COVAD COMMUNICATIONS GROUP INC, 424B3, 2000-08-24

COVAD COMMUNICATIONS GROUP INC
424B3, 2000-08-24
TELEPHONE & TELEGRAPH APPARATUS

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FILED PURSUANT TO RULE 424(b)(3)
REGISTRATION NO. 333-38688

5,013,466 SHARES

[COVAD LOGO]

COMMON STOCK

($0.001 PAR VALUE)

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

This prospectus relates to the public offering of up to 5,013,466 shares of
our common stock, par value $0.001, which are held by some of our current
shareholders and may be offered and sold from time to time by the selling
shareholders. The prices at which such shareholders may sell the shares will be
determined by the prevailing market price for the shares or in negotiated
transactions. We will not receive any of the proceeds from the sale of the
shares, however, we are paying for the costs of registering the shares covered
by this prospectus.

The selling shareholders will receive all of the amounts received upon any
sale by them of the common stock, less any brokerage commissions or other
expenses incurred by them. While this offering is not being underwritten, the
selling shareholders and the brokers or other third parties through whom the
selling shareholders sell the common stock may be deemed "underwriters" as that
term is defined in the Securities Act of 1933, as amended, for purposes of the
resale of the shares of common stock offered in this prospectus.

Our common stock is traded on the Nasdaq National Market under the symbol
"COVD." On August 21, 2000, the last reported sale price for our common stock on
the Nasdaq National Market was $15.13 per share.

SEE "RISK FACTORS" BEGINNING ON PAGE 8 TO READ ABOUT CERTAIN RISKS THAT YOU
SHOULD CONSIDER BEFORE BUYING SHARES OF OUR COMMON STOCK.

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

NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY HAS
APPROVED OR DISAPPROVED THESE SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY
OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

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

You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. The selling shareholders are offering to sell, and
seeking offers to buy, shares of our common stock only in jurisdictions where
offers and sales are permitted. The information contained in this prospectus is
accurate only as of the date of this prospectus, regardless of the time of
delivery of this prospectus or of any sale of our common stock. In this
prospectus, "Covad," "we," "us," and "our" refer to Covad Communications Group,
Inc., its predecessors and its consolidated subsidiaries.

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

The date of this prospectus is August 23, 2000.
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PROSPECTUS SUMMARY

COVAD COMMUNICATIONS GROUP, INC.

OUR COMPANY

We are a leading provider of broadband communications services to Internet
service provider, enterprise, telecommunications carrier and other customers.
These services include a range of high-speed, high capacity Internet and network
access services using digital subscriber line ("DSL") technology, and related
value-added services. Internet service providers purchase our services in order
to provide high-speed Internet access to their business and consumer end-users.
Enterprise customers purchase our services directly or indirectly from us to
provide employees with high-speed remote access to the enterprise's local area
network ("RLAN access"), which improves employee productivity and reduces
network connection cost. Telecommunications carrier customers purchase our
services for resale to their Internet service provider affiliates, Internet
users and enterprise customers.

As of June 30, 2000, we believe we have the nation's largest DSL network
with 1,700 operational central offices passing over at least 42 million homes
and businesses. As of June 30, 2000, we had installed 138,000 DSL based
high-speed access lines and received orders for our services from more than 295
Internet service provider, enterprise, and telecommunications carrier customers,
including AT&T Corporation ("AT&T"), Concentric Network Corporation, Flashcom,
Inc., EarthLink, Inc., Oracle Corporation, Prodigy Communications Corporation,
PSINet, Inc., Qwest Communications International Inc., Stanford University, Sun
Microsystems, Inc., UUNET Technologies (an MCI WorldCom company) and Verio, Inc.

By June 30, 2000, we had deployed our network in a total of 81 metropolitan
statistical areas. When our 165 metropolitan statistical area build-out is
completed, which we expect to be by the end of 2000, our network will pass more
than 45% of homes and 50% of businesses in the United States.

We plan to continue to pursue rapid network expansion and installation of
high-speed access lines. We also plan to develop a variety of services that are
enhanced or enabled by our expanding network by entering into business
arrangements with broadband-related service providers in order to bring a
variety of value-added service offerings to our customers and their end-users.

OUR MARKET OPPORTUNITY

We believe that we have a substantial business opportunity for the
following reasons:

o There is a growing market demand for broadband communications
services.

o Broadband communications services are enabling new applications for
businesses and consumers.

o DSL is a cost-effective technology for broadband communications.

o The current regulatory environment facilitates the provision of
competitive broadband communications service offerings.

OUR COMPETITIVE STRENGTHS

WE OFFER AN ATTRACTIVE VALUE PROPOSITION COMPARED TO ALTERNATIVE
TECHNOLOGIES. For business Internet users, our high-end services offer bandwidth
comparable to that offered by T1 and frame relay circuits (which are up to 25
times the speed of most analog modems) at a substantially lower cost than
traditional T1 service. For the RLAN market, our mid-range services are three to
six times the speed of ISDN lines and up to ten times the speed of most analog
modems at monthly rates similar to or lower than those for heavily-used ISDN
lines. For consumer Internet users, our consumer services are comparably priced
to other services, such as cable modem services, but offer significant
advantages in security, network performance and speed.

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installations. We believe we have the nation's largest DSL network with more
than 1,700 operational central offices passing over more than 42 million homes
and businesses. As of June 30, 2000, we had installed a total of 138,000 lines
nationwide.

OUR SERVICES ARE WIDELY AVAILABLE, CONTINUOUSLY CONNECTED AND SECURE. Our
strategy of providing blanket coverage in each region we serve is designed to
ensure that our services are available to the vast majority of our customers'
end-users. Our networks provide a 24-hour continuous connection, unlike ISDN
lines and analog modems which require customers to dial-up each time for
Internet or RLAN access. Also, because we use dedicated connections from each
end-user to the Internet service provider or enterprise network, our customers
can reduce the risk of unauthorized access. These factors are important to our
customers because any Internet service they market to their end-users must
actually be available for them to purchase and be secure enough to not risk
their own reputation or business with any security lapses.

OUR MANAGEMENT TEAM HAS EXTENSIVE INDUSTRY EXPERIENCE. Our management team
includes individuals with extensive experience in the data communications,
telecommunications and personal computer industries, including Robert Knowling,
Jr., Chairman of the Board, President and Chief Executive Officer (former
Executive Vice President of Operations and Technology at U S WEST
Communications, Inc.), Catherine Hemmer, Executive Vice President and Chief
Operations Officer (former Vice President, Network Reliability and Operations at
U S WEST Communications, Inc., former General Manager, Network Provisioning at
Ameritech Corporation and former Vice President, Network Services at MFS
Communications Company, Inc.), Mark Perry, Executive Vice President and Chief
Financial Officer (former Vice President and Corporate Officer, Finance &
Administration of U S WEST Communications), Robert Davenport, III, Executive
Vice President, Business Development (former Senior Vice President and Chief
Operating Officer of Tele-Communication, Inc.'s Internet Services subsidiary
TCI.NET), Joseph Devich, Executive Vice President, Corporate Services (former
Vice President, Operations and Technologies Staff of U S WEST Communications,
Inc.), Dhruv Khanna, Executive Vice President, General Counsel and Secretary,
Jane Marvin, Executive Vice President of Human Resources (former Vice President
of Human Resources for the General Business Services unit of Ameritech
Corporation), Terry Moya, Executive Vice President, External Affairs (former
Vice President and Chief Financial Officer, Capital Management, Network
Operations and Technologies at U S WEST Communications, Inc), Michael Lach,
Executive Vice President, Corporate Development and Business Integration (former
Vice President, Customer Provisioning and Maintenance of Ameritech Corporation),
John McDevitt, Executive Vice President, Sales and Marketing (former Vice
President of Sales and Marketing at Danly IEM and former Business Director at
Praxair, Inc); Jimmy LaValley, Executive Vice President, Community Relations
(former Vice President, Human Resources at U S WEST); and Rich Wong, Executive
Vice President, Broadband Services (former Associate and Engagement Manager with
McKinsey & Company).

OUR BUSINESS STRATEGY

Our objective is to become the leading nationwide provider of broadband
services and a critical element in the proliferation of e-commerce and other
applications that are enabled or enhanced by broadband communications. The key
elements of our strategy to achieve this objective are as follows:

EXPAND OUR NETWORK AND ROLL OUT SERVICE RAPIDLY IN OUR TARGETED
METROPOLITAN STATISTICAL AREAS. As of June 30, 2000, we introduced our services
in 81 of the top metropolitan statistical areas nationwide. We have announced
our plan to expand our services to a total of 165 metropolitan statistical areas
by the end of 2000. In the aggregate, these 165 metropolitan statistical areas
cover more than 45% of homes and 50% of businesses in the United States. In
addition, we have recently begun to assess the regulatory and competitive
environments in other countries.

PROVIDE PERVASIVE COVERAGE IN EACH METROPOLITAN STATISTICAL AREA. We are
pursuing a blanket coverage strategy of providing service in a substantial
majority of the central offices in each region that we enter since our Internet
service provider customers desire to market their Internet access services on a
region-wide basis. Blanket coverage is also important to our enterprise
customers since most of them desire to offer RLAN access to all employees
regardless of where they reside. In addition, we believe our presence in 165
metropolitan statistical areas will allow us to better serve our Internet
service provider, enterprise, telecommunications carrier and other customers.
These customers are increasingly seeking a single supplier in multiple
metropolitan areas.

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telecommunications carriers and other DSL resellers that can offer their
end-users cost and performance advantages for Internet access using our
services. We primarily provide connections to Internet service providers, which
in turn offer high-speed Internet access using our network. In other cases, we
provide wholesale DSL and Internet access services for resale by our customers
such as Prodigy Communications Corporation and Juno Online Services. In this
way, we:

o carry the traffic of multiple Internet service providers,
telecommunications carriers and other customers in any region,
increasing our volume and reducing our costs;

o leverage our selling efforts through the sales and support staff of
these Internet service providers, telecommunications carriers and
other customers;

o offer Internet service providers, telecommunications carriers and
other customers an alternative, since the traditional telephone
company typically provides its own retail Internet access services in
competition with our customers; and

o provide Internet service providers, telecommunications carriers and
other customers a high-speed service offering to compete with
cable-based Internet access.

DEVELOP A NATIONAL BRAND. We believe that we can enhance our competitive
position and increase demand for our services by actively developing a positive
brand and image for our Company and our services through a combination of
television, print and radio advertisements on both a national and local basis.
In October 1999, we commenced a significant national advertising campaign in
pursuit of this strategy. This branding strategy has created the opportunity for
us to provide end-user leads to our existing customers.

DEVELOP AND COMMERCIALIZE VALUE-ADDED SERVICES. We intend to introduce
value-added services to our customers and leverage the value of the network
access we offer today. Offering services such as voice over DSL, DSL plus
Internet Protocol (DSL + IP), and our Virtual Broadband Service Provider (VBSP)
offering will allow us to bundle service offerings to our customers and improve
the quality of content delivery to their end-users as well as reduce costs. We
believe this is an important part of our strategy and will allow us to build
upon our success to date in adding and retaining subscribers.

ACQUIRE AND ENTER INTO BUSINESS ARRANGEMENTS WITH NETWORK AND
BROADBAND-RELATED SERVICE PROVIDERS. We believe that the pace of deployment of
our network can be increased by acquiring and entering into business
arrangements with other network service providers, some of which may be located
outside of the United States. We also believe our network deployment will enable
the delivery of a variety of broadband-related services and content that are
desired by our customers. We expect to make these services available to our
customers through acquiring and entering into business arrangements with leading
providers of broadband-related services or content. For example, we recently
acquired Laser Link.Net, Inc. This acquisition will allow us to better provide
DSL and IP services on a wholesale basis and better enable us to serve customers
who do not wish to maintain any network facilities. Our agreement to acquire
BlueStar Communications Group will expand our selling capabilities in smaller
cities and rural areas, increase our distribution methods, and will enhance our
ability to deliver enhanced broadband solutions to small businesses.

TAKE ADVANTAGE OF NEW REGULATORY DEVELOPMENTS. In late 1999, the FCC
required the major local phone companies to provide us, and other competitive
local carriers, with "line sharing." This allows us to provide our services over
the same telephone wire used by the traditional telephone companies to provide
analog voice services. In addition, some of the Ameritech/SBC merger conditions
adopted by the FCC in October 1999 also contain provisions on line sharing and
provide for reductions in costs for telephone wires in certain circumstances. In
many cases, line sharing would allow us to provision our asymmetric DSL services
on the same telephone wire as the existing local phone companies' voice service.
Currently, we provide almost all of our DSL services over a separate additional
telephone wire. Asymmetric DSL and standard telephone service can exist on a
single line and most, if not all, of the traditional telephone companies
provision their own asymmetric services on the same line as existing voice
services.

We see line sharing as an extremely important opportunity for us for three
primary reasons. First, line sharing should significantly reduce the monthly
recurring charges we incur for telephone wires. Second, line sharing should
reduce the time it takes traditional telephone companies to deliver telephone
wires because the telephone wire will already exist. Third, line sharing should
resolve lack of telephone wire problems that we have encountered when ordering
telephone wires in some areas of the country. We have entered into interim line
sharing agreements with

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US West Communications, Inc., BellSouth Corporation and Bell Atlantic
Corporation. We have also entered into interim line sharing agreements with SBC
in California and we are negotiating agreements for the remaining states in
SBC's territory. We have entered into a line sharing agreement with GTE for all
of its major markets other than Texas. We recently received a decision from the
Texas Public Utilities Commission implementing line sharing in Texas. We have
started implementing line sharing in several states. We expect the traditional
local phone companies to implement line sharing on a wide scale later this year.

RECENT DEVELOPMENTS

On May 16, 2000, we announced that the American Arbitration Association
issued its Intended Award of Damages to us in our arbitration hearings against
Pacific Bell for violations of the Telecommunications Act of 1996. The
arbitrators awarded us $27.2 million plus attorneys' fees and costs which is in
addition to the panel's January 1999 interim decision to award us $257,166 in
damages and $474,995 in attorneys' fees and costs. In November 1998, the
arbitrators determined that Pacific Bell had violated the 1996
Telecommunications Act as well as its contract with us by failing to timely
deliver collocation space and operable loops.

On June 16, 2000, we announced the signing of a definitive agreement to
acquire BlueStar Communications Group Inc., a provider of broadband and Internet
services for small and medium-sized businesses throughout the Southeastern
United States. Under the acquisition agreement, we will issue up to 8 million
shares of our common stock and stock options for all of BlueStar's outstanding
common and preferred shares, stock options and warrants, plus assumption of all
outstanding BlueStar debt. Up to five million additional shares of our common
stock may be issued to the BlueStar shareholders if certain performance targets
are met by BlueStar over the 2001 fiscal year. We anticipate that this
acquisition will accelerate the national expansion of our network. We anticipate
that our acquisition of BlueStar will provide the following benefits:

o Speed to market in implementing our direct sales strategy in Tier 3
markets.

o A large, experienced direct sales force.

o BlueStar's customer base.

o Increased ability to provide enhanced broadband solutions to small
businesses.

In connection with the merger, Bear Stearns Corporate Lending, Inc.
provided BlueStar with a $40 million financing comitment to fund BlueStar's
continuing operations until the effective time of the merger. If the merger is
not completed, Covad Communications has agreed to purchase the loans made
pursuant to this financing comittment from Bear Stearns in exchange for shares
of Covad common stock. Bear Stearns also has the right to put the loan to Covad
in exchange for Covad common stock in certain other circumstances.

In addition, our acquisition of BlueStar will provide us with 135 new
central offices that were built out by BlueStar and had not been built out by
us. We believe that we acquired these new central offices at a cost savings in
comparison with what it would have cost us to build, operate and support those
central offices and the underlying business associated with the markets they
serve.

In connection with our announcement of the BlueStar acquisition, we
announced a reduction in the number of end-user lines that we expected to be in
service on June 30, 2000. At the same time, we reduced line growth expectations
for 2000 to 330%, primarily because of the channel conflict with our customers
that may result from our acquisition of BlueStar, which sells directly to
end-users.

On July 18, 2000, the United States Court of Appeals for the Eighth Circuit
struck down the FCC's total element long run incremental cost methodology, which
the FCC previously required state commissions to use in setting the prices for
collocation and for unbundled network elements we purchase from the traditional
telephone companies. The Court also rejected an alternative cost methodology
based on "historical costs," which was advocated by the traditional telephone
companies. In rejecting the FCC's cost methodology, the court held that it is
permissible for the FCC to prescribe a forward-looking incremental cost
methodology that is based on actual incremental costs under the 1996
Telecommunications Act. The Eighth Circuit's decision creates some additional
uncertainty concerning the prices that we are obligated to pay the traditional
telephone companies for collocation and unbundled network elements. While the
FCC may appeal the Eighth Circuit's decision, it may also adopt new rules to
reflect the cost methodology that was approved by the Eighth Circuit. If the
decision is appealed, it is uncertain whether the Eighth Circuit's decision will
be affirmed by the United States Supreme Court. It is also
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uncertain whether the FCC and the state commissions will implement a new cost
methodology as a result of this decision.

On August 2, 2000, we announced the appointment of Mark H. Perry as
executive vice president and chief financial officer. Mr. Perry succeeds the
current vice president and chief financial officer, Timothy Laehy, who is
retiring.

On August 10, 2000, we signed an agreement with NTT Communications Corp.,
ACCA Networks and a Japan-based venture capital firm to provide local broadband
network services using digital subscriber lines to major metropolitan areas in
Japan. We will invest approximately $11.5 million in ACCA in exchange for a 41.8
percent interest in ACCA, which will be accounted for as an equity investment on
our balance sheet. The agreement requires no additional financial commitments,
and no additional expenses to be incurred. We will also hold two seats on ACCA's
Board of Directors.

We are currently aware of a Staff Accounting Bulletin entitled SAB 101
"Revenue Recognition in Financial Statements" ("SAB 101"), which was issued in
December 1999 by the Securities and Exchange Commission. SAB 101 provides that,
in certain circumstances, revenues which are received in the first month of a
contract might have to be recognized over an extended period of time, instead of
in the first month of the contract. Due to the complex nature of the widespread
implementation of SAB 101, the SEC has deferred the implementation date of SAB
101 until the quarter ended December 31, 2000 with retroactive application to
the beginning of our fiscal year. The SEC intends to issue further definitive
guidance on the implementation of SAB 101. When and if that guidance is
received, we will fully evaluate this guidance and respond and comply
accordingly. If SAB 101 is implemented and its implementation is contrary to our
current practice, it may have an adverse effect on our financial statements.

THE OFFERING

The shares to be offered for resale in this offering are shares of our
common stock issued to the former shareholders of Laser Link.Net, which we
acquired in March 2000.

<TABLE>

<S> <C>
Securities offered by the selling
shareholders.............................................. 5,013,466 shares of common stock

Common stock outstanding as of
August 1, 2000............................................ 154,770,567 shares(1)

Use of Proceeds........................................... We will not receive any proceeds from the sale of
the common stock by the selling shareholders.
SEE "Use of Proceeds."
Risk Factors.............................................. The shares of common stock offered under this
prospectus involve a high degree of risk. SEE
"Risk Factors."
Nasdaq National Market Symbol............................. COVD
</TABLE>

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(1) This number excludes approximately 33,436,151 shares reserved for issuance
in connection with the Company's stock-based compensation plans or for
conversion and exchange of the Company's convertible and exchangeable
securities.

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The address of our principal executive office is 4250 Burton Drive, Santa
Clara, California 95054, and our telephone number is (408) 987-1000.

"Covad(TM)," "TeleSpeed(R)," "TeleSurfer(SM)," "The Speed to Work(SM),"
"The Internet As It Should Be(SM)" and the Covad logos, names and marks are some
of our trademarks and servicemarks. This prospectus contains other product
names, trade names and trademarks of ours and of other organizations.

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SUMMARY CONSOLIDATED FINANCIAL DATA

YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
-------------------------------------- ----------------------------
1997 1998 1999 1999 2000 (2)
---------- ------------ ------------- ------------ --------------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues.................................. $ 26 $ 5,326 $ 66,488 $ 16,429 $ 99,967
Operating expenses:
Network and product costs.............. 54 4,562 55,347 15,525 74,963
Sales, marketing, general and
administrative....................... 2,374 31,043 140,372 43,089 187,907
Depreciation and amortization.......... 70 3,406 37,602 13,318 41,717
Amortization of goodwill and other
intangible assets.................... -- -- -- -- 23,453
Amortization of deferred compensation.. 295 3,997 4,768 2,887 1,911
Write-off of in-process technology..... -- -- -- -- 3,726
---------- ------------ ------------- ------------ --------------
Total operating expenses............. 2,793 43,008 238,089 74,819 333,677
---------- ------------ ------------- ------------ --------------
Loss from operations...................... (2,767) (37,682) (171,601) (58,390) (233,710)
Net interest expense................... 155 (10,439) (23,796) (12,366) (19,780)
Other income........................... -- -- -- -- 14,787
---------- ------------ ------------- ------------ --------------
Net loss.................................. (2,612) (48,121) (195,397) (70,756) (238,703)
Preferred dividends....................... -- -- (1,146) (1,146) --
---------- ------------ ------------- ------------ --------------
Net loss attributable to common
stockholders........................... $ (2,612) $ (48,121) $ (196,543) $ (71,902) $ (238,703)
========== ============ ============= ============ ==============
Net loss per share--basic and diluted...... $ (.35) $ (3.75) $ (1.83) $ (0.79) $ (1.59)
========== ============ ============= ============ ==============
Weighted average shares used in computing
net loss per share--basic and diluted... 7,360,978 12,844,203 107,647,812 91,396,284 150,060,418
========== ============ ============= ============ ==============

OTHER FINANCIAL DATA:
EBITDA(1)................................. $ (2,402) $ (30,154) $ (129,486) (42,185) (162,903)
Capital expenditures...................... $ 2,253 $ 59,503 $ 208,186 93,748 262,914
Net cash used in operating activities..... (1,895) (9,054) (102,767) (27,721) (105,643)
Net cash used in investing activities..... (2,494) (61,252) (736,096) (194,446) (115,205)
Net cash provided by financing activities. 8,767 130,378 990,451 415,188 427,630
</TABLE>

AS OF DECEMBER 31,
----------------------------------- AS OF JUNE 30,
1997 1998 1999 2000
-------- ----------- ----------- ------------------
(UNAUDITED)
<S> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents and short-term investments.... $ 4,378 $ 64,450 $ 767,357 $ 763,154
Net property and equipment.............................. 3,014 59,145 237,542 466,137
Total assets............................................ 8,074 139,419 1,147,606 1,783,880
Long-term obligations, including current portion........ 783 142,879 375,049 828,910
Total stockholders' equity (net capital deficiency)..... 6,498 (24,706) 690,291 794,319
</TABLE>

AS OF DECEMBER 31,
----------------------------------- AS OF JUNE 30,
1997 1998 1999 2000
-------- ----------- ----------- ------------------
<S> <C> <C> <C> <C>
OTHER OPERATING DATA:
Homes and businesses passed............................ 278,000 6,023,217 29,000,000 42,000,000
Lines installed........................................ 26 3,922 57,000 138,000
</TABLE>
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(1) EBITDA consists of net loss excluding net interest, taxes,
depreciation and amortization, non-cash stock-based compensation
expense and other non-operating income or expenses. We have provided
EBITDA because it is a measure of financial performance commonly used
in the telecommunications industry as well as to enhance an
understanding of our operating results. EBITDA should not be construed
as either:

o an alternative to operating income (as determined in accordance
with generally accepted accounting principles) as an indicator of
our operating performance, or

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o an alternative to cash flows from operating activities (as
determined in accordance with generally accepted accounting
principles) as a measure of liquidity.

EBITDA as calculated by us may be calculated differently than EBITDA
for other companies. See our consolidated financial statements and the
related notes thereto contained elsewhere in this prospectus.

(2) In March 2000, we acquired Laser Link.Net, Inc. in a transaction
accounted for as a purchase. Accordingly, the summary consolidated
statement of operations data for the six months ended June 30, 2000
include the results of operations of Laser Link.Net, Inc. from the
date of acquisition through June 30, 2000. The summary consolidated
financial data for the six months ended June 30, 2000 are not
necessarily indicative of the results that may be expected for the
entire fiscal year or future periods.

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RISK FACTORS

AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. IN
ADDITION TO REVIEWING OTHER INFORMATION IN THIS PROSPECTUS, YOU SHOULD CAREFULLY
CONSIDER THE FOLLOWING FACTORS BEFORE DECIDING TO PURCHASE SHARES OF OUR COMMON
STOCK. THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS
AND UNCERTAINTIES. WE USE WORDS SUCH AS "ANTICIPATES," "BELIEVES," "PLANS,"
"EXPECTS," "FUTURE," "INTENDS" AND SIMILAR EXPRESSIONS TO IDENTIFY
FORWARD-LOOKING STATEMENTS. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN
FACTORS, INCLUDING THE RISKS DESCRIBED BELOW AND ELSEWHERE IN THIS PROSPECTUS.
WE DISCLAIM ANY OBLIGATION TO UPDATE INFORMATION CONTAINED IN ANY
FORWARD-LOOKING STATEMENT.

REJECTIONS OF OUR APPLICATIONS FOR CENTRAL OFFICE AND REMOTE TERMINAL SPACE BY
TRADITIONAL TELEPHONE COMPANIES ARE LIKELY TO DELAY THE EXPANSION OF OUR NETWORK
AND THE ROLL OUT OF OUR SERVICES

We must secure physical space from traditional telephone companies for our
equipment in their central offices in order to provide our services in our
targeted metropolitan statistical areas. In the past, we have experienced
rejections of our applications to secure this space in many central offices, and
we continue to receive rejections in some central offices. In addition, to
provide a full range of DSL services, we must access remote terminals, which are
used by traditional telephone companies to serve end-users through a combination
of fiber optic technology and copper wires. Traditional telephone companies are
increasing their deployment of fiber-fed remote terminal architectures (for
example, SBC and "Project Pronto"). For Covad to provide copper based DSL
services to these end users, Covad needs to access the copper telephone wires
that terminate at these remote terminals.

We expect that, as we proceed with our deployment, we will face additional
rejections of our applications for central office space in our other targeted
metropolitan statistical areas. These rejections have in the past resulted, and
could in the future result, in delays and increased expenses in the rollout of
our services in our targeted metropolitan statistical areas, including delays
and expenses associated with engaging in legal proceedings with the traditional
telephone companies. This has harmed our business and is likely to continue to
harm our business in the future periods.

We face other challenges in dealing with the traditional telephone
companies:

o there may be real limitations on the availability of central office
space in certain central offices and remote terminals;

o they frequently claim lack of available facilities when asked by us to
provide connections between central offices, remote terminals, and
telephone wires to end-users;

o they frequently fail to promise delivery of, and actually deliver,
properly connected telephone wires to our end-users on time;

o they frequently do not cooperate in providing us with relevant
telephone wire information such as the length of the wire;

o they frequently do not deploy and provide us with integrated software
systems that allow us to seamlessly place large volumes of orders for
telephone lines;

o they frequently do not cooperate in maintaining and resolving problems
relating to delivery of telephone lines; and

o they frequently do not cooperate in providing relevant information
about the presence and types of remote terminals that may be serving
end users.

We are engaged in a variety of negotiations, regulatory disputes and legal
actions to resolve these situations. We may be unable to resolve these matters
successfully.

The Federal Communications Commission ("FCC") has been reviewing the
policies and practices of the traditional telephone companies with the goal of
facilitating the efforts of competitive telecommunications companies to obtain
central office space and telephone wires more easily and on more favorable
terms. On March 31, 1999, the FCC adopted rules to make it easier and less
expensive for competitive telecommunications companies to obtain central office
space and to require traditional telephone companies to make new alternative

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arrangements for obtaining central office space. However, the FCC's new rules
have not been uniformly implemented in a timely manner, may not ultimately
enhance our ability to obtain central office space, and have been subject to
litigation.

Moreover, in March 2000, a federal appeals court struck portions of the
FCC's new rules, and has required the FCC to reconsider and review those rules.
In particular, the appeals court has required the FCC to revise its rules
concerning the types of equipment that we may collocate on the traditional
telephone company premises and the steps that traditional telephone companies
may take to separate their equipment from our equipment. The traditional
telephone companies may implement the court's ruling and any subsequent FCC
rules in a manner that impairs our ability to obtain collocation space and
collocate the equipment of our choice on their premises. Such actions by the
traditional telephone companies could adversely affect our business and disrupt
our existing network design, configuration and services.

On November 5, 1999, the FCC adopted rules that require traditional
telephone companies to provide access to remote terminal locations and to
require them to provide access to copper wires that terminate at these
terminals. These rules went into effect in May 2000. These rules are currently
being appealed. In addition, SBC is seeking a waiver from the FCC of one of the
merger conditions it agreed to in its merger with Ameritech; this waiver would
facilitate SBC deploying a remote terminal architecture (called "Project
Pronto"). Covad has been very active in these and other regulatory proceedings
in order to ensure that it receives the full nondiscriminatory access to these
remote terminals and copper wires.

CHARGES FOR UNBUNDLED NETWORK ELEMENTS ARE OUTSIDE OF OUR CONTROL BECAUSE THEY
ARE PROPOSED BY THE TRADITIONAL TELEPHONE COMPANIES AND ARE SUBJECT TO COSTLY
REGULATORY APPROVAL PROCESSES

Traditional telephone companies provide the unbundled DSL-capable lines or
telephone wires that connect each end-user to our equipment located in the
central offices. The 1996 Telecommunications Act generally requires that charges
for these unbundled network elements be cost-based and nondiscriminatory. The
nonrecurring and recurring monthly charges for DSL-capable lines (telephone
wires) that we require vary greatly. These rates are subject to the approval of
the state regulatory commissions. The rate approval processes for DSL-capable
lines and other unbundled network elements typically involve a lengthy review of
the rates proposed by the traditional telephone companies in each state. The
ultimate rates approved typically depend on the traditional telephone company's
initial rate proposals and the policies of the state public utility commission.
These rate approval proceedings are time-consuming and expensive. Consequently,
we are subject to the risk that the non-recurring and recurring charges for
DSL-capable lines and other unbundled network elements will increase based on
rates proposed by the traditional telephone companies and approved by state
regulatory commissions from time to time, which would harm our operating
results.

The Eighth Circuit's decision creates some additional uncertainty
concerning the prices that we are obligated to pay the traditional telephone
companies for collocation and unbundled network elements. While the FCC may
appeal the Eighth Circuit's decision, it may also adopt new rules to reflect the
cost methodology that was approved by the Eighth Circuit. If the decision is
appealed, it is uncertain whether the Eighth Circuit's decision will be affirmed
by the United States Supreme Court. It is also uncertain whether the FCC and the
state commissions will implement a new cost methodology as a result of this
decision.

The impact of these judicial and regulatory decisions on the prices we pay
to the traditional telephone companies for collocation and unbundled network
elements is highly uncertain. There is a risk that any new prices set by the
regulators could be materially higher than current or currently expected prices.
If we are required to pay higher prices to the local telephone companies for
collocation and unbundled network elements, it could have a material adverse
effect on our business.

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THE FAILURE OF TRADITIONAL TELEPHONE COMPANIES TO ADEQUATELY PROVIDE
TRANSMISSION FACILITIES AND PROVISION TELEPHONE WIRES IS LIKELY TO IMPAIR OUR
ABILITY TO INSTALL LINES AND ADVERSELY AFFECT OUR GROWTH RATE

We interconnect with and use traditional telephone companies' networks to
service our customers. This presents a number of challenges because we depend on
traditional telephone companies:

o to use their technology and capabilities to meet certain
telecommunications needs of our customers and to maintain our service
standards;

o to cooperate with us for the provision and maintenance of transmission
facilities; and

o to provide the services and network components that we order, for
which they depend significantly on unionized labor. Labor issues have
in the past, and may in the future, hurt the telephone companies'
performance. For example, on August 6, 2000, employees of Verizon
Communications began a work stoppage that will impair its ability to
provision, maintain and repair the telephone lines that we use to
deliver our services.

Our dependence on the traditional telephone companies has caused and could
continue to cause us to encounter delays in establishing our network and
providing higher speed DSL services. We rely on the traditional telephone
companies to provision telephone wires to our customers and end-users. We must
establish efficient procedures for ordering, provisioning, maintaining and
repairing large volumes of DSL capable lines from the traditional telephone
companies. We must also establish satisfactory electronic billing and payment
arrangements with the traditional telephone companies. We may not be able to do
these things in a manner that will allow us to retain and grow our customer and
end-user base.

It has been and continues to be our experience that, at any given time, one
or more of the traditional telephone companies will fail to deliver the central
office space, transmission facilities, telephone wires or other elements,
features and functions that our business requires. For example, the traditional
telephone companies currently are significantly impairing our ability to
efficiently install our services, and this has adversely affected the growth in
the volume of orders we receive. The failure of the traditional telephone
companies to consistently and adequately deliver operable telephone wires to us
on time has significantly contributed to an increase in the backlog of
uninstalled orders. The continued inadequate performance of the traditional
telephone companies could slow the growth in our revenues and reduce the growth
in orders placed by our customers, which could materially harm our business.

On November 18, 1999, the FCC decided that the traditional local telephone
companies must provide us and other competitive local exchange carriers with
access to line sharing. This allows us to provide our services over the same
telephone wire used by the traditional telephone companies to provide analog
voice services. The FCC has directed the traditional local telephone companies
to enter into agreements with competitors, such as ourselves, and take the
necessary steps to provide such access by mid-2000. However, it is unclear
whether the traditional telephone companies will provide us with such access in
a meaningful way this year.

Although we have entered into interim line sharing agreements with the
major local telephone carriers the permanent rates, terms and conditions of line
sharing access have not yet been mutually agreed to between the traditional
local phone companies and us. Many state commissions have not yet arbitrated
disputes or set line sharing rates in connection with failed negotiations
between traditional local phone companies and us. The efforts of traditional
local telephone companies to provide us with line sharing may inadvertently or
purposefully cause disruption and dislocation to our existing processes for
obtaining full telephone lines and our ability to provide our services.

WE DEPEND ON THE TRADITIONAL TELEPHONE COMPANIES FOR THE QUALITY AND
AVAILABILITY OF THE TELEPHONE WIRES THAT WE USE

We depend significantly on the quality and availability of the traditional
telephone companies' telephone wires, shared lines and the traditional telephone
companies' maintenance of such wires. We may not be able to obtain the telephone
wires and the services we require from the traditional telephone companies at
satisfactory quality levels, rates, terms and conditions. Our inability to do so
could delay the expansion of our network and degrade the quality of our services
to our customers.

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OUR BUSINESS WILL SUFFER IF OUR INTERCONNECTION AGREEMENTS ARE NOT RENEWED OR IF
THEY ARE MODIFIED ON UNFAVORABLE TERMS

We are required to enter into and implement interconnection agreements in
each of our targeted metropolitan statistical areas with the appropriate
traditional telephone companies in order to provide service in those regions. We
have not yet entered into all of the interconnection agreements we require to
complete our 165 metropolitan statistical area build-out. We may be unable to
timely enter into these agreements, which is prerequisite for us to provide
service in those areas. Many of our existing interconnection agreements have a
maximum term of three years. Therefore, we will have to renegotiate these
agreements with the traditional telephone companies when they expire. We may not
succeed in extending or renegotiating them on favorable terms or at all.

As the FCC modifies, changes and implements rules related to unbinding and
collocation, Covad generally has to renegotiate its interconnection agreements
with the traditional telephone companies in order to implement those new or
modified rules. We may be unable to timely renegotiate these agreements, or we
may be forced to arbitrate and litigate with the traditional telephone company
agreement terms that fully comply with FCC rules. As a result, although the FCC
may implement rules or policies designed to speed or improve Covad's ability to
provide its services, Covad may not be able to timely implement those rules or
policies.

Additionally, disputes have arisen and will continue to arise in the future
as a result of differences in interpretations of the interconnection agreements.
For example, we are in litigation proceedings with certain of the traditional
telephone companies. These disputes have delayed the deployment of our network,
and resolution of the litigated matters will cause us ongoing expenditure of
money and management time. They may have also negatively affected our service to
our customers and our ability to enter into additional interconnection
agreements with the traditional telephone companies in other states. In
addition, the interconnection agreements are subject to state commission, FCC
and judicial oversight. These government authorities may modify the terms of the
interconnection agreements in a way that harms our business.

OUR BUSINESS IS DIFFICULT TO EVALUATE BECAUSE WE HAVE A LIMITED OPERATING
HISTORY

We were incorporated in October 1996 and introduced our services
commercially in the San Francisco Bay Area in December 1997. Because of our
limited operating history, you have limited operating and financial data upon
which to evaluate our business. You should consider that we have the risks of an
early stage company in a new and rapidly evolving market. To overcome these
risks, we must:

o rapidly expand the geographic coverage of our services;

o attract and retain customers within our existing and in new
metropolitan statistical areas;

o increase awareness of our services;

o respond to competitive developments;

o continue to attract, retain and motivate qualified persons;

o continue to upgrade our technologies in response to competition and
market factors;

o manage our traditional telephone company suppliers;

o rapidly install high-speed access lines;

o effectively manage the growth of our operations; and

o deliver additional value-added services to our customers without
causing existing customers to cease reselling our services or reducing
the volume or rate of growth of sales of our services.

WE HAVE A HISTORY OF LOSSES AND EXPECT INCREASING LOSSES IN THE FUTURE

We have incurred substantial losses and experienced negative cash flow each
fiscal quarter since our inception. As of June 30, 2000, we had an accumulated
deficit of approximately $484.8 million. We intend to increase our capital
expenditures and operating expenses in order to expand our business. As a
result, we expect to incur substantial additional net losses and substantial
negative cash flow for the next several years due to continued development,
commercial deployment and expansion of our network. We may also make investments
in and
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acquisitions of businesses that are complementary to ours to support the growth
of our business. Our future cash requirements for developing, deploying and
enhancing our network and operating our business, as well as our revenues, will
depend on a number of factors including:

o the number of regions entered, the timing of entry and services
offered;

o network development schedules and associated costs;

o the rate at which customers and end-users purchase our services and
the pricing of such services;

o the level of marketing required to acquired and retain customers and
to attain a competitive position in the market place;

o the rate at which we invest in engineering and development and
intellectual property with respect to existing and future technology;
and

o unanticipated opportunities.

In addition, we expect our net losses to increase in the future due to
interest and amortization charges related to our 13 1/2% senior discount notes
(the "1998 notes") due 2008, our 12 1/2% senior notes (the "1999 notes") due
2009, our 12% senior notes due 2010 (the "2000 notes") and the amortization
charges related to our issuance of preferred stock to AT&T Ventures and two
affiliated funds ("AT&T Ventures"), NEXTLINK Communications, Inc. ("NEXTLINK")
and Qwest Communications International Inc. ("Qwest") in January 1999. For
example:

o Interest and amortization charges relating to the 1998 notes were
approximately $22.3 million during the year ending December 31, 1999.
These charges will increase each year until the year ending December
31, 2004, during which period the interest and amortization charges
will be approximately $36.9 million. This increase is due to the
accretion of the 1998 notes to $260 million through March 2003.

o Interest and amortization charges relating to the 1999 notes were
approximately $24.8 million during the year ending December 31, 1999
and will increase slightly each year to approximately $29.3 million
during the year ending December 31, 2008.

o Interest and amortization charges relating to the 2000 notes will be
approximately $48.2 million during the year ending December 31, 2000
and will be $52.2 million each following year through the maturity of
the notes in February 2010.

o We recorded intangible assets of $28.7 million associated with the
issuance of our preferred stock to AT&T Ventures, NEXTLINK and Qwest.
Amortization charges relating to our preferred stock issuance were
approximately $8.2 million during the year ending December 31, 1999.
These amounts will result in an annual amortization charge of
approximately $8.4 million in each of the years in the two-year period
ending December 31, 2001.

OUR BUSINESS WILL SUFFER IF OUR INTERNET SERVICE PROVIDERS, TELECOMMUNICATIONS
CARRIERS AND OTHER THIRD PARTIES ARE NOT SUCCESSFUL IN MARKETING AND SELLING OUR
SERVICES

We primarily market our Internet access services through Internet service
providers, telecommunications carriers and other customers for resale to their
business and consumer end-users. To date, a limited number of Internet service
providers have accounted for the significant majority of our revenues. As a
result, a significant reduction in the number of end-users or revenues provided
by one or more of our key Internet service providers could materially harm our
operating results in any given period. We expect that our Internet service
provider customers and telecommunications carriers will account for the majority
of our future market penetration and revenue growth. Our agreements with our
customers are generally non-exclusive. Many of our customers also resell
services offered by our competitors. In addition, a number of our customers have
committed to provide large numbers of end-users in exchange for price discounts.
If our customers do not meet their volume commitments or otherwise do not sell
our services to as many end-users as we expect, our business will suffer. In
addition, these and future relationships we may establish with other third
parties may not result in significant line orders or revenues.

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OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE IN FUTURE PERIODS AND, MAY FAIL TO
MEET THE EXPECTATIONS OF SECURITIES ANALYSTS AND INVESTORS

Our annual and quarterly operating results are likely to fluctuate
significantly in the future as a result of numerous factors, many of which are
outside of our control. These factors include:

o the timing and willingness of traditional telephone companies to
provide us with central office space and the prices, terms and
conditions on which they make available the space to us;

o the amount and timing of capital expenditures and other costs relating
to the expansion of our network and the marketing of our services;

o delays in the commencement of operations in new regions and the
generation of revenue because certain network elements have lead times
that are controlled by traditional telephone companies and other third
parties;

o the ability to develop and commercialize new services by us or our
competitors;

o the ability to order or deploy our services on a timely basis to
adequately satisfy end-user demand;

o our ability to successfully operate our network;

o the rate at which customers subscribe to our services;

o decreases in the prices for our services due to competition,
volume-based pricing and other factors;

o our ability to retain Internet service provider, enterprise and
telecommunications carrier customers and limit end-user churn rates;

o the mix of line orders between consumer end-users and business
end-users (which typically have higher margins);

o the success of our relationship with AT&T and other potential third
parties in generating significant end-user demand;

o the development and operation of our billing and collection systems
and other operational systems and processes;

o the rendering of accurate and verifiable bills by our traditional
telephone company suppliers and resolution of billing disputes;

o the incorporation of enhancements, upgrades and new software and
hardware products into our network and operational processes that may
cause unanticipated disruptions;

o the interpretation and enforcement of regulatory developments and
court rulings concerning the 1996 Telecommunications Act,
interconnection agreements and the anti-trust laws; and

o the availability of equipment and services from key vendors.

