBITS

     The following exhibits are, as indicated below, either filed herewith or
have previously been filed with the SEC and are referred to and incorporated
herein by reference to such filings.

<TABLE>
<CAPTION>
EXHIBIT
 NUMBER                               EXHIBIT
--------                              -------
<S>         <C>
 2.1        Form of Merger Agreement among General Instrument
            Corporation, Spencer Trask Investors LLC, Next Level
            Communications, Next Level Communications L.P. and us, which
            was filed as exhibit 2.1 to our registration statement on
            Form S-1 (file no. 333-85999) and is incorporated by
            reference herein.
 3.1        Restated Certificate of Incorporation, which was filed as
            exhibit 3.1 to our registration statement on Form S-1 (file
            No. 333-85999) and is incorporated by reference herein.
 3.2        Bylaws, which were filed as exhibit 3.2 to our registration
            statement on Form S-1 (file No. 333-85999) and are
            incorporated by reference herein.
</TABLE>

                                        45
<PAGE>   48

<TABLE>
<CAPTION>
EXHIBIT
 NUMBER                               EXHIBIT
--------                              -------
<S>         <C>
 4.1        Form of Registration Rights Agreement among General
            Instrument Corporation, Spencer Trask Investors LLC and us,
            which was filed as exhibit 4.2 to our registration statement
            on Form S-1 (file No. 333-85999) and is incorporated by
            reference herein.
 9.1        Form of Voting Trust Agreement among General Instrument
            Corporation, Chasemellon Shareholder Services and us, which
            was filed as exhibit 9.1 to our registration statement on
            Form S-1 (file No. 333-85999) and is incorporated by
            reference herein.
10.1        Form of Indemnification Agreement for our directors and
            officers, which was filed as exhibit 10.1 to our
            registration statement on Form S-1 (file No. 333-85999) and
            is incorporated by reference herein.
10.2        Form of Corporate and Intercompany Agreement for our
            directors and officers, which was filed as exhibit 10. to
            our registration statement on Form S-1 (file No. 333-85999)
            and is incorporated by reference herein.
10.3*       1999 Equity Incentive Plan, which was filed as exhibit 10.3
            to our registration statement on Form S-1 (file No.
            333-85999) and is incorporated by reference herein.
10.4*       1999 Employee Stock Purchase Plan, which was filed as
            exhibit 10.4 to our registration statement on Form S-1 (file
            No. 333-85999) and is incorporated by reference herein.
10.5        Patent and Technical Information Cross-License Agreement,
            which was filed as exhibit 10.5 to our registration
            statement on Form S-1 (file No. 333-85999) and is
            incorporated by reference herein.
10.6**      Agreement between U S WEST Communications, Inc. and us,
            which was filed as exhibit 10.8 to our registration
            statement on Form S-1 (file No. 333-85999) and is
            incorporated by reference herein.
10.7**      Agreement among Telesector Resources group, Inc., General
            Instrument Corporation and us, which was filed as exhibit
            10.8 to our registration statement on Form S-1 (file No.
            333-85999) and is incorporated by reference herein.
10.8**      Agreement between SCI Technology, Inc. and us, which was
            filed as exhibit 10.10 to our registration statement on Form
            S-1 (file No. 333-85999) and is incorporated by reference
            herein.
10.9**      Agreement between CMC Mississippi, Inc. and us, which was
            filed as exhibit 10.11 to our registration statement on Form
            S-1 (file No. 333-85999) and is incorporated by reference
            herein.
10.10*      1999 Stock Plan, which was filed as exhibit 10.12 to our
            registration statement on Form S-1 (file No. 333-85999) and
            is incorporated by reference herein.
10.11       Form of Warrant, which was filed as exhibit 10.13 to our
            registration statement on Form S-1 (file No. 333-85999) and
            is incorporated by reference herein.
10.12       Business Loan Agreement between Bank of America, N.A. and
            us, which was filed as exhibit 10.14 to our registration
            statement on Form S-1 (file No. 33-38618) and is
            incorporated by reference herein.
10.13       Form of Change of Control Agreement which was filed as
            exhibit 10.1 to our third quarterly report on Form 10-Q
            (file No. 000-27877) and is incorporated by reference
            herein.
23.1***     Independent Auditors' Consent
</TABLE>

---------------
*   Management contract or compensatory plan or arrangement.

**  Confidential Treatment has been granted as to certain portions of these
    exhibits.

*** Filed herewith.

                                        46
<PAGE>   49

                                   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.

                                          NEXT LEVEL COMMUNICATIONS, INC.

Date: March 16, 2001
                                          By:     /s/ J. MICHAEL NORRIS
                                            ------------------------------------
                                                     J. Michael Norris
                                                Chief Executive Officer and
                                                          President

     KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below does hereby constitute and appoint Peter W. Keeler and Keith A.
Zar, with full power of substitution and resubstitutions and full power to act
without the other, his or her true and lawful attorneys-in-fact and agents to
act for him or her in his or her name, place or stead, in any and all
capacities, to sign any amendments to this report and to file such amendments,
together with exhibits and other documents in connection therewith, with the
Securities and Exchange Commission, granting to each attorney-in-fact and agent
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 as he or
she might or could do in person, and ratifying and confirming all that the
attorneys-in-fact and agents, or his or her substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.

     Pursuant to the requirements of the Securities 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.

<TABLE>
<CAPTION>
              SIGNATURE                                TITLE                       DATE
              ---------                                -----                       ----
<S>                                    <C>                                    <C>

         /s/ PETER W. KEELER                   Chairman of the Board          March 16, 2001
-------------------------------------
           Peter W. Keeler

        /s/ J. MICHAEL NORRIS               Chief Executive Officer and       March 16, 2001
-------------------------------------          President (Principal
          J. Michael Norris                     Executive Officer)

        /s/ JAMES T. WANDREY               Senior Vice President, Chief       March 16, 2001
-------------------------------------    Financial Officer, and Treasurer
          James T. Wandrey                   (Principal Financial and
                                                Accounting Officer)

         /s/ EUGENE DELANEY                          Director                 March 16, 2001
-------------------------------------
           Eugene Delaney

          /s/ LYNN FORESTER                          Director                 March 16, 2001
-------------------------------------
            Lynn Forester

       /s/ FERDINAND C. KUZNIK                       Director                 March 16, 2001
-------------------------------------
         Ferdinand C. Kuznik

        /s/ PAUL S. LATCHFORD                        Director                 March 16, 2001
-------------------------------------
          Paul S. Latchford

         /s/ JOHN MCCARTNEY                          Director                 March 16, 2001
-------------------------------------
           John McCartney

         /s/ JERRY ROSELAND                          Director                 March 16, 2001
-------------------------------------
           Jerry Roseland

         /s/ RICHARD SEVERNS                         Director                 March 16, 2001
-------------------------------------
           Richard Severns
</TABLE>

                                        47
<PAGE>   50

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                              EXHIBIT
-------                             -------
<S>       <C>
23.1      Independent Auditors' Consent
</TABLE>