Offer To Exchange Certain Outstanding Options

NEXT LEVEL COMMUNICATIONS, INC.


OFFER TO EXCHANGE CERTAIN OUTSTANDING OPTIONS TO PURCHASE
COMMON STOCK UNDER THE 1999 EQUITY INCENTIVE PLAN


THIS OFFER AND WITHDRAWAL RIGHTS EXPIRE
AT 6:00 P.M. PDT ON AUGUST 7, 2001
UNLESS THIS OFFER IS EXTENDED


Next Level Communications, Inc. is offering to exchange certain outstanding options to purchase shares of our common stock granted under the Next Level Communications, Inc. 1999 Equity Incentive Plan for new options that we will grant under the same plan. We are making this offer upon the terms and subject to the conditions set forth in this offer to exchange and in the related Election Concerning Exchange of Stock Options form (which together, as they may be amended from time to time, constitute the "offer"). The number of shares of common stock subject to the new options to be granted to each option holder will be equal to the number of shares subject to the options elected to be exchanged by such option holder and accepted for exchange (the terms "option" or "options" refer to an entire option grant). We will grant the new options as promptly as practicable on or after the first trading day that is at least six months and one day after the date we cancel the options accepted for exchange (the "replacement grant date"). Employees are eligible to participate in the exchange program only if they hold at least one option with an exercise price of $40.00 or higher per share. Employees with a title of senior vice president or higher and our board members are not eligible to participate. If you are eligible and choose to participate, you can elect to exchange any or all options you hold with an exercise price of $40.00 or higher per share. In addition, if you elect to exchange such options, then all options granted to you between February 8, 2001 and August 7, 2001 will also be automatically exchanged, regardless of their exercise price.


This offer is not conditioned upon a minimum number of options being elected for exchange. This offer is subject to certain conditions which we describe in Schedule A of this offer to exchange.


If you elect to exchange options as described in this offer and if your offer is accepted, we will grant you new options under the 1999 Equity Incentive Plan pursuant to a new option agreement between us and you. The exercise price of the new options will be equal to the last reported sale price of our common stock on the Nasdaq National Market on the replacement grant date, as reported in the print edition of The Wall Street Journal. BECAUSE WE WILL NOT GRANT NEW OPTIONS UNTIL AT LEAST SIX MONTHS AND ONE DAY AFTER THE DATE WE CANCEL THE OPTIONS ACCEPTED FOR EXCHANGE, THE NEW OPTIONS MAY HAVE A HIGHER EXERCISE PRICE THAN SOME OR ALL OF YOUR CURRENT OPTIONS.


Once the options elected for exchange are cancelled, you will receive no vesting credit with respect to the cancelled options between the cancellation date and the replacement grant date, a period which will be at least six months and one day. Once the new options are granted, they will resume vesting on the same schedule as the options you elect for exchange, and you will receive full credit for all vesting earned up until the cancellation date. The new options will


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have other terms and conditions that are substantially similar to the cancelled options, except for the exercise price.


ALTHOUGH OUR BOARD OF DIRECTORS HAS APPROVED THIS OFFER, NEITHER WE NOR OUR BOARD OF DIRECTORS MAKES ANY RECOMMENDATION AS TO WHETHER YOU SHOULD ELECT TO EXCHANGE OR REFRAIN FROM ELECTING TO EXCHANGE YOUR OPTIONS. YOU MUST MAKE YOUR OWN DECISION WHETHER TO ELECT TO EXCHANGE YOUR OPTIONS.


Shares of our common stock are quoted on the Nasdaq National Market under the symbol "NXTV." On July 10, 2001, the last reported sale price of the common stock on the Nasdaq National Market was $5.67 per share. WE RECOMMEND THAT YOU OBTAIN CURRENT MARKET QUOTATIONS FOR OUR COMMON STOCK BEFORE DECIDING WHETHER TO ELECT TO EXCHANGE YOUR OPTIONS.


You should direct questions about this offer or requests for assistance to our internal email address at optionquestions@nlc.com or for additional copies of this offer to exchange or the Election Concerning Exchange of Stock Options form at http://intranet/optionquestions/.