As a result, it is likely that in some future quarters our operating
results will be below the expectations of securities analysts and investors. If
this happens, the trading price of our common stock would likely decline.

WE CANNOT PREDICT WHETHER WE WILL BE SUCCESSFUL BECAUSE OUR BUSINESS STRATEGY IS
LARGELY UNPROVEN

We believe that we were the first competitive telecommunications company to
widely provide high-speed Internet and network access using DSL technology. To
date, our business strategy remains significantly unproven. To be successful, we
must develop and market services that achieve broad commercial acceptance by
Internet service provider, enterprise and telecommunications carrier customers
in our targeted metropolitan statistical areas. Because our business and the
demand for high-speed digital communications services are in the early stages of
development, we are uncertain whether our services will achieve broad commercial
acceptance.

It is uncertain whether our strategy of selling and providing our service
through Internet service providers, telecommunication carriers and others will
be successful. This strategy creates marketing, operational and other

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challenges and complexities that are less likely to appear in the case of a
single entity providing integrated DSL and ISP services. For example, cable
modem service providers, such as Excite@Home Corporation and Time Warner, Inc.,
market, sell and provide high-speed services, Internet access and content
services on an integrated basis. Also, our new DSL + IP and VBSP services may
adversely affect our relationship with our current ISP customers, since we will
be providing some of the services that they provide. We do not anticipate that
this will have a substantial adverse effect on our relationship with our ISP
customers because we will be able to provide our ISP customers with these
additional services at a lower cost then they would pay if they developed these
additional services internally.

Three recently-announced mergers and acquisitions--between America Online,
Inc. and Time Warner, Inc., between NTT and Verio, and between NEXTLINK and
Concentric Network Corporation--highlight a growing trend among service
providers and telecommunications carriers to combine the marketing, selling and
provision of high-speed data transmission services, Internet access and content
services. While we do not believe that such combined entities providing
integrated services will adversely affect our business, no assurance can be
given that such combinations will not ultimately have such an adverse effect.
Further, no assurance can be given that additional acquisitions of Internet
service providers by traditional and local competitive telecommunications
carriers, and other strategic alliances between such entities, will not harm our
business.

In light of our acquisition of Laser Link.Net, Inc. and other changes we
have made in our business, some of our existing Internet service provider
customers may perceive us as a potential or actual competitor instead of as a
supplier. Similarly, our agreement to acquire BlueStar, which sells its services
directly to end-users, may cause our existing Internet service provider
customers to view us a a competitor. Such Internet service providers may
therefor reduce the volume or the rate of growth of the sales of our services,
or may cease to resell our services. No assurance can be given that our
provision of additional services will not alienate some or all of our existing
customers and thus harm our business.

WE MAY EXPERIENCE DECREASING PRICES FOR OUR SERVICES, WHICH MAY IMPAIR OUR
ABILITY TO ACHIEVE PROFITABILITY OR POSITIVE CASH FLOW

We may experience decreasing prices for our services due to competition,
volume-based pricing, an increase in the proportion of our revenues generated by
our consumer services and other factors. Currently, we charge higher prices for
some of our services than some of our competitors do for their similar services.
As a result, we cannot assure you that our customers and their end-user
customers will select our services over those of our competitors. In addition,
prices for digital communications services in general have fallen historically,
and we expect this trend to continue. We have provided and expect in the future
to provide price discounts to customers that commit to sell our services to a
large number of their end-user customers. Our consumer-grade services have lower
prices than our business-grade services. As a result, expected increases in the
percentage of our revenues which we derive from our consumer services will
likely reduce our overall profit margins. We also expect to reduce prices
periodically in the future to respond to competition and to generate increased
sales volume. As a result, we cannot predict whether demand for our services
will exist at prices that enable us to achieve profitability or positive cash
flow.

OUR FAILURE TO MANAGE OUR GROWTH EFFECTIVELY MAY DELAY OUR NETWORK EXPANSION AND
SERVICE ROLLOUT

Our strategy is to significantly expand our network within our existing
metropolitan statistical areas and to deploy our network in substantially all of
our 165 targeted metropolitan statistical areas by the end of 2000. The
execution of this strategy involves:

o obtaining the required government authorizations;

o identifying, accessing and initiating service in key central offices
within existing and target regions;

o designing, maintaining and upgrading adequate operational support,
billing and collection systems;

o obtaining central office space and maintaining connections between
central offices;

o obtaining phone lines and electronic ordering facilities from our
traditional telephone company suppliers on a timely basis; and

o entering into and renewing interconnection agreements with the
appropriate traditional telephone companies on satisfactory terms and
conditions.

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To accomplish this strategy, we must, among other things:

o market to and acquire a substantial number of customers and end-users;

o continue to implement and improve our operational, financial and
management information systems, including our client ordering,
provisioning, dispatch, trouble ticketing and other operational
systems as well as our billing, accounts receivable and payable
tracking, collection, fixed assets and other financial management
systems;

o hire and train additional qualified management and technical
personnel;

o manage and resolve any disputes which may arise with our traditional
telephone company suppliers;

o establish and maintain relationships with third parties to market and
sell our services, install network equipment and provide field
service; and

o continue to expand and upgrade our network infrastructure.

We may be unable to do these things successfully. As a result, we may be
unable to deploy our network as scheduled, deploy our services in a timely
manner or achieve the operational growth necessary to achieve our business
strategy.

Our growth has placed, and is expected to continue to place, significant
demands on our management and operational resources. We expect to continue to
significantly increase our employee base to support the deployment of our
network. We also expect to implement system upgrades, new software systems and
other enhancements, which could cause disruption and dislocation in our
business. If we are successful in implementing our marketing strategy, we may
have difficulty responding to demand for our services and technical support in a
timely manner and in accordance with our customers' expectations. We expect
these demands to require the addition of new management personnel and the
increased outsourcing of Company functions to third parties. We may be unable to
do this successfully, in which case we could experience a reduction in the
growth of our line orders and therefore our revenues.

In February to March 2000, we deployed new software systems that caused
some disruption to our business while enhancing the productivity and efficiency
of certain operational practices. Future changes in our processes that we
introduce or we are required to introduce as a result of our arrangements with
the traditional telephone companies could cause similar or more serious
disruption to our ability to provide our services and to our overall business.

Thus far we have electronically linked our own ordering software systems to
the software systems of five of the traditional telephone companies. Such
electronic linkage is essential for us to successfully place a large volume of
orders for access to telephone wires. There is no assurance that we will be
successful in electronically linking our software system to those of all of the
traditional telephone companies who we rely on for the supply of access to their
telephone wires. Even if we have such electronic links, we cannot assure you
that we will be able to process all of our orders through such electronic links,
which would require additional human intervention. Our failure to electronically
link our systems with those of all major traditional telephone companies would
severely harm our ability to provide our services in large volume to our
customers.

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THE MARKETS WE FACE ARE HIGHLY COMPETITIVE AND WE MAY NOT BE ABLE TO COMPETE
EFFECTIVELY, ESPECIALLY AGAINST ESTABLISHED INDUSTRY COMPETITORS WITH
SIGNIFICANTLY GREATER FINANCIAL RESOURCES

The markets we face for business and consumer Internet access and RLAN
access services are intensely competitive. We expect that these markets will
become increasingly competitive in the future. In addition, the traditional
telephone companies dominate the current market and have a monopoly on telephone
wires. We pose a competitive risk to the traditional telephone companies and, as
both our competitors and our suppliers, they have the ability and the motivation
to harm our business. We also face competition from cable modem service
providers, competitive telecommunications companies traditional and new national
long distance carriers, Internet service providers, on-line service providers
and wireless and satellite service providers. Many of these competitors have
longer operating histories, greater name recognition, better strategic
relationships and significantly greater financial, technical or marketing
resources than we do. As a result, these competitors:

o may be able to develop and adopt new or emerging technologies and
respond to changes in customer requirements or devote greater
resources to the development, promotion and sale of their products and
services more effectively than we can;

o may form new alliances and rapidly acquire significant market share;
and

o may be able to undertake more extensive marketing campaigns, adopt
more aggressive pricing policies and devote substantially more
resources to developing high-speed digital services.

The intense competition from our competitors, including the traditional
telephone companies, the cable modem service providers and the competitive
telecommunications companies could harm our business.

The traditional telephone companies represent the dominant competition in
all of our target service areas, and we expect this competition to intensify.
For example, they have an established brand name and reputation for high quality
in their service areas, possess sufficient capital to deploy DSL equipment
rapidly, have their own telephone wires and can bundle digital data services
with their existing analog voice services to achieve economies of scale in
serving customers. Certain of the traditional telephone companies have
aggressively priced their consumer DSL services as low as $19-$29 per month,
placing pricing pressure on our TeleSurfer services. While we may be allowed to
provide our data services over the same telephone wires that they provide analog
voice services, we may be unable to obtain this ability. Even if we do obtain
this ability, there is no assurance that we will be permitted to provide our
services in this manner without running into operational or technical obstacles;
including those created by the traditional telephone companies. Further, they
can offer service to end-users from certain central offices where we are unable
to secure central office space and offer service. In addition, mergers involving
the traditional telephone companies, such as the merger between Verizon
Communications and NorthPoint Communications, may further the traditional
telephone companies' efforts to compete with us since the combined entities will
benefit from the resources of the traditional telephone company. Accordingly, we
may be unable to compete successfully against the traditional telephone
companies.

Cable modem service providers, such as Excite@Home Corporation and
MediaOne, the broadband services arm of MediaOne Group (formerly U S West Media
Group), and their respective cable partners, are deploying high-speed Internet
access services over coaxial cable networks. Where deployed, these networks
provide similar, and in some cases, higher-speed Internet access and RLAN access
than we provide. They also offer these services at lower price points than our
TeleSurfer services. As a result, competition with the cable modem service
providers may have a significant negative effect on our ability to secure
customers and may create downward pressure on the prices we can charge for our
services.

Many competitive telecommunications companies offer high-speed data
services using a business strategy similar to ours. Some of these competitors
have begun offering DSL-based access services and others are likely to do so in
the future. In addition, some competitive telecommunications companies have
extensive fiber networks in many metropolitan areas primarily providing
high-speed digital and voice circuits to large corporations, and have
interconnection agreements with traditional telephone companies pursuant to
which they have acquired central office space in many of our existing and target
markets. Further, certain of our customers have made investments in our
competitors. As a result of these factors, we may be unsuccessful in generating
a significant number of new customers or retaining existing customers.

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OUR LEVERAGE IS SUBSTANTIAL AND WILL INCREASE, MAKING IT MORE DIFFICULT TO
RESPOND TO CHANGING BUSINESS CONDITIONS

As of June 30, 2000 we had approximately $828.9 million of long-term
obligations (including current portion), which consists primarily of the 1998
notes, the 1999 notes and the 2000 notes. Because the 1998 notes accrete to $260
million through March 2003, we will become increasingly leveraged until then,
whether or not we incur new indebtedness in the future. We may also incur
additional indebtedness in the future, subject to certain restrictions contained
in the indentures governing the 1998 notes, the 1999 notes and the 2000 notes,
to finance the continued development, commercial deployment and expansion of our
network and for funding operating losses or to take advantage of unanticipated
opportunities. The degree to which we are leveraged could have important
consequences. For example, it could:

o materially limit or impair our ability to obtain additional financing
or refinancing in the future for working capital, capital
expenditures, acquisitions, general corporate purposes or other
purposes;

o require us to dedicate a substantial portion of our cash flow to the
payment of principal and interest on our indebtedness, which reduces
the availability of cash flow to fund working capital, capital
expenditures, acquisitions, general corporate purposes or other
purposes;

o limit our ability to redeem the 1998 notes, the 1999 notes and the
2000 notes in the event of a change of control; and

o increase our vulnerability to economic downturns, limit our ability to
withstand competitive pressures and reduce our flexibility in
responding to changing business and economic conditions.

WE WILL REQUIRE A SIGNIFICANT AMOUNT OF CASH TO SERVICE OUR INDEBTEDNESS; OUR
ABILITY TO GENERATE CASH DEPENDS ON MANY FACTORS BEYOND OUR CONTROL

We expect to continue to generate substantial net losses and negative cash
flow for at least the next several years. We may be unable to maintain a level
of cash flow from operations sufficient to permit us to pay the principal and
interest on our current indebtedness, and any additional indebtedness we may
incur. The 1998 notes accrete to $260 million through March 2003 and we must
begin paying cash interest on those notes in September 2003. We have provided
for the first six payments on the 1999 notes by setting aside approximately
$74.1 million in government securities to fund such payments. We began paying
cash interest on the 1999 notes in August 1999 and will begin paying cash
interest on the 2000 notes in August 2000.

Our ability to make scheduled payments with respect to indebtedness will
depend upon, among other things:

o our ability to achieve significant and sustained growth in cash flow;

o the rate and success of the commercial deployment of our network;

o successful operation of our network;

o the market acceptance, customer demand, rate of utilization and
pricing for our services;
o our ability to successfully complete development, upgrades and
enhancements of our network; and

o our ability to complete additional financings, as necessary.

Each of these factors is affected by economic, financial, competitive and
other factors, many of which are beyond our control. If we are unable to
generate sufficient cash flow to service our indebtedness, we may have to reduce
or delay network deployments, restructure or refinance our indebtedness or seek
additional equity capital, strategies that may not enable us to service and
repay our indebtedness. Any failure to satisfy our obligations with respect to
the 1998 notes, the 1999 notes or the 2000 notes at or before maturity would be
a default under the related indentures and could cause a default under
agreements governing our other indebtedness. If such defaults occur, the holders
of the indebtedness would have enforcement rights, including the right to
accelerate payment of the entire amount of the debt and the right to commence an
involuntary bankruptcy proceeding against us.

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OUR INTELLECTUAL PROPERTY PROTECTION MAY BE INADEQUATE TO PROTECT OUR
PROPRIETARY RIGHTS, AND WE MAY BE SUBJECT TO INFRINGEMENT CLAIMS

We regard certain aspects of our products, services and technology as
proprietary. We attempt to protect them with patents, copyrights, trademarks,
trade secret laws, restrictions on disclosure and other methods. These methods
may not be sufficient to protect our technology. We also generally enter into
confidentiality or license agreements with our employees and consultants, and
generally control access to and distribution of our documentation and other
proprietary information. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use our products, services or
technology without authorization, or to develop similar technology
independently.

Currently, we have been issued one patent and we have a number of
additional patent applications pending. We intend to prepare additional
applications and to seek patent protection for our systems and services. These
patents may not be issued to us. If issued, they may not protect our
intellectual property from competition. Competitors could seek to design around
or invalidate these patents.

Effective patent, copyright, trademark and trade secret protection may be
unavailable or limited in certain foreign countries. The global nature of the
Internet makes it virtually impossible to control the ultimate destination of
our proprietary information. The steps that we have taken may not prevent
misappropriation or infringement of our technology. Litigation may be necessary
in the future to enforce our intellectual property rights, to protect our trade
secrets or to determine the validity and scope of the proprietary rights of
others. Such litigation could result in substantial costs and diversion of
resources and could harm our business.

In addition, others may sue us with respect to infringement of their
intellectual property rights. Last year we were sued by Bell Atlantic for an
alleged infringement of a patent issued to them September 1998 entitled
"Variable Rate and Variable Mode Transmission System." Although the court
recently held that we do not infringe Bell Atlantic's patent, Bell Atlantic has
filed a notice of appeal with respect to the court's ruling. As litigation is
inherently unpredictable, there is no guarantee that we will prevail on an
appeal of this ruling. An unfavorable outcome on appeal of this ruling, or in
any other lawsuit that may be brought against us, could limit our ability to
provide all our services and require us to pay damages, which could
significantly harm our business.

WE WILL NEED ADDITIONAL FUNDS IN THE FUTURE IN ORDER TO CONTINUE TO GROW OUR
BUSINESS

We believe our current capital resources will be sufficient for our funding
and working capital requirements for the deployment and operation of our network
into the second quarter of 2001. Thereafter, we will be required to raise
additional capital through the issuance of debt or equity financings. We may
choose to raise additional capital sooner, depending on market conditions. The
actual amount and timing of our future capital requirements will depend upon a
number of factors, including:

o the number of geographic areas targeted and entered and the timing of
entry and services offered;

o network deployment schedules and associated costs;

o the rate at which customers and end-users purchase our services and
the pricing of such services;

o the level of marketing required to acquire and retain customers and to
attain a competitive position in each region we enter;

o the rate at which we invest in engineering and development and
intellectual property with respect to existing and future technology;
and

o investment opportunities in complementary businesses, acquisitions or
other opportunities.

We also may be unsuccessful in raising sufficient capital at all or on
terms that we consider acceptable. If this happens, our ability to continue to
expand our business or respond to competitive developments would be impaired.

In addition, indentures governing our existing indebtedness contain
covenants that may restrict our business activities and our ability to raise
additional funds. As a result, we may not be able to undertake certain
activities which management believes are in our best interest to develop our
business. We also may be unable to raise as much additional funding through the
issuance of debt securities as we may need in the future. This could require us
to raise funding through the issuance of equity securities or amend our
indentures, which we may be unable to do on acceptable terms.

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THE SCALABILITY AND SPEED OF OUR NETWORK REMAIN LARGELY UNPROVEN

As of June 30, 2000, we had deployed our network in a total of 81
metropolitan statistical areas, many of which have been deployed only in the
last several months. As a result, the ability of our DSL networks and
operational support systems to connect and manage a substantial number of online
end-users at high speeds is still unknown. Consequently, there remains a risk
that we may not be able to scale our network and operational support systems up
to our expected end-user numbers while achieving superior performance. Peak
digital data transmission speeds currently offered across our DSL networks are
1.5 megabits per second downstream. However, the actual data transmission speeds
over our network could be significantly slower and will depend on a variety of
factors, including:

o the type of DSL technology deployed;

o the distance an end-user is located from a central office;

o the configuration of the telecommunications line being used;

o quality of the telephone wires provisioned by traditional telephone
companies; and

o our operational support systems which manage our network.

As a result, our network may be unable to achieve and maintain the highest
possible digital transmission speed. Our failure to achieve or maintain
high-speed digital transmissions would significantly reduce customer and
end-user demand for our services.

INTERFERENCE IN THE TRADITIONAL TELEPHONE COMPANIES' COPPER PLANT COULD DEGRADE
THE PERFORMANCE OF OUR SERVICES

Certain tests indicate that some types of DSL technology may cause
interference with, and be interfered with by other signals present in a
traditional telephone company's copper plant, usually with lines in close
proximity. In addition, as we continue to implement line sharing with the
traditional local telephone companies, our deployment of our ADSL data services
could interfere with the voice services of the traditional local telephone
companies carried over the same line or adjacent lines. If it occurs, such
interference could cause degradation of performance of our services or the
services of the traditional local telephone companies and render us unable to
offer our services on selected lines. The amount and extent of such interference
will depend on the condition of the traditional telephone company's copper plant
and the number and distribution of DSL and other signals in such plant and
cannot now be ascertained.

When interference occurs, it is difficult to detect. The procedures to
resolve interference issues between competitive telecommunications companies and
traditional telephone companies are still being developed and may not be
effective. In the past we have agreed to interference resolution procedures with
certain traditional telephone companies. However, we may be unable to
successfully negotiate similar procedures with other traditional telephone
companies in future interconnection agreements or in renewals of existing
interconnection agreements. In addition, the failure of the traditional
telephone companies to take timely action to resolve interference issues could
harm the provision of our services. If our TeleSpeed and TeleSurfer services
cause widespread network degradation or are perceived to cause that type of
interference, actions by the traditional telephone companies or state or federal
regulators could harm our reputation, brand image, service quality, customer
satisfaction and retention, and overall business. Moreover, ostensible
interference concerns have in the past been, continue to currently and may in
the future be used by the traditional telephone companies as a pretext to delay
the deployment of our services and otherwise harm our business.

A SYSTEM FAILURE COULD DELAY OR INTERRUPT SERVICE TO OUR CUSTOMERS

Our operations depend upon our ability to support our highly complex
network infrastructure and avoid damage from fires, earthquakes, floods, power
losses, excessive sustained or peak user demand, telecommunications failures,
network software flaws, transmission cable cuts and similar events. The
occurrence of a natural disaster or other unanticipated problem at our network
operations center or any our regional data centers could cause interruptions in
our services. Additionally, failure of a traditional telephone company or other
service provider, such as competitive telecommunications companies, to provide
communications capacity that we require, as a result of a natural disaster,
operational disruption any other reason, could cause interruptions in our
services. Any damage or failure that causes interruptions in our operations
could harm our business.

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A BREACH OF NETWORK SECURITY COULD DELAY OR INTERRUPT SERVICE TO OUR CUSTOMERS

Our network may be vulnerable to unauthorized access, computer viruses and
other disruptive problems. Internet service provider, telecommunications carrier
and corporate networks have in the past experienced, and may in the future
experience, interruptions in service as a result of accidental or intentional
actions of Internet users, current and former employees and others. Unauthorized
access could also potentially jeopardize the security of confidential
information stored in the computer systems of our customers and the customers'
end-users. This might result in liability to our customers and also might deter
potential customers. We intend to implement security measures that are standard
within the telecommunications industry and newly developed security measures. We
have not done so yet and may not implement such measures in a timely manner.
Moreover, if and when implemented, such measures may be circumvented, and
eliminating computer viruses and alleviating other security problems may require
interruptions, delays or cessation of service to our customers and such
customers' end-users, which could harm our business.

WE DEPEND ON A LIMITED NUMBER OF THIRD PARTIES FOR EQUIPMENT SUPPLY SERVICE, AND
INSTALLATION

We rely on outside parties to manufacture our network equipment and provide
certain network services. These services and equipment include:

o digital subscriber line access multiplexers;

o customer premise equipment modems;

o network routing and switching hardware;

o network management software;

o systems management software;

o database management software;

o collocation space; and

o Internet connectivity and Internet protocol services.

As we sign additional service contracts, we will need to increase
significantly the amount of manufacturing and other services supplied by third
parties in order to meet our contractual commitments. For example, we have a
service arrangement with Lucent Technologies Inc. to increase our ability to
install our central office facilities and associated equipment.

We have in the past experienced supply problems with certain of our
vendors. These vendors may not be able to meet our needs in a satisfactory and
timely manner in the future. In addition, we may not be able to obtain
additional vendors when needed. We have identified alternative suppliers for
technologies that we consider critical. However, it could take us a significant
period of time to establish relationships with alternative suppliers for
critical technologies and substitute their technologies into our network.

Our reliance on third-party vendors involves additional risks, including:

o the absence of guaranteed capacity; and

o reduced control over delivery schedules, quality assurance, production
yields and costs.

The loss of any of our relationships with these suppliers could harm our
business.

OUR SUCCESS DEPENDS ON OUR RETENTION OF CERTAIN KEY PERSONNEL, OUR ABILITY TO
HIRE ADDITIONAL KEY PERSONNEL AND THE MAINTENANCE OF GOOD LABOR RELATIONS

We depend on the performance of our executive officers and key employees.
In particular, our senior management has significant experience in the data
communications, telecommunications and personal computer industries, and the
loss of any of them, such as the losses of Robert Roblin and Tim Laehy, could
negatively affect our ability to execute our business strategy. Additionally, we
do not have "key person" life insurance policies on any of our employees.

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Our future success also depends on our continuing ability to identify,
hire, train and retain other highly qualified technical, sales, marketing, legal
and managerial personnel in connection with our expansion within our existing
regions and the deployment, legal and marketing of our network into targeted
regions. Competition for such qualified personnel is intense. This is
particularly the case in software development, network engineering and product
management. We also may be unable to attract, assimilate or retain other highly
qualified technical, operations, sales, marketing and managerial personnel. Our
business will be harmed if we cannot attract the necessary technical, sales,
marketing and managerial personnel. In addition, in the event that our employees
unionize, we could incur higher ongoing labor costs and disruptions in our
operations in the event of a strike or other work stoppage.

WE HAVE MADE AND MAY MAKE ACQUISITIONS OF COMPLEMENTARY TECHNOLOGIES OR
BUSINESSES IN THE FUTURE, WHICH MAY DISRUPT OUR BUSINESS AND BE DILUTIVE TO OUR
EXISTING STOCKHOLDERS

In addition to our acquisition of Laser Link.Net, Inc. and our agreement to
acquire BlueStar Communications Group, we intend to consider acquisitions of
businesses and technologies in the future on an opportunistic basis.
Acquisitions of businesses and technologies involve numerous risks, including
the diversion of management attention, difficulties in assimilating the acquired
operations, loss of key employees from the acquired company, and difficulties in
transitioning key customer relationships. In addition, these acquisitions may
result in dilutive issuances of equity securities, the incurrence of additional
debt, large one-time expenses and the creation of goodwill or other intangible
assets that result in significant amortization expense. Any of these factors
could materially harm our business or our operating results in a given period.

AN ECONOMIC DOWNTURN COULD ADVERSELY IMPACT DEMAND FOR OUR SERVICES

In the last few years the general health of the economy, particularly the
California economy, has been relatively strong and growing, a consequence of
which has been increasing capital spending by individuals and growing companies
to keep pace with rapid technological advances. To the extent the general
economic health of the United States or of California declines from recent
historically high levels, or to the extent individuals or companies fear such a
decline is imminent, such individuals and companies may reduce, in the near
term, expenditures such as those for our services. Any such decline or concern
about an imminent decline could delay decisions among certain of our customers
to roll out our services or could delay decisions by prospective customers to
make initial evaluations of our services. Such delays would have a material
adverse effect on our business, prospects, operating results and financial
condition.

OUR STOCK PRICE HAS BEEN AND IS LIKELY TO CONTINUE TO BE VOLATILE

The trading price of our common stock has been and is likely to continue to
be highly volatile. Our stock price could fluctuate widely in response to
factors such as the following:

o actual or anticipated variations in quarterly operating results,
including the pace of the expansion of our business;

o announcements of new products or services by us or our competitors or
new competing technologies;

o the addition or loss of ISP or enterprise customers or subscribers;

o changes in financial estimates or recommendations by securities
analysts;

o the adoption of new, or changes in existing, accounting rules,
guidelines and practices, which may materially impact our financial
statements and may materially alter the expectations of securities
analysts or investors;

o conditions or trends in the telecommunications industry, including
regulatory developments;

o growth of the Internet and online commerce industries;

o announcements by us of significant acquisitions, strategic
partnerships, joint ventures or capital commitments;

o additions or departures of key personnel;

o future equity or debt offerings or our announcements of such
offerings;

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o general market and general economic conditions; and

o other events or factors, many of which are beyond our control.

FUTURE SALES OF OUR COMMON STOCK MAY DEPRESS OUR STOCK PRICE

Sales of a substantial number of shares of our common stock in the public
market, or the appearance that such shares available for sale, could adversely
affect the market price for our common stock. As of August 1, 2000, we had
154,770,567 shares of common stock outstanding. We have a significant number of
these shares of which are not currently publicly traded but are available for
immediate resale to the public, subject to certain volume limitations and under
the securities laws and lock-up arrangements. We also have 32,383,377 shares of
our common stock remaining that are reserved for issuance pursuant to options
under our 1997 Stock Plan, and of which 25,700,808 shares were subject to
outstanding options at August 1, 2000. We have reserved 1,006,050 shares of our
common stock for issuance pursuant to options we assumed in connection with our
acquisition of Laser Link.Net. We have also reserved 1,732,716 shares of common
stock for issuance under our 1998 Employee Stock Purchase Plan as of August 1,
2000. Shares underlying vested options are generally eligible for immediate
resale in the public market. In addition, a significant portion of our
stockholders have certain registration rights with respect to their shares.

ANTITAKEOVER EFFECTS OF CERTAIN CHARTER AND BYLAW PROVISIONS, DELAWARE LAW, OUR
INDENTURES AND STOCKHOLDER PROTECTION RIGHTS PLAN

Our Board of Directors has the authority to issue up to 5,000,000 shares of
preferred stock and to determine the price, rights, preferences, privileges and
restrictions, including voting rights, of those shares without any further vote
or action by the stockholders. The issuance of preferred stock, while providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire a majority of our outstanding voting stock. Our charter
and bylaws provide for a classified board of directors, limitations on the
ability of stockholders to call special meetings and act by written consent, the
lack of cumulative voting for directors and procedures for advance notification
of stockholder nominations and proposals. These provisions, as well as Section
203 under the Delaware General Corporation Law to which we are subject, could
discourage potential acquisition proposals and could delay or prevent a change
of control.

The indentures relating to the 1998 notes, 1999 notes and 2000 notes
provide that, in the event of certain changes in control, each holder of the
notes will have the right to require us to repurchase such holder's notes at a
premium over the aggregate principal amount or the accreted value, as the case
may be, of such debt. In addition, our Stockholder Protection Rights Plan
contains provisions that make a hostile takeover prohibitively expensive and, in
effect, requires interested suitors to cooperate with the Board of Directors
prior to acquiring more than 15% of the Company. There is no guarantee that the
Stockholder Protection Rights Plan will not discourage takeover attempts which
would otherwise result in a premium to our stockholders.

The provisions in the charter, bylaws, indentures and Stockholder
Protection Rights Plan could have the effect of discouraging others from making
tender offers for our shares and, as a consequence, they also may inhibit
increases in the market price of our shares that could result from actual or
rumored takeover attempts. Such provisions also may have the effect of
preventing changes in our management.

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OUR FAILURE AND THE FAILURE OF THIRD PARTIES TO BE YEAR 2000 COMPLIANT COULD
NEGATIVELY IMPACT OUR BUSINESS

Many currently installed computer systems and software products are coded
to accept only two-digit entries in the date code filed and cannot distinguish
21st century dates from 20th century dates. These date code fields will need to
distinguish 21st century dates from 20th century dates and, as a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements.

We have reviewed our internally developed information technology systems
and programs and believe that our systems are Year 2000 compliant and that there
are not significant Year 2000 issues within our systems or services. We have not
reviewed our non-information technology systems for Year 2000 issues relating to
embedded microprocessors. To the extent that such issues exist, these systems
may need to be replaced or upgraded to become Year 2000 compliant. We believe
that our non-information technology systems will not present any significant
Year 2000 issues, although there can be no assurance in this regard. In
addition, we utilize third-party equipment and software and interact with
traditional telephone companies that have equipment and software that may not be
Year 2000 compliant. Failure of such third-party or traditional telephone
company equipment or software to operate properly with regard to the Year 2000
and thereafter could require us to incur unanticipated expenses to remedy any
problems, which could have a material adverse effect on our business, prospects,
operating results and financial condition.

To date, we have not experienced any problems in complying with Year 2000
requirements, nor have we experienced any operational difficulties related to
Year 2000 issues.

THE BROADBAND COMMUNICATIONS INDUSTRY IS UNDERGOING RAPID TECHNOLOGICAL CHANGES,
AND NEW TECHNOLOGIES MAY BE SUPERIOR TO THE TECHNOLOGY WE USE

The broadband communications industry is subject to rapid and significant
technological change, including continuing developments in DSL technology, which
does not presently have widely accepted standards, and alternative technologies
for providing broadband communications, such as cable modem technology. As a
consequence:

o we will rely on third parties, including some of our competitors and
potential competitors, to develop and provide us with access to
communications and networking technology;

o our success will depend on our ability to anticipate or adapt to new
technology on a timely basis; and

o we expect that new products and technologies will emerge that may be
superior to, or may not be compatible with, our products and
technologies.

If we fail to adapt successfully to technological changes or fail to obtain
access to important technologies, our business will suffer.

OUR STRATEGY DEPENDS ON GROWTH IN DEMAND FOR DSL-BASED SERVICES

The demand for high-speed Internet and RLAN access is in the early stages
of development. As a result, we cannot predict the rate at which this demand
will grow, if at all, or whether new or increased competition will result in
satisfying all demand. Various providers of high-speed digital communications
services are testing products from various suppliers for various applications.
We do not know whether DSL will offer the same or more attractive
price-performance characteristics. Critical issues concerning commercial use of
DSL for Internet and RLAN access, including security, reliability ease and cost
of access and quality of service remain unresolved and may impact the growth of
such services. If the demand for our services grows more slowly than we
anticipate or is satisfied by competitors, our ability to achieve revenue growth
and positive cash flow will be harmed.

WE MUST COMPLY WITH FEDERAL AND STATE TAX AND OTHER SURCHARGES ON OUR SERVICE
THE LEVELS OF WHICH ARE UNCERTAIN

Telecommunications providers pay a variety of surcharges and fees on their
gross revenues from interstate services and intrastate services. Interstate
surcharges include Federal Universal Service Fees, Common Carrier Regulatory
Fees and TRS Fund fees. In addition, state regulators impose similar surcharges
and fees on intrastate services. The division of our services between interstate
services and intrastate services is a matter of interpretation and may in the
future be contested by the FCC or relevant state commission authorities. The FCC
is currently

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considering the jurisdictional nature of ISP-bound traffic, as a result of a
March 24, 2000 decision by the United States Court of Appeals for the D.C.
Circuit related to the jurisdictional nature of analog, dial-up traffic to the
Internet. A change in the characterization of their jurisdictions could cause
our payment obligations, pursuant to the relevant surcharges, to increase. In
addition, pursuant to periodic revisions by state and federal regulators of the
applicable surcharges, we may be subject to increases in the surcharges and fees
currently paid. Also, a determination of the jurisdictional nature of our DSL
services may require us to commit additional resources to regulatory compliance,
such as tariff filings.

OUR SERVICES ARE SUBJECT TO GOVERNMENT REGULATION, AND CHANGES IN CURRENT OR
FUTURE LAWS OR REGULATIONS COULD ADVERSELY AFFECT OUR BUSINESS

Our services are subject to federal, state and local government
regulations. The 1996 Telecommunications Act, which became effective in February
1996, introduced widespread changes in the regulation of the telecommunications
industry, including the digital access services segment in which we operate. The
1996 Telecommunications Act eliminates many of the pre-existing legal barriers
to competition in the telecommunications services business and sets basic
criteria for relationships between telecommunications providers.

Among other things, the 1996 Telecommunications act removes barriers to
entry in the local telecommunications markets by preempting state and local laws
that restrict competition by providing competitors interconnection, access to
unbundled network elements, collocation, and retail services at wholesale rates.
The FCC's primary rules interpreting the 1996 Telecommunications Act were issued
on August 8, 1996. These rules have been reviewed by the U.S. Court of Appeals
for the Eighth Circuit, the U.S. Court of Appeals for the District of Columbia,
and the U.S. Supreme Court. The U.S. Supreme Court overruled the Eighth Circuit
in January 1999 and upheld most of the FCC rules. On November 5, 1999, the FCC
implemented unbundling rules that responded to the Supreme Court's January 1999
decision. Currently pending before the Eighth Circuit are the legality of the
FCC's decision to require traditional telephone companies to sell unbundled
network elements to companies like Covad at total element, long-run incremental
cost. An adverse decision in that proceeding could increase the amount we must
pay these for copper wires, transport links, and collocation.

Since August 1996, the FCC has proposed and adopted further rules related
to our ability to obtain access to unbundled network elements and other
services.

In August 1998, the FCC stated that its rules required traditional local
telephone companies to provide us access to copper wires in order to provide
"advanced services", such as our DSL services. In that same proceeding, the FCC
proposed new rules that would allow traditional telephone companies to provide
their own DSL services free from traditional telephone company regulation
through a separate affiliate. The provision of DSL services by an affiliate of a
traditional telephone company not subject to such regulation could harm our
business. The FCC has not implemented such separate affiliate rules as of this
date. However, the FCC, in approving the merger of SBC and Ameritech in October
1999, required SBC/Ameritech to create such an affiliate throughout the
SBC/Ameritech service territory. In June 2000, Bell Atlantic and GTE were
ordered by the FCC to create such an affiliate, in the context of their merger.
The FCC requires SBC/Ameritech and Bell Atlantic/GTE to provide all of their
in-region DSL services through this "separate affiliate".

In March 1999, the FCC revised its collocation and unbundled network
element rules, in order to facilitate the deployment of advanced services by
companies like Covad. In March 2000, the U.S. Circuit Court for the District of
Columbia struck portions of the FCC's new collocation rules and has required the
FCC to reconsider and review those rules. In particular, the D.C. Circuit
required the FCC to revise its rules concerning the types of equipment that we
may collocate on the traditional telephone company premises, the method in which
we may be permitted to connect that equipment to other new entrants, and the
steps that traditional telephone companies may take to separate their equipment
from our equipment. The traditional telephone companies may implement the
court's ruling and any subsequent FCC rules in a manner that impairs our ability
to obtain collocation space and collocate the equipment of our choice on their
premises. Such actions by the traditional telephone companies could adversely
affect our business and disrupt our existing network design, configuration and
services.

In November 1999, the FCC ruled that traditional local telephone companies
must provide access to "line-sharing" on an unbundled basis. Line-sharing
permits us to provide a DSL service on the same telephone wire in which an
end-user has analog, local telephone service. Only certain DSL technologies,
such as ADSL, are

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designed to work on the same line as analog telephone service. Most traditional
telephone companies provide ADSL service excusively over line-sharing. Without
access to line-sharing, we have to have the traditional telephone company
install an additional telephone line to an end-user's premises. Without
line-sharing, we may not be able to provide a product that is competitive with
the traditional telephone company's offering. A group of traditional telephone
companies has appealed this decision, and an adverse result in that court
proceeding could harm our business.

We have not entered into interconnection agreements that take full
advantage of these new federal rules. We anticipate that traditional telephone
companies will challenge these new rules in regulatory proceedings and court
challenges. In addition, we anticipate that traditional telephone companies will
resist full implementation of these federal and state rules. Any unfavorable
decisions by the courts, the FCC, or state telecommunications regulatory
commissions could harm our business. In addition, a failure to enforce these
rules by the appropriate court, FCC, or state authority in a timely basis could
slow down our deployment of services or could otherwise harm our business.

Changes to current regulations, the adoption of new regulations by the FCC
or state regulatory authorities, court decisions, or legislation, such as
changes to the 1996 Telecommunications Act, could harm our business. In
particular, several bills pending before the 106th Congress, including H.R.
2420, H.R. 1686, and S. 877, would directly harm our business by taking away
some of the legal rights we have to unbundled network elements and collocation,
or by diminishing the incentive the Regional Bell Operating Companies have to
provide us the elements, collocation and services we need to provide our
services. Passage of any of these bills or similar legislation would adversely
and significantly harm our business, and may cause us to eliminate or even
disconnect certain services to particular end-users. In addition, passage of any
of these bills may cause us to disrupt and change our existing network design
and configuration.

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USE OF PROCEEDS

The proceeds from the sale of the common stock offered pursuant to this
prospectus are solely for the account of the shareholders who may be selling
pursuant to this prospectus. Accordingly, we will not receive any proceeds from
the sale of the shares by the selling shareholders.

DETERMINATION OF OFFERING PRICE

Because this prospectus relates only to the resale of previously issued
shares of the common stock, we did not determine an offering price. The selling
shareholders will individually determine the offering price of the common stock.
The selling shareholders may use this prospectus from time to time to sell their
common stock. The price at which the common stock is sold may be based on market
prices prevailing at the time of sale, at prices relating to such prevailing
market prices, or at negotiated prices.

DIVIDEND POLICY

We have not paid any cash dividends since our inception. We currently
anticipate that we will retain all of our future earnings for use in the
expansion and operation of our business. Thus, we do not anticipate paying any
cash dividends on our capital stock in the foreseeable future. In addition, the
terms of the indentures relating to the 1998 notes, the 1999 notes and the 2000
notes restrict our ability to pay cash dividends on our capital stock.

PRICE RANGE OF OUR COMMON STOCK

Our common stock has been traded on the NASDAQ National Market under the
symbol "COVD" since January 22, 1999, the date of our initial public offering.
Prior to that time, there was no public market for our common stock. The
following table sets forth, for the period indicated, the high and low closing
sales prices for our common stock as reported by the NASDAQ National Market.
THESE PRICES HAVE BEEN SPLIT-ADJUSTED TO ACCOUNT FOR THE STOCK SPLITS IN MAY,
1999 AND MARCH, 2000.

FISCAL YEAR ENDED DECEMBER 31, 1999 HIGH LOW
----------------------------------- -------- -------
First Quarter...................................... 47.50 12.00
Second Quarter...................................... 72.38 39.56
Third Quarter....................................... 67.50 37.31
Fourth Quarter...................................... 65.38 38.78

FISCAL YEAR ENDED DECEMBER 31, 2000
-----------------------------------

First Quarter....................................... 66.25 38.63
Second Quarter...................................... 45.75 15.44
Third Quarter (Through August 18)................... 23.06 15.63

On August 18, 2000 the last reported sale price for our common stock on the
NASDAQ National Market was $15.63 per share. As of August 1, 2000, there were
613 holders of record of our common stock, and there were no holders of record
of our class B common stock.

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SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
OF COVAD COMMUNICATIONS GROUP, INC.

The following selected consolidated financial data for the years ended
December 31, 1997, 1998 and 1999 have been derived from our audited Consolidated
Financial Statements and the related Notes, which are included elsewhere in this
prospectus. You should read the following selected consolidated financial data
together with "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and our Consolidated Financial Statements and the related
Notes included elsewhere in this prospectus.

In March 2000, we acquired Laser Link.Net, Inc. in a transaction
accounted for as a purchase. Accordingly, the selected consolidated statement of
operations data for the six months ended June 30, 2000 include the results of
operations of Laser Link.Net, Inc. from the date of acquisition through June 30,
2000. The selected consolidated financial data for the six months ended June 30,
2000 are not necessarily indicative of the results that may be expected for the
entire fiscal year or future periods.

YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
---------------------------------------- ----------------------------
1997 1998 1999 1999 2000
------------ ------------ ------------- ------------ --------------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS
DATA:
Revenues................................. $ 26 $ 5,326 $ 66,488 $ 16,429 $ 99,967
Operating expenses:
Network and product costs............. 54 4,562 55,347 15,525 74,963
Sales, marketing, general and
administrative...................... 2,374 31,043 140,372 43,089 187,907
Depreciation and amortization.........
Amortization of goodwill and other 70 3,406 37,602 13,318 41,717
intangible assets................... -- -- -- -- 23,453
Amortization of deferred compensation. 295 3,997 4,768 2,887 1,911
Write-off of in-process technology.... -- -- -- -- 3,726
----------- ------------ -------------- ------------ --------------
Total operating expenses............ 2,793 43,008 238,089 74,819 333,677
----------- ------------ -------------- ------------ --------------
Loss from operations..................... (2,767) (37,682) (171,601) (58,390) (233,710)
Net interest expense.................. 155 (10,439) (23,796) (12,366) (19,780)
Other income.......................... -- -- -- -- 14,787
----------- ------------ -------------- ------------ --------------
Net loss................................. (2,612) (48,121) (195,397) (70,756) (238,703)
Preferred dividends...................... -- -- (1,146) (1,146) --
----------- ------------ -------------- ------------ --------------
Net loss attributable to common
stockholders............................. $ (2,612) $ (48,121) $ (196,543) $ (71,902) $ (238,703)
=========== ============ ============== ============ ==============
Net loss per share--basic and diluted.... $ (0.35) $ (3.75) $ (1.83) $ (0.79) $ (1.59)
=========== ============ ============== ============ ==============
Weighted average shares used in
computing net loss per share--basic
and diluted......................... 7,360,978 12,844,203 107,647,812 91,396,284 150,060,418
=========== ============ ============== ============ ==============

OTHER FINANCIAL DATA:
EBITDA(1)................................ $ (2,402) $ (30,154) $ (129,486) (42,185) (162,903)
Capital expenditures..................... $ 2,253 $ 59,503 $ 208,186 93,748 262,914
Net cash used in operating activities.... (1,895) (9,054) (102,767) (27,721) (105,643)
Net cash used in investing activities.... (2,494) (61,252) (736,096) (194,446) (115,205)
Net cash provided by financing activities 8,767 130,378 990,451 415,188 427,630
</TABLE>

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------------------- AS OF JUNE 30,
1997 1998 1999 2000
--------- ----------- ------------ --------------------
(UNAUDITED)
<S> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents and short-term investments. $ 4,378 $ 64,450 $ 767,357 $ 763,154
Net property and equipment........................... 3,014 59,145 237,542 466,137
Total assets......................................... 8,074 139,419 1,147,606 1,783,880
Long-term obligations, including current portion..... 783 142,879 375,049 828,910
Total stockholders' equity (net capital deficiency).. 6,498 (24,706) 690,291 794,319
</TABLE>

27
<PAGE>

AS OF DECEMBER 31,
----------------------------------- AS OF JUNE 30,
1997 1998 1999 2000
--------- ----------- ------------ --------------------
<S> <C> <C> <C> <C>
OTHER OPERATING DATA:
Homes and businesses passed.......................... 278,000 6,023,217 29,000,000 42,000,000
Lines installed...................................... 26 3,922 57,000 138,000
</TABLE>

--------------
(1) EBITDA consists of net loss excluding net interest, taxes, depreciation
and amortization, non-cash stock-based compensation expense and other
non-operating income or expenses. We have provided EBITDA because it is a
measure of financial performance commonly used in the telecommunications
industry as well as to enhance an understanding of our operating results.
EBITDA should not be construed as either:

o an alternative to operating income (as determined in accordance with
generally accepted accounting principles) as an indicator of our
operating performance, or

o an alternative to cash flows from operating activities (as determined
in accordance with generally accepted accounting principles) as a
measure of liquidity.

EBITDA as calculated by us may be calculated differently than EBITDA for
other companies. See our consolidated financial statements and the
related notes thereto contained elsewhere in this prospectus.

28
<PAGE>

COVAD MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF
OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL
STATEMENTS AND THE RELATED NOTES THERETO INCLUDED ELSEWHERE IN THIS PROSPECTUS.
THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THE ACCURACY OF WHICH
INVOLVES RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY
FROM THOSE ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS FOR MANY REASONS
INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED IN "RISK FACTORS" AND ELSEWHERE
IN THIS PROSPECTUS. WE DISCLAIM ANY OBLIGATION TO UPDATE INFORMATION CONTAINED
IN ANY FORWARD-LOOKING STATEMENT. SEE "--FORWARD LOOKING STATEMENTS."

OVERVIEW

We are a leading provider of broadband communications services to Internet
service providers, enterprise and telecommunications carriers, and other
customers. Since March 1998, we have raised $1,537.2 million of gross proceeds
from debt and equity financings to fund the deployment and expansion of our
network to date. As of June 30, 2000, we offered our services in 81 metropolitan
statistical areas ("MSAs"). We plan to build our networks and offer our services
in 165 MSAs (which includes MSAs that will be added as a result of the
acquisition of BlueStar Communications discussed in "Recent Developments"
below). As of June 30, 2000, our networks passed 42 million homes and
businesses, and we had installed 138,000 end-user lines.

In connection with our expansion within existing metropolitan statistical
areas and into new metropolitan statistical areas, we expect to significantly
increase our capital expenditures, as well as our sales and marketing
expenditures, to deploy our networks and support additional end-users in those
regions. Accordingly, we expect to incur substantial and increasing net losses
for at least the next several years.

We derive revenue from:

o monthly recurring service charges for connections from the end-user to
our facilities and for backhaul services from our facilities to
Internet service provider or enterprise customer;

o service order set-up and other non-recurring charges; and

o the sale of customer premise equipment that we provide to our
customers due to the general unavailability of customer premise
equipment through retail channels.

We expect prices for the major components of both recurring and
non-recurring revenues to decrease each year in part due to the effects of
competitive pricing and future volume discounts. We believe our revenues from
the sale of customer premise equipment will decline over time, as prices for
such equipment decrease and customer premise equipment becomes more generally
available. We expect that the prices we charge to customers for customer premise
equipment will decrease each year.

The following factors comprise our network and service costs:

o Monthly non-recurring and recurring circuit fees. We pay traditional
telephone companies and other competitive telecommunications companies
non-recurring and recurring fees for services including installation,
activation, monthly line costs, maintenance and repair of circuits
between and among our digital subscriber line access multiplexers and
our regional data centers, customer backhaul, and end-user lines. As
our end-user base grows, we expect that in the near future the largest
element of network and product cost will be the traditional telephone
companies' charge for our leased copper wires; and

o Other costs. Other costs that we incur include those for materials in
installation and the servicing of customers and end-users, and the
cost of customer premise equipment.

The development and expansion of our business will require significant
expenditures. The principal capital expenditures incurred during the buildup
phase of any metropolitan statistical area involve the procurement, design and
construction of our central office cages, end-user DSL line cards, and
expenditures for other elements of our network design. Currently, the average
cost to deploy our facilities in a central office, excluding end-user line
cards, is approximately $85,000 per central office facility. This cost may vary
in the future due to the quantity and type of equipment we initially deploy in a
central office facility as well as regulatory limitations imposed on the
traditional

29
<PAGE>

phone companies relative to pricing of central office space, including cageless
physical collocation. Following the buildout of our central office space, the
major portion of our capital expenditures is the purchase of line cards to
support incremental end-users. We expect that the average cost of such line
cards will decline over the next several years. Network expenditures will
continue to increase with the number of end-users. However, once an operating
region is fully built out, a substantial majority of the regional capital
expenditures will be tied to incremental customer and end-user growth. In
addition to developing our networks, we will use our capital for marketing our
services, acquiring Internet service provider, enterprise, and telecommunication
carrier customers, and funding our customer care and field service operations.

In connection with rolling out service on a national basis we have
commenced a branding campaign to differentiate our service offerings in the
marketplace. As a result, we expect our selling, general and administrative
expenses to increase significantly in future periods as we implement increased
marketing efforts as part of the campaign.

RECENT DEVELOPMENTS

On June 16, 2000, we announced the signing of a definitive agreement to
acquire BlueStar Communications Group Inc., a provider of broadband and Internet
services for small- and medium-sized businesses throughout the Southeastern
United States. Under the acquisition agreement, we will issue up to 8 million
shares of our common stock and stock options for all of BlueStar's outstanding
common and preferred shares, stock options and warrants, plus assumption of all
outstanding BlueStar debt. Up to 5 million additional shares of our common stock
may be issued to the BlueStar shareholders if certain performance targets are
met by BlueStar over the 2001 fiscal year. We anticipate that this acquisition
will accelerate the national expansion of our network. We anticipate that our
acquisition of BlueStar will provide the following benefits:

o Speed to market in implementing our direct sales strategy in Tier 3
markets.

o A large, experienced direct sales force.

o BlueStar's customer base.

o Increased ability to provide enhanced broadband solutions to small
businesses.

In connection with the merger, Bear Stearns Corporate Lending, Inc.
provided BlueStar with a $40 million financing commitment to fund BlueStar's
continuing operations until the effective time of the merger. If the merger is
not completed, we have agreed to purchase the loans made pursuant to this
financing commitment from Bear Stearns in exchange for shares of our common
stock. Bear Stearns also has the right to put the loan to us in exchange for our
common stock in certain other circumstances.

30
<PAGE>

advocated by the traditional telephone companies. In rejecting the FCC's cost
methodology, the court held that it is permissible for the FCC to prescribe a
forward-looking incremental cost methodology that is based on actual incremental
costs under the 1996 Telecommunications Act. The Eighth Circuit's decision
creates some additional uncertainty concerning the prices that we are obligated
to pay the traditional telephone companies for collocation and unbundled network
elements. While the FCC may appeal the Eighth Circuit's decision, it may also
adopt new rules to reflect the cost methodology that was approved by the Eighth
Circuit. If the decision is appealed, it is uncertain whether the Eighth
Circuit's decision will be affirmed by the United States Supreme Court. It is
also uncertain whether the FCC and the state commissions will implement a new
cost methodology as a result of this decision.

RESULTS OF OPERATIONS

SIX MONTHS ENDED JUNE 30, 1999 AND 2000

REVENUES

We recorded revenues of $100.0 million for the six months ended June 30,
2000 compared to $16.4 million for the six months ended June 30, 1999. This
increase is attributable to growth in the number of customers and end-users
resulting from our increased sales and marketing efforts and the expansion of
our national network. We expect revenues to increase in future periods as we
expand our network within our existing regions, deploy networks in new regions
and increase our sales and marketing efforts in all of our regions.

NETWORK AND PRODUCT COSTS

We recorded network and product costs of $75.0 million for the six months
ended June 30, 2000 and $15.5 million for the six months ended June 30, 1999.
This increase is attributable to the expansion of our networks and increased
orders resulting from our sales and marketing efforts. We expect network and
product costs to increase significantly in future periods due to increased sales
activity and expected revenue growth.

SALES, MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES

Sales, marketing, general and administrative expenses consist primarily of
salaries, expenses for the development of our business, the development of
corporate identification, promotional and advertising materials, expenses for
the establishment of our management team, and sales commissions. Sales,
marketing, general and administrative expenses were $187.9 million for the six
months ended June 30, 2000 and $43.1 million for the six months ended June 30,
1999. This increase is attributable to growth in headcount in all areas of our
company, continued expansion of our sales and marketing efforts, deployment of
our networks and building of our operating

<PAGE>

infrastructure. Sales, marketing, general and administrative expenses are
expected to increase significantly as we continue to expand our business.

DEPRECIATION AND AMORTIZATION

Depreciation and amortization includes:

o depreciation of network costs and related equipment;

o depreciation of information systems, furniture and fixtures;

o amortization of improvements to central offices, regional data centers
and network operations center facilities and corporate facilities;

o amortization of capitalized software costs; and

o amortization of intangible assets.

In January 1999, we recorded intangible assets of $28.7 million from the
issuance of preferred stock to AT&T Ventures, NEXTLINK and Qwest. Amortization
of these assets was $2.1 and $4.2 million during the three and six months ended
June, 2000, respectively, and is included in depreciation amortization on the
accompanying consolidated statement of operations. Annual amortization of these
assets will be approximately $8.4 million in each of the years in the three year
period ending December 31, 2001, decreasing to approximately $1.2 million per
year for each subsequent year through the year ending December 31, 2004.

Depreciation and amortization was approximately $41.7 million for the six
months ended June 30, 2000 and $13.3 million for the six months ended June 30,
1999. This increase is due to the increase in equipment and facilities placed in
service throughout the periods as well as amortization of intangible assets. We
expect depreciation and amortization to increase significantly as we increase
our capital expenditures to expand our networks.

DEFERRED COMPENSATION

Through June 30, 2000, we recorded a total of approximately $19.3 million
of deferred compensation, with an unamortized balance of approximately $8.4
million on our June 30, 2000 consolidated balance sheet. This deferred
compensation is a result of us granting stock options to our employees, certain
of our directors, and certain contractors with exercise prices per share below
the fair values per share for accounting purposes of our common stock at the
dates of grant. We are amortizing the deferred compensation over the vesting
period of the applicable option using the graded vesting method. Amortization of
deferred compensation was $1.9 million for the six months ended June 30, 2000
and $2.9 million for the six months ended June 30, 1999.

GOODWILL AND OTHER INTANGIBLE ASSETS

In connection with the Laser Link acquisition completed in the first
quarter of 2000 (as discussed in Note 4 to the Unaudited Condensed Consolidated
Financial Statements), we recorded on our balance sheet a total of approximately
$402 million of goodwill and other intangible assets in March 2000. Goodwill was
determined based on the residual difference between the amount paid for Laser
Link and the values assigned to identified tangible and intangible assets. We
are amortizing goodwill and other intangible assets on a straight line basis
over its estimated useful life of five years. For the six months ended June 30,
2000, amortization of goodwill and other intangible assets was $23.5 million.

NET INTEREST INCOME AND EXPENSE

Net interest income and expense consists primarily of interest income on
our cash balance and interest expense associated with our debt. Net interest
expense for the six months ended June 30, 2000 was $19.8 million. Net interest
expense during this period consisted primarily of interest expense on the 1998
notes, the 1999 notes, and the 2000 notes and capital lease obligations
partially offset by interest income earned primarily from the investment of the
proceeds raised from the issuance of the 1998 notes, the 1999 notes, and the
2000 notes as well as our initial public offering and our issuance of preferred
stock to AT&T Ventures, NEXTLINK and Qwest. Net interest expense for the six
months ended June 30, 1999 was $12.4 million. Net interest expense during this
period consisted primarily of interest expense on the 1998 notes and capital
lease obligations, partially offset by interest income

32
<PAGE>

earned primarily from the investment of the proceeds raised from the issuance of
the 1998 notes. We expect interest expense to increase significantly over time.

INCOME TAXES

Covad Communications made no provision for taxes because it operated at a
loss for the years ended December 31, 1997, 1998 and 1999 and the six months
ended June 30, 2000.

THREE YEARS ENDED DECEMBER 31, 1999

REVENUES

Covad Communications recorded revenues of $66.5 million for the year ended
December 31, 1999. $5.3 million for the year ended December 31, 1998, and
$26,000 for the year ended December 31, 1997. The increase in revenues in all
periods is attributable to growth in the number of customers and end-users
resulting from its increased sales and marketing efforts and the expansion of
its national network. Covad Communications expects revenues to increase in
future periods as it expands its network within its existing regions, deploys
networks in new regions and increases its sales and marketing efforts in all of
its regions.

NETWORK AND PRODUCT COSTS

Covad Communications recorded network and product costs of $55.3 million
for the year ended December 31, 1999, $4.6 million for the year ended December
31, 1998, and $54,000 for the year ended December 31, 1997. The increase in
network costs in all periods is attributable to the expansion of its network and
increased orders resulting from sales and marketing efforts. Covad
Communications expects network and product costs to increase significantly in
future periods due to increased sales activity and expected revenue growth.

SALES, MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES

Sales, marketing, general and administrative expenses were $140.4 million
for the year ended December 31, 1999, $31.0 million for the year ended December
31, 1998, and $2.4 million for the year ended December 31, 1997. Sales,
marketing, general and administrative expenses consist primarily of salaries,
expenses for the development of business, the development of corporate
identification, promotional and advertising materials, expenses for the
establishment of its management team, and sales commissions. The increase in
sales, marketing, general and administrative expense for all years is
attributable to growth in headcount in all areas of Covad Communications
continued expansion of its sales and marketing efforts, deployment of its
network, expansion of its facilities and building of its operating
infrastructure. In addition, in 1999, sales, marketing, general and
administrative increased over 1998 due to its advertising campaign initiated in
1999. Sales, marketing, general and administrative expenses are expected to
increase significantly as Covad Communications continues to expand its business.

DEFERRED COMPENSATION

Through December 31, 1999, Covad Communications recorded a total of
approximately $15.6 million of deferred compensation, with an unamortized
balance of approximately $6.5 million remaining on its December 31, 1999
consolidated balance sheet. Deferred compensation is a result of Covad
Communications' granting stock options to its employees, certain of its
directors, and certain contractors with exercise prices per share below the fair
values per share for accounting purposes of its common stock at the dates of
grant. Covad Communications is amortizing the deferred compensation over the
vesting period of the applicable option using a graded vesting method.
Amortization of deferred compensation was $4.8 million for the year ended
December 31, 1999, $4.0 million for the year ended December 31, 1998, and
$295,000 for the year ended December 31, 1997.

DEPRECIATION AND AMORTIZATION

Depreciation and amortization includes:

o depreciation of network costs and related equipment;

o depreciation of information systems, furniture and fixtures;

33
<PAGE>

o amortization of improvements to central offices, regional data centers
and network operations center facilities and corporate facilities;

o amortization of capitalized software costs; and

o amortization of intangible assets.

In January 1999, Covad Communications recorded intangible assets of $28.7
million from the issuance of preferred stock to AT&T Ventures, NEXTLINK and
Qwest. Amortization of these assets was $8.2 million during the year ended
December 31, 1999, and is included in depreciation and amortization on the
accompanying consolidated statement of operations. Annual amortization of these
assets will be approximately $8.4 million in each of the years in the two-year
period ending December 31, 2001, decreasing to approximately $1.2 million per
year for each subsequent year through the year ending December 31, 2004,
decreasing to approximately $1.2 million per year for each subsequent year
through the year ending December 31, 2004.

Depreciation and amortization was approximately $37.6 million for the year
ended December 31, 1999, $3.4 million for the year ended December 31, 1998, and
$70,000 for the year ended December 31, 1997. The increase for both years was
due to the addition of equipment and facilities placed in service throughout the
year as well as amortization of intangible assets recorded in 1999. Covad
Communications expects depreciation and amortization to increase significantly
as it increases its capital expenditures to expand its network.

NET INTEREST INCOME AND EXPENSE

Net interest expense for the years ended December 31, 1999 1998 and 1997
was $23.8 million, $10.4 million and ($155,000), respectively. Net interest
expense during these periods consisted primarily of interest expense on its 13
1/2% senior discount notes due 2008 issued in March 1998 and its 12 1/2% senior
notes due 2009 issued in February 1999 and capital lease obligations. Net
interest expense was partially offset by interest income earned primarily from
the investment of the proceeds raised from the issuance of the 1998 notes and
the 1999 notes as well as its initial public offering and its issuance of
preferred stock to AT&T Ventures, NEXTLINK and Qwest. Covad Communications
expects interest expense to increase significantly over time, primarily because
the 1998 notes and 1999 notes mature in 2008 and 2009, respectively, and because
Covad Communications issued $425.0 million of new long-term debt in January
2000.

INCOME TAXES

Covad Communications made no provision for taxes because it operated at a
loss for the years ended December 31, 1999, 1998 and 1997.

34
<PAGE>

QUARTERLY FINANCIAL INFORMATION

The following table presents certain unaudited consolidated statements of
operations data for our most recent eight quarters. This information has been
derived from our unaudited consolidated financial statements. In our opinion,
this unaudited information has been prepared on the same basis as the annual
consolidated financial statements and includes all adjustments (consisting only
of normal recurring adjustments) necessary for a fair presentation of the
information for the quarters presented. This information should be read in
conjunction with the consolidated financial statements and related notes
included elsewhere in this prospectus. The operating results for any quarter are
not necessarily indicative of results for any future period.

<TABLE>
<CAPTION>
SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30,
1998 1998 1999 1999 1999 1999 2000 2000
--------- --------- --------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues................. $ 1,565 $ 2,766 $ 5,596 $ 10,833 $ 19,141 $ 30,918 $ 41,807 $ 58,160
Operating Expenses:
Network and products
costs................. 1,355 2,246 4,960 10,565 16,694 23,128 31,349 43,614
Sales, marketing,
general and
administrative........ 10,681 13,812 18,113 24,976 37,697 59,586 85,445 102,462
Depreciation and
amortization.......... 738 2,058 4,647 8,671 10,593 13,691 17,432 24,285
Amortization of goodwill
and other intangible
assets................ -- -- -- -- -- -- 3,350 20,103
Amortization of deferred
compensation.......... 1,837 1,302 1,653 1,234 1,008 873 1,186 725
Write-off of in-process
technology............ -- -- -- -- -- -- 3,726 --
--------- --------- --------- --------- --------- --------- ---------- ----------
Total operating expenses. 14,611 19,418 29,373 45,446 65,992 97,278 142,488 191,189
--------- --------- --------- --------- --------- --------- ---------- ----------
Loss from operations..... (13,046) (16,652) (23,777) (34,613) (46,851) (66,360) (100,681) (133,029)
Net interest income
(expense)............. (3,511) (3,208) (5,127) (7,239) (7,254) (4,176) (7,543) (12,237)
Other income............. -- -- -- -- -- -- 999 13,788
--------- --------- --------- --------- --------- --------- ---------- ----------
Net loss................. (16,557) (19,860) (28,904) (41,852) (54,105) (70,536) (107,225) (131,478)
Preferred dividends...... - - (1,146) - - - - -
Net loss attributable to
common stockholders... $(16,557) $(19,860) $(30,050) $(41,852) $(54,105) $(70,536) $(107,225) $(131,478)
========= ========= ========= ========= ========= ========= ========== ==========
Net loss per share $ (1.23) $ (1.22) $ (0.39) $ (0.41) $ (0.47) $ (0.53) $ (0.73) $ (0.86)
========= ========= ========= ========= ========= ========= ========== ==========
</TABLE>

We have generated increasing revenues in each of the last eight quarters,
reflecting increases in the number of customers and end-users. Our network and
product costs have increased in every quarter, reflecting costs associated with
customer and end-user growth and the deployment of our network in existing and
new regions. Our selling, marketing, general and administrative expenses have
increased in every quarter and reflect sales and marketing costs associated with
the acquisition of customers and end-users, including sales commissions, and the
development of regional and corporate infrastructure. Depreciation and
amortization has increased in each quarter, primarily reflecting the purchase of
equipment associated with the deployment of our networks. We have experienced
increasing net losses on a quarterly basis as we increased operating expenses
and increased depreciation as a result of increased capital expenditures, and we
expect to sustain increasing quarterly losses for at least the next several
years. See "Risk Factors--We have a history of losses and expect increasing
losses in the future." Our annual and quarterly operating results may fluctuate
significantly in the future as a result of numerous factors. Factors that may
affect our operating results include:

o the willingness, timing and ability of traditional telephone companies
to provide us with central office space;

o the rate at which traditional telephone companies can provide us
telephone wires over which we sell our service;

o the rate at which customers subscribe to our services;

o decreases in the prices for our services due to competition,
volume-based pricing and other factors;

o our ability to retain Internet service provider, enterprise and
telecommunications carrier customers and limit end-user churn rates;

o the success of our relationships with strategic partners, and other
potential third parties in generating significant subscriber demand;

o the ability to order or deploy our services on a timely basis to
adequately satisfy end-user demand;

35
<PAGE>

o the mix of line orders between consumer end-users and business
end-users (which typically have higher margins);

o the amount and timing of capital expenditures and other costs relating
to the expansion of our network;

o the ability to develop and commercialize new services by us or our
competitors;

o the impact of regulatory developments, including interpretations of
the 1996 Telecommunications Act; and

o our ability to successfully operate our network.

Many of these factors are outside of our control. In addition, we plan to
increase operating expenses to fund operations, sales, marketing, general and
administrative activities and infrastructure, including increased expenses
associated with our relationships with strategic partners. If these expenses are
not accompanied by an increase in revenues, we could experience a material
adverse effect on our business, prospects, operating results and financial
condition and our ability to service and repay our indebtedness. See "Risk
Factors--Our operating results are likely to fluctuate in future periods and,
therefore, are difficult to predict."

LIQUIDITY AND CAPITAL RESOURCES

Our operations have required substantial capital investment for the
procurement, design and construction of our central office cages, the purchase
of telecommunications equipment and the design and development of our networks.
Capital expenditures were approximately $262.9 million for the six months ended
June 30, 2000. We expect that our capital expenditures will be less in future
periods in connection with the purchase of infrastructure equipment necessary
for the development and expansion of our networks and the development of new
regions.

From our inception through June 30, 2000, we financed our operations
primarily through private placements of $10.6 million of equity securities,
$129.3 million in net proceeds raised from the issuance of the 1998 notes,
$150.2 million in net proceeds raised from our initial public offering, $60.0
million in net proceeds raised from strategic investors, $205.0 million in net
proceeds raised from the issuance of the 1999 notes, $568.8 million in net
proceeds raised from our public offering on November 3, 1999 and $413.3 million
in net proceeds from the issuance of the 2000 notes. As of June 30, 2000, we had
an accumulated deficit of $484.8 million, and cash, cash equivalents, and
short-term investments of $763.2 million.

Net cash used in our operating activities was $105.6 million for the six
months ended June 30, 2000. The net cash used for operating activities during
this period was primarily due to net losses and increases in current assets,
offset by non-cash expenses and increases in accounts payable and accrued
liabilities. Net cash used in our investing activities was $115.2 million for
the six months ended June 30, 2000. The net cash used for investing activities
during this period was primarily due to purchases of property and equipment, the
acquisition of Laser Link, and the proceeds received from the sale of
investments.

Net cash provided by financing activities for the six months ended June 30,
2000 was $427.6 million, which primarily related to the net proceeds of $413.3
million from the issuance of the 2000 notes with an aggregate principal amount
of $425.0 million.

We believe that our current cash, cash equivalents and short-term
investments, including the proceeds received from our recently completed
issuance of 12% senior notes, will be sufficient to meet our anticipated cash
needs for working capital and capital expenditures into the second quarter of
2001.

We expect to experience substantial negative cash flow from operating
activities and negative cash flow before financing activities for at least the
next several years due to continued development, commercial deployment and
expansion of our networks. We may also make investments in and acquisitions of
businesses that are complementary to ours to support the growth of our business.
Our future cash requirements for developing, deploying and enhancing our
networks and operating our business, as well as our revenues, will depend on a
number of factors including:

o the number of regions entered, the timing of entry and services
offered;

o network development schedules and associated costs;

o the rate at which customers and end-users purchase our services and
the pricing of such services;

36
<PAGE>

o the level of marketing required to acquire and retain customers and to
attain a competitive position in the marketplace;

o the rate at which we invest in engineering and development and
intellectual property with respect to existing and future technology;

o existing and future technology; and

o unanticipated opportunities.

We will be required to raise additional capital, the timing and amount of
which we cannot predict. We expect to raise additional capital through debt or
equity financings, depending on market conditions, to finance the continued
development, commercial deployment and expansion of our networks and for funding
operating losses or to take advantage of unanticipated opportunities. If we are
unable to obtain required additional capital or are required to obtain it on
terms less satisfactory than we desire, we may be required to delay the
expansion of our business or take or forego actions, any or all of which could
harm our business.

In addition, we may wish to selectively pursue possible acquisitions of or
investments in businesses, technologies or products complementary to ours in the
future in order to expand our geographic presence and achieve operating
efficiencies. We may not have sufficient liquidity, or we may be unable to
obtain additional debt or equity financing on favorable terms or at all, in
order to finance such an acquisition or investment.

YEAR 2000 ISSUES

Many currently installed computer systems and software products are coded
to accept only two-digit entries in the date code field and cannot distinguish
21st century dates from 20th century dates. These date code fields will need
to distinguish 21st century dates from 20th century dates and, as a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements.

We have reviewed our internally developed information technology systems
and programs and believe that our systems are Year 2000 compliant and that there
are no significant Year 2000 issues within our systems or services. We have not
reviewed our non-information technology systems for Year 2000 issues relating to
embedded microprocessors. To the extent that such issues exist, these systems
may need to be replaced or upgraded to become Year 2000 compliant. We believe
that our non-information technology systems will not present any significant
Year 2000 issues, although there can be no assurance in this regard. In
addition, we utilize third-party equipment and software and interact with
traditional telephone companies that have equipment and software that may not be
Year 2000 compliant. Failure of such third-party or traditional telephone
company equipment or software to operate properly with regard to the year 2000
and thereafter could require us to incur unanticipated expenses to remedy any
problems, which could have a material adverse effect on our business, prospects,
operating results and financial condition.

To date, we have not experienced any problems in complying with Year 2000
requirements, nor have we experienced any operational difficulties related to
Year 2000 issues.

FORWARD-LOOKING STATEMENTS

The statements contained in this prospectus that are not historical facts
are "forward-looking statements" (as such term is defined in Section 27A of the
Securities Act and Section 21E of the Exchange Act), which can be identified by
the use of forward-looking terminology such as "estimates," "projects,"
"anticipates," "expects," "intends," "believes," or the negative thereof or
other variations thereon or comparable terminology, or by discussions of
strategy that involve risks and uncertainties. Examples of such forward-looking
statements include but are not limited to:

o our plans to expand our existing networks or to commence service in
new metropolitan statistical areas;

o estimates regarding the timing of launching our service in new
metropolitan statistical areas;

o expectations regarding the time frames, rates, terms and conditions
for implementing "line sharing;"

o expectations regarding the extent to which enterprise customers roll
out our service;

o expectations regarding our relationships with our strategic partners
and other potential third parties;

37
<PAGE>

o expectations as to pricing for our services in the future;

o expectations as to the impact of our TeleSurfer service offerings on
our margins;

o the possibility that we may obtain significantly increased sales
volumes;

o the impact of our national advertising campaign on brand recognition
and operating results;

o plans to make strategic investments and acquisitions and the affect of
such investments and acquisitions;

o estimates of future operating results;

o plans to develop and commercialize value-added services;

o our anticipated capital expenditures;

o plans to enter into business arrangements with broadband-related
service providers;

o expectations regarding the commencement of our voice service;

o the effect of regulatory reform and regulatory litigation; and

o other statements contained in this prospectus regarding matters that
are not historical facts.

These statements are only estimates or predictions and cannot be relied
upon. We can give you no assurance that future results will be achieved. Actual
events or results may differ materially as a result of risks facing us or actual
results differing from the assumptions underlying such statements. Such risks
and assumptions that could cause actual results to vary materially from the
future results indicated, expressed or implied in such forward-looking
statements include our ability to:

o successfully market our services to current and new customers;

o generate customer demand for our services in the particular regions
where we plan to market services;

o achieve favorable pricing for our services;

o respond to increasing competition;

o manage growth of our operations; and

o access regions and negotiate suitable interconnection agreements with
the traditional telephone companies, all in a timely manner, at
reasonable costs and on satisfactory terms and conditions consistent
with regulatory, legislative and judicial developments.

All written and oral forward-looking statements made in connection with
this prospectus which are attributable to us or persons acting on our behalf are
expressly qualified in their entirety by the "Risk Factors" and other cautionary
statements included in this prospectus. We disclaim any obligation to update
information contained in any forward-looking statement.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to financial market risk, including changes in interest
rates and marketable equity security prices, relates primarily to our investment
portfolio and outstanding debt obligations. We typically do not attempt to
reduce or eliminate our market exposure on our investment securities because a
substantial majority of our investments are in fixed-rate, short-term
securities. We do not have any derivative instruments. The fair value of our
investments portfolio or related income would not be significantly impacted by
either a 100 basis point increase or decrease in interest rates due mainly to
the fixed-rate, short-term nature of the substantial majority of our investment
portfolio. In addition, substantially all of our outstanding indebtedness at
June 30, 2000 including our 1998 notes, our 1999 notes, and our 2000 notes, is
fixed-rate debt.

38
<PAGE>

SELECTED CONSOLIDATED FINANCIAL DATA

The selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and the notes to those
statements included in this prospectus. The consolidated balance sheet data at
December 31, 1998 and 1999 and the consolidated statements of operations data
for the years ended December 31, 1998 and 1999 have been derived from audited
consolidated financial statements included in this prospectus. The consolidated
balance sheet data at June 30, 2000 and the consolidated statements of
operations data for the three months ended June 30, 1999 and 2000 have been
derived from our unaudited consolidated financial statements that are included
elsewhere in this prospectus. The unaudited consolidated financial statements
include, in the opinion of management, all adjustmnets, consisting of normal,
recurring adjustments, necessary for a fair presentation of the information set
forth. We have not presented any financial information prior to January 1, 1998,
due to our limited revenues, expenses and cash flow for the period from
inception (March 7, 1997) to December 31, 1997. See Notes to the audited and
unaudited consolidated financial statements for additional information.

EBITDA consists of net loss excluding net interest, taxes, depreciation
and amortization, including amortization of deferred compensation. We have
presented data related to EBITDA because it is a measure of performance commonly
used in the telecommunications industry to enhance an understanding of operating
results. We believe that EBITDA may be used by investors as supplemental
information to evaluate a company's financial performance, including its ability
to incur and/or service debt. However, EBITDA may be needed to make other
payments prior to servicing debt. Negative EBITDA implies that a company is not
currently generating sufficient income to fund its operations or service its
debt. Our calculation of EBITDA may not be comparable to that of other
companies.

EBITDA is not a measure of performance under generally accepted
accounting principles and should not be used as a substitute for net income, net
cash provided by operating activities or other operating or cash flow statement
data prepared in accordance with generally accepted accounting principles.

EBITDA and cash flows from operating activities reflected in the
statement of cash flows differ significantly. Cash from operating activities
is net of interest and taxes paid and is a more comprehensive determination of
periodic income on a cash (rather than accrual) basis, exclusive of non-cash
items of income and expenses such as depreciation and amortization. In contrast,
EBITDA is derived from accrual basis income and is not reduced by cash invested
in working capital. Consequently, EBITDA is not affected by the timing of
receivable collections or when accrued expenses are paid.

<PAGE>

SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
OF BLUESTAR COMMUNICATIONS GROUP, INC.

YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
------------------------------ ------------------------------
1998 1999 1999 2000
-------------- -------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
-------------------------------------------------
Revenue.......................................... $ 12,101 $ 771,108 $ 136,211 $ 3,625,031

Operating Expenses:
Network and product costs..................... 199,973 8,082,759 950,659 20,612,551
Selling and marketing......................... 76,572 4,809,590 323,581 17,349,024
General and administrative.................... 426,250 6,949,442 863,145 12,235,957
Amortization of deferred compensation......... -- 425,840 3,976 1,095,963
Depreciation & amortization................... 28,402 263,972 24,493 1,934,852
-------------- -------------- -------------- --------------
Total Operating Expenses.................... 730,197 20,531,603 2,165,854 53,228,347
-------------- -------------- -------------- --------------
Loss from Operations............................. (718,096) (19,760,494) (2,029,643) (49,603,316)

Net Interest Income (expense).................... 467 541,714 40,010 403,319
One time charges & debt fees..................... -- -- -- (1,454,244)
-------------- -------------- -------------- --------------
Net Loss......................................... $ (717,629) $ (19,218,780) $ (1,989,633) $ (50,654,241)
============== ============== ============== ==============
Net loss per share:..............................
Basic and diluted............................. $ (0.07) $ (2.15) $ (0.19) $ (5.31)
============== ============== ============== ==============
Weighted average shares....................... 10,154,010 8,959,153 10,425,501 9,539,643
============== ============== ============== ==============

Other Data:
EBITDA........................................ $ (689,694) $ (19,070,682) $ (2,001,074) $ (48,026,745)
Net cash used in operating activities......... (496,606) (12,842,434) (1,277,479) (36,611,549)
Net cash used by investing activities......... (89,556) (12,023,658) (1,236,441) (15,503,185)
Net cash provided by financing activities..... 1,087,773 37,266,188 6,182,071 40,133,696

Balance Sheet Data:
Cash and cash equivalents..................... $ 501,611 $ 12,901,707 $ 920,669
Working capital (deficit), excluding cash and
cash equivalents............................ (347,621) (7,294,784) (25,600,888)
Total assets.................................. 671,246 26,506,367 31,649,660
Redeemable convertible preferred stock........ -- 37,016,697 70,991,697
Total stockholders' deficit................... (29,048) (18,882,097) (68,073,505)
</TABLE>

<PAGE>

BLUESTAR MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

BlueStar provides broadband communications and Internet access services to
small- and medium-sized businesses in Tier 2 and Tier 3 markets. It initiated
its service in September 1998 and rapidly began to deploy its network in the
fourth quarter of 1999. As of June 30, 2000, BlueStar provided services in 38
markets, representing 131 cities.

When BlueStar enters a new market, it establishes a local market presence,
incurring significant selling and marketing and general and administrative
expenses. As part of entering a new market, BlueStar leases equipment from
Lucent and contracts with it or another third party to install the equipment
into targeted central offices. These operating leases and central office
installation expenses are expensed as network and product costs. Once BlueStar
has deployed its network in a market, additional expenditures primarily include
leasing costs associated with DSL line cards and customer premise equipment.

BlueStar derives a majority of its revenues from Internet access and
broadband communications services, including real private networking (RPN)
services. BlueStar offers its services directly to customers at retail prices.
BlueStar bills its customers monthly for recurring charges based on the data
transfer speeds selected by the customer. BlueStar currently offers flat rate
plans at prices that include its fully bundled Internet services and its
high-speed access and connectivity services on contracts with terms generally
ranging from one to three years. In addition to monthly service fees, BlueStar
bills customers for nonrecurring service activation, equipment and installation
charges. On occasion, BlueStar reduces or waives equipment or installation
charges to encourage potential customers to enter into multi-year contracts.
BlueStar expects that prices for its services will decline over time as a result
of competition and changes in its product mix.

BlueStar's expenses are recognized as incurred and consist of the following
principal categories:

o network and product costs, which consist primarily of equipment costs,
access charges and technical salaries;

o selling and marketing expenses, which consist primarily of advertising
costs, compensation and related expenses;

o general and administrative expenses, which consist primarily of
corporate, management and administrative salaries and corporate office
expenses; and

o depreciation and amortization expenses, which include non-cash charges
related to property and equipment and collocation fees.

BlueStar incurred operating losses, net losses and negative earnings before
interest, taxes, depreciation and amortization, including amortization of
deferred compensation, or EBITDA. As of June 30, 2000, BlueStar had total
stockholders' deficit of $68.1 million.

BlueStar incurred stock compensation expense as a result of the granting of
stock options to employees and others with exercise prices per share
subsequently determined to be below the fair values per share of its common
stock for financial reporting purposes at the dates of grant. The stock
compensation is being charged immediately or is being amortized over the vesting
period of the applicable options, which is generally 48 months.

BlueStar's consolidated financial statements include the activity of
BlueStar Communications, LLC and BlueStar Properties, Inc., a Tennessee
corporation, as predecessor entities. Revenue, expense and cash flow

41
<PAGE>

information for the period from its inception on March 7, 1997 to December 31,
1997 were all less than $6,700, and, as a result, BlueStar has not included a
full set of consolidated financial statements for 1997.

RESULTS OF OPERATIONS

SIX MONTHS ENDED JUNE 30, 1999 AND 2000

REVENUES

BlueStar recorded revenues of $3.6 million for the six months ended June
30, 2000, and $136,211 for the six months ended June 30, 1999. This increase is
attributable to growth in the number of BlueStar customers resulting from its
increased sales and marketing efforts and the expansion of BlueStar's network in
the Southeast. As of June 30, 2000 and June 30, 1999, BlueStar had sold 9,067
and 87 high-speed access lines, respectively. BlueStar had installed 3,694 and
58 lines at June 30, 2000 and June 30, 1999, respectively. Average recurring
revenues per installed line for the six months ended June 30, 2000 were
approximately $230 per month.

BlueStar earns revenues from recurring monthly service and non-recurring
equipment sales and installation charges. During 1999 and the six months ended
June 30, 2000, approximately 45% and 32% of total revenues was non-recurring,
respectively. BlueStar recognizes expenses related to non-recurring revenues in
the same period as it recognizes the revenue.

NETWORK AND PRODUCT EXPENSES

Network and product expenses were $20.6 million for the six months ended
June 30, 2000, and $1.0 million for the six months ended June 30, 1999. This
increase is attributable to the increased operational needs of BlueStar's
network and increased orders resulting from sales and marketing efforts.
Operating lease expenses for network equipment increased to $3.1 million for the
six months ended June 30, 2000, from $0.5 million for the six months ended June
30, 1999. The remainder of the increase is primarily attributable to network
circuit backhaul, Internet access costs and salaries and wage expense.

SELLING AND MARKETING EXPENSES

BlueStar recorded selling and marketing expenses of $17.3 million for the
six months ended June 30, 2000, and $0.3 million for the six months ended June
30, 1999. This increase is attributable to a $9.9 million increase in salaries,
wage and sales commission expense, a $2.4 million increase in advertising
expense, and a $1.6 million increase in employee benefit expense.

GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative expenses increased to $12.2 million for the six
months ended June 30, 2000, from $0.9 million for the six months ended June 30,
1999. This increase is primarily attributable to a $3.6 million increase in
salaries, wages and consulting expense, a $1.2 million increase in recruiting
and relocation expense, a $1.5 million increase in office rent and equipment
expense, and a $0.8 million increase in phone expenses.

AMORTIZATION OF DEFERRED COMPENSATION

Amortization of deferred compensation increased to $1.1 million during the
six months ended June 30, 2000 from $3,967 for the six months ended June 30,
1999.

DEPRECIATION AND AMORTIZATION

Depreciation and amortization expenses were $1.9 million for the six months
ended June 30, 2000, and $24,493 for the six months ended June 30, 1999. The
increase was due to an increase in equipment and facilities placed in service
throughout the period and the installation of BlueStar's internal hardware and
software systems.

INCOME TAXES

For the six months ended June 30, 2000, and June 30, 1999, BlueStar
recognized no tax benefits with regard to operating losses due to the
uncertainty of future taxable income sufficient to utilize the losses during the
periods.

42
<PAGE>

TWO YEARS ENDED DECEMBER 31, 1998 AND 1999

REVENUES

BlueStar recorded revenues of $0.8 million for the year ended December 31,
1999, and $12,101 for the year ended December 31, 1998. This increase is
attributable to growth in the number of BlueStar customers resulting from its
increased sales and marketing efforts and the expansion of its networks in the
Southeast. As of December 31, 1999 and December 31, 1998, BlueStar had sold
1,224 and five lines, respectively. BlueStar had installed 428 and five lines at
December 31, 1999 and December 31, 1998, respectively. Average recurring
revenues per installed line for 1999 were approximately $330 per month. During
1999, approximately 45% of total revenues was non-recurring.

NETWORK AND PRODUCT EXPENSES

Network and product expenses were $8.1 million for the year ended December
31, 1999, and $0.2 million for the year ended December 31, 1998. This increase
is attributable to the increased operational needs of the network and increased
orders resulting from sales and marketing efforts. Operating lease expenses for
network equipment were $2.9 million for 1999, and $128,896 for 1998. The
remainder of the increase is primarily attributable to network circuit backhaul
and Internet access costs and salaries and wage expense.

SELLING AND MARKETING EXPENSES

BlueStar recorded selling and marketing expenses of $4.8 million for the
year ended December 31, 1999, and $76,572 for the year ended December 31, 1998.
This increase is attributable to a $2.3 million increase in salaries and wage
expense, a $0.9 million increase in advertising expense, a $0.6 million increase
in recruiting expense and a $0.5 million increase in sales commission expense.

GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative expenses increased to $6.9 million for the year
ended December 31, 1999, from $0.4 million for the year ended December 31, 1998.
This increase is attributable to a $2.4 million increase in salaries, wages and
consulting expense, a $1.1 million increase in recruiting and relocation expense
and a $0.4 million increase in office rent.

AMORTIZATION OF DEFERRED COMPENSATION

Amortization of deferred compensation was $0.4 million during the year
ended December 31, 1999. BlueStar did not incur any deferred compensation for
the year ended December 31, 1998. Through December 31, 1999, BlueStar recorded
$3.6 million of deferred compensation, with an unamortized balance of
approximately $3.2 million as of December 31, 1999.

DEPRECIATION AND AMORTIZATION

Depreciation and amortization expenses were $0.3 million for the year ended
December 31, 1999, and $28,402 for the year ended December 31, 1998. The
increase was due to an increase in equipment and facilities placed in service
throughout the period and the installation of internal hardware and software
systems.

INCOME TAXES

For the years ended December 31, 1999 and December 31, 1998, BlueStar
recognized no tax benefits with regard to operating losses due to the
uncertainty of future taxable income sufficient to utilize the losses during the
periods.

43
<PAGE>

SELECTED QUARTERLY RESULTS OF OPERATIONS

The following tables set forth BlueStar's unaudited consolidated statements
of operations data for the four fiscal quarters ended December 31, 1999 and the
first and second fiscal quarters ended March 31, 2000 and June 30, 2000
respectively. This unaudited quarterly information has been prepared on the same
basis as BlueStar's audited consolidated financial statements and, in the
opinion of BlueStar's management, reflects all normal recurring adjustments that
BlueStar considers necessary for a fair presentation of the information of the
periods presented. Operating results for any three month period are not
necessarily indicative of results for any future period.

MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30,
1999 1999 1999 1999 2000 2000
---------- ------------ ----------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Revenues............................. $ 34,534 $ 101,677 $ 208,481 $ 426,417 $ 1,131,593 $ 2,493,438
Operating expenses:
Network and product costs......... 245,683 704,976 1,840,033 5,292,067 8,265,728 12,346,823
Selling and marketing............. 85,166 238,415 905,480 3,580,529 7,914,871 9,434,153
General and administrative........ 241,990 621,155 1,907,683 4,178,614 5,304,594 6,931,363
Amortization of deferred
compensation.................... -- 3,976 33,505 388,359 548,846 547,117
Depreciation and amortization..... 6,858 17,635 18,666 220,813 720,658 1,214,194
---------- ------------ ----------- ------------- ------------ ------------
Total operating expenses........ 579,697 1,586,157 4,705,367 13,660,382 22,754,697 30,473,650
---------- ------------ ----------- ------------- ------------- ------------
Loss from operations................. (545,163) (1,484,480) (4,496,886) (13,233,965) (21,623,104) (27,980,212)
Net interest (expense) income........ (187) 40,197 185,439 316,265 279,282 124,037
One time charges and debt fees....... (1,454,244)
Net loss........................ $(545,350) $(1,444,283) $(4,311,447) $(12,917,700) $(21,343,822) $(29,310,419)
========== ============ ============ ============= ============= =============
</TABLE>

BlueStar has increased revenues in each of the last five quarters,
reflecting increases in the number of its installed customer base. BlueStar's
network and product costs have increased in every quarter, reflecting costs
associated with customer growth and the deployment of its network in existing
and new markets. The expenses related to network operating leases were $149,802,
$378,020, $847,501 and $1.5 million for the first, second, third and fourth
quarters of 1999, respectively. The expenses related to network operating leases
were $1.6 million and $1.6 million for the quarters ended March 31, 2000 and
June 30, 2000 respectively. BlueStar's selling and marketing expenses have
increased in every quarter, reflecting sales and marketing costs associated with
the acquisition of customers, including sales commissions. General and
administrative expenses have increased in every quarter and reflect costs
associated with the development of regional and corporate infrastructure.
Depreciation and amortization has increased in each quarter, primarily
reflecting the purchase of equipment associated with the deployment of
BlueStar's network. BlueStar has experienced increasing net losses on a
quarterly basis as it has increased operating expenses and incurred network
build-out costs. BlueStar expects to sustain increasing quarterly losses for the
foreseeable future.

BlueStar's quarterly revenue and operating results are difficult to predict
and may fluctuate significantly from quarter to quarter as a result of a variety
of factors, many of which are outside BlueStar's control, including:

o amount and timing of expenditures relating to the rollout of
BlueStar's network and services'

o ability to obtain and the timing of necessary regulatory approvals;

o rate at which BlueStar is able to attract customers within its target
markets and its ability to retain those customers at sufficient
aggregate revenue levels;

o ability to deploy BlueStar's network on a timely basis;

o availability of financing to continue BlueStar's expansion;

o technical difficulties or network downtime;

o availability of collocation space in traditional telephone companies'
central offices and timing of the installation of BlueStar's
equipment in those spaces; and

o introduction of new services or technologies by our competitors and
resulting pressures on the pricing of BlueStar's services.

44
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

As of June 30, 2000, BlueStar had a stockholders' deficit of $68.1 million
and cash and cash equivalents of approximately $0.9 million. For the six months
ended June 30, 2000 and June 30, 1999, the net cash used in BlueStar's operating
activities was approximately $39.7 million and $1.3 million, respectively.
During 1999 and 1998, the net cash used in BlueStar's operating activities was
approximately $12.8 million and $0.5 million, respectively. This cash was used
for a variety of operating purposes, including personnel costs, consulting and
legal expenses, network operations and other administrative expenses.

The net cash used in investing activities for the six months ended June 30,
2000 and June 30, 1999 was approximately $13.2 million and $1.2 million
respectively. During 1999 and 1998, net cash used in investing activities was
$12.0 million and $89,556, respectively. Net cash used in investing activities
primarily resulted from collocation costs and the purchase of networking and
other equipment.

Net cash provided by financing activities for the six months ended June 30,
2000 and June 30, 1999 was approximately $40.9 million and $6.1 million,
respectively. During 1999 and 1998, net cash provided by financing activities
was approximately $37.3 million and $1.1 million, respectively. Net cash
provided by financing activities primarily resulted from the sale of common and
preferred stock and borrowings against the Lucent working capital line of
credit.

During the year ended December 31, 1998, BlueStar sold 1,725,000 shares of
common stock to an initial round of investors at a price of $0.33 per share,
resulting in net proceeds to it of $575,000.

In March 1999, BlueStar issued 12,345,003 shares of redeemable,
convertible, voting preferred stock designated as Series A preferred stock for
$0.49 per share. In August 1999, BlueStar issued 8,177,040 shares of redeemable,
convertible, voting preferred stock designated as Series B preferred stock for
$3.80 per share. BlueStar received $37,149,060 in total net proceeds from the
sale of Series A and Series B preferred stock.

During 1999, BlueStar repurchased 2,020,971 shares of common stock from one
of its founders at a cost of $99,030. In January 2000, BlueStar repurchased
1,784,935 shares of common stock from one of its founders for $0.049 per share
at a cost of $87,462.

In January and February 2000, BlueStar issued 2,165,603 shares of
redeemable, convertible, voting preferred stock designated as Series C preferred
stock for $15.70 per share. BlueStar received $33,975,000 in net proceeds from
the sale of the Series C preferred stock.

In 1998 and 1999, BlueStar borrowed a total of $1.0 million from Lucent
under a credit agreement, which bears interest at 8.5% for the first $500,000
and 7.75% for the second $500,000, and which amounts mature in August 2001 and
February 2002, respectively. The credit agreement provides for maximum borrowing
of $1.0 million.

In December 1999, BlueStar issued a short-term note in the amount of
$541,526 to Oracle Corporation to finance software. The note bears interest at
an annual rate of 15% with equal monthly principal and interest payments of
$58,704 through October 2000.

In May 1999, BlueStar entered into an equipment operating lease facility
with Ascend, which later merged with Lucent, that provides up to $109.0 million
of equipment and network services provided by Lucent and other third party
vendors for equipment utilized in BlueStar's central office and multi-tenant
building installations. Under the terms of the Lucent facility, BlueStar is
required to use Lucent as a vendor if its equipment meets competitive price and
performance standards. If BlueStar fails to make required payments under the
facility, Lucent may terminate the facility and take back its equipment. The
first tranche of $30.0 million is available to BlueStar through July 2001.
BlueStar may utilize up to $30.0 million under the equipment lease facility
without restriction, and may utilize up to $50.0 million under this facility
upon meeting certain equity requirements, which BlueStar has satisfied.
Utilization of amounts in excess of $50.0 million requires that BlueStar
maintain a minimum of $10.0 million of unrestricted cash. As of June 30, 2000,
BlueStar had utilized $ 50.5 million of the facility and had $124.5 million
available under the Lucent equipment lease facility. The lease payments are due
through 2002.

In April 2000, BlueStar renegotiated the Lucent equipment operating lease
facility to provide an additional $66.0 million of equipment and network service
financing. At June 30, 2000, BlueStar had utilized $50.5 million of the facility
and had $124.5 million available.

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<PAGE>

In April 2000, BlueStar entered into an equipment operating lease facility
with Cisco Systems Capital that provides up to $50.0 million of equipment and
network services provided by Cisco. BlueStar may utilize up to $10.0 million of
the facility provided it maintains an average minimum cash balance of not less
than $2.0 million. Utilization of amounts in excess of $10.0 million require
that BlueStar maintain an average minimum cash balance of not less than
$7.0 million.

In June 2000, BlueStar entered into a $40.0 million demand loan agreement
with Bear Stearns Corporate Lending Inc. Under the terms of the loan agreement,
BlueStar may request up to $5.0 million every two weeks, not to exceed an
aggregate of $40.0 million. Bear Stearns, however, is not obligated to provide
any portion of the requested amount. Any amounts borrowed under the loan
agreement bear interest, at BlueStar's discretion, at either (1) the prime rate
publicly announced by Citibank, N.A. plus 600 basis points or (2) the interest
rate which eurodollar deposits for one month are offered in the interbank
eurodollar market plus 700 basis points. Under either interest rate election,
the minimum interest rate is 13.0%. The loan agreement matures at the earliest
of (1) demand by Bear Stearns, (2) the date of commencement by or against
BlueStar or any of its subsidiaries of any bankruptcy proceeding, (3)
termination of the merger agreement in accordance with its terms, (4)
consummation of the merger with Covad Communications or any other change in
control of BlueStar or (5) December 15, 2000.

During 2000, BlueStar entered into additional operating leases for
equipment with a market value of approximately $34.4 million under the Lucent
equipment lease facility, primarily for equipment and network services. In
addition, BlueStar expects to make capital expenditures of approximately
$12.0 million during 2000 that will be used primarily for software, furniture
and fixtures for its corporate and regional offices.

The development and expansion of BlueStar's business requires significant
capital expenditures. The principal capital expenditures incurred to enter each
market include the procurement, design and construction of collocation space. In
addition, BlueStar enters into significant operating lease obligations with
Lucent to acquire and install necessary telecommunications equipment. The number
of central offices that BlueStar expects to target in a given market will vary,
as will the average capital cost to enter a market.

If the merger with Covad Communications does not occur, BlueStar believes
that cash generated from operations and amounts available under its commercial
credit facilities will not be sufficient to meet its expected working capital
and capital expenditure requirements for the next 12 months. BlueStar will be
required to raise additional funds through private or public sales of
securities, bank debt, financing under leasing arrangements or otherwise, the
availability of which cannot be assessed.

QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK

Due to the nature of its short-term investments, BlueStar has concluded
that it has no material market risk exposure.

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<PAGE>

BUSINESS

THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE
RISKS AND UNCERTAINTIES. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE
ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS
INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED IN "RISK FACTORS" AND ELSEWHERE
IN THIS PROSPECTUS. WE DISCLAIM ANY OBLIGATION TO UPDATE INFORMATION CONTAINED
IN ANY FORWARD-LOOKING STATEMENT. SEE "COVAD MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--FORWARD LOOKING
STATEMENTS."

OVERVIEW

We are a leading provider of broadband communications services to Internet
service provider, enterprise telecommunications carrier and other customers.
These services include a range of high-speed, high capacity Internet and network
access services using digital subscriber line (DSL) technology, and related
value-added services. Internet service providers purchase our services in order
to provide high-speed Internet access to their business and consumer end-users.
Enterprise customers purchase our services directly or indirectly from us to
provide employees with high-speed remote access to the enterprise's local area
network (RLAN access), which improves employee productivity and reduces network
connection cost. Telecommunications carrier customers purchase our services for
resale to their Internet service provider affiliates, Internet users and
enterprise customers.

As of June 30, 2000, we believe we have the nation's largest DSL network
with 1,700 operational central offices passing over at least 42 million homes
and businesses. As of June 30, 2000, we had installed 138,000 DSL based
high-speed access lines and received orders for our services from more than 295
Internet service provider, enterprise, and telecommunications carrier customers,
including AT&T, Concentric Network, Flashcom, MindSpring Enterprises Inc. (now
Earthlink, Inc.), Oracle Corporation, Prodigy Communications Corporation,
PSINet, Qwest Communications International Inc., Stanford University, Sun
Microsystems, UUNET Technologies (an MCI WorldCom Company) and Verio.

By June 30, 2000, we had deployed our network in a total of 81 metropolitan
statistical areas. When our 165 metropolitan statistical area (MSA's) build-out
is completed, which we expect to be by the end of 2000, our network will pass
more than 45% of homes and 50% of businesses in the United States.

We plan to continue to pursue rapid network expansion and installation of
high-speed access lines, and to develop a variety of services that are enhanced
or enabled by our expanding network, by entering into business arrangements with
broadband-related service providers in order to bring a variety of value-added
service offerings to our customers and their end-users.

INDUSTRY BACKGROUND

GROWING MARKET DEMAND FOR BROADBAND COMMUNICATIONS BANDWIDTH SERVICES

High-speed connectivity has become important to small- and medium-sized
businesses and consumers due to the dramatic increase in Internet usage.
According to International Data Corporation, the number of Internet users
worldwide reached approximately 196 million in 1999 and is forecasted to grow to
approximately 502 million by 2003. The popularity of the Internet with consumers
has driven the rapid proliferation of the Internet as a commercial medium.
Businesses are increasingly establishing Web sites and corporate intranets and
extranets to expand their customer reach and improve their communications
efficiency. Consumers are increasingly using the Internet to carry out
commercial transactions. International Data estimates that the value of goods
and services sold world wide via the Internet will increase from $111 billion in
1999 to over $1.3 trillion in 2003. Accordingly, to remain competitive, small-
and medium-sized businesses increasingly need high-speed Internet connections to
maintain complex Web sites, access critical business information and communicate
more effectively with employees, customers and business partners. Broadband
connections are also becoming increasingly important to businesses and consumers
as rich Internet content--such as multi-media advertising, news and
entertainment--and on-line consumer transactions and e-commerce become more
widely available and widely used.

The demand for broadband communications services for RLAN access is also
growing rapidly. Over the past ten years, high-speed local area networks have
become increasingly important to enterprises to enable employees to share
information, send e-mail, search databases and conduct business. We believe that
a large majority of personal computers used in enterprises are connected to
local area networks. Enterprises are now seeking to extend this same

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<PAGE>

high-speed connectivity to employees accessing the local area networks from home
to improve employee productivity and reduce operating costs. The number of home
office households on the Internet grew from 12.0 million at the end of 1997 to
an estimated 27 million by the end of 1999 and is expected to grow to 30.2
million households by 2002. Only 3.7% of these users currently access the
Internet through a broadband connection of any type.

As use of the Internet, intranets and extranets increases, we expect the
market size for both small- and medium-sized business and consumer Internet and
RLAN access to continue to grow rapidly causing the demand for broadband
communications services to also grow rapidly. However, the full potential of
Internet and local area network applications cannot be realized without removing
the performance bottlenecks of the existing public switched telephone network.
Increases in telecommunications bandwidth have significantly lagged improvements
in microprocessor performance over the last ten years. Since 1988,
microprocessor performance has improved nearly 80-fold, while the fastest
consumer modem connection has improved from 9.6 kilobits per second to 56.6
kilobits per second, a factor of six. According to industry analysts, there are
nearly 40 million personal computers in U.S. homes today, and most of them can
only connect to the Internet or their corporate local area network by low-speed
analog lines. Higher speed connections are available, including:

o INTEGRATED SERVICES DIGITAL NETWORKS--An ISDN line provides standard
interfaces for digital communication networks and is capable of
carrying data, voice, and video over digital circuits. ISDN protocols
are used worldwide for connections to public ISDN networks or to
attach ISDN devices to compatible PBX systems.

o T1 LINE AND FRACTIONAL T1--These are telephone industry terms for a
digital transmission link with a capacity of 1.544 megabits per second
or portions thereof.

o FRAME-RELAY--A high-speed packet-switched data communications
protocol.

o CABLE MODEM--Internet access over hybrid fiber coaxial cable.

While these services have recently experienced dramatic growth in the U.S.,
they are frequently expensive, complex to order, install and maintain, and in
some cases are not as widely available as DSL technology.

EMERGENCE OF DSL TECHNOLOGY

DSL technology first emerged in the 1990s and is commercially available
today to address performance bottlenecks of the public switched telephone
network. DSL equipment, when deployed at each end of standard copper telephone
lines, increases the data carrying capacity of copper telephone lines from
analog modem speeds of 56.6 kilobits per second, for the fastest consumer
modems, and ISDN speeds of 128 kilobits per second to DSL speeds of up to 6
megabits per second depending on the length and condition of the copper line.
Recent advances in semiconductor technology and digital signal processing
algorithms and falling equipment prices have made the widespread deployment of
DSL technology more economical over time. We anticipate that equipment prices
will continue to fall as a result of continued advances in semiconductor
technologies and increases in equipment production volumes.

Because DSL technology reuses the existing copper plant, it is
significantly less expensive to deploy on a broad scale than alternative
technologies, such as cable modems, wireless data and satellite data. As a
result, a significant portion of the investment in a DSL network is
success-based, requiring a comparatively lower initial fixed investment.
Subsequent variable investments in DSL technology are directly related to the
number of paying customers.

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<PAGE>

IMPACT OF REGULATORY DEVELOPMENTS

The passage of the 1996 Telecommunications Act created a legal framework
for competitive telecommunications companies to provide local analog and digital
communications services in competition with the traditional telephone companies.
The 1996 Telecommunications Act eliminated a substantial barrier to entry for
competitive telecommunications companies by enabling them to leverage the
existing infrastructure built by the traditional telephone companies, which
required a $200 billion investment by these telephone companies and their
ratepayers, rather than constructing a competing infrastructure at significant
cost. The 1996 Telecommunications Act requires traditional telephone companies,
among other things:

o to allow competitive telecommunications companies to lease telephone
wires on a line by line basis;

o to provide central office space for the competitive telecommunications
companies' DSL and other equipment required to connect to the leased
telephone wires;

o to lease access on their inter-central office fiber backbone to link
the competitive telecommunications companies' equipment; and

o to allow competitive telecommunications companies to electronically
connect into their operational support systems to place orders and
access their databases.

The 1996 Telecommunications Act, as interpreted by the Federal
Communications Commissions (FCC), in particular emphasized the need for
competition-driven innovations in the deployment of advanced telecommunications
services, such as DSL services.

OUR COMPETITIVE STRENGTHS

We were formed to capitalize on the substantial business opportunity
created by the growing demand for broadband Internet and network access, the
commercial availability of low-cost DSL technology and the passage of the 1996
Telecommunications Act. Key aspects of our solution to provide broadband
communications services include:

o an attractive value proposition that provides high-speed connections
at similar or lower prices than alternative high-speed technologies
currently available to customers;

o a rapid network deployment and service rollout with significant
increases in line installations to date;

o a widely available, continuously connected, secure network that
facilitates deployment of Internet and intranet applications; and

o a management team experienced in the data communications,
telecommunications and personal computer industries.

ATTRACTIVE VALUE PROPOSITION. We offer higher bandwidth digital connections
than alternative services at similar or lower prices that do not vary with
usage. For business Internet users, our high-end services offer bandwidth
comparable to that offered by T1 and frame-relay circuits at approximately 25%
of the cost. For the RLAN market, our mid-range services are three to six times
the speed of ISDN lines and up to ten times the speed of analog modems at
monthly rates similar to or lower than those for heavily used ISDN lines. We
believe that many of our enterprise customers can justify deploying lines to
their employees if their productivity improves by only a few hours per month
based on increases in the number of hours worked and decreases in commute time
and time spent waiting for information. For consumer Internet users, our
consumer services are comparably priced to current cable modem services. Unlike
cable modems, the speed of our service does not decrease when more users are
added.

WE HAVE LEVERAGED OUR FIRST-MOVER ADVANTAGE TO RAPIDLY EXPAND OUR NETWORK
AND GROW OUR NUMBER OF LINES INSTALLED. We were the first to widely roll out DSL
services on a commercial basis, making DSL service available for purchase in the
San Francisco Bay Area in December 1997. We believe that we have leveraged our
first-mover advantage to rapidly expand our network into our targeted
metropolitan regions and grow our number of line installations. We believe we
have the nation's largest DSL network with more than 1,700 operational central
offices passing over more than 42 million homes and businesses. As of June 30,
2000, we had installed a total of 138,000 lines nationwide.

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<PAGE>

WIDELY AVAILABLE, ALWAYS-CONNECTED SECURE NETWORK. Our strategy of
providing blanket coverage in each region we serve is designed to ensure that
our services are available to the vast majority of our customers' end-users. Our
network provides 24-hour, always-on connectivity, unlike ISDN lines and analog
modems which require customers to dial-up each time for Internet or RLAN access.
Also, because we use dedicated connections from each end-user to the Internet
service provider or enterprise network, our customers can reduce the risk of
unauthorized access. These factors are important to our customers because any
Internet service they market to their end-users must actually be available for
them to purchase and be secure enough to not risk their own reputation or
business with any security lapses.

EXPERIENCED MANAGEMENT TEAM. Our management team includes individuals with
extensive experience in the data communications, telecommunications and personal
computer industries, including Robert Knowling, Jr., Chairman of the Board,
President and Chief Executive Officer (former Executive Vice President of
Operations and Technology at U S WEST Communications), Catherine Hemmer,
Executive Vice President and Chief Operations Officer (former Vice President,
Network Reliability and Operations at U S WEST Communications, Inc., former
General Manager, Network Provisioning at Ameritech Corporation and former Vice
President, Network Services at MFS), John McDevitt, Executive Vice President,
Sales and Marketing (former Vice President of Sales and Marketing at Danly IEM
and former Business Director at Praxair, Inc.), Mark Perry, Executive Vice
President and Chief Financial Officer (former Vice President and Corporate
Officer, Finance & Administration of U S WEST Communications), Robert Davenport,
III, Executive Vice President, Business Development (former Senior Vice
President and Chief Operating Officer of Tele-Communication, Inc.'s Internet
Services subsidiary TCI.NET), Joseph Devich, Executive Vice President, Corporate
Services (former Vice President, Operations and Technologies Staff of U S WEST
Communications), Dhruv Khanna, Executive Vice President, General Counsel and
Secretary, Jane Marvin, Executive Vice President of Human Resources (former Vice
President of Human Resources for the General Business Services unit of Ameritech
Corporation), Terry Moya, Executive Vice President, External Affairs (former
Vice President & Chief Financial Officer, Capital Management, Network Operations
and Technologies at U S WEST Communications, Inc), Michael Lach, Executive Vice
President, Corporate Development and Business Integration (former Vice
President, Customer Provisioning and Maintenance of Ameritech Corporation); and
Jimmy La Valley, Executive Vice President, Community Relations (former Vice
President, Human Resources at US WEST).

BUSINESS STRATEGY

EXPAND OUR NETWORK AND ROLL OUT SERVICE RAPIDLY IN OUR TARGETED
METROPOLITAN STATISTICAL AREAS. As of June 30, 2000, we introduced our services
in 81 of the top metropolitan statistical areas nationwide. We plan to expand
our services to a total of 165 metropolitan statistical areas by the end of
2000. In the aggregate, these 165 metropolitan statistical areas cover more than
45% of homes and 50% of businesses in the United States. In addition, we have
recently begun to assess the regulatory and competitive environments in other
countries.

PROVIDE PERVASIVE COVERAGE IN EACH METROPOLITAN STATISTICAL AREA. We are
pursuing a blanket coverage strategy of providing service in a substantial
majority of the central offices in each region that we enter since our Internet
service provider customers desire to market their Internet access services on
region-wide basis. Blanket coverage is also important to our enterprise
customers since most of them desire to offer RLAN access to all employees
regardless of where they reside. In addition, we believe our presence in 165
metropolitan statistical areas will allow us to better serve our Internet
service provider, enterprise, telecommunications carrier and other customers.
These customers are increasingly seeking a single supplier in multiple
metropolitan areas.

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ESTABLISH AND MAINTAIN SALES AND MARKETING RELATIONSHIPS WITH LEADING
INTERNET SERVICE PROVIDERS, TELECOMMUNICATIONS CARRIERS AND OTHER DSL RESELLERS.
We principally target Internet service providers, telecommunications carriers
and other DSL resellers that can offer their end-users cost and performance
advantages for Internet access using our services. We primarily provide
connections to Internet service providers, which in turn offer high-speed
Internet access using our network. In other cases, we provide wholesale DSL and
Internet access services for resale by our customers such as Prodigy
Communications Corporation and Juno Online Services. In this way, we:

o carry the traffic of multiple Internet service providers,
telecommunications carriers and other customers in any region,
increasing our volume and reducing our costs;

o leverage our selling efforts through the sales and support staff of
these Internet service providers, telecommunications carriers and
other customers;

o provide Internet service providers, telecommunications carriers and
other customers a high-speed service offering to compete with
cable-based Internet access.

DEVELOP A NATIONAL BRAND. We believe that we can enhance our competitive
position and increase demand for our services by actively developing a positive
brand and image for our Company and our services through a combination of
television, print and radio advertisements on both a national and local basis.
In October 1999, we commenced a significant national advertising campaign in
pursuit of this strategy. This branding strategy has created the opportunity
fours to provide end-user leads to our existing customers.

DEVELOP AND COMMERCIALIZE VALUE-ADDED SERVICES. We intend to introduce
value-added services to our customers and leverage the value of the network
access we offer today. Offering services such as voice over DSL, DSL plus
International Protocol (DSL + IP), and our Virtual Broadband Service Provider
(VBSP) offering will allow us to bundle service offerings to our customers and
improve the quality of content delivery to their end-users as well as reduce
costs. We believe this is an important part of our strategy and will allow us to
build upon our success to date in adding and retaining subscribers.

ACQUIRE AND ENTER INTO BUSINESS ARRANGEMENTS WITH NETWORK AND
BROADBAND-RELATED SERVICE PROVIDERS. We believe that the pace of deployment of
our network can be increased by acquiring and entering into business
arrangements with other network service providers, some of which may be located
outside of the United States. We also believe our network deployment will enable
the delivery of a variety of broadband-related services and content that are
desired by our customers. We expect to make these services available to our
customers through acquiring and entering into business arrangements with leading
providers of broadband-related services or content. For example, we recently
acquired Laser Link. Net, Inc. This acquisition will allow us to better provide
DSL and IP services on a wholesale basis and better enable us to serve customers
who do not wish to maintain any network facilities. Our agreement to acquire
BlueStar Communications Group will expand our selling capabilities in smaller
cities and rural areas, increase our distribution methods, and will enhance our
ability to deliver enhanced broadband solutions to small businesses.

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<PAGE>

already exist. Third, line sharing should resolve lack of telephone wire
problems that we have encountered when ordering telephone wires in some areas of
the country. We have signed interim line-sharing agreements with Bell South,
Bell Atlantic and U S WEST. We have also entered into interim line sharing
agreements with SBC in California and we are negotiating agreements for the
remaining states in SBC's territory. We have entered into an interim line
sharing agreement with GTE for all of its major markets other than Texas. We
recently received a decision from the Texas Public Utilities Commission
implementing line sharing in Texas. We have implemented line sharing in nine
states. We expect all of the major traditional local phone companies to
implement line sharing on a wide scale later this year.

OUR SERVICE OFFERINGS

We offer six business-grade services under the TeleSpeed brand to connect
our customers' end-users to our regional data centers and two consumer-grade
service offerings called TeleSurfer and TeleSurfer Pro. In March 2000, we
introduced two new services--DSL+IP and VBSP. We also offer business consumers
Virtual Private Network (VPN) technology over DSL. In addition, Internet service
provider and enterprise customers may purchase backhaul services from us to
connect their facilities to our regional data centers.

TELESPEED SERVICES

Our TeleSpeed services connect individual end-users on conventional
telephone wires to our DSL equipment in their serving central office and from
there to our network serving that metropolitan statistical area. A traditional
telephone company's infrastructure consists of numerous central offices which
are connected by a fiber optic backbone to a regional office that routes local
and long distance traffic. Each central office collects the individual telephone
wires from end-users' premises in the neighborhood.

The particular TeleSpeed service available to an end-user depends in large
part on the user's distance to the central office. We believe that substantially
all, if not all, of our potential end-users in our target markets generally can
be served with one of our services. We estimate that approximately 70% of
end-users are within 18,000 feet of a central office and can be served by at
least our TeleSpeed 384 service. However, the specific number of potential
end-users for the higher speeds will vary by central office and by region and
will be affected by line quality. The chart below compares the performance and
markets for each of our intraregional end-user services as of July 1, 2000:
<TABLE>
<CAPTION>

MAXIMUM MAXIMUM
INTRAREGIONAL SPEED TO SPEED FROM RANGE*
SERVICES END-USER END-USER (FEET) MARKET USAGE
-------------------- ------------ -------------- ---------- -----------------------------
<S> <C> <C> <C> <C>
TeleSpeed 144........................ 144 Kbps 144 Kbps 35,000 ISDN replacement
TeleSpeed 192........................ 192 Kbps 192 Kbps 18,000 Business Internet, RLAN
TeleSpeed 384........................ 384 Kbps 384 Kbps 18,000 Business Internet, RLAN
TeleSpeed 768........................ 768 Kbps 768 Kbps 13,500 Business Internet
TeleSpeed 1.1........................ 1.1 Mbps 1.1 Mbps 12,000 Business Internet
TeleSpeed 1.5S....................... 1.5 Mbps 1.5 Kbps 15,000 High-speed Web access
</TABLE>

--------------
* Estimated maximum distance from the end-user to the central office.

Prices for our end-user services may vary depending upon the performance
level of the service. For example, our TeleSpeed 144 and 192 services are our
lowest priced end-user services and our TeleSpeed 1.1 and 1.5 services are our
highest priced end-user services. Our prices also vary across regions and for
high volume customers that are eligible for volume discounts. See "Risk
Factors--We may experience decreasing prices for our services, which may impair
our ability to achieve profitability or positive cash flow" for a discussion of
the risks associated with our ability to sustain current price levels in the
future.

TELESPEED 144. Our TeleSpeed 144 service operates at up to 144 kilobits per
second in each direction, which is similar to the performance of an ISDN line.
This service, which can use existing ISDN equipment at the end-user site, is
targeted at the ISDN replacement market where its per month flat rate can
compare favorably to ISDN services from the traditional telephone company when
per-minute usage charges apply. It is also the service that we offer on
telephone wires that are either too long to carry our higher speed services or
are served by digital loop carrier systems or similar equipment where a
continuous copper connection is not available from the end-user site to a
central office.

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TELESPEED 192. This service provides one and a half to three times the
performance of ISDN lines at similar or lower price points to heavily-used ISDN
lines.

TELESPEED 384. This service provides three to six times the performance of
ISDN lines at similar price points to heavily-used ISDN lines.

TELESPEED 768. This service provides one-half the bandwidth of a T1 data
circuit at substantially less than one-half of the monthly price that we
estimate is typical for T1 service. The target market for the TeleSpeed 768
service is small businesses needing moderate speed access to the Internet but
who have previously been unable to afford the price of such service. The service
also competes favorably from a price/performance standpoint with traditional
fractional T1 and frame-relay services for these same customers.

TELESPEED 1.1. This service provides over two-thirds the bandwidth of a
T1data circuit at less than one-half of the monthly price that we estimate is
typical for T1 service. The target market for the TeleSpeed 1.1 service is small
businesses needing T1-level access to the Internet which have previously been
unable to afford the price of such service. The service also competes favorably
from a price/performance standpoint with traditional fractional T1 and
frame-relay services for these same customers.

TELESPEED 1.5S. This service provides bandwidth comparable to a T1 data
circuit of less than one-half of the monthly price that we estimate is typical
for T1 service. The service also provides the highest performance of any
TeleSpeed service to stream video or other multimedia content to end-user
locations.

TELESPEED REMOTE. TeleSpeed Remote provides high-speed network access for
end-users located in remote regions to their corporate networks. This service is
targeted at businesses that want high-speed remote office connections at a lower
cost than ISDN or frame-relay services. For example, this service can provide a
corporation's employees located in Boston high-speed access to their corporate
network located in San Francisco.

TELESURFER SERVICES
<TABLE>
<CAPTION>
MAXIMUM MAXIMUM
SPEED TO SPEED FROM RANGE*
INTRAREGIONAL SERVICES END-USER END-USER (FEET) MARKET/USAGE
---------------------- ------------- --------------- ---------- ------------------
<S> <C> <C> <C> <C>
Telesurfer ADSL............................... 608 Kbps 128 Kbps 12,000 Consumer
TeleSurfer Pro ADSL........................... 1.5 Mbps 384 Kbps 12,000 Consumer
</TABLE>

--------------
* Estimated maximum distance from the end-user to the central office.

TELESURFER ADSL. This consumer-grade service is an asymmetric service,
offering up to 608 kilobits per second downstream and up to 128 kilobits per
second upstream. This service is the base consumer service. The target market
for this service is consumers using either dial-up analog or ISDN connections
for web browsers.

TELESURFER PRO ADSL. This is a premium consumer-grade asymmetric service,
offering up to 1.5 megabits per second downstream and up to 384 kilobits per
second upstream. The target market for this service is consumers using analog or
ISDN connections for web browsers.

DSL + IP

This service currently bundles Internet protocol services with our existing
TeleSurfer services. We also plan to offer it with our TeleSpeed services. The
additional Internet protocol services include end-user authentication,
authorization and accounting, Internet protocol address assignment and
management, domain name service and Internet protocol routing and connectivity.

VBSP

We plan to offer this additional service which provides a complete solution
for organizations and businesses that want to offer broadband Internet services
to their customers without having to develop their own Internet capabilities. We
will provide Internet services to end-users under the brand name of our
customer. Our Internet services will be a turnkey solution that includes
registration, connection and Internet software, web sites, network
authentication, electronic mail, billing and reporting, news and personal
web-space for end-users and end-user service and technical support.

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<PAGE>

VPN OVER DSL

In August 1999 we introduced our VPN over DSL service. This service uses
the public Internet backbone or a private data network, combined with DSL
connections, as a channel for sharing information and applications within a
closed circle of users in different locations. We offer two levels of VPN over
DSL service.

COVAD BRANCH OFFICE. This service is available for remote or branch offices
that require high-speed inter-office connectivity across multiple locations.

COVAD TELEWORKER. This service is available for telecommuters and other
remote users who secure access to their corporate network and the Internet from
home.

OTHER SERVICES

We also provide a DS3 backhaul service from our regional network to an
Internet service provider or enterprise customer site. This service aggregates
all individual end-users in a metropolitan statistical area and transmits the
packet information to the customer on a single high-speed line. The service
utilizes an asynchronous transfer mode (ATM) protocol that efficiently handles
the high data rates involved and operates at up to 45 megabits per second. In
addition to monthly service charges, we impose non-recurring order set-up
charges for Internet service provider and RLAN end-users for our DS3 backhaul
service. Customers must also purchase a DSL modem from us or a third party for
each end-user of our services.

CUSTOMERS

We offer our services to Internet service providers, enterprises,
telecommunications carriers and other DSL resellers. As of June 30, 2000, we had
installed 138,000 DSL lines and received orders for our services from more than
295 Internet service provider, enterprise and telecommunications carrier
customers. The following is a list of selected Internet service provider,
enterprise, telecommunications carrier and other customers:

SELECTED INTERNET SERVICE PROVIDER CUSTOMERS SELECTED ENTERPRISE CUSTOMERS SELECTED TELECOMMUNICATIONS CARRIERS
--------------------------------------------- ----------------------------- ------------------------------------
<S> <C> <C>
Concentric Network Corporation Apple Computer AT&T
Flashcom Inktomi e.spire
Juno Intel IGC
Earthlink Oracle Corporation Qwest
PSINet Stanford University RCN Corporation
Prodigy Sun Microsystems
UUNET WebTV
Verio
</TABLE>

Our agreements with Internet service providers and other DSL resellers
generally have terms of one year and are nonexclusive. We do not require
Internet service providers to generate a minimum number of end-users and
generally grant volume discounts based on order volume. We serve Internet
service providers who provide their own Internet access service and have started
serving Internet service providers who choose to obtain access to the Internet
through us. In both cases, the Internet service providers purchase our service
son a wholesale basis and sell such services under their own brand.

Our practice with respect to our enterprise customers has been to enter
into an arrangement or a negotiated price to install the service initially to a
small number of end-users. An enterprise customer decides whether to implement
abroad rollout of our services after evaluating the results of this initial
phase of deployment. To date, a typical enterprise customer's initial phase of
deployment and its decision to roll out our service to additional end-users has
taken at least six months, and has generally taken longer than we originally
expected. As of June 30, 2000, a substantial majority of our enterprise
customers had not yet rolled out our services broadly to their employees.

We will not receive significant revenue from an enterprise customer until
and unless these rollouts occur. During the lengthy sales cycle for an
enterprise customer, we incur significant expenses in advance of the receipt of
revenues. We also enter into customer agreements with telecommunications
carriers, including competitive telecommunications companies and interexchange
carriers. Under these agreements our telecommunication carrier customers
typically resell our services to their new and existing customers. These
carriers currently market our

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Internet and RLAN services primarily to small, medium and enterprise businesses
that purchase voice services from them.

SALES AND MARKETING

BUSINESS AND CONSUMER INTERNET. For the business and consumer Internet
access markets, we sell our service to Internet service providers,
telecommunications carriers and others. These customers can either combine our
lines with their Internet access services, or purchase wholesale Internet access
services from us, and resell the combination to their existing and new
end-users. We address these markets through sales and marketing personnel
dedicated to the Internet service provider sales channel. We supplement our
sales efforts to Internet service providers through training programs and
marketing programs that include promotions and sales incentives designed to
encourage the Internet service providers to sell our services instead of those
of our competitors.

REMOTE LOCAL AREA NETWORK. We market our RLAN services to businesses
through a direct sales force, augmented by marketing programs with value-added
resellers and interexchange carriers. The sales force is directed to deal
directly with the chief information officer and the telecommunications manager
responsible for remote access within an enterprise. We augment our sales efforts
to RLAN customers through partnerships with value-added resellers, including
systems integrators that can offer our TeleSpeed service as part of a complete
work-at-home solution to businesses.