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IMPORTANT


If you wish to elect to exchange your options, you must complete and sign the Election Concerning Exchange of Stock Options form in accordance with its instructions, and send it to us by internal mail or post to Bob Vereschagin, Human Resources Department, Next Level Communications, Inc., 6085 State Farm Drive, Rohnert Park, California 94928.


We are not making this offer to, nor will we accept any election to exchange options from or on behalf of, option holders in any jurisdiction in which this offer or the acceptance of any election to exchange options would not be in compliance with the laws of such jurisdiction. However, we may, at our discretion, take any actions necessary for us to make this offer to option holders in any such jurisdiction.


WE HAVE NOT AUTHORIZED ANY PERSON TO MAKE ANY RECOMMENDATION ON OUR BEHALF AS TO WHETHER YOU SHOULD ELECT TO EXCHANGE OR REFRAIN FROM ELECTING TO EXCHANGE YOUR OPTIONS PURSUANT TO THIS OFFER. YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT OR TO WHICH WE HAVE REFERRED YOU. WE HAVE NOT AUTHORIZED ANYONE TO GIVE YOU ANY INFORMATION OR TO MAKE ANY REPRESENTATION IN CONNECTION WITH THIS OFFER OTHER THAN THE INFORMATION AND REPRESENTATIONS CONTAINED IN THIS DOCUMENT OR IN THE RELATED ELECTION CONCERNING EXCHANGE OF STOCK OPTIONS FORM. IF ANYONE MAKES ANY RECOMMENDATION OR REPRESENTATION TO YOU OR GIVES YOU ANY INFORMATION, YOU MUST NOT RELY UPON THAT RECOMMENDATION, REPRESENTATION OR INFORMATION AS HAVING BEEN AUTHORIZED BY US.


NOTHING IN THIS DOCUMENT SHALL BE CONSTRUED TO GIVE ANY PERSON THE RIGHT TO REMAIN IN THE EMPLOY OF THE COMPANY OR TO AFFECT THE RIGHT OF THE COMPANY TO TERMINATE THE EMPLOYMENT OF ANY PERSON AT ANY TIME WITH OR WITHOUT CAUSE TO THE EXTENT PERMITTED UNDER LAW. NOTHING IN THIS DOCUMENT SHOULD BE CONSIDERED A CONTRACT OR GUARANTEE OF WAGES OR COMPENSATION. THE EMPLOYMENT RELATIONSHIP BETWEEN THE COMPANY AND EACH EMPLOYEE REMAINS "AT WILL."


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TABLE OF CONTENTS


PAGE
---- SUMMARY TERM SHEET..........................................................................................................1


INTRODUCTION...............................................................................................................11


THIS OFFER.................................................................................................................13


1. Number of Options; Expiration Date..............................................................................13
2. Purpose of This Offer...........................................................................................14
3. Procedures for Electing to Exchange Options.....................................................................15
4. Withdrawal Rights...............................................................................................16
5. Acceptance of Options for Exchange and Issuance of New Options..................................................17
6. Price Range of Common Stock Underlying the Options..............................................................18
7. Source and Amount of Consideration; Terms of New Options........................................................18
8. Information Concerning Next Level Communications................................................................20
9. Interests of Directors, Officers and Affiliates; Transactions and Arrangements Concerning the Options...........24
10. Status of Options Acquired by Us in this Offer; Accounting Consequences Of the Offer............................25
11. Legal Matters; Regulatory Approvals.............................................................................26
12. Material Federal Income Tax Consequences........................................................................26
13. Extension of Offer; Termination; Amendment......................................................................27
14. Fees and Expenses...............................................................................................28
15. Additional Information..........................................................................................28
16. Miscellaneous...................................................................................................29


SCHEDULE A CONDITIONS OF THIS OFFER


SCHEDULE B INFORMATION CONCERNING THE DIRECTORS AND EXECUTIVE OFFICERS OF
NEXT LEVEL COMMUNICATIONS, INC.