THIRD-PARTY RELATIONSHIPS. A key element of our strategy is to enter into
relationships with leading telecommunications companies, including competitive
telecommunications carriers and interexchange carriers, pursuant to which those
companies resell our TeleSpeed and TeleSurfer services to their customers. For
example, we have entered into commercial agreement with AT&T providing for the
purchase and resale of our services, primarily to their small business and
enterprise customers. We believe that these indirect sales channels will enable
us to penetrate our target markets more rapidly and eventually will generate the
majority of sales of our services.

BRANDING AND MARKETING PROGRAMS. In October 1999 we commenced a branding
and advertising effort to educate the market about our broadband service
offerings and increase recognition of our brand. This program, which uses
television, print and radio advertising on both a national and regional basis,
is intended to inform the market about the availability of our service,
differentiate the products and services offered by our Company and simplify the
process through which these products and services are ordered.

We are also pursuing several types of joint marketing arrangements with our
Internet service provider, telecommunications carrier customers and other DSL
resellers. In addition, certain of our equipment suppliers have promoted our
services through seminars to corporate information technology managers in the
San Francisco Bay Area. We also support our sales efforts with marketing efforts
that include advertising programs through radio and other popular media,
attendance at trade shows and presentations at industry conferences. See "Risk
Factors--Our business will suffer if our Internet service providers,
telecommunications carriers and other third parties are not successful in the
marketing and sale of our services."

SERVICE DEPLOYMENT AND OPERATIONS

Internet service providers, telecommunications carriers and corporate
information technology managers typically have had to assemble their digital
communications connections using multiple service and equipment suppliers,
leading to additional work, cost and coordination problems. With our services,
we emphasize a one-stop service solution for our customers. This service
solution includes:

o extending our network to customers and end-users with various needs
and configuration requirements;

o end-user premise wiring and DSL modem configuration;

o ongoing network monitoring and customer reporting;

o customer service and technical support; and

o operational support system.

EXTENDING OUR NETWORK TO CUSTOMERS AND END-USERS. We work with our Internet
service provider, enterprise, telecommunications carrier and other customers to
extend our network to each customer premise and each end-user premise bordering
circuits from the traditional telephone company or a competitive
telecommunications company,

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interconnecting the customers and end-users to our network, testing the
circuits, configuring customer routers or switches and end-user routers and
monitoring the circuits from the network operations center.

END-USER PREMISES WIRING AND DSL MODEM CONFIGURATION. We use our own and
subcontracted field service crews and trucks to perform any required inside
wiring and to configure DSL modems at each end-user site.

NETWORK MONITORING. We monitor our network from our network operations
center, which helps us to identify and correct network problems. We have also
developed network capability to provide Internet service provider, enterprise
and telecommunications carrier customers direct monitoring access of their
end-users for more efficient monitoring of their own network performance.

CUSTOMER REPORTING. We communicate regularly with our customers about the
status of their end-users. We also operate a toll-free customer care help line.
Additionally, we provide Web-based tools to allow individual Internet service
providers and enterprise information technology managers and telecommunications
carriers to monitor their end-users directly, to place orders for new end-users,
to enter trouble tickets on end-user lines and to communicate with us on an
ongoing basis.

CUSTOMER SERVICE AND TECHNICAL SUPPORT. We provide 24x7 on-line support to
our Internet service provider customers and enterprise information technology
managers. The Internet service provider and information technology manager and
telecommunications carriers serve as the initial contact for service and
technical support, and we provide the second level of support. For customers
using our VBSP offering, we will provide the first level of support for their
end users.

OPERATIONAL SUPPORT SYSTEM. We have developed what we believe to be the
industry-leading operational support system for DSL networks. Our operational
support system is based on web interfaces and is highly automated. These
features are intended to and should allow us to scale our businesses rapidly
because they eliminate many manual processes such as line testing, network path
configuration, equipment configuration, order taking and verification, billing
and telephone wire supplier management.

NETWORK ARCHITECTURE AND TECHNOLOGY

The key design principles of our network attempt to provide the following
attributes which we believe are important requirements of our existing and
potential customers:

ROBUST NETWORK SECURITY. Modem access to enterprise networks presents
significant security risks, since any telephone can be used to attempt to access
such a network simply by dialing the telephone number. As a result, enterprises
expend significant effort and resources to prevent unauthorized access.
Enterprises also typically limit remote access users to reading e-mail or other
non-sensitive applications. Our network is designed to ensure secure
availability of all internal applications and information for remote locations.
Our permanent virtual circuit network architecture connects individual end-users
at fixed locations to a single enterprise, which reduces the possibility of
unauthorized access and allows our customers to safely transmit sensitive
information and applications over our TeleSpeed lines.

CONSISTENT AND SCALABLE PERFORMANCE. We believe that eventually public
packet networks will evolve to replace the over 40 million modems currently
connected to circuit switched networks that have been deployed in the U.S. As
such, we designed our network for scalability and consistent performance to all
users as the networks grow. We have designed a "star topology" network similar
to the most popular local area network architecture currently used in
high-performance enterprise networks. In this model, new capacity is added
automatically as each new user receives a new line. We also use asynchronous
transfer mode equipment in our network that implements packet switching directly
in silicon circuits rather than slower router-based designs that implement
switching in router software.

INTELLIGENT END-TO-END NETWORK MANAGEMENT. Because the customers' and end
users' lines are continuously connected, they can also always be monitored. We
have visibility from the Internet service provider or enterprise site across the
network and into the end-user's home or business. Because our network is
centrally managed, we can identify and dynamically enhance network quality,
service and performance and address network problems promptly.

FLEXIBILITY. We have designed our network to be flexible in handling
various types of network traffic, starting with data, but able to accommodate
voice and video. This flexibility will allow us to directly offer, or enter into

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arrangements with other entities to offer, not only value-added services such as
voice over DSL, but also control the prioritization of content delivery within
our national network.

The primary components of our network is the network operations center, our
high-speed private metropolitan networks, central office spaces, including
digital subscriber line access multiplexers (DSLAMs), copper telephone lines and
DSL modems.

NETWORK OPERATIONS CENTERS. Our entire network is managed from two network
operations centers. We provide end-to-end network management using advanced
network management tools on a 24x7 basis, which enhances our ability to address
performance or connectivity issues before they affect the end-user experience.
From the network operations centers, we can monitor the equipment and circuits
in each metropolitan network (including the asynchronous transfer mode
equipment), each central office (including DSLAMs) and potentially individual
end-user lines (including the DSL modems). Presently, one network operations
center is located in the San Francisco Bay Area and the second network
operations center is on the East Coast.

PRIVATE METROPOLITAN NETWORK. We operate our own private metropolitan
network in each region that we enter. The network consists of high-speed
asynchronous transfer mode communications circuits that we lease to connect our
asynchronous transfer mode hubs, our equipment in individual central offices and
our Internet service provider, enterprise and telecommunications carrier
customers. This network operates at a speed of 45 to 155 megabits per second.

CENTRAL OFFICE SPACES. Through our interconnection agreements with the
traditional telephone companies, we seek to secure space in every central office
where we intend to offer service. These central office spaces are designed to
offer the same high reliability and availability standards as the traditional
telephone company's other central office space. We require access to these
spaces for our equipment and for persons employed by, or under contract with,
us. We place DSLAMs in our central office spaces to provide the high-speed DSL
signals on each copper line to our end-users. As of June 30, 2000, we had 1,700
central office spaces operational. In addition, we have a significant number of
additional spaces under construction as well as other spaces on order from
various traditional telephone companies. In December 1998, we entered into a
professional service arrangement with Lucent Technologies to augment and
accelerate our ability to deploy our central office facilities.

TELEPHONE WIRES. We lease the telephone wires running to end-users from the
traditional telephone companies under terms specified in our interconnection
agreements. We lease lines that, in numerous cases, must be specially
conditioned by the traditional telephone companies to carry digital signals,
usually at an additional charge relative to that for voice grade telephone
wires. The price we are obligated to pay for these lines currently varies from
$4 to $70 per month per line with additional one-time charges in some cases for
installation, modification or removal of lines.

DSL MODEMS AND ON-SITE CONNECTION. We buy our DSL modems from our suppliers
for resale to our Internet service provider or enterprise customers for use by
their end-users. We configure and install these modems along with any required
on-site wiring needed to connect the modem to the copper line leased from the
traditional telephone company. For the most part, the DSL modem and DSLAM
equipment used have come from the same vendor for all services, since there
aren't yet interoperability standards for the equipment used in our higher-speed
services. We are also pursuing a program of ongoing network development. Our
service development and engineering efforts focus on the design and development
of new technologies and services to increase the speed, efficiency, reliability
and security of our network and to facilitate the development of network
applications by third parties that will increase the use of our network. See
"Risk Factors--The scalability and speed of our network remain largely
unproven."

COMPETITION

The markets for business and consumer Internet access and network access
services are intensely competitive. We expect that these markets will become
increasingly competitive in the future. The principal bases of competition in
our markets include:

o price/performance;

o breadth of service availability;

o reliability of service;

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o network security;

o ease of access and use;

o content bundling;

o customer support;

o brand recognition;

o operating experience;

o relationships with Internet service providers and other third parties;
and

o capital resources.

We face competition from traditional telephone companies, cable modem
service providers, competitive telecommunications companies, traditional and new
national long distance carriers, Internet service providers, on-line service
providers and wireless and satellite service providers.

TRADITIONAL TELEPHONE COMPANIES. All of the largest traditional telephone
companies in our target markets have begun offering DSL services. As a result,
the traditional telephone companies represent strong competition in all of our
target service areas, and we expect this competition to intensify. The
traditional telephone companies have an established brand name and reputation
for high quality in their service areas, possess sufficient capital to deploy
DSL equipment rapidly, own the telephone wires themselves and can bundle digital
data services with their existing voice services to achieve economies of scale
in serving their customers. Certain of the traditional telephone companies have
aggressively priced their consumer DSL services as low as $19-$29 per month,
placing pricing pressure on our TeleSurfer services. The traditional telephone
companies are also in a position to offer service from central offices where we
are unable to secure space and offer service because of asserted or actual space
restrictions.

CABLE MODEM SERVICE PROVIDERS. Cable modem service providers such as AT&T,
Excite@Home, Cox, Time Warner, Road Runner and MediaOne (and their respective
cable partners) are deploying high-speed Internet access services over hybrid
fiber coaxial cable networks. Hybrid fiber coaxial cable is a combination of
fiber optic and coaxial cable, and has become the primary architecture utilized
by cable operators in recent and ongoing upgrades of their systems. Where
deployed, these networks provide similar and in some cases higher-speed Internet
access than we provide. They also offer these services at lower price points
than our TeleSurfer services. We believe the cable modem service providers face
a number of challenges that providers of DSL services do not face. For example,
different regions within a metropolitan statistical area may be served by
different cable modem service providers, making it more difficult to offer the
blanket coverage required by potential business customers. Also, much of the
current cable infrastructure in the U.S. must be upgraded to support cable
modems, a process which we believe is significantly more expensive and
time-consuming than the deployment of DSL-based networks.

COMPETITIVE TELECOMMUNICATIONS COMPANIES. Many competitive
telecommunications companies such as NorthPoint Communications, Rhythms
NetConnections and Network Access Solutions offer high-speed digital services
using a business strategy similar to ours. Some of these competitors have begun
offering DSL-based access services and others are likely to do so in the future.
Companies such as NEXTLINK Communications have extensive fiber networks in many
metropolitan areas, primarily providing high-speed digital and voice circuits to
large corporations. They also have interconnection agreements with the
traditional telephone companies pursuant to which they have acquired central
office space in many markets targeted by us. Further, certain of our customers
have made investments in our competitors.

NATIONAL INTEREXCHANGE CARRIERS. Interexchange carriers, such as AT&T,
Sprint, WorldCom, Qwest, Level 3 and Global Crossing have deployed large-scale
Internet access networks and ATM networks, sell connectivity to businesses and
residential customers, and have high brand recognition. They also have
interconnection agreements with many of the traditional telephone companies and
a number of spaces in central offices from which they are currently offering or
could begin to offer competitive DSL services.

INTERNET SERVICE PROVIDERS. Internet service providers such as Genuity,
UUNET Technologies (acquired by MCI WorldCom), EarthLink Network, Concentric
Network Corporation (acquired by NEXTLINK), and PSINet provide Internet access
to residential and business customers, generally using the existing public
switched telephone network at integrated services digital network speeds or
below. Some Internet service providers such as UCNET

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Technologies in California and New York, HarvardNet Inc. and InterAccess have
begun offering DSL-based services. To the extent we are not able to recruit
Internet service providers as customers for our service, Internet service
providers could become competitive DSL service providers.

ON-LINE SERVICE PROVIDERS. On-line service providers include companies such
as AOL, Yahoo!, CompuServe (acquired by AOL), MSN (a subsidiary of Microsoft
Corp.) and Web TV (a subsidiary of Microsoft Corp.) that provide, over the
Internet and on proprietary online services, content and applications ranging
from news and sports to consumer video conferencing. These services are designed
for broad consumer access over telecommunications-based transmission media,
which enable the provision of digital services to the significant number of
consumers who have personal computers with modems. In addition, they provide
Internet connectivity, ease-of-use and consistency of environment. Many of these
on-line service providers have developed their own access networks for modem
connections. If these on-line service providers were to extend their access
networks to DSL or other high-speed service technologies, they would become
competitors of ours.

WIRELESS AND SATELLITE DATA SERVICE PROVIDERS. Wireless and satellite data
service providers are developing wireless and satellite-based Internet
connectivity. We may face competition from terrestrial wireless services
including future third-generation wireless networks, two Gigahertz (Ghz) and 28
Ghz wireless cable systems (Multi-channel Microwave Distribution System (MMDS)
and Local Multi-channel Distribution System (LMDS)), and 18 Ghz and 39 Ghz
point-to-point microwave systems. For example, the FCC is currently considering
new rules to permit MMDS licensees to use their systems to offer two-way
services, including high-speed data, rather than solely to provide one-way video
services. The FCC also recently auctioned spectrum for LMDS services in all
markets. This spectrum is expected to be used for wireless cable and telephony
services, including high-speed digital services. In addition, companies such as
Teligent Inc., Advanced Radio Telecom Corp. and WinStar Communications, Inc.,
hold point-to-point microwave licenses to provide fixed wireless services such
as voice, data and videoconferencing.

We also may face competition from satellite-based systems. Motorola
Satellite Systems, Inc., Hughes Communications (a subsidiary of General Motors
Corporation), Globalstar, Lockheed, Teledesic and others have filed applications
with the FCC for global satellite networks which can be used to provide
broadband voice and data services, and the FCC has authorized several of these
applicants to operate their proposed networks.

INTERCONNECTION AGREEMENTS WITH TRADITIONAL TELEPHONE COMPANIES

A critical aspect of our business is our interconnection agreements with
the traditional telephone companies. These agreements cover a number of aspects
including:

o the price we pay to lease access to the traditional telephone company's
telephone wires;

o the special conditioning the traditional telephone company provides on
certain of these lines to enable the transmission of digital signals;

o the price and terms of central office space for our equipment in the
traditional telephone company's central offices and remote terminals;

o the price we pay and access we have to the traditional telephone
company's transport facilities;

o the operational support systems and interfaces that we can use to place
orders, report network problems and monitor the traditional telephone
company's response to our requests;

o the dispute resolution process that we use to resolve disagreements on
the terms of the interconnection contract; and

o the term of the interconnection agreement, its transferability to
successors, its liability limits and other general aspects of the
traditional telephone company relationship.

As of June 30, 2000, we have entered into interconnection agreements with
or otherwise obtained interconnection rights from the different major
traditional telephone companies in all the states covering our metropolitan
statistical areas. Traditional telephone companies do not in many cases agree to
our requested provisions in interconnection agreements and we have not
consistently prevailed in obtaining all of our desired provisions in such
agreements either voluntarily or through the interconnection arbitration
process. We cannot be sure that we will be able to continue to sign
interconnection agreements with existing or other traditional telephone

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companies. We are currently negotiating agreements with several traditional
telephone companies in order to expand our services into 165 targeted
metropolitan statistical areas. The traditional telephone companies are also
permitting competitive telecommunications companies to adopt previously signed
interconnection agreements. In certain instances, we have adopted the
interconnection agreement of another competitive telecommunications company.
Other competitive telecommunications companies have also adopted the same or
modified versions of our interconnection agreements, and may continue to do so
in the future.

Many of our interconnection agreements have a term of three years. We will
have to renegotiate these agreements when they expire. Although we expect to
renew the interconnection agreements that require renewal and believe the 1996
Telecommunications Act and the agreements themselves limit the ability of
traditional telephone companies not to renew such agreements, we may not succeed
in extending or renegotiating our interconnection agreements on favorable terms.
Additionally, disputes have arisen and will likely arise in the future as a
result of differences in interpretations of the interconnection agreements. For
example, we are in litigation proceedings with certain of the traditional
telephone companies. These disputes have delayed our deployment of our network.
They have also adversely affected our service to our customers and our ability
to enter into additional interconnection agreements with the traditional
telephone companies in other states. Finally, the interconnection agreements are
subject to state commission, FCC and judicial oversight. These government
authorities may modify the terms of the interconnection agreements in a way that
hurts our business.

GOVERNMENT REGULATION

OVERVIEW. Our services are subject to a variety of federal regulations.
With respect to certain activities and for certain purposes, we have submitted
our operations to the jurisdiction of state and local authorities who may also
assert more extensive jurisdiction over our facilities and services. The FCC has
jurisdiction over all of our services and facilities to the extent that we
provide interstate and international services. To the extent we provide
identifiable intrastate services, our services and facilities are subject to
state regulations. Rates for the services and network elements we purchase from
the traditional local telephone companies are generally determined by the States
consistent with federal law. In addition, local municipal government authorities
also assert jurisdiction over our facilities and operations. The jurisdictional
reach of the various federal, state and local authorities is subject to ongoing
controversy and judicial review, and we cannot predict the outcome of such
review.

FEDERAL REGULATION. We must comply with the requirements of the
Communications Act of 1934, as amended by the 1996 Telecommunications Act, as
well as the FCC's regulations under the statute. The 1996 Telecommunications Act
eliminates many of the pre-existing legal barriers to competition in the
telecommunications and video programming communications businesses, preempts
many of the state barriers to local telecommunications service competition that
previously existed in state and local laws and regulations, and sets basic
standards for relationships between telecommunications providers. The law
delegates to the FCC and the states broad regulatory and administrative
authority to implement the 1996 Telecommunications Act.

Among other things, the 1996 Telecommunications Act removes barriers to
entry in the local telecommunications market. It does this by preempting certain
state and local laws that are barriers to competition and by requiring
traditional telephone companies to provide nondiscriminatory access and
interconnection to potential competitors, such as cable operators, wireless
telecommunications providers, interexchange carriers and competitive
telecommunications companies such as us.

Regulations promulgated by the FCC under the 1996 Telecommunications Act
specify in greater detail the requirements of the 1996 Telecommunications Act
imposed on the traditional telephone companies to open their networks to
competition by providing competitors interconnection, central office and remote
terminal space, access to unbundled network elements, retail services at
wholesale rates and nondiscriminatory access to telephone poles, ducts,
conduits, and rights-of-way. The requirements enable companies such as us to
interconnect with the traditional telephone companies in order to provide local
telephone exchange services and to use portions of the traditional telephone
companies' existing networks to offer new and innovative services such as our
TeleSpeed and TeleSurfer services. In January 1999, the U.S. Supreme Court ruled
on challenges to the FCC regulations. Although the U.S. Supreme Court upheld
most of the FCC's authority and its regulations, it required the FCC to
reexamine and redefine which unbundled network elements the traditional
telephone companies must offer. The FCC issued its revised list of unbundled
network elements in September 1999. The 1996 Telecommunications Act also allows
the Regional Bell Operating Companies (RBOCs), which are the traditional
telephone companies created by AT&T's divestiture of its local exchange
business, to enter the long distance market within their own local service
regions

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upon meeting certain requirements. The remaining RBOCs include BellSouth,
Verizon (formerly Bell Atlantic Corporation), Ameritech Corporation, U S WEST
Communications, Inc. (recently acquired by Qwest) and SBC Communications, Inc.
The timing of the various RBOCs' entry into their respective in-region long
distance service businesses is extremely uncertain. In December 1999, Atlantic's
(now Verizon) application to provide in-region long distance services in New
York state was granted by the FCC. The FCC recently granted Southwestern Bell
Telephone Company's application to provide in-region long distance service in
Texas. Given the FCC's grant of the New York and Texas applications, the FCC is
likely to thereafter grant similar applications by Verizon and the other RBOCs
in other states. The timing of the various RBOCs' in-region long distance entry
will likely affect the level of cooperation we receive from each of the RBOCs.
The approval of such entry will likely adversely affect the level of
cooperation.

In addition, the 1996 Telecommunications Act provides relief from the
earnings restrictions and price controls that have governed the local telephone
business for many years. Traditional telephone company tariff filings at the FCC
have been subjected to increasingly less regulatory review. However, precisely
when and to what extent the traditional telephone companies will secure pricing
flexibility or other regulatory freedom for their services is uncertain. For
example, under the 1996 Telecommunications Act, the FCC is considering
eliminating certain regulations that apply to the traditional telephone
companies' provision of services that are competitive with ours. The timing and
the extent of regulatory freedom and pricing flexibility and regulatory freedom
granted to the traditional telephone companies will affect the competition we
face from the traditional telephone companies' competitive services. Pursuant to
recent merger conditions, SBL and Verizon have established in-region separate
affiliates to provide DSL services. Those affiliates will be subject to less
regulation than if the services were provided on an integrated basis.

Further, the 1996 Telecommunications Act provides the FCC with the
authority to forbear from regulating entities such as us who are classified as
"non-dominant" carriers. The FCC has exercised its forbearance authority. As a
result, we are not obligated to obtain prior certificate approval from the FCC
for our interstate services or file tariffs for such services. We have
determined not to file tariffs for our interstate services. We provide our
interstate services to our customers on the basis of contracts rather than
tariffs. We believe that it is unlikely that the FCC will require us to file
tariffs for our interstate services in the future.

On March 18, 1999, the FCC adopted rules to make it easier and less
expensive for competitive telecommunications companies to obtain central office
space and to require traditional telephone companies to make new alternative
arrangements for obtaining central office space. However, in March 2000, the
U.S. Court of Appeal for the District of Columbia issued a decision casting
doubt on whether new entrants will be able to locate certain kinds of equipment
in the traditional local telephone companies central offices. The FCC's rules on
location of new entrant's equipment in central offices remain somewhat
uncertain, and have not been uniformly implemented. In the March 1999
announcement, the FCC also provided notice of proposed rule-making to determine
whether carriers should be able to provide asymmetric DSL over the same line
over which traditional telephone companies provide voice service. On November
18, 1999, the FCC required the traditional local phone companies to provide us
and other competitive local carriers with line sharing access. If implemented by
the traditional local phone companies these rules could materially lower the
price we pay to lease access to the traditional telephone company's telephone
wires. While we believe that these rules are advantageous to us, the traditional
telephone companies may balk at, delay, or thwart the implementation of such
rules.

In its March 2000 ruling, the federal appeals court struck portions of the
FCC's new rules concerning the location of new entrants' equipment in
traditional local telephone companies' central offices, and has required the FCC
to reconsider and review those rules. In particular, the appeals court has
required the FCC to revise its rules concerning the types of equipment that we
may collocate on the traditional telephone company premises and the steps that
traditional telephone companies may take to separate their equipment from our
equipment. The traditional telephone companies may implement the court's ruling
and any subsequent FCC rules in a manner that impairs our ability to obtain
collocation space and collocate the equipment of our choice on their premises.
Such actions by the traditional telephone companies could adversely affect our
business and disrupt our existing network design, configuration and services.

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The Eighth Circuit's decision creates some additional uncertainty
concerning the prices that we are obligated to pay the traditional telephone
companies for collocation and unbundled network elements. While the FCC may
appeal the Eighth Circuit's decision, it may also adopt new rules to reflect the
cost methodology that was approved by the Eighth Circuit. If the decision is
appealed, it is uncertain whether the Eighth Circuit's decision will be affirmed
by the United States Supreme Court. It is also uncertain whether the FCC and
state commissions will implement a new cost methodology as a result of this
decision.

Any changes in applicable federal law and regulations, in particular,
changes in its interconnection agreements with traditional telephone companies,
the prospective entry of the RBOCs into the in-region long distance business and
grant of regulatory freedom and pricing flexibility to the traditional telephone
companies, could harm our business.

STATE REGULATION. To the extent we provide identifiable intrastate services
or have otherwise submitted ourselves to the jurisdiction of the relevant state
telecommunications regulatory commissions, we are subject to such jurisdiction.
In addition, certain states have required prior state certification as a
prerequisite for processing and deciding an arbitration petition for
interconnection under the 1996 Telecommunications Act. As of December 31,
1999,we were authorized under state law to operate as a competitive local
exchange carrier in 34 states, and intend to obtain authorization in the other
states necessary to cover our 165 targeted metropolitan statistical areas. We
have pending arbitration proceedings in different states for interconnection
arrangements with the relevant traditional telephone companies. We have
concluded arbitration proceedings in a number of states by entering into
interconnection agreements with the relevant traditional telephone companies. We
have filed tariffs in certain states for intrastate services as required by
state law or regulation. We are also subject to periodic financial and other
reporting requirements of these states with respect to our intrastate services.

The different state commissions have various proceedings to determine the
rates, charges and terms and conditions for unbundled network elements
(unbundled network elements are the various portions of a traditional telephone
company's network that a competitive telecommunications company can lease for
purposes of building a facilities-based competitive network, including telephone
wires, central office collocation space, inter-office transport, operational
support systems, local switching and rights of way), as well as the discount for
wholesale services that we purchase from the relevant traditional telephone
company. The rates set forth in many of our interconnection agreements are
interim rates and will be prospectively, and, in some cases, retroactively,
affected by the permanent rates set by the various state commissions for such
unbundled network elements as unbundled loops and interoffice transport. We have
participated in unbundled network element rate proceedings in several states in
an effort to reduce these rates. If any state commission decides to increase
unbundled network element rates our operating results could suffer. The
applicability of the various state regulations on our business and compliance
requirements will be further affected by the extent to which our services are
determined to be intrastate services. Jurisdictional determinations of our
services as intrastate services could harm our business.

LOCAL GOVERNMENT REGULATION. We may be required to obtain various permits
and authorizations from municipalities in which we operate our own facilities.
The issue of whether actions of local governments over the activities of
telecommunications carriers, including requiring payment of franchise fees or
other surcharges, pose barriers to entry for competitive telecommunications
companies which may be preempted by the FCC is the subject of litigation.
Although we rely primarily on the unbundled network elements of the traditional
telephone companies, in certain instances we deploy our own facilities,
including fiber optic cables, and therefore may need to obtain certain municipal
permits or other authorizations. The actions of municipal governments in
imposing conditions on the grant of permits or other authorizations or their
failure to act in granting such permits or other authorizations could harm our
business.

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<PAGE>

The foregoing does not purport to describe all present and proposed
federal, state and local regulations and legislation affecting the
telecommunications industry. Other existing federal regulations are currently
the subject of judicial proceedings, legislative hearings and administrative
proposals, which could change, in varying degrees, the manner in which
communications companies operate in the U.S. In particular, several bills
pending in the 106th Congress would significantly alter or repeal
pro-competitive FCC rules and portions of the 1996 Telecommunications Act.
Passage of any these bills could adversely affect our business. The ultimate
outcome of these proceedings and the ultimate impact of the 1996
Telecommunications Act or any final regulations adopted pursuant to the 1996
Telecommunications Act or our business cannot be determined at this time but may
well be adverse to our interests. We cannot predict the impact, if any, that
future regulation or regulatory changes may have on our business and we can give
you no assurance that such future regulation or regulatory changes will not harm
our business. See "Risk Factors--Rejections of our applications for central
office space by traditional telephone companies are likely to delay the
expansion of our network and the rollout of our services" and "Our services are
subject to government regulation, and changes in current or future laws or
regulations could adversely affect our business."

INTELLECTUAL PROPERTY

We regard certain aspects of our products, services and technology as
proprietary and attempt to protect them with patents, copyrights, trademarks,
trade secret laws, restrictions on disclosure and other methods. These methods
may not be sufficient to protect our technology. We also generally enter into
confidentiality or license agreements with our employees and consultants, and
generally control access to and distribution of our documentation and other
proprietary information. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use our products, services or
technology without authorization, or to develop similar technology
independently.

Currently we have one patent and a number of patent applications pending,
and intend to prepare additional applications and to seek additional patent
protection for our systems and services to the extent possible. The pending and
any future patents may not be issued to us, and if issued, they may not protect
our intellectual property from competition which could seek to design around or
invalidate these patents.

Further, effective patent, copyright, trademark and trade secret protection
may be unavailable or limited in certain foreign countries. The global nature of
the Internet makes it virtually impossible to control the ultimate destination
of our proprietary information. Steps taken by us may not prevent
misappropriation or infringement of our intellectual property rights, and
litigation may be necessary in the future to enforce our intellectual property
rights to protect our trade secrets or to determine the validity and scope of
the proprietary rights of others. Such litigation could result in substantial
costs and diversion of resources.

In addition, others may sue us with respect to infringement of their
intellectual property rights. We were recently sued by Bell Atlantic for an
alleged infringement of a patent issued to them in September 1998 entitled
"Variable Rate and Variable Mode Transmission System." On February 18, 2000, we
were granted a summary judgement ruling in the Bell Atlantic lawsuit. The court
ruled that we had not infringed on Bell Atlantic's patent. Bell Atlantic has
filed a notice of appeal of this decision and, while we expect that we will
prevail on appeal, the outcome of such an appeal is inherently uncertain. Such
lawsuits, including an appeal in the Bell Atlantic lawsuit, could significantly
harm our business.

EMPLOYEES

As of June 30, 2000, we had approximately 1,700 employees, excluding
temporary personnel and consultants. None of our employees are represented by a
labor union, and we consider our relations with our employees to be good. Our
ability to achieve our financial and operational objectives depends in large
part upon the continued service of our senior management and key technical,
sales, marketing, legal and managerial personnel, and our continuing ability to
attract and retain highly qualified technical, sales, marketing, legal and
managerial personnel. Competition for such qualified personnel is intense,
particularly in software development, network engineering and product
management. In addition, in the event that our employees unionize, we could
incur higher ongoing labor costs and disruptions in our operations in the event
of a strike or other work stoppage.

<PAGE>

PROPERTIES

We are headquartered in Santa Clara, California in facilities pursuant to
leases that will expire beginning on or before July 14, 2002. We also lease
office space in many of the metropolitan statistical areas in which we conduct
operations.

We have recently expanded our headquarters space in Santa Clara by leasing
additional office space, and have expanded our operational space with a new
facility lease in Denver, Colorado. Through a subsidiary, we have also acquired
land and have built a 100,000 square foot network operations center in Prince
Williams County, Virginia.

We also lease central office space from the traditional telephone company
in each region that we operate or plan to operate under the terms of our
interconnection agreements and obligations imposed by state public utilities
commissions and the FCC. While the terms of these leases are perpetual, the
productive use of our central office space is subject to the terms of our
interconnection agreements which expire on or before March 2001. We will
increase our central office space as we expand our network geographically.

LEGAL PROCEEDINGS

We are engaged in a variety of negotiations, arbitrations and regulatory
and court proceedings with multiple traditional telephone companies. These
negotiations, arbitrations and proceedings concern the traditional telephone
companies' denial of physical central office space to us in certain central
offices, the cost and delivery of central office spaces, the delivery of
transmission facilities and telephone lines, billing issues and other
operational issues. We have also filed a lawsuit against Pacific Bell and
certain of its affiliates, including SBC Communications, in federal court. We
are pursuing a variety of contract, tort, and antitrust and other claims, such
as violations of the Telecommunications Act, in these proceedings. In November
1998, we prevailed in our commercial arbitration proceeding against Pacific
Bell. The arbitration panel found that Pacific Bell breached its interconnection
agreement with us and failed to act in good faith on multiple counts. The
arbitration panel ruled in favor of awarding us direct damages, as well as
attorneys' fees and costs of the arbitration. Pacific Bell is currently
attempting to have the decision vacated. On May 15, 2000, the arbitration panel
stated its intention to grant an award of partial damages to us in the amount of
$27.5 million, including $257,166 previously awarded to us by the panel. The
panel also ruled that Pacific Bell must pay Covad's reasonable attorneys' fees
and costs.

We have also filed a lawsuit against Bell Atlantic and its affiliates in
federal court. We are pursuing antitrust and other claims in this lawsuit. In
addition, Bell Atlantic has separately filed suit against us asserting
infringement of a patent issued to them in September 1998 entitled "Variable
Rate and Variable Mode Transmission System." However, on February 18, 2000 the
court issued a summary judgment ruling holding that we had not infringed Bell
Atlantic's patent. Bell Atlantic has filed a notice of appeal and, while we
expect that we will prevail on an appeal, the outcome of such an appeal is
inherently uncertain.

One of our former employees has filed a complaint against us in California
Superior Court, alleging that he was terminated wrongfully and is entitled to
commissions and other amounts arising from his employment with us. We contend
that this employee resigned and that we do not owe him any money, but litigation
is unpredictable and there is no guarantee we will prevail. Another group of our
former employees have filed a complaint against us in California Superior Court,
alleging that they were terminated wrongfully and are entitled to various
amounts arising from their employment with us. We believe that we do not owe
these employees any money, but litigation is unpredictable and we cannot
guarantee that we will prevail in this matter. A third employee has filed a
complaint against us in California Superior Court, alleging that he was
terminated wrongfully based on his age. We also believe that we do not owe this
employee any money. Failure to resolve these various legal disputes and
controversies without excessive delay and cost and in a manner that is favorable
to us could significantly harm our business.

We are not currently engaged in any other legal proceedings that we believe
could have a material adverse effect on our business, prospects, operating
results and financial condition. We are, however, subject to state commission,
FCC and court decisions as they relate to the interpretation and implementation
of the 1996 Telecommunications Act, the interpretation of competitive
telecommunications company interconnection agreements in general and our
interconnection agreements in particular. In some cases, we may be deemed to be
bound by the results of ongoing proceedings of these bodies or the legal
outcomes of other contested interconnection agreements that are similar to our
agreements. The results of any of these proceedings could harm our business.

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<PAGE>

BLUESTAR ACQUISITION

o Speed to market in implementing our direct sales strategy in Tier 3
markets.

o A large, experienced direct sales force.

o BlueStar's customer base.

o Increased ability to provide enhanced broadband solutions to small
businesses.

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<PAGE>

MANAGEMENT

DIRECTORS AND EXECUTIVE OFFICERS

Our directors and executive officers, and their respective ages as of
August 1, 2000, are as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Robert Knowling, Jr.............. 44 Chairman of the Board, President and Chief Executive Officer
Mark Perry....................... 50 Executive Vice President and Chief Financial Officer
Robert Davenport, III............ 40 President and Chief Executive Officer, Covad Communications
International, B.V.
Catherine Hemmer................. 41 Executive Vice President and Chief Operating Officer
John McDevitt.................... 48 Executive Vice President, Sales and Marketing
Joseph Devich.................... 42 Executive Vice President, Corporate Services
Dhruv Khanna..................... 40 Executive Vice President, General Counsel and Secretary
Jane Marvin...................... 40 Executive Vice President, Human Resources
Terry Moya....................... 41 Executive Vice President, External Affairs
Michael Lach..................... 38 Executive Vice President, Corporate Development and Business Integration
Jimmy LaValley................... 46 Executive Vice President, Community Relations
Rich Wong........................ 31 Executive Vice President, Broadband Services
Robert Hawk...................... 60 Director
Hellene Runtagh.................. 51 Director
Daniel Lynch..................... 58 Director
Frank Marshall................... 53 Director
Rich Shapero..................... 51 Director
Larry Irving..................... 43 Director
Debra Dunn....................... 44 Director
</TABLE>

ROBERT KNOWLING, JR. has been our President, Chief Executive Officer and a
member of our board of directors since July 1998. As of September 1999, he also
became Chairman of the Board of Directors. From October 1997 through July 1998,
Mr. Knowling served as the Executive Vice President of Operations and
Technologies at U S WEST Communications, Inc., a regional telecommunications
service provider. In this capacity, Mr. Knowling was responsible for planning,
delivering and maintaining high-quality telecommunications services for more
than 25 million customers in 14 western and midwestern states. From March 1996
through September 1997, he served as Vice President of Network Operations at U S
WEST Communications, Inc. From November 1994 through March 1996, he served as
Vice President of Network Operations for Ameritech Corporation. Mr. Knowling
began his career in 1977 at Indiana Bell where he progressed through a variety
of assignments in operations, engineering and marketing. When Indiana Bell
became a part of Ameritech Corporation, Mr. Knowling assumed positions of
increasing responsibility in marketing, product development, large business
marketing and network operations, including service on Ameritech Corporation's
re-engineering breakthrough development team. As lead architect of the Ameritech
Corporation transformation, Mr. Knowling reported directly to the Chairman. In
July 2000, Mr. Knowling was appointed to the board of directors for Ariba, Inc.
a business-to-business eCommerce platform provider, and Hewlett-Packard Company,
a leading global provider of computing and imaging solutions and services.

MARK PERRY joined us in August 2000 as our Chief Financial Officer and
Executive Vice President, Finance. Prior to joining us, he was with U S WEST
Communications. He began in 1996 as its Vice President and Corporate Officer,
Finance & Administration and subsequently became its Vice President, Operations
and Merger Integration. From 1995 to 1996, he was U S WEST Communications'
Managing Director with Cable Plus, a cable television/telecommunications joint
venture that consisted of ten operating companies. From 1994 to 1995, he was the
Vice President, Finance of Comcast International. From 1988 to 1994 he served in
a variety of management roles with U S WEST Communications, including Assistant
Corporate Controller and Chief Auditor, Vice President and Chief Financial
Officer of the Cable Communications Division. From 1976 to 1988, he was with RCA
Corporation, where he served as its Controller and as a Director, Billing and
Receivables.

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<PAGE>

ROBERT DAVENPORT, III joined us in January 1999. He served as our Vice
President, Business Development until February 1999 and has served as our
Executive Vice President, Business Development since that date. Prior to joining
us, Mr. Davenport was Senior Vice President and Chief Operating Officer at
Tele-Communications, Inc.'s Internet Services subsidiary, TCI.NET from 1997 to
1999. Between 1995 and 1997, Mr. Davenport was with Tele-Communications, Inc.,
as Vice President, Finance and Development for the Telephony Services
subsidiary. From 1992 to 1995, he was Managing Partner of RD Partners, LLC, a
private investment firm focused on leveraged equity investments.

CATHERINE HEMMER joined us in August 1998. She served as our Vice
President, Operations until February 1999 and served as our President, Network
Services from February 1999 to September 1999, and currently serves as our
Executive Vice President and Chief Operating Officer. From 1996 to August 1998,
she was Vice President, Network Reliability and Operations at U S WEST
Communications, Inc. From 1995 to 1996, she served as General Manager, Network
provisioning at Ameritech Services, Inc., a telecommunications company. From
1987 to 1995, she served in various capacities, including Vice President,
Network Services, at MFS Telecom, Inc. From 1981 to 1987, she served in various
management roles at MCI Communications Inc. (now MCI Worldcom, Inc.), providing
management information systems support for the network operations organization.

JOHN MCDEVITT has served as our Executive Vice President, Sales and
Marketing since July 2000. Prior to joining us, he was Vice President of Sales
and Marketing for Danly IEM from 1998 to June 2000. From 1996 to 1998, Mr.
McDevitt served as Business Director with Praxair, Inc. Between 1978 and 1996,
Mr. McDevitt was with Liquid Carbonic Corporation, where he served as Vice
President of Sales and Marketing, General Manager and as a National and Regional
Manager.

JOSEPH DEVICH joined us in August 1998. He served as Vice President and
General Manager of our Western Region until February 1999 and served as
President and General Manager of the Western Region from February 1999 to
September 1999. Since September 1999, he has served as Executive Vice President,
Corporate Services. Prior to joining us, from November 1996 to August 1998, Mr.
Devich was Vice President, Operations and Technologies Staff of U S WEST
Communications, Inc., where he served on the strategic leadership council and
was responsible for leading staff support functions, methodical and procedural
process support, results reporting and analysis, systems planning and
integration, customer value analysis, disaster recovery/business continuity
planning, network security, supplier management and operations strategy
planning. From August 1986 to November 1996, Mr. Devich worked in several
capacities at Ameritech Corporation, including Manager of Product
Management--Technical Support, and Director in the areas of customer support in
the large business market, service reliability within custom business services,
process improvement of network operations and network provisioning.

DHRUV KHANNA is one of our founders. He served as our Vice President,
General Counsel and Secretary from October 1996 until February 1999 and has
served as our Executive Vice President, General Counsel and Secretary since that
date. He was an in-house counsel for Intel Corporation's communications products
division and its Senior Telecommunications Attorney between 1993 and 1996.
Between 1987 and 1993, Mr. Khanna was an associate at Morrison & Foerster, LLP,
where his clients included Teleport Communications Group (now AT&T Corp.), McCaw
Cellular Communications, Inc. (now AT&T Wireless), and Southern Pacific Telecom
(now Qwest Communications International, Inc.). Mr. Khanna has extensive
experience with regulatory matters, litigation and business transactions
involving the RBOCs and other telecommunications companies. While at Intel, he
helped shape the computer industry's positions on the Telecommunications Act of
1996 and the FCC's rules implementing the 1996 Act.

JANE MARVIN joined us in April 1999 as our Senior Vice President, Human
Resources. Prior to joining us, from August 1995 to April 1999, Ms. Marvin was
Vice President, Human Resources for the General Business, Small Business and
Enhanced Business Services units and Director, Leadership and Executive
Development of Ameritech Corporation. In these capacities, she re-engineered and
streamlined multiple HR processes and drove corporate-wide change initiatives.
From 1991 to 1995, Ms. Marvin was Human Resources Director with the Pepsi Cola
Company, a division of Pepsico Inc., where she improved business processes in
the areas of recruitment, selection, training, and compensation. From 1984 to
1991, Ms. Marvin worked in progressively broader HR leadership roles at
DataGeneral Corporation, a provider of enterprise hardware and software
solutions.