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INDEX TO SUMMARY TERM SHEET


1. What securities are we offering to exchange?...........................................................................1 2. Why are we making this offer to exchange?..............................................................................1 3. Who is eligible to participate in this exchange?.......................................................................1 4. Are employees located outside the United States eligible to participate?...............................................2 5. How does this exchange work?...........................................................................................2 6. What do I need to do to participate in this offer to exchange?.........................................................2 7. Is this a repricing?...................................................................................................2 8. Why can't Next Level Communications just reprice my options?...........................................................2 9. Why can't I just be granted additional options?........................................................................3 10. Wouldn't it be easier to quit Next Level Communications and then get rehired?..........................................3 11. If I elect to participate in this exchange program, why must all options granted to me in the last
six months, which have a fairly low exercise price, also be exchanged?...............................................3 12. If I participate, what will happen to my exchanged options?............................................................3 13. What is the deadline to elect to exchange and how do I elect to exchange?..............................................3 14. What will happen if I do not turn in my form by the deadline?..........................................................4 15. During what period of time can I withdraw previously elected options?..................................................4 16. Am I eligible to receive future grants if I participate in this exchange?..............................................4 17. Does Next Level Communications plan to make any company-wide option grants between the
cancellation date and the replacement grant date?....................................................................4 18. Is there any tax consequence to my participation in this exchange?.....................................................4 19. How should I decide whether or not to participate?.....................................................................4 20. What do the officers and the members of our Board of Directors think of this offer?....................................5 21. What if I leave Next Level Communications between the date my options are cancelled and the replacement grant date?....5 22. What are the conditions to this offer?.................................................................................5 23. Which options can be exchanged?........................................................................................5 24. Can I choose which options I want to exchange if I have multiple options?..............................................6 25. Can I exchange the remaining portion of an option that I have already partially exercised?.............................6 26. Can I select which portion of an option to exchange?...................................................................6 27. Can I exchange both vested and unvested options?.......................................................................6 28. Can I exchange options that I have already exercised?..................................................................6 29. If I participate, what will happen to my options that will be cancelled?...............................................6 30. If I participate, am I required to exchange my options received in January 2001? ......................................6 31. How many shares will be subject to my new option?......................................................................7 32. Will there be a press release that announces fourth quarter earnings prior to the replacement grant date? .............7 33. What will be my new option exercise price?.............................................................................7 34. When will I receive my new option?.....................................................................................7 35. Why won't I receive my new option immediately after the expiration date of this offer?.................................7 36. When will I see the new option at http://www.aststockplan.com and when will I receive my new option notice?...........8 37. How can I view a summary of my options?................................................................................8 38. When will the new option vest?.........................................................................................8 39. Will I receive vesting credit towards my new options during the six month and one day
waiting period?......................................................................................................8 40. What will be the terms and conditions of my new option?................................................................8 41. Can I have some examples of a hypothetical exchange?...................................................................9 42. What happens if Next Level Communications is subject to a change in control after the
new options are granted?............................................................................................10 43. What happens if Next Level Communications is subject to a change in control before the
new options are granted?............................................................................................10 44. After the replacement grant date, what happens if my options end up underwater again?.................................10


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SUMMARY TERM SHEET


The following are answers to some of the questions that you may have about this offer. We urge you to read carefully the remainder of this offer to exchange and the accompanying Election Concerning Exchange of Stock Options form because the information in this summary is not complete, and additional important information is contained in the remainder of this offer to exchange and the Election Concerning Exchange of Stock Options form. We have included page references to the remainder of this offer to exchange where you can find a more complete description of the topics in this summary.


GENERAL QUESTIONS ABOUT THE EXCHANGE


1. What securities are we offering to exchange?


We are offering to exchange all options to purchase shares of Next Level Communications common stock which are outstanding under the 1999 Equity Incentive Plan held by current employees of Next Level Communications with an exercise price of $40.00 or higher per share for new options under the same plan. In addition, employees who elect to participate in this exchange program with respect to such options will automatically be deemed to also have elected to exchange all stock options granted to them between February 8, 2001 and August 7, 2001, regardless of exercise price. (Page 11)


2. Why are we making this offer to exchange?


We are implementing this offer to exchange because a considerable number of our employees have stock options, whether or not they are currently exercisable, with exercise prices that are significantly above our current and recent trading prices. We believe these options are unlikely to be exercised in the foreseeable future, which does not serve the original purpose of such options. This program is VOLUNTARY and will allow employees to choose whether to keep their current stock options at their current exercise price or to exchange those options for new options to purchase the same number of shares to be granted as promptly as practicable on or after the first trading day that is at least six months and one day after the date we cancel the options accepted for exchange (the "replacement grant date"). We hope that this program will ameliorate the current underwater options issue, but this cannot be guaranteed considering the ever-present risks associated with a volatile and unpredictable stock market. By making this offer to exchange outstanding options for new options that will have an exercise price equal to the market value of our common stock on the replacement grant date, we intend to provide our employees with the benefit of owning options that over time may have a greater potential to increase in value, create better performance incentives for employees and thereby maximize stockholder value. (Page 14)


3. Who is eligible to participate in this exchange?


Generally, anyone who is currently employed by Next Level Communications from the cancellation date through the replacement grant date who holds at least one stock option with an exercise price of $40.00 or higher per share is eligible to participate. However, employees in


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positions of senior vice president or higher and members of our Board of Directors are not eligible to participate. (Page 11)


4. Are employees located outside the United States eligible to participate?


Yes, employees located outside of the United States are eligible to participate. These employees are urged to educate themselves about special financial or tax considerations that may impact their decision whether to exchange by consulting a financial or tax advisor in the country where they reside and work.


5. How does this exchange work?


Participating in the exchange program requires an eligible employee to make a voluntary, irrevocable election to exchange outstanding stock options on August 8, 2001 for a one-for-one grant of a new option to be issued on the replacement grant date and priced at Next Level Communications' closing market price on that date. Once the options elected for exchange are cancelled, you will receive no vesting credit with respect to the cancelled options between the cancellation date and the replacement grant date, a period which will be at least six months and one day. Once the new options are granted, they will resume vesting on the same schedule as the options you elect for exchange, and you will receive full credit for all vesting earned up until the cancellation date. The new options will have other terms and conditions that are substantially similar to the cancelled options, except for the exercise price. To participate, employees can elect to exchange any or all options (previously defined as an entire option grant) with an exercise price of $40.00 or higher per share. However, any employee who elects to exchange any such options will automatically be deemed to also have elected to exchange all options granted them between February 8, 2001 and August 7, 2001, regardless of exercise price. (Page 13)


6. What do I need to do to participate in this offer to exchange?


To participate, you must complete the Election Concerning Exchange of Stock Options form, sign it, and ensure that the Next Level Human Resources Department receives it no later than 6:00 p.m. PDT on Tuesday, August 7, 2001. You can return your form by either internal mail or post to Bob Vereschagin, Human Resources Department, Next Level Communications, Inc., 6085 State Farm Drive, Rohnert Park, California 94928, USA. (Page 15)


7. Is this a repricing?


This is not a stock option repricing in the traditional sense. Under a traditional stock option repricing, an employee's current options would be immediately repriced and Next Level Communications would have a variable accounting charge against earnings. (Page 25)


8. Why can't Next Level Communications just reprice my options?


In 1998, the Financial Accounting Standards Board adopted unfavorable accounting charge consequences for companies that reprice options. If we were to simply reprice options, the company's potential for profitability would be diminished, as we would be required to take a charge against earnings on any future appreciation of the repriced options. (Page 25)


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9. Why can't I just be granted additional options?


Because of the large number of underwater options currently outstanding at Next Level Communications, a total re-grant of new options would have a severe negative impact on Next Level Communications' dilution and outstanding shares. Additionally, Next Level Communications has a limited pool of options that it is allowed to grant without stockholder approval, and therefore our current reserves must be conserved for new hires and ongoing grants.