TERRY MOYA joined us in July 1999 as our Senior Vice President, External
Affairs. Prior to joining us, from January 1999 to July 1999, Terry served as
Vice President & Chief Financial Officer, Capital Management,

67
<PAGE>

Network/Operations and Technologies at U S WEST Communications, Inc. From August
1998 to January 1999, Terry served as Vice President, Operations for U S WEST
Communications, Inc., where he managed over $2 billion in capital expenditures
and over $320 million in engineering and construction transaction costs. From
February 1997 to August 1998, Terry served as Vice President, Construction,
Operations and Technologies and led the outside plant construction contracting
organization for U S WEST Communications, Inc. From August 1992 to February
1997, Terry spent time in over a half dozen foreign countries establishing and
improving several different lines of business for U S WEST Communications, Inc.
These countries include Poland, Russia, the Czech Republic, Hungary, Brazil and
the United Kingdom. Prior to August 1992, Terry was at KPMG Peat Marwick, LLP in
New Orleans.

MICHAEL LACH joined us in January 2000 as our Executive Vice President,
Corporate Development and Business Integration. Prior to joining us, from May
1997 to December 1999, Mr. Lach was Vice President, Customer Provisioning and
Maintenance of Ameritech Corporation, where he was responsible for the
installation and repair of residential phone lines across a five-state region.
From October 1995 to May 1997, Mr. Lach was General Manager, Network Operations
West of Ameritech Corporation, where he was responsible for provisioning and
maintaining central offices and the transport network in a three state region.
From September 1994 to October 1995, Mr. Lach was Division Manager, Technical
Support of Ameritech Corporation, where he supported the development and
implementation of new product for residential and business customers. From March
1993 to August 1994, Mr. Lach was Director, Business Development for Siemens
Stromberg-Carlson, Inc. From January 1984 to February 1993, Mr. Lach served in
various management roles with Ameritech Corporation relating to its network.

JIMMY LAVALLEY joined us in April 2000 as Executive Vice President of
Community Relations. Prior to joining the Company, from June 1979 to April 2000,
Mr. LaValley was with U S WEST Communications, Inc. Most recently, from February
1999 to April 2000, Mr. LaValley was Vice President, Human Resources,
responsible for Strategic Staffing Services and Management Development for U S
WEST's 58,000 employees. From October 1997 to February 1999, Mr. LaValley was
Vice President Human Resources supporting Network Services, the largest U S WEST
Business Unit. In this role, all aspects of Human Resources support were
provided to 28,000 employees. Prior to these assignments, Mr. LaValley held
leadership positions in all aspects of the Human Resources disciplines at U S
WEST. A former police officer in Tahlequah Oklahoma, Mr. LaValley holds a
bachelor's degree in criminal justice/pre-law from Northeastern Oklahoma State
University.

RICH WONG joined us in January 1999 as our Director of Product Marketing
and Vice President of Marketing and, in July 2000, became our Executive Vice
President, Broadband Services. From January 1996 to January 1999, he was an
Associate and an Engagement Manager with McKinsey & Company. From June 1991 to
December 1995 he was a Brand Manager in the Brand Management Group with Procter
& Gamble.

ROBERT HAWK has served as a member of our board of directors since April
1998. Mr. Hawk is President of Hawk Communications and recently retired as
President and Chief Executive Officer of U S WEST Multimedia Communications, a
regional telecommunications service provider, where he headed the cable, data
and telephony communications business from May 1996 to April 1997. He was
president of the Carrier Division of U S West Communications, Inc., from
September 1990 to May 1996. Prior to that time, Mr. Hawk was Vice President of
Marketing and Strategic Planning for CXC Corporation. Prior to joining CXC
Corporation, Mr. Hawk was director of Advanced Systems Development for
AT&T/American Bell. He currently serves on the boards of PairGain Technologies,
Inc., COM21, Inc., Concord Communications, Inc., Radcom, Ltd., Efficient
Networks, Inc. and several privately held companies.

DANIEL LYNCH has served as a member of our board of directors since April
1997. Mr. Lynch is also a founder of CyberCash, Inc. and has served on its board
of directors since August 1994. From December 1990 to December 1995, he served
as chairman of the board of directors of Softbank Forums, a provider of
education and conference services for the information technology industry. Mr.
Lynch founded Interop Company in 1986, which is now a division of ZD Comdex and
Forums. Mr. Lynch is a member of the Association for Computing Machinery and the
Internet Society. He is also a member of the Board of Trustees of the Santa Fe
Institute, the Bionomics Institute and CommerceNet. He previously served as
Director of the Information Processing Division for the Information Sciences
Institute in Marina del Rey, where he led the Arpanet team that made the
transition from the original NCP protocols to the current TCP/IP based
protocols. He has served as a member of the board of directors of Exodus
Communications since January 1998. Mr. Lynch previously served as a member of
the board of directors at UUNET Technologies, Inc., from April 1994 until August
1996.

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<PAGE>

FRANK MARSHALL has served as a member of our board of directors since
October 1997. Mr. Marshall currently serves on the board of directors of
PMC-Sierra, Inc. and several private companies. Mr. Marshall also serves on the
technical advisory board of several high technology private companies. He is a
member of the InterWest Partners Advisory Committee and a Venture Partner at
Sequoia Capital. From 1992 to 1997, Mr. Marshall served as Vice President of
Engineering and Vice President and General Manager, Core Business Unit of Cisco
Systems, Inc. From 1982 to 1992, he served as Senior Vice President, Engineering
at Convex Computer Corporation.

RICH SHAPERO has served as a member of our board of directors since July
1997. Mr. Shapero has been a general partner of Crosspoint Venture Partners,
L.P., a venture capital investment firm, since April 1993. From January 1991 to
June 1992, he served as Chief Operating Officer of Shiva Corporation, a computer
network company. Previously, he was a Vice President of Sun Microsystems, Inc.,
Senior Director of Marketing at AST Research, Inc., and held marketing and sales
positions at Informatics General Corporation and UNIVAC's Communications
Division. Mr. Shapero serves as a member of the board of directors of Sagent
Technology, Inc., a provider of real-time eBusiness intelligence, and several
privately held companies.

HELLENE RUNTAGH has served as a member of our board of directors since
November 3, 1999. Ms. Runtagh has served as Executive Vice President of
Universal Studios since January 1999. In this capacity, she is responsible for
overseeing the activities of the Universal Studios Operations Group, Universal
Studios Consumer Products Group, Universal Studios Corporate Marketing and
Sponsorships, and the Spencer Gift retail operations, Universal Studios'
worldwide information technology, and Seagram's global sourcing and real estate
operations. From February 1997 to January 1999, she held the position of senior
vice president of reengineering effort at Universal. Previously, Ms. Runtagh
spent 25 years at General Electric, where she served as President and Chief
Executive Officer of GE Information Services from 1989 to 1996 and held general
management roles with GE's capital and software businesses.

LARRY IRVING has served as a member of our Board of Directors since April
2000. Mr. Irving is the President and CEO of UrbanMagic.com, an Internet portal
for the African American community scheduled to be launched later this year.
Prior to joining UrbanMagic.com, Mr. Irving served for almost seven years as
Assistant Secretary of Commerce for Communications and Information, where he was
a principal advisor to the President, Vice President and Secretary of Commerce
on domestic and international communications and information policy issues,
including the development of policies related to the Internet and Electronic
Commerce. He was a point person in the Administration's successful efforts to
reform the United States' telecommunications law, which resulted in the passage
of the Telecommunications Act of 1996. Mr. Irving is widely credited with
popularizing the term "Digital Divide" and was the principal author of the
landmark Federal survey, FALLING THROUGH THE NET, which tracked access to
telecommunications and information technologies, including computers and the
Internet, across racial, economic, and geographic lines. In recognition of his
work to promote policies and develop programs to ensure equitable access to
advanced telecommunication and information technologies, Irving was named one of
the fifty most influential persons in the "Year of the Internet" by Newsweek
Magazine. Prior to joining the Clinton-Gore Administration, Mr. Irving served
ten years on Capitol Hill, most recently as Senior Counsel to the U.S. House of
Representatives Subcommittee on Telecommunications and Finance. He also served
as Legislative Director, Counsel and Chief of Staff (acting) to the late
Congressman Mickey Leland (D-Texas). During the previous three years, Mr. Irving
was associated with the Washington, D.C. law firm of Hogan & Hartson,
specializing in communications law, antitrust law and commercial litigation.

DEBRA DUNN has served as a member of our Board of Directors since April
2000. Since late 1999, Ms. Dunn has been the vice president of Strategy and
Corporate Operations for Hewlett-Packard Company and has global responsibility
for driving the broad range of efforts required to reposition Hewlett-Packard.
She is responsible for corporate-wide functions including corporate strategy,
development, communications, philanthropy and government affairs. Ms. Dunn
joined Hewlett-Packard in 1983 as an executive development manager in
Hewlett-Packard's Corporate Training division in Palo Alto. She held a wide
range of development and marketing management positions from 1986 to 1992, and
was promoted to manufacturing manager for Hewlett-Packard's Video Communication
division in 1992, marketing manager in 1993 and was named general manager of the
division in 1996. Ms. Dunn was promoted to general manager of Hewlett-Packard's
executive committee in 1998 and led the Hewlett-Packard/Agilent split process
and Hewlett-Packard's new business creation function.

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<PAGE>

CLASSIFIED BOARD

The board of directors is divided into three classes. The term of office
and directors consisting of each class is as follows:

CLASS DIRECTORS TERM OF OFFICE

Class I Daniel Lynch o expires at the annual meeting of
Rich Shapero stockholders in 2003 and at each third
Larry Irving succeeding annual meeting thereafter

Class II Frank Marshall o expires at the annual meeting of
Hellene Runtagh stockholders in 2001 and at each third
succeeding annual meeting thereafter

Class III Robert Hawk o expires at the annual meeting of
Robert Knowling, Jr. stockholders in 2002 and at each third
Debra Dunn succeeding annual meeting thereafter

The classification of directors has the effect of making it more difficult
to change the composition of the board of directors.

BOARD COMMITTEES

In April 1998, our board of directors established an audit committee and a
compensation committee. The audit committee consists of three of our outside
directors, Mr. Lynch, Mr. Hawk and Ms. Runtagh. The audit committee's primary
responsibilities include:

o conducting a post-audit review of the financial statements and audit
findings;

o reviewing our independent auditors proposed audit scope and approach;
and

o reviewing on a continuous basis the adequacy of our system of
internal accounting controls.

The compensation committee also consists of three of our outside directors,
Ms. Runtagh, Ms. Dunn and Mr. Shapero. Mr. Marshall, also an outside director,
serves as an alternate on the committee. The primary responsibilities of the
compensation committee include:

o reviewing and determining the compensation policy for our executive
officers and directors, and other employees as directed by the board
of directors;

o reviewing and determining all forms of compensation to be provided to
our executive officers; and

o reviewing and making recommendations to our board of directors
regarding general compensation goals and guidelines for our employees
and the criteria by which bonuses to our employees are determined.

We also have a pricing committee and management compensation committee. The
pricing committee currently consists of three outside directors, Messrs.
Shapero, Irving and Marshall, and one inside director, Mr. Knowling. The
function of the pricing committee is to set the price for the sale of our common
stock to third-parties. The function of the management compensation committee,
which consists solely of one inside director, Mr. Knowling, is to review and
determine the compensation policy for employees other than our executive
officers and directors and to review and determine all forms of compensation for
such employees.

DIRECTOR COMPENSATION

Except for grants of stock options subject to vesting and restricted stock
subject to repurchase, directors generally do not receive compensation for
services provided as a director or committee member. New directors will receive
a stock option grant to purchase 60,000 shares of common stock which will vest
over four years. We do not pay additional amounts for committee participation or
special assignments of the Board of Directors, except for reimbursement of
expenses in attending Board and committee meetings.

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<PAGE>

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

No interlocking relationship exists between the Board of Directors or the
Compensation Committee and the Board of Directors or compensation committee of
any other company, nor has any such interlocking relationship existed in the
past. Mr. Shapero is affiliated with Crosspoint Venture Partners L.P., which was
a party along with the Company, to a Series C Preferred Stock and Warrant
Subscription Agreement dated February 23, 1998. See "--Certain Relationships and
Related Transactions."

EXECUTIVE COMPENSATION

The following table sets forth certain information with respect to
compensation awarded to, earned by or paid to each person who served as our
Chief Executive Officer or was one of our four other most highly compensated
executive officers (collectively, the "Named Executive Officers") during the
fiscal year ended December 31, 1999. All share numbers have been adjusted in
light of the 3-for-2 stock split, effected in the form of a stock dividend,
effective March 31, 2000.

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<PAGE>

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
----------------------------
ANNUAL COMPENSATION RESTRICTED SECURITIES
NAME AND PRINCIPAL FISCAL ----------------------- STOCK UNDERLYING ALL OTHER
POSITION YEAR SALARY BONUS AWARDS($) OPTIONS/SARS(#) COMPENSATION
-------------------------- ------ ---------- ----------- ---------- --------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Robert Knowling, Jr............. 1999 $ 399,996 $ 500,000 -- -- $ 750,420(8)
Chairman, Board of 1998 $ 180,768(2)$ 250,000 -- 4,725,000 $ 750,343(9)
Directors, President and 1997 -- -- -- -- --
Chief Executive Officer (1)

Robert Roblin................... 1999 $ 232,692 $ 140,250 $ 882,500(7) -- $ 405(10)
Executive Vice President, 1998 $ 21,154(3)$ 9,493 -- 562,500 $ 74(10)
Sales and Marketing(13) 1997 -- -- -- -- --

Catherine Hemmer................ 1999 $ 180,769 $ 109,500 $ 882,500(7) -- $ 240(10)
Chief Operating Officer 1998 $ 58,359(4)$ 56,000 -- 437,713 $ 84,363(11)
1997 -- -- -- -- --

Joseph Devich................... 1999 $ 167,308 $ 101,250 $ 882,500(7) -- $ 210(10)
Executive Vice President, 1998 $ 52,981(5)$ 20,137 -- 380,622 $ 76,961(12)
Corporate Services 1997 -- -- -- -- --

Robert Davenport, III........... 1999 $ 183,077(6)$ 91,667 -- 450,001 $ 171(10)
Executive Vice President, 1998 -- -- -- -- --
Business Development 1997 -- -- -- -- --
</TABLE>
--------------
(1) In September 1999, Mr. Knowling became Chairman of our Board of
Directors.
(2) Pro rated based on an annual salary of $400,000 from hiring date of
July 8, 1998.
(3) Pro rated based on an annual salary of $220,000 from hiring date of
November 16, 1998.
(4) Pro rated based on an annual salary of $150,000 from hiring date of
August 10, 1998.
(5) Pro rated based on an annual salary of $150,000 from hiring date of
August 13, 1998.
(6) Pro rated based on an annual salary of $200,000 from hiring date of
January 20, 1999.
(7) This value is based upon the split-adjusted closing price of $29.416
for 30,000 post-split shares grantedon November 3, 1999 to Mr.
Roblin, Ms. Hemmer and Mr. Devich. As of December 31, 1999, all of
these shares were unvested and valued at $1,118,750 based on a
split-adjusted closing price of $37.29. Twenty-five percent of
these shares will vest on the four consecutive anniversaries of
the grant date.
(8) Includes $750,000 for the final installment of Mr. Knowling's sign-on
bonus as well as $420 for term life insurance premium.
(9) Includes $750,000 for the first installment of Mr. Knowling's sign-on
bonus as well as $343 for term life insurance premium.
(10) The dollar amount in this column represents premium payments the
Company made for executive's term life insurance policies.
(11) Includes a payment of $84,275 as a sign-on bonus as well as $88 for
term life insurance premium.
(12) Includes a payment of $76,883 as a sign-on bonus as well as $78 for
term life insurance premium.
(13) On May 12, 2000, we announced the resignation of Robert Roblin. John
McDevitt has been appointed to replace Mr. Roblin.

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<PAGE>

OPTION / SAR GRANTS IN LAST FISCAL YEAR

The following table sets forth information regarding stock options granted
to Named Executive Officers during the fiscal year ended December 31, 1999.
During the last fiscal year, Mr. Davenport was the only Named Executive Officer
to receive any option grant and none of the Named Executive Officers received
stock appreciation rights during the year ended December 31, 1999. All share
numbers have been adjusted in light of the 3-for-2 stock split, effected in the
form of a stock dividend, effective March 31, 2000.

INDIVIDUAL GRANTS
-----------------------------------------------------
PERCENT OF
TOTAL POTENTIAL REALIZABLE
NUMBER OF OPTIONS ---------------------------
SECURITIES GRANTED TO VALUE AT ASSUMED ANNUAL
UNDERLYING EMPLOYEES EXERCISE RATES OF STOCK PRICE
OPTIONS IN FISCAL PRICE EXPIRATION APPRECIATION FOR OPTION
NAME GRANTED(#)(1) 1999(%)(2) PER SHARE DATE TERM($)(3)
------- -------------- ------------- ---------- ------------ ---------------------------
5% 10%
<S> <C> <C> <C> <C> <C> <C>
Robert Davenport, III......... 450,001 5.14% $ 7.53 1/20/2007 $ 1,623,354 $ 3,888,215
</TABLE>
--------------

(1) The material terms of the option grant to Mr. Davenport during 1999 is as
follows: (i) the options consist of qualified and nonqualified stock
options; (ii) all have an exercise price equal to the fair market value
on the date of grant; (iii) all have an 8-year term and become
exercisable over a four-year period, with 12.5% of the option shares
vesting on the six-month anniversary of the grant date and the remainder
vesting in 42 equal monthly installments; (iv) the options are not
transferable and (v) all options are otherwise subject to the terms and
provisions of our 1997 Stock Plan. See "--1997 Stock Plan."

(2) Based on options covering an aggregate of 8,750,826 shares
(split-adjusted) we granted during 1999 pursuant to our 1997 Stock Plan.

(3) These amounts represent hypothetical gains that could be achieved for the
options if exercised at the end of the option term. The potential
realizable values are calculated by assuming that our common stock
appreciates at the annual rate shown, compounded annually, from the date
of grant until expiration of the granted options. The assumed 5% and 10%
rates of stock price appreciation are mandated by the rules of the
Securities and Exchange Commission and do not represent our estimate or
projection of future stock price growth.

AGGREGATED OPTION / SAR EXERCISES IN LAST FISCAL YEAR AND YEAR-END OPTION
/SAR VALUES

The following table sets forth information with respect to the exercise of
stock options during the year ended December 31, 1999 and the number and
year-end value of shares of our common stock underlying the unexercised options
held by the Named Executive Officers. None of the Named Executive Officers
exercised or held stock appreciation rights during the year ended December 31,
1999. All share numbers have been adjusted in light of the 3-for-2 stock split,
effected in the form of a stock dividend, effective March 31, 2000.

NUMBER OF SECURITIES
OPTIONS EXERCISED DURING 1999 UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
--------------------------- OPTIONS AT DECEMBER IN-THE-MONEY OPTIONS AT
SHARE 31, 1999 DECEMBER 31, 1999($)(1)
ACQUIRED ON VALUE ------------------------ ------------------------------
NAME EXERCISE(#) REALIZED($)(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
------- ----------- -------------- ---------- ------------ -------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Robert Knowling, Jr...... 491,250 $14,324,166.56 1,088,437 3,145,312 $40,105,898.20 $115,896,027.95
Robert Roblin (3)........ 22,500 $ 582,575.00 129,843 410,152 $ 4,384,437.41 $ 13,849,862.47
Catherine Hemmer......... 54,000 $ 1,588,502.00 91,902 291,811 $ 3,192,316.10 $ 10,136,396.75
Joseph Devich............ 54,129 $ 2,146,621.00 39,800 177,862 $ 2,073,745.85 $ 9,267,351.35
Robert Davenport, III.... -- -- 68,750 231,251 $ 3,066,536.48 $ 10,314,758.22
</TABLE>
--------------
(1) Value represents the fair market value at exercise minus the exercise
price.
(2) Value represents the difference between the exercise price and the market
value (i.e., split-adjusted closing price) of common stock of $37.29 on
December 31, 1999. An option is "in-the-money" if the market value of the
common stock exceeds the exercise price.
(3) On May 12, 2000, we announced the resignation of Mr. Roblin. John
McDevitt has been appointed to replace Mr. Roblin.

EMPLOYMENT AGREEMENTS AND CHANGE IN CONTROL ARRANGEMENTS

<PAGE>

compensation in the form of a $400,000 annual base salary and a $250,000 minimum
annual bonus. Mr. Knowling received (i) a signing bonus of $1,500,000, one half
of which was paid when he began working for us, and the remaining half of which
was paid once he worked for us for one full year (July 1999), and (ii) stock
options to purchase 4,725,000 post-split shares of our common stock at a
split-adjusted exercise price of $.45 per share. If we terminate Mr. Knowling's
employment relationship without cause (as that term is defined in the
agreement), or if Mr. Knowling resigns for good reason (as that term is defined
in the agreement), we must continue to pay Mr. Knowling's annual salary and
targeted bonus for a period of two years after the date of termination so long
as Mr. Knowling does not become employed by one of our direct competitors. Mr.
Knowling has agreed to be bound by customary confidentiality provisions. As
provided in the agreement, in August 1998 we loaned Mr. Knowling $500,000
pursuant to a Note Secured by Deed of Trust that bears no interest during his
employment. The loan has provisions for forgiveness based on continued
employment and matures in four years, subject to acceleration in certain events.
See "Certain Relationships and Related Transactions--Employee Loans."

With respect to all options granted under our 1997 Stock Plan, in the event
that we merge with or into another corporation resulting in a change of control
involving a shift in 50% or more of the voting power of our capital stock, or
the sale of all or substantially all of our assets, the options will fully vest
and become exercisable one year after the change of control or earlier in the
event the individual is constructively terminated or terminated without cause or
in the event the successor corporation refuses to assume the options. See
"--1997 Stock Plan."

We have also entered into restricted stock purchase agreements with certain
of our officers and directors. The shares of our common stock issued pursuant to
these restricted stock purchase agreements are subject to our right of
repurchase which lapses in accordance with the vesting schedule of the
agreements. The agreements also include similar provisions to the stock options,
providing for accelerated vesting in the event of a change of control. See
"Certain Relationships and Related Transactions--Issuance of Common Stock."

1997 STOCK PLAN

STRUCTURE

The 1997 Plan consists of three types of equity incentive programs: (i)
qualifying stock options ("Incentive Stock Options") intended to qualify within
the meaning of Section 422 of the Code; (ii) non-qualifying stock options (or
"Non-Statutory Stock Options") not intended to qualify within the meaning of
Section 422 of the Code; and (iii) stock purchase rights ("SPRs") for shares of
common stock.

ADMINISTRATION

The Plan is administered by our Board of Directors or a committee appointed
by the Board of Directors and consisting of non-employee directors within the
meaning of Section 16(b) of the Exchange Act and outside directors within the
meaning of Section 162(m) of the Code (referred to as the "Administrator").
Subject to the provisions of the Plan, the Administrator has the authority, in
its discretion: (i) to determine the fair market value of our common stock; (ii)
to select the employees, directors or consultants to whom options and SPRs may
be granted under the Plan; (iii) to determine the number of shares of common
stock to be covered by each option and SPR granted under the Plan; (iv) to
approve forms of agreement for use under the Plan; (v) to determine the terms
and conditions of any option or SPR granted under the Plan such as the exercise
price, the time or times when options or SPRs may be exercised (which may be
based on performance criteria), any vesting acceleration or waiver of forfeiture
restrictions; (vi) to reduce the exercise price of any option or SPR to the then
current fair market value; (vii) to institute an option exchange program; (viii)
to construe and interpret the terms of the Plan and awards granted pursuant to
the Plan; (ix) to prescribe, amend and rescind rules and regulations relating to
the Plan; (x) to modify or amend each option or SPR; (xi) to allow optionees to
satisfy withholding tax obligations by electing to have us withhold from the
shares to be issued upon exercise of an option or SPR that number of shares
having a fair market value equal to the amount required to be withheld; (xii) to
authorize any person to execute on behalf of us any instrument required to
effect the grant of an option or SPR previously granted by the Administrator;
and (xiii) to make all other determinations deemed necessary or advisable for
administering the Plan.

ELIGIBILITY

All employees, directors and consultants are eligible to participate in the
1997 Plan. Incentive Stock Options may be granted only to employees (including
officers and directors). Non-Statutory Stock Options and SPRs may be

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<PAGE>

granted to employees, directors and consultants. To the extent that the
aggregate fair market value of the shares with respect to which Incentive Stock
Options are exercisable for the first time by an optionee during any calendar
year (under all plans of the Company and any parent or subsidiary) exceed
$100,000, such options are treated as Non-Statutory Stock Options. No optionee
may be granted, in any fiscal year, options to purchase more than 2,000,000
shares; provided that, in connection with his or her initial service, an
optionee may be granted options to purchase up to an additional 2,000,000 shares
that shall not count against such limit.

SECURITIES SUBJECT TO THE PLAN

The number of shares of our common stock which are reserved for issuance
under the Plan is 35,092,635 post-split shares, plus an annual increase on the
first day of each fiscal year equal to the lesser of (i) 3% of the outstanding
shares on such date or (ii) an amount determined by our Board of Directors, with
the total increase being capped at 20,000,000 shares and an additional 5,000,000
and 10,000,000 post-split shares for the Year 2000 and Year 2001, respectively.
As of January 1, 2000, there were 12,425,857 post-split shares available for
issuance under the Plan, which includes the 3% annual increase of 4,400,533
post-split shares and 5,000,000 additional post-split shares.

These shares may be authorized, but unissued, or reacquired common stock.
If an option or SPR expires or becomes unexercisable without having been
exercised in full, or is surrendered pursuant to an option exchange program, the
unpurchased shares that were subject thereto may become available for future
grant or sale under the Plan.

TERMS AND CONDITIONS OF OPTIONS

Each option granted pursuant to the Plan is evidenced by a written stock
option agreement (an "Option Agreement") between the optionee and us and is
subject to the following terms and conditions:

TERM OF OPTIONS. The term of each option is stated in each Option
Agreement. In the case of an Incentive Stock Option, the term is ten years from
the date of grant or such shorter terms as may be provided in the Option
Agreement. In the case of an Incentive Stock Option granted to an optionee who,
at the time the Incentive Stock Option is granted, owns stock representing more
than ten percent of the total combined voting power of all classes of stock of
us or any parent or subsidiary, the term of the Incentive Stock Option is five
years from the date of grant or such shorter term as may be provided in the
Option Agreement.

EXERCISE PRICE. The per share exercise price for the shares to be issued
pursuant to the exercise of an option is determined by the Administrator,
subject to the following: (i) in the case of an Incentive Stock Option (A)
granted to an employee who, at the time the Incentive Stock Option is granted,
owns stock representing more than ten percent of the voting power of all classes
of stock of us or any parent or subsidiary, the per share exercise price may be
no less than 110% of the fair market value per share on the date of grant and
(B) granted to any employee other than an employee described in (A) immediately
preceding, the per share exercise price may be no less than 100% of the fair
market value per share on the date of grant; (ii) in the case of a Non-Statutory
Stock Option, the per share exercise price maybe determined by the
Administrator; and (iii) in the case of a Non-Statutory Stock Option intended to
qualify as "performance-based compensation" within the meaning of Section 162(m)
of the Code, the per share exercise price may be no less than 100% of the fair
market value per share on the date of grant. Notwithstanding the foregoing,
options may be granted with a per share exercise price of less than 100% of the
fair market value per share on the date of grant pursuant to a merger or other
corporate transaction.

WAITING PERIOD AND EXERCISE DATES. At the time an option is granted, the
Administrator fixes the period within which the option may be exercised (i.e.,
vests) and determines any conditions that must be satisfied before the option
may be exercised. Options generally vest at a rate of 12.5% of the shares
subject to the option on the date six months following the grant date and 1/48th
of the shares subject to the option at the end of each one-month period
thereafter and generally expire eight years from the date of grant. Unless the
Administrator provides otherwise, vesting of options granted under the 1997 Plan
are tolled during any unpaid leave of absence.

FORM OF CONSIDERATION. The Administrator determines the acceptable form of
consideration for exercising an option, including the method of payment. In the
case of an Incentive Stock Option, the Administrator determines the acceptable
form of consideration at the time of grant. Such consideration may consist
entirely of (a) cash; (b) check; (c) promissory note; (d) other shares that (i)
in the case of shares acquired upon exercise of an option, have been owned by
the optionee for more than six months on the date of surrender, and (ii) have a
fair market value on the

75
<PAGE>

date of surrender equal to the aggregate exercise price of the shares as to
which such option is exercised, consideration received by us under a cashless
exercise program implemented by us in connection with the Plan, a reduction in
the amount of any liability to the optionee, including any liability
attributable to the optionee's participation in any company-sponsored deferred
compensation program or arrangement, any combination of the foregoing methods of
payment; or (e) any other consideration and method of payment for the issuance
of shares to the extent permitted by applicable laws.

EXERCISE OF OPTION. Any option granted under the Plan is exercisable
according to the terms of the Plan and at such times and under such conditions
as determined by the Administrator and set forth in the Option Agreement.
Exercise of an option in any manner shall result in a decrease in the number of
shares thereafter available, both for purposes of the Plan and for sale under
the option, by the number of shares as to which the option is exercised.

TERMINATION OF RELATIONSHIP. If an optionee ceases to be an employee,
director or consultant, other than upon the optionee's death or disability, the
optionee may exercise his or her option within such period of time as is
specified in the Option Agreement to the extent that the option is vested on the
date of termination (but in no event later than the expiration of the term of
such option as set forth in the Option Agreement). In the absence of a different
specified time in the Option Agreement, the option remains exercisable for three
months following the optionee's termination. If, on the date of termination, the
optionee is not vested as to his or her entire option, the shares covered by the
unvested portion of the option revert to the Plan. If, after termination, the
optionee does not exercise his or her option within the time specified by the
Administrator, the option terminates, and the shares covered by such option
revert to the Plan.

DISABILITY OF OPTIONEE. If an optionee ceases to be an employee, director
or consultant as a result of the optionee's disability, the optionee may
exercise his or her option within such period of time as is specified in the
Option Agreement to the extent the option is vested on the date of termination
(but in no event later than the expiration of the term of such option as set
forth in the Option Agreement). In the absence of a different specified time in
the Option Agreement, the option will remain exercisable for twelve months
following the optionee's termination. If, on the date of termination, the
optionee is not vested as to his or her entire option, the shares covered by the
unvested portion of the option revert to the Plan. If, after termination, the
optionee does not exercise his or her option within the time specified, the
option will terminate, and the shares covered by such option revert to the Plan.

DEATH OF OPTIONEE. If an Optionee dies while an employee, director or
consultant, the option may be exercised within such period of time as is
specified in the Option Agreement (but in no event later than the expiration of
the term of such option as set forth in the Option Agreement), by the optionee's
estate or by a person who acquires the right to exercise the option by bequest
or inheritance, but only to the extent that the option is vested on the date of
death. In the absence of a specified time in the Option Agreement, the option
will remain exercisable for twelve months following the optionee's termination.
If, at the time of death, the optionee is not vested as to his or her entire
option, the shares covered by the unvested portion of the option will revert to
the Plan. The option may be exercised by the executor or Administrator of the
optionee's estate or, if none, by the person(s) entitled to exercise the option
under the optionee's will or the laws of descent or distribution. If the option
is not so exercised within the time specified, the option terminates, and the
shares covered by such option revert to the Plan.

BUYOUT PROVISIONS. The Administrator may at any time offer to buy out for a
payment in cash, shares or otherwise an option previously granted based on such
terms and conditions as the Administrator establishes and communicates to the
optionee at the time that such offer is made.

STOCK PURCHASE RIGHTS

RIGHTS TO PURCHASE. Stock purchase rights may be issued either alone, in
addition to, or in tandem with other awards granted under the Plan and/or cash
awards made outside of the Plan. After the Administrator determines that it will
offer SPRs under the Plan, it will advise the offeree in writing or
electronically, by means of a Notice of Grant, of the terms, conditions and
restrictions related at the offer, including the number of shares that the
offeree will be entitled to purchase, the price to be paid, and the time within
which the offeree must accept such offer. The offer will be accepted by
execution of a restricted stock purchase agreement in the form determined by the
Administrator.

REPURCHASE OPTION. Unless the Administrator determines otherwise, the
restricted stock purchase agreement will grant us a repurchase option
exercisable upon the voluntary or involuntary termination of the purchaser's

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<PAGE>

service with us for any reason (including death or disability). The purchase
price for shares repurchased pursuant to the restricted stock purchase agreement
will be the original price paid by the purchaser and may be paid by cancellation
of any indebtedness of the purchaser to us. The repurchase option will lapse at
a rate determined by the Administrator.

OTHER PROVISIONS. The restricted stock purchase agreement will contain such
other terms, provisions and conditions not inconsistent with the Plan as may be
determined by the Administrator in its sole discretion.

RIGHTS AS A STOCKHOLDER. Once the SPR is exercised, the purchaser will have
the rights equivalent to those of a stockholder, and will be a stockholder when
his or her purchase is entered upon the records of the duly authorized transfer
agent.

NON-TRANSFERABILITY OF OPTIONS AND STOCK PURCHASE RIGHTS

Unless determined otherwise by the Administrator, an option or SPR may not
be sold, pledged, assigned, hypothecated, transferred, or disposed of in any
manner other than by will or by the laws of descent or distribution and may be
exercised, during the lifetime of the optionee, only by the optionee.

ADJUSTMENTS UPON CHANGES IN CAPITALIZATION, DISSOLUTION, MERGER OR ASSET
SALE

CHANGES IN CAPITALIZATION. Subject to any required action by stockholders,
the number of shares of common stock covered by each outstanding option and SPR,
and the number of shares of common stock that have been authorized for issuance
under the Plan but as to which no options or SPRs have yet been granted or that
have been returned to the Plan upon cancellation or expiration of an option or
SPR, as well as the price per share of common stock covered by each such
outstanding option or SPR, will be proportionately adjusted for any increase or
decrease in the number of issued shares of common stock resulting from a stock
split, reverse stock split, stock dividend, combination or reclassification of
the common stock, or any other increase or decrease in the number of issued
shares of common stock effected without receipt of consideration by us.

DISSOLUTION OR LIQUIDATION. In the event of the proposed dissolution or
liquidation, the Administrator will notify each optionee as soon as practicable
prior to the effective date of such proposed transaction. The Administrator in
its discretion may provide for an optionee to have the right to exercise his or
her option until ten days prior to such transaction as to all of the optioned
stock covered thereby, including shares as to which the option would not
otherwise be exercisable. In addition, the Administrator may provide that any
repurchase option applicable to any shares purchased upon exercise of an option
or SPR will lapse as to all such shares, provided the proposed dissolution or
liquidation take place at the time and in the manner contemplated. To the extent
it has not been previously exercised, an option or SPR will terminate
immediately prior to the consummation of such proposed action.

MERGER OR ASSET SALE. In the event of a merger of us with or into another
corporation, or the sale of substantially all of our assets, each outstanding
option and SPR will be assumed or an equivalent option or right substituted by
the successor corporation or a parent or subsidiary of the successor
corporation. In the event that the successor corporation refuses to assume or
substitute for the option or SPR, the optionee will fully vest in and have the
right to exercise the option or SPR as to all of the optioned stock, including
shares as to which it would not otherwise be vested or exercisable. If an option
or stock repurchase right becomes fully vested and exercisable in lieu of
assumption or substitution in the event of a merger or sale of assets, the
Administrator will notify the Optionee in writing or electronically that the
option or SPR shall be fully vested and exercisable for a period of fifteen days
from the date of such notice, and the option or SPR shall terminate upon the
expiration of such period.

ACCELERATION IN CONNECTION WITH CHANGE OF CONTROL. All stock options and
SPRs to officers, employees, directors and consultants provide that in the event
the Company merges with or into another corporation resulting in a change of
control involving a shift in 50% or more of the voting power of our capital
stock, or the sale of all or substantially all of our assets, the options will
fully vest and become exercisable one year after the change of control. In the
event the individual is constructively terminated or terminated without cause or
in the event that the successor corporation refuses to assume or substitute the
options, the options or SPRs will fully vest and become exercisable at that
time.

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<PAGE>

AMENDMENT AND TERMINATION OF THE PLAN

The Board may at any time amend, alter, suspend or terminate the Plan;
provided that we are required to obtain stockholder approval of any Plan
amendment to the extent necessary and desirable to comply with applicable laws.

FEDERAL INCOME TAX CONSEQUENCES

The following discussion of federal income tax consequences does not
purport to be a complete analysis of all of the potential tax effects of the
Plan. It is based upon laws, regulations, rulings and decisions now in effect,
all of which are subject to change. No information is provided with respect to
persons who are not citizens or residents of the United States, or foreign,
state or local tax laws, or estate, gift and excise tax considerations. In
addition, the tax consequences to a particular participant may be affected by
matters not discussed herein.

NON-STATUTORY STOCK OPTIONS

Under current federal income tax law, the grant of a Non-Statutory Stock
Option has no tax effect on us or the optionee to whom it is granted. If the
shares of common stock received on the exercise of a Non-Statutory Stock Option
are not subject to restrictions on transfer or risk of forfeiture, the exercise
of the Non-Statutory Stock Option will result in ordinary income to the optionee
equal to the excess of the fair market value of the shares at the time of
exercise over the option price. The optionee's tax basis in the shares will be
equal to the aggregate exercise price paid by the optionee plus the amount of
taxable income recognized upon the exercise of the option. Upon any subsequent
disposition of the shares, any gain or loss recognized by the optionee will be
treated as capital gain or loss and will be long-term capital gain or loss if
the shares are held for more than one year after exercise. At the time of
recognition of ordinary income by the optionee upon exercise, we will normally
be allowed to take a deduction for federal income tax purposes in an amount
equal to such recognized income.

INCENTIVE STOCK OPTIONS

The federal income tax consequences associated with Incentive Stock Options
are generally more favorable to the optionee and less favorable to us than those
associated with Non-Statutory Stock Options. Under current federal income tax
law, the grant of an Incentive Stock Option does not result in income to the
optionee or in a deduction for us at the time of the grant. Generally, the
exercise of an Incentive Stock Option will not result in income for the optionee
if the optionee does not dispose of the shares within two years after the date
of grant nor within one year after the date of exercise. If these requirements
are met, the basis of the shares of common stock upon a later disposition will
be the option price, any gain on the later disposition will be taxed to the
optionee as long-term capital gain, and we will not be entitled to a deduction.
The excess of the market value on the exercise date over the option price is an
adjustment to regular taxable income in determining alternative minimum taxable
income, which could cause the optionee to be subject to the alternative minimum
tax. If the optionee disposes of the shares before the expiration of either of
the holding periods described above (a "Disqualifying Disposition"), the
optionee will have compensation taxable as ordinary income, and the Company will
normally be entitled to a deduction, equal to the lesser of (a) the fair market
value of the shares on the exercise date minus the option price, or (b) the
amount realized on the disposition minus the option price. If the price realized
in any such Disqualifying Disposition of the shares exceeds the fair market
value of the shares on the exercise date, the excess will be treated as
long-term or short-term capital gain, depending on the optionee's holding period
for the shares.

STOCK PURCHASE RIGHTS

Under current federal income tax law, the grant of an SPR has no tax effect
on us or the individual to whom it is granted. The income tax consequences
resulting from a purchase of restricted stock pursuant to the exercise of a
stock purchase right will vary depending on whether the purchaser makes an
election under Section 83(b) of the Code. Such election maybe made within 30
days of the date the restricted stock is purchased with respect to some or all
of the shares of restricted stock purchased. If no election is made, the
participant will not recognize any income as a result of the purchase of shares
subject to the transfer restrictions and forfeiture provisions (i.e., our
repurchase right) described above. The participant will recognize compensation
income when the transfer restrictions or forfeiture provisions lapse or are
otherwise removed in an amount equal to the difference between the purchase
price paid for such shares and the fair market value of such shares when such
restrictions lapse or are otherwise removed.

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In addition, any dividends paid on any shares while such shares are subject to
transfer restrictions and forfeiture provisions will be considered compensation
income and not dividend income.

If the participant makes an election under Section 83(b) of the Code, the
participant recognizes compensation income when he or she purchases the shares
in an amount equal to the difference between the fair market value of such
shares at the time of purchase (determined without regard to the transfer
restrictions) and the purchase price paid for such shares. The participant
recognizes no additional income upon the subsequent lapse or removal of the
transfer restrictions or forfeiture provisions with respect to such shares, and
any dividends paid on the shares while such shares are subject to the transfer
restrictions and forfeiture provisions will be taxed as dividend (rather than
compensation) income.

In general, we are entitled to a deduction in the amount of the
compensation income recognized by the participant at the time the participant
recognizes such income, provided certain reporting requirements are timely met.

If and to the extent any shares are forfeited (i.e., repurchased by us),
the participant will be allowed to deduct--as an ordinary deduction if no
Section 83(b) election was made or as a capital loss if such an election was
made--an amount equal to the difference, if any, between the purchase price paid
for the shares and the amount received as a result of the forfeiture. The
participant will recognize a capital gain or loss upon the subsequent sale or
other taxable disposition of such shares (other than a sale to us as a result of
the forfeiture provisions), in an amount equal to the difference between the
proceeds realized from the sale or other disposition and the sum of (a) the
purchase price paid for such shares plus (b) in the case of a gain taxable to a
participant who made a Section 83(b) election, the amount of gross income
taxable as compensation to such participant as a result of the purchase of the
shares.

We are not entitled to any deduction corresponding to any capital gains
realized by a participant.

$1,000,000 LIMIT ON DEDUCTIBLE COMPENSATION

Section 162(m) of the Code provides that any publicly-traded corporation
will be denied a deduction for compensation paid to certain executive officers
to the extent that the compensation exceeds $1,000,000 per officer per year.
However, the deduction limit does not apply to "performance-based compensation,"
as defined in Section 162(m). Compensation is performance-based compensation if
(i) the compensation is payable on account of the attainment of one or more
performance goals; (ii) the performance goals are established by a compensation
committee of the board of directors consisting of "outside directors"; (iii) the
material terms of the compensation and the performance goals are disclosed to
and approved by the stockholders in a separate vote; and (iv) the compensation
committee certifies that the performance goals have been satisfied. We believe
that the stock options granted under the plan (unless granted for purchase
prices below the fair market value of the stock subject to the options) will
satisfy the requirements to be treated as performance-based compensation, and
accordingly will not be subject to the deduction limit of Section 162(m) of the
Code. We believe, however, that it is unlikely that SPRs granted under the Plan,
or the purchase of restricted stock there under, will qualify as
performance-based compensation. Our ability to deduct compensation attributable
to the purchase of restricted stock under stock purchase rights will therefore
probably be subject to the limit of Section 162(m) of the Code.

EXCESS PARACHUTE PAYMENTS

Under Section 4999 of the Code, certain officers, stockholders, or
highly-compensated individuals ("Disqualified Individuals") will be subject to
an excise tax (in addition to federal income taxes) of 20% of the amount of
certain "excess parachute payments" which they receive as a result of a change
in control of us. Furthermore, Section 280G of the Code prevents us from taking
a deduction for any "excess parachute payments." The cash out or acceleration of
the vesting of stock options or restricted stock upon a change in control may
cause the holders of such stock options and restricted stock who are
Disqualified Individuals to recognize certain amounts as "excess parachute
payments" on which they must pay the 20% excise tax, and for which we will be
denied a tax deduction.

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SPECIAL RULES; WITHHOLDING OF TAXES

Special tax rules may apply to a participant who is subject to Section 16
of the Exchange Act. Other special tax rules will apply if a participant
exercises a stock option by delivering shares of common stock which he or she
already owns, or through a "cashless exercise."

PARTICIPATION IN THE PLAN

As of August 1, 2000, 25,700,808 split-adjusted shares of common stock were
subject to outstanding options and SPRs under the Plan, 38,081,278
split-adjusted options had been issued under the Plan (net of cancelled
options), and 6,268,360 split-adjusted shares of common stock remained available
for future issuance.

The actual benefits, if any, to the holders of stock options issued under
the Plan are not determinable as all grants to be made under the Plan are
discretionary and, prior to exercise, the value, if any, of such stock options
to their holders is represented by the difference between the market price of a
share of our common stock on the date of exercise and the exercise price of a
holder's stock option. During the fiscal year ended December 31, 1999: (i)
options to purchase 8,750,826 split-adjusted shares of common stock were issued
pursuant to the Plan; (ii) options to purchase 163,500 split-adjusted shares of
common stock were issued pursuant to the Plan to the current directors who are
not executive officers, as a group (5 persons); (iii) options to purchase
1,060,500 split-adjusted shares of common stock were issued to current executive
officers, as a group (9 persons); and (iv) options to purchase 7,526,826
split-adjusted shares of common stock were issued pursuant to the Plan to all
other employees and consultants, including current officers who are not
executive officers, as a group (approximately 800 persons). The split-adjusted
closing price of the common stock on December 31, 1999 was $37.29 per share.

The Plan is not a qualified deferred compensation plan under Section 401(a)
of the Code, and is not subject to the provisions of the Employee Retirement
Income Security Act of 1974, as amended.

1998 EMPLOYEE STOCK PURCHASE PLAN

The 1998 Employee Stock Purchase Plan was adopted by our Board of Directors
in December 1998, and approved by the stockholders in January 1999. A total of
2,250,000 post-split shares of our common stock have been reserved for issuance
under this plan, plus annual increases equal to the lesser of (i) 2% of the
outstanding shares on such date or (ii) an amount determined by the Board of
Directors. To date, 334,776 post-split shares have been issued under the 1998
Employee Stock Purchase Plan.

The 1998 Employee Stock Purchase Plan, which is intended to qualify under
Section 423 of the Internal Revenue Code of 1986, as amended (the "Code"),
contains consecutive, overlapping, twenty-four month offering periods. Each
offering period includes four six-month purchase periods. The offering periods
generally start on the first trading day on or after May 1 and November 1 of
each year, except for the first offering period which commenced on the first
trading day after the Company's initial public offering (January 22, 1999) and
ends on the last trading day on or before October 31, 2000.

Employees are eligible to participate if they are customarily employed by
us or any of our participating subsidiaries for at least 30 hours per week and
more than five months in any calendar year. However, no employee may be granted
a right to purchase stock under the 1998 Employee Stock Purchase Plan (i) to the
extent that, immediately after the grant of the right to purchase stock, the
employee would own stock possessing 5% or more of the total combined voting
power or value of all classes of our capital stock, or (ii) to the extent that
his or her rights to purchase stock under all our employee stock purchase plans
accrues at a rate which exceeds $25,000 worth of stock for each calendar year.
The 1998 Employee Stock Purchase Plan permits participants to purchase our
common stock through payroll deductions of up to 12% of the participant's
"compensation." Compensation is defined as the participant's base straight time
gross earnings and commissions but excludes payments for overtime, shift
premium, incentive compensation, incentive payments, bonuses and other
compensation. The maximum number of shares a participant may purchase during a
single purchase period is 5,000 shares.

Amounts deducted and accumulated by the participant are used to purchase
shares of our common stock at the end of each purchase period. The price of
stock purchased under the 1998 Employee Stock Purchase Plan is generally 85% of
the lower of the fair market value of our common stock (i) at the beginning of
the offering period or (ii) at the end of the purchase period. In the event the
fair market value at the end of a purchase period is less than the fair market
value at the beginning of the offering period, the participants will be
withdrawn from the current

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offering period following exercise and automatically re-enrolled in a new
offering period. The new offering period will use the lower fair market value as
of the first date of the new offering period to determine the purchase price for
future purchase periods. Participants may end their participation at any time
during an offering period, and they will be paid their payroll deductions to
date. Participation ends automatically upon termination of employment.

Rights to purchase stock granted under the 1998 Employee Stock Purchase
Plan are not transferable by a participant other than by will, the laws of
descent and distribution, or as otherwise provided under the plan. The 1998
Employee Stock Purchase Plan provides that, in the event we merge with or into
another corporation or sell substantially all of our assets, each outstanding
right to purchase stock may be assumed or substituted for by the successor
corporation. If the successor corporation refuses to assume or substitute for
the outstanding rights to purchase stock, the offering period then in progress
will be shortened and a new exercise date will be set.

Our Board of Directors has the authority to amend or terminate the 1998
Employee Stock Purchase Plan, except that no such action may adversely affect
any outstanding rights to purchase stock under the Employee Stock plan. Our
Board of Directors may terminate an offering period on any exercise date if it
determines that the termination of the plan is in our best interests and the
best interest of our stockholders. The Board of Directors may in its sole
discretion amend the plan to the extent necessary and desirable to avoid
unfavorable financial accounting consequences by altering the purchase price for
any offering period, shortening any offering period or allocating remaining
shares among the participants. Unless sooner terminated by our Board of
Directors, the plan will automatically terminate ten years from the effective
date of our initial public offering.

LASER LINK.NET, INC. 1997 STOCK PLAN

On March 20, 2000, pursuant to the Agreement and Plan of Merger dated as of
March 8, 2000, Laser Link.Net, Inc. was acquired in a merger of Lightsaber
Acquisition Co. ("Lightsaber"), our wholly-owned subsidiary, with Laser Link in
which Lightsaber was the surviving entity (the "Merger"). As part of the Merger,
we agreed to assume the Laser Link.Net, Inc. 1997 Stock Option Plan (the "Laser
Link Plan") and each outstanding option under the Laser Link Plan. As a result,
we will issue shares of our common stock, subject to adjustment in the number of
shares and exercise price of the original options, upon exercise of outstanding
stock options previously issued under the Laser Link Plan. In the Merger, each
share of Laser Link common stock was converted into .173535 share of our common
stock (the "Exchange Ratio").

PURPOSE OF THE LASER LINK PLAN

The purpose of the Laser Link Plan is to provide additional incentive to
officers, key employees, directors and consultants and to align their interests
with those of the shareholders. The Laser Link Plan is not subject to the
Employee Retirement Income Act of 1974.

STRUCTURE

The Laser Link Plan consists of two types of equity incentive programs: (i)
qualifying stock options ("Incentive Stock Options") intended to qualify within
the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the
"Code") and (ii) non-qualifying stock options (or "Non-Statutory Stock Options")
not intended to qualify within the meaning of Section 422 of the Code.

ADMINISTRATION

The Laser Link Plan is administered by either our's Board of Directors or
an Option Committee consisting of outside directors appointed by the Board of
Directors (the "Administrator"). Subject to the provisions of the Laser Link
Plan, the Administrator has the authority, in its discretion: (i) to select the
employees, directors or consultants to whom options may be granted under the
Laser Link Plan; (ii) to determine the number of shares of common stock to be
covered by each option granted under the Laser Link Plan; (iii) to determine the
time or times at which options may be granted and whether those options are
Incentive Stock Options or Non-Statutory Stock Options; (iv) to determine the
price at which options are exercisable, the rate of exercisability and the
duration of each option; and (v) to prescribe, amend and rescind rules and
regulations relating to the Laser Link Plan.

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ELIGIBILITY

All key employees, directors and important consultants are eligible to
participate in the Laser Link Plan. However, in view of the Merger, it is
anticipated that no further options will be granted under the Laser Link Plan.

Under the Laser Link Plan Incentive Stock Options may be granted only to
employees (including officers and directors who are employees). Non-Statutory
Stock Options may be granted to employees, directors and consultants of our. No
optionholder may be granted options to purchase more than 90% of the shares
authorized for issuance under the Laser Link Plan.

SECURITIES SUBJECT TO THE LASER LINK PLAN

As of the date of the Merger, 10,000,000 shares of Laser Link's common
stock, par value $0.01, were reserved for issuance under the Laser Link Plan.
After the Merger, based on the Exchange Ratio, a maximum of 1,735,350 shares of
our's common stock will be available for issuance under the Laser Link Plan.

TERMS AND CONDITIONS OF OPTIONS

Each option granted pursuant to the Laser Link Plan is evidenced by a
written stock option agreement (an "Option Agreement") between the optionholder
and Laser Link and is subject to the following terms and conditions:

EXERCISE OF OPTIONS AND FORM OF CONSIDERATION. Options shall vest upon the
exercisability dates, as set forth in the Option Agreement for each option
grant. Options not subject to Deferral Agreements (as described below) became
fully vested and exercisable on the closing of the Merger.

Many optionholders have entered into written agreements with our deferring
the acceleration of the exercisability of their options ("Deferral Agreements").
The Deferral Agreements postpone the acceleration of vesting that would have
occurred on the closing of the Merger under the terms of the Option Agreements.
Options subject to the Deferral Agreements will become fully vested upon the
first anniversary of the Merger, unless the optionholder has (a) been terminated
"for cause," as defined in the Deferral Agreements; (b) resigned, other than (i)
death or disability; (ii) a change in location of the optionholder's employment
beyond the 50 mile radius of the current location of Laser Link.Net, Inc. or
(iii) a material diminution in the optionholder's duties. Pending the first
anniversary of the closing of the Merger, the options will continue to vest as
set forth in the Option Agreements.

Exercise of an option in any manner shall result in a decrease in the
number of shares thereafter available under the option by the number of shares
as to which the option is exercised. An optionholder may exercise an option by
giving written notice to the Secretary of our accompanied by payment of the
option price for the total number of options exercised. Payment may consist of
cash, check, cash from a brokerage firm in a cashless exercise or-unless
prohibited by the Administrator-shares of our or a combination thereof.

Pursuant to the terms of the Merger, and irrespective of Deferral
Agreements, during the escrow period as provided by the Merger agreement, 10% of
the shares issued upon the exercise of an option will be deposited into an
escrow fund. The escrow fund is intended to serve as security for the
indemnification of our, among others, from and against damages, as defined by
the Merger agreement, arising out of any breach of or default in any
representation, warranty, covenant or agreement given or made by Laser Link.Net,
Inc. in connection with the Merger. Accordingly, the escrow fund will be
available to compensate our for such damages, and, in such event, an
optionholder may not receive all of the option shares he would otherwise
receive. The escrow period expires on the first anniversary of the effective
time of the merger, when all shares not applied in satisfaction of the
indemnification obligations will be distributed, subject to the terms of the
Merger, in accordance with each shareholder's percentage of the escrow fund as
determined by the terms of the Merger.

TERM OF OPTIONS. In general, the term of each option is ten years from the
date of grant or such shorter terms as may be provided in the Option Agreement.
This term is not extended by the Deferral Agreements.

EXERCISE PRICE. The per share exercise price for the shares issued pursuant
to the Laser Link Plan is at least equal to the fair market value of the Laser
Link's common stock on the date of the grant. Pursuant to the terms of the
Merger, the exercise price listed in your option agreement has been adjusted by
accounting for any post-grant Laser Link stock splits, if applicable, dividing
the exercise price by the Exchange Ratio and rounding the quotient up to the
nearest whole cent.

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WAITING PERIOD AND EXERCISE DATES. At the time options were granted, the
Administrator fixed the period within which the option vests and determined any
conditions that must be satisfied before the option may be exercised. Most
options will vest at a rate of 25% of the shares subject to the option grant on
each anniversary of the grant.

All Option Agreements provided that any unvested options were accelerated
upon a "change of control," including a transaction such as the closing of the
Merger. However, with respect to optionholders who executed Deferral Agreements,
this acceleration will not occur until March 20, 2001, the one-year anniversary
of the closing of the Merger, and is subject to the terms of the Laser Link
Plan, the Option Agreements and the Deferral Agreements.

TERMINATION OF RELATIONSHIP. If an optionholder ceases to be an employee,
director or consultant, other than upon the optionholder's death or disability,
the optionholder may exercise his or her option within three months of such
termination (but in no event later than the termination date of such option as
set forth in the Option Agreement). If, on the date of termination, the
optionholder is not vested as to his or her entire option, the shares covered by
the unvested portion of the option revert to the Laser Link Plan. If, after
termination, the optionholder does not exercise his or her option within three
months, the option terminates.

DISABILITY OF OPTIONHOLDER. If an optionholder ceases to be an employee,
director or consultant as a result of the optionholder's disability, the
optionholder may generally exercise his or her option within twelve months
following the optionholder's termination (but in no event later than the
termination date of such option as set forth in the Option Agreement). If, on
the date of termination, the optionholder is not vested as to his or her entire
option, the shares covered by the unvested portion of the option revert to the
Laser Link Plan. If, after termination, the optionholder does not exercise his
or her option within twelve months, the option will terminate.

DEATH OF OPTIONHOLDER. If an optionholder dies while an employee, director
or consultant, the option may generally be exercised within twelve months
following the optionholder's death (but in no event later than the termination
date of such option as set forth in the Option Agreement), by the optionholder's
heirs, executor or administrator, but only to the extent that the option is
vested on the date of death. If, at the time of death, the optionholder is not
vested as to his or her entire option, the shares covered by the unvested
portion of the option will revert to the Laser Link Plan. If the option is not
so exercised within the time specified, the option terminates.

NON-TRANSFERABILITY OF OPTIONS

Options granted under the Laser Link Plan are not transferable otherwise
than by will or the laws of descent and distribution, and are exercisable during
the lifetime of the optionholder only by the optionholder including, for this
purpose, the optionholder's legal guardian or custodian in the event of
disability. Until the option price has been paid in full pursuant to due
exercise of the option and the purchased shares are delivered, an optionholder
does not have any rights as a shareholder of our. We reserve the right not to
deliver the shares purchased by virtue of the exercise of an option during any
period of time in which our deems, in its sole discretion, that such delivery
would violate a federal, state, local or securities exchange rule, regulation or
law.

ADJUSTMENTS UPON CHANGES IN CAPITALIZATION AND CONTROL

CHANGES IN CAPITALIZATION. In the event of any change in the outstanding
shares of the common stock of our by reason of a stock dividend, stock split,
combination of shares, recapitalization, merger, consolidation, transfer of
assets, reorganization, conversion or what the Administrator deems in its sole
discretion to be similar circumstances, the number and kind of shares subject to
an option and the option price of such shares shall be appropriately adjusted in
a manner to be determined in the sole discretion of the Administrator.

ACCELERATION IN CONNECTION WITH A CHANGE OF CONTROL. All Option Agreements
provide that the vesting of options accelerate upon a "change of control,"
including a transaction such as the closing of the Merger. Thus, options not
subject to the Deferral Agreements became fully vested upon the closing of the
Merger on March 20, 2000.

With respect to options subject to Deferral Agreements, while all options
vested at the closing of the Merger are not subject to deferral and unvested
options continue to vest at the rate set forth in the Option Agreements,
unvested options will become fully vested upon the first anniversary of the
Merger, March 20, 2001, unless the optionholder has (a) been terminated "for
cause," as defined in the Deferral Agreements; (b) resigned, other than

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(i) death or disability; (ii) a change in location of the optionholder's
employment beyond the 50 mile radius of the current location of Laser Link.Net,
Inc. or (iii) a material diminution in the optionholder's duties. Pending the
first anniversary of the closing of the Merger, the options will continue to
vest as set forth in the Option Agreements.

AMENDMENT AND TERMINATION OF THE LASER LINK PLAN.

The Board may at any time amend, alter, suspend or terminate the Laser Link
Plan; provided that our is required to obtain stockholder approval of any Plan
amendment to the extent necessary and desirable to comply with applicable laws
and that no such action shall affect options granted under the Laser Link Plan
prior to the actual date on which such action occurred.

ARBITRATION

Any disputes or disagreements between optionholders and our shall be
settled by arbitration in accordance with the Commercial Arbitration Rules of
the American Arbitration Association or its successor, as amended from time to
time. However, prior to submission to arbitration optionholders must attempt to
resolve such disputes or disagreements with our amicably and informally, in good
faith, for a period not to exceed two weeks. Thereafter, the dispute or
disagreement will be submitted to arbitration.

Optionholders and our shall equally share the costs charged by the American
Arbitration Association or its successor, but optionholders and our shall
otherwise be solely responsible for their own respective counsel fees and
expenses. The decision of the arbitrator(s) shall be made in writing, setting
forth the award, the reasons for the decision and award and shall be binding and
conclusive on optionholders and our. Further, neither optionholders nor our
shall appeal any such award. Judgment of a court of competent jurisdiction may
be entered upon the award and may be enforced as such in accordance with the
provisions of the award.

FEDERAL INCOME TAX MATTERS

The Laser Link Plan is not subject to any of the provisions of the Employee
Retirement Income Security Act of 1974 ERISA and is not qualified under Section
401(a) of the Code.

NON-STATUTORY STOCK OPTIONS.

Under current federal income tax law, the grant of a Non-Statutory Stock
Option has no tax effect on our or the optionholder to whom it is granted. If
the shares of common stock received on the exercise of a Non-Statutory Stock
Option are not subject to restrictions on transfer or risk of forfeiture, the
exercise of the Non-Statutory Stock Option will result in ordinary income to the
optionholder equal to the excess of the fair market value of the shares at the
time of exercise over the option price. The optionholder's tax basis in the
shares will be equal to the aggregate exercise price paid by the optionholder
plus the amount of taxable income recognized upon the exercise of the option.
Upon any subsequent disposition of the shares, any gain or loss recognized by
the optionholder will be treated as capital gain or loss and will be long-term
capital gain or loss if the shares are held for more than one year after
exercise. At the time of recognition of ordinary income by the optionholder upon
exercise, our will normally be allowed to take a deduction for federal income
tax purposes in an amount equal to such recognized income.

INCENTIVE STOCK OPTIONS.

The federal income tax consequences associated with Incentive Stock Options
are generally more favorable to the optionholder and less favorable to our than
those associated with Non-Statutory Stock Options. Under current federal income
tax law, the grant of an Incentive Stock Option does not result in income to the
optionholder or in a deduction for our at the time of the grant. Generally, the
exercise of an Incentive Stock Option will not result in income for the
optionholder if the optionholder does not dispose of the shares within two years
after the date of grant nor within one year after the date of exercise. If these
requirements are met, the basis of the shares of common stock upon a later
disposition will be the option price, any gain on the later disposition will be
taxed to the optionholder as long-term capital gain, and our will not be
entitled to a deduction. The excess of the market value on the exercise date
over the option price is an adjustment to regular taxable income in determining
alternative minimum taxable income, which could cause the optionholder to be
subject to the alternative minimum tax. If the optionholder disposes of the
shares before the expiration of either of the holding periods described above (a
"Disqualifying Disposition"), the optionholder will have compensation taxable as
ordinary income, and our will

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normally be entitled to a deduction, equal to the lesser of (a) the fair market
value of the shares on the exercise date minus the option price, or (b) the
amount realized on the disposition minus the option price. If the price realized
in any such Disqualifying Disposition of the shares exceeds the fair market
value of the shares on the exercise date, the excess will be treated as
long-term or short-term capital gain, depending on the optionholder's holding
period for the shares.

SPECIAL RULES; WITHHOLDING OF TAXES.

We may take whatever steps it deems appropriate to comply with any
applicable withholding tax obligation, including requiring any participant to
pay the amount of any applicable withholding tax to our in cash. We may, in our
discretion, authorize "cashless withholding."

LIMITATION ON LIABILITY AND INDEMNIFICATION MATTERS

Our Amended and Restated Certificate of Incorporation limits the liability
of our directors to the maximum extent permitted by Delaware law, and our Bylaws
provide that we will indemnify our directors and officers and may indemnify our
other employees and agents to the fullest extent permitted by law. We also
entered into agreements to indemnify our directors and executive officers, in
addition to the indemnification provided for in our Bylaws. Our Board of
Directors believe that these provisions and agreements are necessary to attract
and retain qualified directors and executive officers. At present, there is no
pending litigation or proceeding involving any of our directors, officers,
employees or agents in which indemnification will be required or permitted. We
are not aware of any threatened litigation or proceeding that might result in a
claim for such indemnification.

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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

SERIES C PREFERRED STOCK AND WARRANT SUBSCRIPTION AGREEMENT

On February 20, 1998, we entered into a Series C Preferred Stock and
Warrant Subscription Agreement (the "Subscription Agreement") with Warburg,
Pincus Ventures, L.P. ("Warburg") & Crosspoint Venture Partners 1996
("Crosspoint") and Intel Corporation ("Intel"). Under this agreement, Warburg
and Crosspoint unconditionally agreed to purchase an aggregate of 8,646,214
shares of our Series C Preferred Stock and warrants to purchase an aggregate of
7,094,250 shares of our Series C Preferred Stock for an aggregate purchase price
of $16.0 million at a date that we were to determine but, in any event, not
later than March 11, 1999. We agreed to either call this commitment or complete
an alternate equity financing of at least $16.0 million by March 11, 1999. A
proposed alternate equity financing providing for a price per share greater than
or equal to $1.8511and including securities that were equal in right with, or
more favorable to us than, our Series C Preferred Stock as set forth in our
Amended and Restated Certificate of Incorporation required unanimous approval by
a majority of our disinterested directors. In consideration of this commitment,
we issued to Warburg and Crosspoint warrants to purchase an aggregate of
2,541,222 post-split shares of our common stock at a split-adjusted purchase
price of $0.0022 per share. The parties agreed that the stock purchases by AT&T
Ventures and NEXTLINK Communications Inc. constituted an alternate equity
financing (see below). As a result, we did not issue and sell our Series C
Preferred Stock to Warburg and Crosspoint. Messrs. Henry Kressel and Joseph
Landy, two of our former directors, are affiliated with Warburg, and Mr.
Shapero, one of our current directors, is affiliated with Crosspoint.

On April 24, 1998, the Subscription Agreement was amended pursuant to an
Assignment and Assumption Agreement to which we were a party along with Warburg,
Crosspoint and Mr. Hawk. By the terms of this agreement, Warburg and Crosspoint
assigned to Mr. Hawk their obligation to purchase 54,022 shares of our Series C
Preferred Stock and 44,338 warrants to purchase Series C Preferred Stock for an
aggregate purchase price of $100,001.65. On the same date, Mr. Hawk purchased
54,022 shares of our Series C Preferred Stock at a price per share of $1.8511.
As a result of this amendment, the aggregate obligation of Warburg and
Crosspoint to purchase our Series C Preferred Stock and warrants to purchase
Series C Preferred Stock was reduced from 8,646,214 shares to 8,592,192 shares
and from 7,094,250 shares to 7,049,911 shares, respectively, for an aggregate
purchase price of $15.9 million (reduced from $16.0 million). On the same date,
the Amended and Restated Stockholder Rights Agreement dated March 11, 1998 (the
"Stockholder Rights Agreement") was amended to add Mr. Hawk as a party.

The warrants to purchase our common stock issued upon the signing of the
Subscription Agreement had five-year terms (but had to be exercised prior to the
closing of our initial public offering), had split-adjusted purchase prices of
$0.0015 per share, were immediately exercisable and contained net exercise
provisions. Prior to our initial public offering, Warburg and Crosspoint
exercised their warrants to purchase Series C Preferred Stock for 3,048,907 and
762,364 post-split shares of our common stock.

On March 11, 1998, we amended the Stockholder Rights Agreement, to extend
the rights held by Warburg, Crosspoint, and Intel to our warrants to purchase
common stock, Series C Preferred Stock and warrants to purchase Series C
Preferred Stock issued or issuable to Warburg, Crosspoint and Intel pursuant to
the Subscription Agreement (see below).

THE INTEL STOCK PURCHASE

As provided in the Subscription Agreement, Intel purchased 540,216 shares
of our Series C Preferred Stock and warrants to purchase 443,250 shares of our
Series C Preferred Stock for an aggregate purchase price of $1.0 million
concurrently with the issuance of our 1998 notes in March 1998. We did not have
any obligation to issue the warrants to purchase Series C Preferred Stock to
Intel until such time as Warburg and Crosspoint funded their respective
commitments under the Subscription Agreement. The parties agreed that our
initial public offering constituted an alternate equity financing and,
therefore, we did not issue the warrants to purchase Series C Preferred Stock to
Intel. In connection with its agreement to purchase such Series C Preferred
Stock and warrants to purchase Series C Preferred Stock, we issued to Intel
warrants to purchase an aggregate of 238,167 post-split shares of our common
stock at a split-adjusted purchase price of $0.0015 per share. Prior to our
initial public offering, Intel exercised its warrants for 238,167 post-split
shares of our common stock.

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<PAGE>

TRANSACTIONS IN CONNECTION WITH THE FORMATION OF THE DELAWARE HOLDING COMPANY

We were originally incorporated in California as Covad Communications
Company ("Covad California") in October 1996. In July 1997, we were incorporated
in Delaware as part of our strategy to operate through a holding company
structure and to conduct substantially all of our operations through
subsidiaries. To effect the holding company structure, in July 1997 we entered
into an Exchange Agreement with the existing holders of the common stock and
Series A Preferred Stock of Covad California to acquire all of such stock in
exchange for a like number of shares of our common and preferred stock, so that
after giving effect to the exchange Covad California became our wholly-owned
subsidiary. In addition, we entered into an Assumption Agreement pursuant to
which we assumed certain outstanding obligations of Covad California, including
a $500,000 demand note issued to Warburg and certain commitments to issue stock
options to two of our consultants.

In connection with the Exchange Agreement, two of our former officers,
Messrs. Charles McMinn and Charles Haas, and one of our current officers, Mr.
Khanna, each exchanged 6,750,000 shares of common stock of Covad California,
originally purchased for $.0019 per share, for a like number of our pre-split
shares of common stock pursuant to restricted stock purchase agreements. In
addition, Mr. Lynch, one of our directors, exchanged 324,000 shares of common
stock of Covad California, originally purchased for $0.148 per share, for a like
number of our pre-split shares of common stock pursuant to a restricted stock
purchase agreement. The common stock issued to Messrs. McMinn, Khanna, Haas and
Lynch are generally subject to vesting over a period of four years. This vesting
is subject to acceleration upon a change of control involving a merger, sale of
all or substantially all our assets or a shift in 50% or more of the voting
power of our capital stock. Our repurchase rights lapse one year after the
change of control or earlier in the event the individual is constructively
terminated or terminated without cause, or in the event the successor
corporation refuses to assume the agreements.

ISSUANCE OF COMMON STOCK

On July 15, 1997, we issued 2,531,250 post-split shares of our common
stock to Mr. Rex Cardinale, one of our former officers, for a split-adjusted
purchase price of $0.148 per share. On August 30,1997, we issued 776,250
post-split shares of our common stock to Mr. Laehy, one of our former officers,
for a split-adjusted purchase price of $0.0222 per share. On October 14, 1997,
we issued 324,000 post-split shares of our common stock to Mr. Marshall, one of
our directors, for a split-adjusted purchase price of $0.0222 per share. On
April 24, 1998, we issued 216,000 post-split shares of our common stock to Mr.
Hawk, one of our directors, for a split-adjusted purchase price of $0.296 per
share. On August 28, 1998, we issued 90,000 post-split shares of our common
stock to Mr. Hawk for a split-adjusted purchase price of $2.555 per share. The
shares of our common stock issued to Messrs. Cardinale, Laehy, Marshall, and
Hawk were issued pursuant to restricted stock purchase agreements which contain
vesting and change of control provisions similar to those contained in the
above-described restricted stock purchase agreements of Messrs. McMinn, Khanna,
Haas and Lynch.

ISSUANCE OF SERIES A PREFERRED STOCK

On June 30, 1997 Covad California issued 225,000 shares of Series A
Preferred Stock to each of Messrs. McMinn, Khanna and Haas and 450,000 shares of
Series A Preferred Stock to Mr. Lynch for a purchase price of $0.222 per share.
In July 1997, these shares were exchanged for a like number of our shares of
Series A Preferred Stock pursuant to the Exchange Agreement.

ISSUANCE OF SERIES B PREFERRED STOCK

In July 1997, we sold an aggregate of 25,500,001 shares of our Series B
Preferred Stock, of which 18,000,000 shares were sold to Warburg, 4,500,000
shares were sold to Crosspoint and 3,000,001 shares were sold to Intel. The
purchase price of our Series B Preferred Stock was $0.333 per share. A portion
of the purchase price of the Series B Preferred Stock was paid by cancellation
of a $500,000 demand note issued to Warburg in June 1997. Messrs. Kressel and
Landy, each of whom formerly served as members of our Board of Directors, are
affiliated with Warburg. Mr. Shapero, who currently serves on our Board of
Directors, is affiliated with Crosspoint. On February 12, 1998, we sold an
additional 150,003 shares of Series B Preferred Stock at a purchase price of
$0.666 per share to Mr. Marshall, one of our directors.

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<PAGE>

THE STRATEGIC INVESTMENTS AND RELATIONSHIPS

In January 1999, we received equity investments from AT&T Ventures,
NEXTLINK Communications Inc. and Qwest Communications International, Inc. AT&T
Ventures purchased an aggregate of 2,250,874 shares of our Series C-1 Preferred
Stock at $1.8511 per share and an aggregate of 1,736,112 shares of our Series
D-1 Preferred Stock at $12.00 per share. These purchases represent an aggregate
investment of $25 million, of which $11 million was invested by AT&T Venture
Fund II, LP and $14 million was invested by two affiliated funds. NEXTLINK
Communications Inc. purchased 1,800,699 shares of our Series C-1 Preferred Stock
at $1.8511 per share and 925,926 shares of our Series D-1 Preferred Stock at
$12.00 per share, representing an investment of $20 million. Qwest
Communications International, Inc. purchased 1,350,523 shares of our Series C-1
Preferred Stock at $1.8511 per share and 1,041,667 shares of our Series D-1
Preferred Stock at $12.00 per share, representing an aggregate investment of $15
million. At the completion of our initial public offering, our Series C-1
Preferred Stock converted into our class B common stock on a one-for-one basis.
The Series D-1 Preferred Stock also converted into our class B common stock at
that time on a one-for-one basis. These strategic investors have agreed not to
transfer any of our Series C-1 Preferred Stock, Series D-1 Preferred Stock or
class B common stock to any non-affiliated third party until January 2000. They
have also each agreed not to acquire more than 10% of our voting stock without
our consent until January 2002. In addition, until January 2002, they have
agreed to vote any voting securities they hold as recommended by our Board of
Directors. Since this time, all of our class B common stock has been converted
into our common stock.

Concurrently with these strategic equity investments, we entered into
commercial agreements with AT&T Corp., NEXTLINK Communications Inc. and Qwest
Communications International, Inc. These agreements provide for the purchase,
marketing and resale of our services at volume discounts, our purchase of fiber
optic transport bandwidth at volume discounts, collocation of network equipment
and development of new DSL services. These agreements have terms ranging from
six months to several years subject to earlier termination in certain
circumstances. We cannot predict the number of line orders that AT&T Corp.,
NEXTLINK Communications Inc. or Qwest Communications International, Inc. will
generate, if any, whether line orders will be below our expectations or the
expectations of, AT&T Corp., NEXTLINK Communications Inc. or Qwest
Communications International, Inc. or whether AT&T Corp., NEXTLINK
Communications Inc. or Qwest Communications International, Inc. will discontinue
selling our services entirely.

EQUIPMENT LEASE FINANCING

Through December 31, 1999, we incurred a total of $865,000 of equipment
lease financing obligations (including principal and interest) through a sale
lease-back transaction with Charter Financial, Inc. ("Charter Financial").
Through December 31, 1999, we made total payments of approximately $525,000 to
Charter Financial on these obligations. Warburg, a principal stockholder of us
at the time this transaction was entered into, owns a majority of the capital
stock of Charter Financial. We believe that the terms of the lease financing
with Charter Financial were completed at rates similar to those available from
alternative providers. Our belief that the terms of the sale lease-back
arrangement are similar to those available from alternative providers is based
on the advice of its our officers who reviewed at least two alternative
proposals and who reviewed and negotiated the terms of the arrangement with
Charter Financial.

VENDOR RELATIONSHIP

Crosspoint, who was one of our principal stockholders, previously owned
approximately 12% of the capital stock of Diamond Lane, one of our vendors.
Payments to Diamond Lane in 1999 totaled approximately $51,539,000. We believe
that the terms of our transactions with Diamond Lane were completed at rates
similar to those available from alternative vendors. This belief is based on our
management team's experience in obtaining vendors and the fact that we sought
competitive bidders before entering into the relationship with Diamond Lane.

REGISTRATION RIGHTS

Certain holders of our common stock are entitled to registration rights.
Pursuant to the Stockholder Rights Agreement holders of 30,112,927 post-split
shares of common stock and holders of 6,379,177 shares of class B common stock
(collectively, the "Rights Holders") are entitled to certain rights with respect
to the registration under the Securities Act of the shares of common stock held
by them or issuable upon conversion of the class B common

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<PAGE>

stock. Commencing January 2000, the class B common stock became convertible into
common stock at the election of the holder. As of April 2000, all class B common
stock had been so converted.

The Rights Holders are entitled to demand, "piggy-back" and S-3
registration rights, subject to certain limitations and conditions. The number
of securities requested to be included in a registration involving the exercise
of demand and "piggy-back" rights are subject to a pro rata reduction based on
the number of shares of common stock held by each Rights Holder and any other
security holders exercising their respective registration rights to the extent
that the managing underwriter advises that the total number of securities
requested to be included in the underwriting is such as to materially and
adversely affect the success of the offering. The registration rights terminate
as to any Rights Holder at the later of (i) three years after our initial public
offering or (ii) such time as such Rights Holder may sell under Rule 144 in a
three month period all registrable securities then held by such Rights Holder.

Pursuant to the Warrant Registration Rights Agreement dated March 11,
1999, between us and Bear, Stearns & Co. Inc. and BT Alex. Brown Incorporated,
holders of the warrants that were issued in connection with our 1998 note
offering in March 1998 are entitled to certain registration rights with respect
to the shares of common stock issuable upon exercise of such warrants. The
warrant holders are entitled to demand and "piggy-back" registration rights,
subject to certain limitations and conditions. Like the Rights Holders, the
number of securities that a warrant holder may request to be included in a
registration involving an exercise of its demand or "piggy-back" rights is
subject to a pro rata reduction. Such a reduction will be based upon the number
of shares held by each warrant holder and any other security holders exercising
their respective registration rights to the extent that the managing underwriter
advises us that the total number of securities requested to be included in the
underwriting is such as to materially and adversely affect the success of the
offering.

EMPLOYMENT AGREEMENTS

In 1998, we entered into a written employment agreement with Robert
Knowling, Jr., the Chairman of the Board of Directors, President and Chief
Executive Officer. The agreement provides that Mr. Knowling will receive
compensation in the form of a $400,000 annual base salary and a $250,000 minimum
annual bonus. Mr. Knowling received (i) a signing bonus of $1,500,000, one half
of which was paid when he began working for us, and the remaining half of which
was paid once he worked for us for one full year in July 1999, and (ii) stock
options to purchase 4,725,000 post-split shares of our common stock at a
split-adjusted exercise price of $ .45 per share. If we terminate Mr. Knowling's
employment relationship without cause (as that term is defined in the
agreement), or if Mr. Knowling resigns for good reason (as that term is defined
in the agreement), we must continue to pay Mr. Knowling's annual salary and
targeted bonus for a period of two years after the date of termination so long
as Mr. Knowling does not become employed by one of our direct competitors. Mr.
Knowling has agreed to be bound by customary confidentiality provisions. As
provided in the agreement, in August 1998 we loaned Mr. Knowling $500,000
pursuant to a Note Secured by Deed of Trust that bears no interest during his
employment. The loan has provisions for forgiveness based on continued
employment and matures in four years, subject to acceleration in certain events.
See "Certain Relationships and Related Transactions--Employee Loans."

With respect to all options granted under our 1997 Stock Plan, in the
event that we merge with or into another corporation resulting in a change of
control involving a shift in 50% or more of the voting power of our capital
stock, or the sale of all or substantially all of our assets, the options will
fully vest and become exercisable one year after the change of control or
earlier in the event the individual is constructively terminated or terminated
without cause or in the event the successor corporation refuses to assume the
options. See "--1997 Stock Plan."

We have also entered into restricted stock purchase agreements with
certain of the Company's officers and directors. The shares of our common stock
issued pursuant to these restricted stock purchase agreements are subject to the
Company's right of repurchase which lapses in accordance with the vesting
schedule of the agreements. The agreements also include similar provisions to
the stock options, providing for accelerated vesting in the event of a change of
control. See "Certain Relationships and Related Transactions--Issuance of Common
Stock."

EMPLOYEE LOANS

In August 1998, we loaned Robert Knowling, Jr., our Chairman of the
Board, President and Chief Executive Officer, pursuant to his employment
agreement, the principal amount of $500,000 pursuant to a Note Secured by Deed
of Trust, which was secured by certain real property of Mr. Knowling. The entire
principal balance of this note

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<PAGE>

becomes due and payable in one lump sum on August 14, 2002. No interest is
charged on the note. This note has provisions for forgiveness based on continued
employment and is subject to acceleration in certain events.

In August 1998, we loaned Joseph Devich, one of our officers, the
principal amount of $200,000 pursuant to a Note Secured by Deed of Trust, which
was secured by certain real property of Mr. Devich. The outstanding principal
balance of this note becomes due and payable in four equal installments
commencing August 13, 1999, with the last installment due on August13, 2002. No
interest is charged on the note. This note has provisions for forgiveness based
on continued employment and is subject to acceleration in certain events.

In October 1998, we loaned Catherine Hemmer, our Executive Vice President
and Chief Operating Officer, and her husband, one of the Company's employees,
the principal amount of $600,000 pursuant to a Note Secured By Deed of Trust,
which was secured by certain real property of the Hemmers. The outstanding
principal balance of this note becomes due in four equal annual installments
commencing August 10, 1999, with the last installment due on August 10, 2002. No
interest is charged on the note. This note has provisions for forgiveness based
upon continued employment of each of the Hemmers and is subject to acceleration
in certain events.

In April 2000, we loaned Jane Marvin, one of our officers, the principal
amount of $500,000 for the purchase of a principal residence. The loan is
secured by such principal residence. The principal balance of the loan is due
and payable in four equal annual installments beginning at the first year
anniversary of the commencement of Ms. Marvin's employment, and no interest will
be charged for the loan. Furthermore, the loan will be forgiven based upon her
continued employment and is subject to acceleration in certain events. In
addition, in December 1999, we loaned Ms. Marvin $80,705.46 pursuant to a note
secured by a pledge of shares of our common stock. The entire principal balance
of this note becomes due and payable in one lump sum on the earlier to occur of
October 2000 or the sale of the pledged shares. Interest is payable on the note
at a rate of 5.89% per annum, compounded semiannually.

In May 1999, we loaned Robert Davenport, one of our officers, the
principal amount of $600,000 for the purchase of a principal residence. The loan
is secured by such principal residence. The outstanding principal balance of
this note becomes due in four equal installments commencing January 20, 2000,
with the last installment due on January 20, 2003. No interest is charged on the
note. The note has provisions for forgiveness based upon continued employment
and is subject to acceleration in certain events.

In January 2000, we committed to extend a loan to Michael Lach, one of
our officers, in the principal amount of $200,000, for the purchase of a
principal residence. The loan will be secured by such principal residence. The
loan will provide that the principal balance will be due and payable in four
equal annual installments, beginning at the first year anniversary of the
commencement of Mr. Lach's employment. No interest will be charged on this loan.
The loan will have provisions for forgiveness based on continued employment and
is subject to acceleration in certain events.

In August 2000, we loaned John McDevitt, one of our officers, the
principal amount of $100,000 pursuant to a note. The entire principal balance of
the note becomes due and payable in one lump sum in August 2001. Interest is
payable on the note at a rate of 6.60% per annum, compounded semiannually.