10. Wouldn't it be easier to quit Next Level Communications and then get
rehired?


This is not an alternative for us because this would be treated the same as a repricing if the rehire and resulting re-grant are within six months of the option cancellation date. Again, such a repricing would cause Next Level Communications to incur a variable accounting charge against earnings. In addition, by leaving Next Level Communications and then later being rehired, an employee would not receive credit for prior service for vesting purposes. (Page 25)


11. If I elect to participate in the exchange program, why must all
options granted to me in the last six months, which have a fairly
low exercise price, also be exchanged?


If we were to allow participating employees to keep options that were granted within six months before the date options are cancelled in this offer, then the financial accounting rules applicable to us could require us to recognize significant charges in our financial statements. These charges could reduce our reported earnings for each fiscal quarter that the options issued in the last six months remained outstanding. This could have a negative impact on our stock price performance. (Page 25)


12. If I participate, what will happen to my exchanged options?


Options designated to be exchanged under this program will be cancelled on August 8, 2001 and will no longer be seen in your options summary at http://www.aststockplan.com.


13. What is the deadline to elect to exchange and how do I elect to
exchange?


The deadline to participate in this program is 6:00 p.m. PDT on Tuesday, August 7, 2001 unless it is extended by us. This means that Bob Vereschagin in the Human Resources Department must have your form in his hands before that time. We may, in our discretion, extend this offer at any time, but we cannot assure you that this offer will be extended or, if extended, for how long. If this offer is extended, we will make a public announcement of the extension no later than 9:00 a.m. on the next business day following the previously scheduled expiration of this offer period. If this offer is extended by us beyond that time, you must deliver your form before the extended expiration of this offer. (Page 13)


We reserve the right to reject any or all options elected for exchange that we determine are not in appropriate form or that we determine are unlawful to accept. Otherwise, we will accept properly and timely elected options that are not validly withdrawn. Subject to our rights


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to extend, terminate and amend this offer, we currently expect that we will accept all such properly elected options promptly after the expiration of this offer.


14. What will happen if I do not turn in my form by the deadline?


If you do not turn in your election form by the deadline, then you will not participate in the option exchange, and all stock options currently held by you will remain intact at their original price and original terms. (Page 15)


15. During what period of time can I withdraw previously elected
options?


You can withdraw your options elected for exchange at any time before 6:00 p.m. PDT on Tuesday, August 7, 2001. If this offer is extended by us beyond that time, you can withdraw your options elected for exchange at any time until the extended expiration of this offer. To withdraw options elected for exchange, you must deliver to us a written notice of withdrawal with the required information while you still have the right to withdraw the options elected for exchange, and we must receive the withdrawal notice before the election deadline. It is your responsibility to confirm that we have received your withdrawal notice before the deadline. Once you have withdrawn options, you can re-elect to exchange options only by again following the delivery procedures described above. (Page 16)


16. Am I eligible to receive future grants if I participate in this
exchange?


Because of the accounting limitations, participants in this program are ineligible for any additional stock option grants until after the replacement grant date. After the replacement grant date, participants in this program will be eligible for future stock option grants. (Page 25)


17. Does Next Level Communications plan to make any company-wide option
grants between the cancellation date and the replacement grant date?


No. We do not anticipate making any company-wide option grants until after the replacement grant date.


18. Is there any tax consequence to my participation in this exchange?


No. If you accept this offer and reside and work in the United States, you will not recognize income for federal income tax purposes either at the time your exchanged options are cancelled or when the new options are granted. However, we recommend that you consult with your own tax advisor to determine the tax consequences of electing to exchange options pursuant to this offer. Employees who reside or work outside the United States should consult a tax advisor to learn about the tax consequence of participating in this exchange. We make no representations to these employees regarding their participation in this exchange. (Page 19)


19. How should I decide whether or not to participate?


We understand that this will be a challenging decision for all employees. THE PROGRAM DOES CARRY CONSIDERABLE RISK, AND THERE ARE NO GUARANTEES OF OUR FUTURE STOCK PERFORMANCE OR THE PRICE OF OUR STOCK ON THE


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REPLACEMENT GRANT DATE. So, the decision to participate must be each individual employee's personal decision, and it will depend largely on each employee's assumption ...