90
<PAGE>

PRINCIPAL AND SELLING SHAREHOLDERS

The following table sets forth certain information regarding ownership of
our common stock as of July 1, 2000 by:

(i) each Named Executive Officer,

(ii) each of our directors,

(iii)all of our executive officers and directors as a group,

(iv) all persons who directly own 5% or more of our common stock, and

(v) our selling shareholders. The selling shareholders are former
shareholders of Laser Link.Net who received our common stock when
we acquired Laser Link.Net.

Share ownership in each case includes shares issuable upon exercise of
outstanding options and warrants that are exercisable within 60 days of July 1,
2000 as described in the footnotes below. Percentage ownership is calculated
pursuant to SEC Rule 13d-3(d)(1). Shares listed as beneficially owned after the
offering assumes the selling shareholder sold the maximum number of shares
eligible to be sold in the offering. Except as otherwise indicated, the address
of each of the persons in this table, other than the selling stockholders, is as
follows: c/o Covad Communications Group, Inc., 4250 Burton Drive, Santa Clara,
California 95054.

<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED PRIOR TO THE SHARES BENEFICIALLY
OFFERING SHARES OWNED AFTER THE OFFERING
------------------------- ELIGIBLE -------------------------
BENEFICIAL OWNER NUMBER PERCENTAGE TO BE SOLD NUMBER PERCENTAGE
---------------- ------------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
DIRECTORS, EXECUTIVE OFFICERS
AND FIVE PERCENT STOCKHOLDERS:
Putnam Investments, Inc. (1).................. 11,728,230 7.59% 0 11,728,230 7.59%
Fidelity Management & Research Company (2).... 12,310,722 7.97% 0 12,310,722 7.97%
Robert Knowling Jr. (3)....................... 1,833,946 1.2% 0 1,833,946 1.2%
Robert Roblin (4)............................. 183,132 * 0 183,132 *
Catherine Hemmer (5).......................... 174,953 * 0 174,953 *
Joseph Devich (6)............................. 217,189 * 0 217,189 *
Robert Davenport, III (7)..................... 136,123 * 0 136,123 *
Robert Hawk (8)............................... 258,982 * 0 258,982 *
Daniel Lynch (9).............................. 518,995 * 0 518,995 *
Frank Marshall (10)........................... 604,356 * 0 604,356 *
Rich Shapero (11)............................. 14,373 * 0 14,373 *
Hellene Runtagh (12).......................... 17,873 * 0 17,873 *
Larry Irving (27)............................. 4,999 * 0 4,999 *
Debra Dunn (28)............................... 4,999 * 0 4,999 *
All current executive officers and directors as
a group (15 persons)..................... 9,951,221 6.49% 0 9,951,221 6.49%

SELLING SHAREHOLDERS:
George McGovern (13).......................... 1,510,127 1.04 1,492,774 17,353 *
Ed Sullivan (14).............................. 1,459,731 1.01 1,451,055 8,676 *
Liberty Partners.............................. 1,047,542 * 1,047,542 0 *
G. Michael Stakias (22)....................... 156,178 * 104,118 52,060 *
Eugene J. Malaady............................. 8,676 * 8,676 0 *
Darryl Copeland (23).......................... 159,649 * 107,589 52,060 *
David Dulaney (24)............................ 63,166 * 11,106 52,060 *
William Fromholzer (25)....................... 128,373 * 76,353 52,060 *
James Lynch (26).............................. 124,942 * 72,882 52,060 *
Dennis M. & Audrey B. Durkin.................. 3,469 * 3,469 0 *
Thomas Feeney................................. 20,823 * 20,823 0 *
Stanley & Carolyn Ellis....................... 17,352 * 17,352 0 *
</TABLE>

91
<PAGE>
<TABLE>
<CAPTION>

SHARES BENEFICIALLY
OWNED PRIOR TO THE SHARES BENEFICIALLY
OFFERING SHARES OWNED AFTER THE OFFERING
------------------------- ELIGIBLE -------------------------
BENEFICIAL OWNER NUMBER PERCENTAGE TO BE SOLD NUMBER PERCENTAGE
---------------- ------------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Donald Guinan................................. 38,176 * 38,176 0 *
Andrew Guinan (21)............................ 67,677 * 12,147 55,530 *
Guinan Family Ltd. Partnership................ 10,411 * 10,411 0 *
William Napier Macartney III.................. 38,176 * 38,176 0 *
Darryl Copeland, Jr........................... 39,215 * 39,215 0 *
Thaddeus Newell III........................... 4,338 * 4,338 0 *
W. Sherwood Robertson......................... 17,352 * 17,352 0 *
H. L. Yoh..................................... 17,352 * 17,352 0 *
Larry & Randi Yogel........................... 8,676 * 8,676 0 *
W. Dale Haas.................................. 17,352 * 17,352 0 *
Huntoon, Paige & Co., Inc..................... 17,352 * 17,352 0 *
Gregory P. Evans.............................. 10,411 * 10,411 0 *
Mark Fiato (15)............................... 43,036 * 43,036 0 *
Michael Azeez................................. 3,469 * 3,469 0 *
James Dengler................................. 6,940 * 6,940 0 *
David Farrugut................................ 6,940 * 6,940 0 *
Frank Gilday.................................. 3,469 * 3,469 0 *
Steve Griffith................................ 2,275 * 2,275 0 *
Judiane Griffith.............................. 9,217 * 9,217 0 *
Christopher Lange............................. 1,734 * 1,734 0 *
Seth Lehr..................................... 3,469 * 3,469 0 *
Joan H. Lewis................................. 3,469 * 3,469 0 *
Patrick McCloskey............................. 3,469 * 3,469 0 *
Colleen McGovern.............................. 19,629 * 19,629 0 *
Daniel McGovern............................... 24,835 * 24,835 0 *
Mary McGovern................................. 2,275 * 2,275 0 *
Guy Messick................................... 1,734 * 1,734 0 *
Jill Neyer.................................... 9,217 * 9,217 0 *
Steven Neyer.................................. 2,275 * 2,275 0 *
Arthur Jackson................................ 3,469 * 3,469 0 *
Darcy Falbey.................................. 3,469 * 3,469 0 *
Leslie Kogan.................................. 17,352 * 17,352 0 *
Richard McMahon............................... 6,940 * 6,940 0 *
Thomas Sheridan............................... 3,469 * 3,469 0 *
Kevin Seeger.................................. 1,734 * 1,734 0 *
Judy Welde.................................... 1,734 * 1,734 0 *
Carey Wilkinson............................... 5,746 * 5,746 0 *
Kristin Wilkinson............................. 5,746 * 5,746 0 *
Lynn Wilkinson................................ 19,629 * 19,629 0 *
Michael & Christine Breslin................... 2,275 * 2,275 0 *
Thomas & Debra Breslin........................ 2,275 * 2,275 0 *
John & Patricia Golato........................ 2,275 * 2,275 0 *
Edward & Patricia Sullivan.................... 2,275 * 2,275 0 *
Sullivan Family Ltd. Partnership.............. 6,829 * 6,829 0 *
Shane McGovern (16)........................... 43,489 * 19,629 23,860 *
Daniel Malcolm (17)........................... 76,528 * 2,775 73,753 *
Malcolm Family Ltd. Partnership............... 11,106 * 11,106 0 *
Mike Breslin (18)............................. 5,311 * 2,276 3,036 *
Sherwood W. Newell............................ 4,338 * 4,338 0 *
Dana B. Newell................................ 4,338 * 4,338 0 *
Gordon D. Newell.............................. 4,338 * 4,338 0 *
Herbert J. Nevyas............................. 3,469 * 3,469 0 *
Brad Copeland (19)............................ 34,531 * 12,840 21,691 *
</TABLE>

92
<PAGE>

SHARES BENEFICIALLY
OWNED PRIOR TO THE SHARES BENEFICIALLY
OFFERING SHARES OWNED AFTER THE OFFERING
------------------------- ELIGIBLE -------------------------
BENEFICIAL OWNER NUMBER PERCENTAGE TO BE SOLD NUMBER PERCENTAGE
---------------- ------------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Paul Hondros.................................. 3,469 * 3,469 0 *
Robert Sullivan (20).......................... 26,135 * 2,275 23,860 *
PaineWebber International (U.K.) Ltd. (29).... 99,954 * 99,954 0 *
Total Selling Stockholders............... 5,013,466 522,766 *
--------------
</TABLE>
* Represents beneficial ownership of less than 1% of our outstanding stock.
(1) Based on a Form 13G filed March 10, 2000 with the Securities and
Exchange Commission by Marsh & McLennan Companies, Inc. and its direct
and indirect wholly-owned subsidiaries, Putnam Investments, Inc.,
Putnam Investment Management, Inc. and The Putnam Advisory Company,
Inc.
(2) Based on a Form 13G filed June 9, 2000 with the Securities and
Exchange Commission by Fidelity International Limited and FMR Corp.
and its wholly-owned subsidiaries, Fidelity Management & Research
Company, Fidelity Management Trust Company and Strategic Advisers,
Inc.
(3) Includes 1,694,572 shares of common stock subject to options
exercisable within 60 days of July 1, 2000.
(4) Includes 181,122 shares of common stock subject to options exercisable
within 60 days of April 1, 2000.
(5) Includes 174,230 shares of common stock subject to options exercisable
within 60 days of July 1, 2000.
(6) Includes 28,050 shares of common stock subject to options exercisable
within 60 days of July 1, 2000.
(7) Includes 132,186 shares of common stock subject to options exercisable
within 60 days of July 1, 2000.
(8) Includes 53,748 shares of common stock subject to options exercisable
within 60 days of July 1, 2000.
(9) Includes 54,873 shares of common stock subject to options exercisable
within 60 days of July 1, 2000.
(10) Includes 54,873 shares of common stock subject to options exercisable
within 60 days of July 1, 2000.
(11) Includes 14,373 shares of common stock subject to options exercisable
within 60 days of July 1, 2000.
(12) Includes 19,873 shares of common stock subject to options exercisable
within 60 days of July 1, 2000.
(13) Includes of 17,353 shares of common stock subject to options
exercisable within 60 days of July 1, 2000. Mr. McGovern is employed
by us as CEO, Covad Integrated Services Division.
(14) Includes of 8,676 shares of common stock subject to options
exercisable within 60 days of July 1, 2000. Mr. Sullivan is employed
by us as our Senior Vice President, Technical Marketing.
(15) Includes of 34,707 shares of common stock which will be issued upon
exercise of options issued to Mr. Fiato by Laser Link.Net for
consulting services.
(16) Includes of 23,860 shares of common stock subject to options
exercisable within 60 days of July 1, 2000. Mr. McGovern is employed
by us as a Regional Sales Manager.
(17) Includes of 73,753 shares of common stock subject to options
exercisable within 60 days of July 1, 2000. Mr. Malcolm is employed by
us Senior Vice President, Sales Development.
(18) Includes of 3,036 shares of common stock subject to options
exercisable within 60 days of July 1, 2000. Mr. Breslin is employed by
us as an Account Manager.
(19) Includes 34,531 shares of common stock subject to options exercisable
within 60 days of July 1, 2000. Mr. Copeland is employed by us as a
Director of Project Management.
(20) Consists of 23,860 shares of common stock subject to options
exercisable within 60 days of July 1, 2000. Mr. Sullivan is employed
by us as a Database Administrator.
(21) Includes 55,530 shares of common stock subject to options exercisable
within 60 days of July 1, 2000. Mr. Guinan is employed by us as our
Vice President, Business Integration.
(22) Includes 52,060 shares of common stock subject to options exercisable
within 60 days of July 1, 2000. Mr. Stakias was formerly a director of
Laser Link.Net.
(23) Includes 52,060 shares of common stock subject to options exercisable
within 60 days of July 1, 2000. Mr. Copeland was formerly a director
of Laser Link.Net.
(24) Includes 52,060 shares of common stock subject to options exercisable
within 60 days of July 1, 2000. Mr. Dulaney was formerly a director of
Laser Link.Net.
(25) Includes 52,060 shares of common stock subject to options exercisable
within 60 days of July 1, 2000. Mr. Fromholzer was formerly a director
of Laser Link.Net.
(26) Includes 52,060 shares of common stock subject to options exercisable
within 60 days of July 1, 2000. Mr. Lynch was formerly a director of
Laser Link.Net.
(27) Includes 4,999 shares of common stock subject to options exercisable
within 60 days of July 1, 2000.
(28) Includes 4,999 shares of common stock subject to options exercisable
within 60 days of July 1, 2000.
(29) Consists of shares of common stock received in a private placement
from David Dulaney, also a selling shareholder herein, in a
transaction exempt under the Securities Act of 1933, as amended,
pursuant to Section 4.

93
<PAGE>

DESCRIPTION OF CAPITAL STOCK

The following summary describes the material terms of our capital stock.
However, it does not purport to be complete and is qualified in its entirety by
the actual terms of our capital stock contained in our Amended and Restated
Certificate of Incorporation and other agreements referenced below.

As of August 1, 2000 our authorized capital stock currently consists of
600,000,000 shares of common stock, 10,000,000 shares of class B common stock
and 5,000,000 shares of preferred stock. As of July 1, 2000, there were 613
holders of record of common stock and no holders of class B common stock. The
common stock and preferred stock each have a par value of $0.001 per share. As
of August 1, 2000, there were 154,770,567 shares of common stock, outstanding.
As of August 1, 2000, options to purchase 25,700,808shares of common stock at a
weighted average exercise price of $21.41 per share were outstanding.

COMMON STOCK

The holders of our common stock are entitled to one vote per share on all
matters submitted to a vote of the stockholders. Subject to preferential rights
of any outstanding series of preferred stock, the holders of common stock are
entitled to receive ratably such dividends, if any, as may be declared from time
to time by the board of directors out of funds legally available for that
purpose. In the event of our liquidation, dissolution or winding up, the holders
of common stock are entitled to share ratably in all our remaining assets after
payment of liabilities and satisfaction of preferential rights of any
outstanding series of preferred stock. The common stock has no preemptive or
conversion rights or other subscription rights. There are no redemption or
sinking fund provisions applicable to the common stock. All outstanding shares
of common stock are fully paid and non-assessable.

CLASS B COMMON STOCK

Although there are 10,000,000 shares of class B common stock authorized,
there is, currently, no class B common stock outstanding.

PREFERRED STOCK

The board of directors has the authority to issue up to 5,000,000 shares of
preferred stock in one or more series without any further action or vote by the
stockholders. In addition, the board of directors is authorized, without
stockholder approval, to fix the rights, preferences, privileges, and
restrictions granted to or imposed upon such preferred stock, including:

o dividend rights;

o conversion rights;

o terms of redemption;

o liquidation preferences;

o voting rights;

o sinking fund terms; and

o the number of shares constituting any series or the designation of
such series.

As a result, the board of directors could issue additional preferred stock
with voting and conversion rights which could adversely affect the voting power
of the holders of common stock. Issuing preferred stock could also have the
effect of delaying, deferring or preventing a change in control or the removal
of our management. We have no present plan to issue any shares of preferred
stock.

WARRANTS

In connection with the issuance of our senior discount notes in March 1998,
we issued warrants to purchase an aggregate of 11,370,969 shares of our common
stock with exercise prices of $0.0015 per share. We also issued to a consultant
a five-year warrant to purchase 303,750 split-adjusted shares with an exercise
price of $0.4445 per share. This warrant is immediately exercisable. In April
1999, we issued a warrant to purchase 450,000 shares of

<PAGE>

common stock to a customer. This warrant vested with respect to 225,000 shares
on April 1, 2000 and will vest with respect to the remaining 225,000 shares on
April 1, 2001, subject to the customer achieving certain performance goals. The
exercise price for 225,000 of the shares is $48.4375. The exercise price for the
remaining 225,000 shares will be the fair market value of the common stock on
the ten trading days preceding the second vesting date.

REGISTRATION RIGHTS

Certain holders of our common stock are entitled to registration rights.
Pursuant to the Stockholder Rights Agreement holders of 29,859,175 shares of
common stock and the former holders of 6,379,177 shares of class B common stock
(collectively, the "Rights Holders") are entitled to certain rights with respect
to the registration under the Securities Act of the shares of common stock held
by them or issued as a result of the conversion of the class B common stock. The
6,379,177 shares of class B common stock have been converted into 14,353,147
shares of common stock. The Rights Holders are entitled to demand, "piggy-back"
and S-3 registration rights, subject to certain limitations and conditions. The
number of securities requested to be included in a registration involving the
exercise of demand and "piggy-back" rights are subject to a pro rata reduction
based on the number of shares of common stock held by each Rights Holder and any
other security holders exercising their respective registration rights to the
extent that the managing underwriter advises that the total number of securities
requested to be included in the underwriting is such as to materially and
adversely affect the success of the offering. The registration rights terminate
as to any Rights Holder at the later of (i) three years after our initial public
offering or (ii) such time as such Rights Holder may sell under Rule 144 in a
three month period all registrable securities then held by such Rights Holder.

Pursuant to the Warrant Registration Rights Agreement dated March 11, 1998,
between us and Bear, Stearns & Co. Inc. and BT Alex. Brown Incorporated, holders
of warrants that remain outstanding after this offering are entitled to certain
registration rights with respect to the shares of common stock issuable upon
exercise of such warrants. Like the Rights Holders, the number of securities
that a warrant holder may request to be included in any registration is subject
to a pro rata reduction. Such a reduction will be based on the number of shares
held by each warrant holder and any other security holders exercising their
respective registration rights to the extent that the managing underwriter
advises us that the total number of securities requested to be included in the
underwriting is such as to materially and adversely affect the success of the
offering.

ANTITAKEOVER EFFECTS OF CERTAIN PROVISIONS OF OUR CHARTER, BYLAWS, DELAWARE LAW
AND OUR STOCKHOLDER PROTECTION RIGHTS PLAN.

As noted above, our board of directors, without stockholder approval, has
the authority under our charter to issue preferred stock with rights superior to
the rights of the holders of common stock. As a result, preferred stock could be
issued quickly and easily, could adversely affect the rights of the common stock
holders and could be issued with terms calculated to delay or prevent a change
of control of our company or make removal of management more difficult.

ELECTION AND REMOVAL OF DIRECTORS. Our charter and bylaws provide for the
division of our board of directors into three classes with the directors in each
class serving for a three-year term, and one class being elected each year by
our stockholders. Our directors may be removed only for cause.

This system of electing and removing directors may tend to discourage a
third party from making a tender offer or otherwise attempting to obtain control
of our company and may maintain the incumbency of the board of directors, as it
generally makes it more difficult for stockholders to replace a majority of the
directors. See "Management--Classified Board."

STOCKHOLDER MEETINGS AND WRITTEN CONSENT. Under our bylaws, the
stockholders may not call a special meeting of the stockholders of our company.
Rather, only our board of directors, the chairman of our board of directors and
the President or Chief Executive Officer may call special meetings of our
stockholders. Our charter provides that stockholders may not act by written
consent. As a result, stockholders can only act at a meeting.

REQUIREMENTS FOR ADVANCE NOTIFICATION OF STOCKHOLDER NOMINATIONS AND
PROPOSALS. Our bylaws establish advance notice procedures with respect to
stockholder proposals and the nomination of candidates for election as
directors, other than nominations made by or at the direction of the board of
directors or a committee thereof.

95
<PAGE>

SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW. We are subject to
Section 203 of the Delaware General Corporation Law. Section 203 prohibits a
publicly held Delaware corporation from engaging in a "business combination"
with an "interested stockholder" for a period of three years after the date of
the transaction in which the person became an interested stockholder, unless

o prior to such date, the board of directors of the corporation
approves either the business combination or the transaction that
resulted in the stockholder's becoming an interested stockholder,

o upon consummation of the transaction that resulted in the
stockholder's becoming an interested stockholder, the interested
stockholder owns at least 85% of the outstanding voting stock,
excluding shares held by directors, officers and certain employee
stock plans, or

o on or after the consummation date the business combination is
approved by the board of directors and by the affirmative vote at an
annual or special meeting of stockholders of at least 66 2/3% of the
outstanding voting stock that is not owned by the interested
stockholder.

For purposes of Section 203, a "business combination" includes, among other
things, a merger, asset sale or other transaction resulting in a financial
benefit to the interested stockholder. An "interested stockholder" is generally
a person who, together with affiliates and associates of such person,

o owns 15% or more of the corporation's voting stock or

o is an affiliate or associate of the corporation and was the owner of
15% or more of the outstanding voting stock of the corporation as any
time within the prior three years.

These charter and bylaw provisions and provisions of Delaware law may have
the effect of delaying, deterring or preventing a change of control of our
company.

STOCKHOLDER PROTECTION RIGHTS PLAN. In addition, our Board of Directors has
adopted a Stockholder Protection Rights Plan under which stockholders received
one right for each share of our common stock owned by them. The rights become
exercisable, in most circumstances, upon the accumulation by a person or group
of 15% or more of the our outstanding shares of common stock. Each right
entitles the holder to purchase from us, as provided by the Stockholder
Protection Rights Agreement, one one-thousandth of a share of Participating
Preferred Stock, par value $.001 per share, for $400.00 subject to adjustment.
The Rights Plan is not intended to, and will not, prevent a takeover of Covad at
a full and fair price. However, the rights may cause substantial dilution to a
person or group acquiring 15% of more of our common stock unless the rights are
first redeemed by the board of directors.

96
<PAGE>

SHARES ELIGIBLE FOR FUTURE SALE

Future sales of a substantial number of shares of our common stock in the
public market, or the appearance that such shares are available for sale, could
adversely affect prevailing market prices for our common stock and our ability
to raise capital through an offering of equity securities.

As of August 1, 2000 we had 154,770,567 shares of common stock outstanding
and no class B common stock outstanding. Of these shares, the 5,013,466 shares
of common stock sold in this offering will be freely tradeable in the public
market without restriction under the Securities Act, unless such shares are
purchased by our "affiliates" as that term is defined in Rule 144 under the
Securities Act. In addition, 89,432,727 shares of our common stock (the
"Restricted Shares") were issued and sold by us in reliance on exemptions from
the registration requirements of the Securities Act. These shares may be sold or
may have been sold in the public market only if they are registered or if they
qualify for an exemption from registration, such as Rule 144 or 701 under the
Securities Act, which are summarized below.

Stock Plans. In addition, as of August 1, 2000 we have 31,969,168 shares of
our common stock reserved for issuance pursuant to options under our 1997 Stock
Plan, of which 25,700,808 shares were subject to outstanding options as of
August 1, 2000, and we have 1,732,716 shares of our common stock reserved for
issuance pursuant to our 1998 Employee Stock Purchase Plan. We have also
reserved 1,006,050 shares of our common stock for issuance pursuant to options
we assumed in connection with our acquisition of LaserLink.net. Accordingly,
shares underlying vested options will be eligible for resale in the public
market at various times.

Warrants. We also have 460,933 shares underlying outstanding warrants. The
shares underlying these warrants will be eligible for resale in the public
market upon expiration of their one-year holding period under Rule 144. However,
to the extent that warrant holder effects a "cashless" exercise of this warrant,
the underlying shares would be eligible for sale in the public markets.

REGISTRATION RIGHTS

Certain holders of our common stock are entitled to registration rights.
Pursuant to the Stockholder Rights Agreement holders of 29,859,175 shares of
common stock and the former holders of 6,379,177 shares of class B common stock
(collectively, the "Rights Holders") are entitled to certain rights with respect
to the registration under the Securities Act of the shares of common stock held
by them or issuable upon conversion of the class B common stock. The 6,379,177
shares of class B common stock have been converted into 14,353,147 shares of
common stock. The Rights Holders are entitled to demand, "piggy-back" and S-3
registration rights, subject to certain limitations and conditions. The number
of securities requested to be included in a registration involving the exercise
of demand and "piggy-back" rights are subject to a pro rata reduction based on
the number of shares of common stock held by each Rights Holder and any other
security holders exercising their respective registration rights to the extent
that the managing underwriter advises that the total number of securities
requested to be included in the underwriting is such as to materially and
adversely affect the success of the offering. The registration rights terminate
as to any Rights Holder at the later of (i) three years after our initial public
offering or (ii) such time as such Rights Holder may sell under Rule 144 in a
three month period all registrable securities then held by such Rights Holder.

Summary of Rule 144. In general, under Rule 144 as currently in effect, a
person (or persons whose shares are aggregated) who has beneficially owned
shares for at least one year (including the holding period of any prior owner,
except an affiliate) is entitled to sell within any three-month period a number
of shares that does not exceed the greater of:

(i) one percent of the number of shares of common stock then outstanding;
or

97
<PAGE>

(ii) the average weekly trading volume of the common stock during the our
calendar weeks preceding the required filing of a Form 144 with
respect to such sale.

Sales under Rule 144 are generally subject to certain manner of sale
provisions and notice requirements and to the availability of current public
information about us. Under Rule 144(k), a person who is not deemed to have been
an affiliate of ours at any time during the 90 days preceding a sale, and who
has beneficially owned the shares proposed to be sold for at least two years, is
entitled to sell such shares without having to comply with the manner of sale,
public information, volume limitation or notice provisions of Rule 144. Under
Rule 701, persons who purchase shares upon exercise of options granted prior to
the effective date of our initial public offering became entitled to sell such
shares 90 days after the effective date of our initial public offering in
reliance on Rule 144, without having to comply with the holding period
requirements of Rule 144 and, in the case of non-affiliates, without having to
comply with the public information, volume limitation or notice provisions of
Rule 144.

98
<PAGE>

PLAN OF DISTRIBUTION

The shares covered by this prospectus may be offered and sold from time
to time by the selling shareholders. The selling shareholders will act
independently of us in making decisions with respect to the timing, manner and
size of each sale. The selling shareholders may sell the shares being offered
hereby on the Nasdaq National Market, or otherwise, at prices and under terms
then prevailing or at prices related to the then current market price or at
negotiated prices. Shares may be sold by one or more of the following means of
distribution:

o block trades in which the broker-dealer so engaged will attempt to
sell such shares as agent, but may position and resell a portion of
the block as principal to facilitate the transaction;

o purchases by a broker-dealer as principal and resale by such
broker-dealer for its own account
pursuant to this prospectus;

o over-the-counter distributions in accordance with the rules of the
Nasdaq National Market;

o ordinary brokerage transactions and transactions in which the broker
solicits purchasers; and

o privately negotiated transactions.

To the extent required, this prospectus may be amended and supplemented
from time to time to describe a specific plan of distribution. In connection
with distributions of such shares or otherwise, the selling shareholders may
enter into hedging transactions with broker-dealers or other financial
institutions. In connection with such transactions, broker-dealers or other
financial institutions may engage in short sales of our common stock in the
course of hedging the positions they assume with the selling shareholders. The
selling shareholders may also sell our common stock short and redeliver the
shares to close out such short positions. The selling shareholders may also
enter into option or other transactions with broker-dealers or other financial
institutions which require the delivery to such broker-dealer or other financial
institution of the shares offered hereby, which shares such broker-dealer or
other financial institution may resell pursuant to this prospectus (as
supplemented or amended to reflect such transaction). The selling shareholders
may also pledge such shares to a broker-dealer or other financial institution,
and, upon a default, such broker-dealer or other financial institution, may
effect sales of such pledged shares pursuant to this prospectus (as supplemented
or amended to reflect such transaction). In addition, any such shares that
qualify for sale pursuant to Rule 144 may be sold under Rule 144 rather than
pursuant to this prospectus.

In effecting sales, brokers, dealers or agents engaged by the selling
shareholder may arrange for other brokers or dealers to participate. Brokers,
dealers or agents may receive commissions, discounts or concessions from the
selling shareholders in amounts to be negotiated prior to the sale. Such brokers
or dealers and any other participating brokers or dealers may be deemed to be
"underwriters" within the meaning of the Securities Act of 1933 in connection
with such sales, and any such commissions, discounts or concessions may be
deemed to be underwriting discounts or commissions under the Securities Act of
1933. We will pay all reasonable expenses incident to the registration of the
shares being offered hereby other than any commissions and discounts of
underwriters, dealers or agents.

In order to comply with the securities laws of certain states, if
applicable, the shares being offered hereby must be sold in such jurisdictions
only through registered or licensed brokers or dealers. In addition, in certain
states such shares may not be sold unless they have been registered or qualified
for sale in the applicable state or an exemption from the registration or
qualification requirement is available and there has been compliance thereof.

We have advised the selling shareholders that the anti-manipulation rules
of Regulation M under the Securities Exchange Act of 1934 may apply to sales of
shares in the market and to the activities of the selling shareholders and their
affiliates. In addition, we will make copies of this prospectus available to the
selling shareholder and have informed them of the need for delivery of copies of
this prospectus to purchasers at or prior to the time of any sale of the shares
offered hereby. The selling shareholders may indemnify any broker-dealer that
participates in transactions involving the sale of the shares against certain
liabilities, including liabilities arising under the Securities Act of 1933. We
have agreed to indemnify the selling shareholders against certain liabilities.

Subject to certain limitations, we will keep the registration statement,
of which this prospectus constitutes a part, from the date of the prospectus
through March 20, 2001 or, if earlier, with respect to the selling shareholders,
until the selling shareholders are able to sell all shares offered pursuant to
this registration statement.

99
<PAGE>

WHERE YOU CAN FIND MORE INFORMATION

We have filed with the Securities and Exchange Commission a registration
statement on Form S-1, of which this prospectus is a part, under the Securities
Act with respect to the shares of common stock offered hereby. This prospectus
does not contain all of the information included in the registration statement.
Statements contained in this prospectus concerning the provisions of any
document are not necessarily complete. You should refer to the copy of these
documents filed as an exhibit to the registration statement or otherwise filed
by us with the Securities and Exchange Commission ("SEC") for a more complete
understanding of the matter involved. Each statement concerning these documents
is qualified in its entirety by such reference.

We are also subject to the informational requirements of the Securities
Exchange Act of 1934. In accordance with the Exchange Act, we file reports,
proxy statements and other information with the SEC. The registration statement,
including the attached exhibits and schedules, may be inspected and copied at
the public reference facilities maintained by the SEC, Room 1024, Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the regional
offices of the Commission located at Seven World Trade Center, New York, New
York 10048, and 500 West Madison Street, Chicago, Illinois 60661. Please call
the SEC at 1-800-SEC-0330 for further information about the public reference
rooms. The SEC maintains a Web site that contains reports, proxy and information
statements and other information regarding registrants that file electronically
with the SEC. Copies of the registration statement and the reports, proxy and
information statements and other information that we file with the SEC may be
obtained from the SEC's Internet address at http://www.sec.gov.

LEGAL MATTERS

The validity of the common stock offered hereby will be passed upon for
us by Irell & Manella LLP, Los Angeles, California.

EXPERTS

The consolidated financial statements of the Company as of December 31,
1998 and 1999 and for each of the three years in the period ended December 31,
1999, appearing in this Prospectus and Registration Statement, have been audited
by Ernst & Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein, and are included in reliance upon such report given
on the authority of such firm as experts in accounting and auditing.

The consolidated financial statements of the BlueStar Communications
Group, Inc. as of December 31, 1998 and 1999 and for the years ended December
31, 1998 and December 31, 1999 included in this Prospectus and the Registration
Statement have been audited by Arthur Andersen LLP, independent public
accountants, as indicated in their report with respect thereto, and are included
herein in reliance upon the authority of said firm as experts in giving paid
reports.

The consolidated financial statements of Laser Link.Net, Inc. as of
December 31, 1998 and 1999 and for each of the three years in the period ended
December 31, 1999, appearing in this Prospectus and Registration Statement, have
been audited by PricewaterhouseCoopers LLP, independent auditors, as set forth
in their report thereon appearing elsewhere herein, and are included in reliance
upon such report given on the authority of such firm as experts in accounting
and auditing.

100
<PAGE>

INDEX TO FINANCIAL STATEMENTS

PAGE
------
COVAD COMMUNICATIONS GROUP, INC
ANNUAL FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors................................................... F-2
Consolidated Balance Sheets at December 31, 1998 and 1999........................................... F-3
Consolidated Statements of Operations for the years ended December 31, 1997, 1998 and 1999.......... F-4
Consolidated Statements of Stockholders' Equity (Net Capital Deficiency) for the years ended
December 31, 1997, 1998 and 1999.................................................................. F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1998 and 1999.......... F-6
Notes to Consolidated Financial Statements.......................................................... F-7

INTERIM FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheet at June 30, 2000............................................... F-19
Condensed Consolidated Statements of Operations for the three and six months ended June 30, 1999 and
2000.............................................................................................. F-20
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 1999 and 2000..... F-21
Notes to Condensed Consolidated Financial Statements................................................ F-22

UNAUDITED PRO FORMA CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS
Overview............................................................................................ F-28
Unaudited Pro Forma Condensed Combined Consolidated Balance Sheets at June 30, 2000................. F-29
Unaudited Pro Forma Condensed Combined Consolidated Statements of Operations for the year ended
December 31, 1999................................................................................. F-30
Unaudited Pro Forma Condensed Combined Consolidated Statements of Operations for the six months
ended June 30, 2000............................................................................... F-31
Notes to Unaudited Pro Forma Condensed Combined Consolidated Financial Information.................. F-32

LASER LINK NET, INC
ANNUAL FINANCIAL STATEMENTS
Report of Independent Accountants................................................................... F-38
Balance Sheets at December 31, 1999 and 1998........................................................ F-39
Statements of Operations for the years ended December 31, 1997, 1998 and 1999....................... F-40
Statements of Stockholders' Equity for the years ended December 31, 1997, 1998 and 1999............. F-41
Statements of Cash Flows for the years ended December 31, 1997, 1998 and 1999....................... F-42
Notes to Financial Statements....................................................................... F-43

BLUESTAR COMMUNICATIONS GROUP, INC
ANNUAL FINANCIAL STATEMENTS
Report of Independent Public Accountants............................................................ F-50
Consolidated Balance Sheets at December 31, 1998 and December 31, 1999.............................. F-51
Consolidated Statements of Operations for the years ended December 31, 1998 and 1999................ F-52
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998 and 1999...... F-53
Consolidated Statements of Cash Flows for the years ended December 31, 1998 and 1999................ F-54
Notes to Consolidated Financial Statements.......................................................... F-55

INTERIM FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheets at June 30, 2000.............................................. F-66
Condensed Consolidated Statements of Operations for six months ended June 30, 1999 and 2000......... F-67
Condensed Consolidated Statements of Stockholders' Equity for the six months ended June 30, 2000.... F-68
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 1999 and 2000..... F-69
Notes to Condensed Consolidated Financial Statements................................................ F-70
</TABLE>

F-1
<PAGE>

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders of
Covad Communications Group, Inc.

We have audited the accompanying consolidated balance sheets of Covad
Communications Group, Inc. as of December 31, 1998 and 1999, and the related
consolidated statements of operations, stockholders' equity (net capital
deficiency), and cash flows for each of the three years in the period ended
December 31, 1999. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to herein
present fairly, in all material respects, the consolidated financial position of
Covad Communications Group, Inc. as of December 31, 1998 and 1999, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 1999 in conformity with accounting
principles generally accepted in the United States.

/s/ ERNST & YOUNG LLP

Walnut Creek, California
January 21, 2000, except for Note 9,
as to which the date is April 3, 2000

F-2
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1998 1999
---------- -------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents......................................................... $ 64,450 $ 216,038
Accounts receivable, net of allowances for uncollectibles of $220 and $2,857 at
December 31, 1998 and 1999...................................................... 1,933 15,393
Short-term investments............................................................ -- 551,319
Unbilled revenue.................................................................. 663 5,419
Inventories....................................................................... 946 8,547
Prepaid expenses.................................................................. 1,183 6,048
Other current assets.............................................................. 514 1,219
---------- -------------
Total current assets ........................................................... 69,689 803,983
PROPERTY AND EQUIPMENT:
Networks and communication equipment.............................................. 55,189 233,260
Computer equipment................................................................ 4,426 24,057
Furniture and fixtures............................................................ 1,119 4,383
Leasehold improvements............................................................ 1,887 6,884
Land.............................................................................. -- 1,120
---------- -------------
62,621 269,704
Less accumulated depreciation and amortization....................................... (3,476) (32,162)
---------- -------------
Net property and equipment...................................................... 59,145 237,542
OTHER ASSETS:
Restricted cash................................................................... 225 63,308
Deposits ......................................................................... 337 1,131
Deferred debt issuance costs, net ................................................ 8,112 12,369
Deferred charge, net.............................................................. -- 20,529
Other long term assets............................................................ 1,911 8,744
---------- -------------
10,585 106,081
---------- -------------
Total Assets.................................................................... $ 139,419 $ 1,147,606
========== =============

LIABILITIES AND STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
CURRENT LIABILITIES:
Accounts payable.................................................................. $ 14,975 $ 41,126
Unearned revenue.................................................................. 551 5,238
Accrued network costs............................................................. 1,866 8,798
Other accrued liabilities......................................................... 3,854 27,104
Current portion of capital lease obligations...................................... 263 268
---------- -------------
Total current liabilities....................................................... 21,509 82,534
Long-term debt, net of discount...................................................... 142,300 374,737
Long-term capital lease obligations.................................................. 316 44
---------- -------------
Total liabilities............................................................... 164,125 457,315

Commitments and contingencies (see notes 4 and 8)

STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY):
Preferred stock ($0.001 par value):
Authorized shares--30,000,000 at December 1998 and 5,000,000 at December 31,1999.. -- --
Issued and outstanding shares--27,369,243 at December 31, 1998 and 0 at
December 31, 1999............................................................... 18 --
Common Stock ($0.001 par value):
Authorized shares--65,000,000 at December 31, 1998 and 190,000,000 at December 31,
1999 ........................................................................... -- --
Issued and outstanding shares--26,491,494 at December 31, 1998 and
132,331,316 at December 31, 1999................................................ 12 82
Common Stock--Class B ($0.001 par value)
Authorized shares--0 at December 31, 1998 and 10,000,000 at December 31, 1999 .... -- --
Issued and outstanding shares--0 at December 31, 1998 and 6,379,177 at December 31,
1999............................................................................ -- 6
Additional paid-in capital........................................................... 30,685 851,589
Deferred compensation................................................................ (4,688) (6,513)
Accumulated other comprehensive income, net of tax effect............................ -- 91,257
Accumulated deficit ................................................................. (50,733) (246,130)
---------- -------------
Total stockholders' equity (net capital deficiency)............................. (24,706) 690,291
---------- -------------
Total liabilities and stockholders' equity (net capital deficiency)............. $ 139,419 $ 1,147,606
========== =============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

F-3
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1997 1998 1999
------------ ------------- -------------
<S> <C> <C> <C>
Revenues............................................................. $ 26 $ 5,326 $ 66,488
Operating expenses:
Network and product costs......................................... 54 4,562 55,347
Sales, marketing, general and administrative...................... 2,374 31,043 140,372
Amortization of deferred compensation............................. 295 3,997 4,768
Depreciation and amortization..................................... 70 3,406 37,602
------------ ------------- -------------
Total operating expenses........................................ 2,793 43,008 238,089
------------ ------------- -------------
Loss from operations................................................. (2,767) (37,682) (171,601)
Interest income (expense):
Interest income................................................... 167 4,778 20,676
Interest expense.................................................. (12) (15,217) (44,472)
------------ ------------- -------------
Net interest income (expense)..................................... 155 (10,439) (23,796)
------------ ------------- -------------
Net loss............................................................. (2,612) (48,121) (195,397)
Preferred dividends.................................................. -- -- (1,146)
------------ ------------- -------------
Net loss attributable to Common Stockholders......................... $ (2,612) $ (48,121) $ (196,543)
============ ============= =============
Net loss per share--basic and diluted................................. $ (0.35) $ (3.75) $ (1.83)
============ ============= =============
Weighted average shares used in computing net loss per
share--basic and diluted......................................... 7,360,978 12,844,203 107,647,812
============ ============= =============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

F-4
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(NET CAPITAL DEFICIENCY)
(AMOUNTS IN 000'S, EXCEPT SHARE AMOUNTS)

CONVERTIBLE PREFERRED STOCK
------------------------------------
SHARES AMOUNT
------------------ ---------------
<S> <C> <C>
Initial issuance of Common Stock............................ -- $ --
Repurchase of Common Stock.................................. -- --
Issuance of Common Stock.................................... -- --
Issuance of Series A Preferred Stock ....................... 1,125,000 1
Issuance of Series B Preferred Stock
(net of $43 of financing costs)......................... 25,500,002 17

Deferred compensation ...................................... -- --
Amortization of deferred.................................... -- --
Net loss.................................................... -- --
------------------ ---------------
Balances at December 31, 1997 .............................. 26,625,002 18
Issuance of Common Stock.................................... -- --
Issuance of Series B Preferred Stock........................ 150,003 --
Issuance of Series C Preferred Stock........................ 594,238 --
Issuance of Common Stock warrants as part of debt offering
issuance costs......................................... -- --
Issuance of Common Stock warrants
Pursuant to debt offering............................... -- --
Deferred compensation ...................................... -- --
Amortization of deferred compensation....................... -- --
Net loss.................................................... -- --
------------------ ---------------
Balances at December 31, 1998............................... (27,369,243) 18
Issuance of Common Stock ................................... -- --
Issuance of Common Stock upon exercise of warrants.......... -- --
Issuance of Series C and D Preferred Stock.................. 9,568,766 6
Deferred charge related to issuance of
Series C and D Preferred Stock ......................... -- --
Conversion of Series A, Series B and Series C Preferred
Stock to Common Stock................................... (27,369,243) (18)
Conversion of Series C1 and D1
Preferred stock......................................... (9,568,766) (6)
Preferred dividends ........................................ -- --
Conversion of convertible Preferred Stock................... -- --
Deferred compensation....................................... -- --
Amortization of deferred compensation....................... -- --
Unrealized gains (losses) on investments.................... -- --
Net loss.................................................... -- --
------------------ ---------------
Balances at December 31, 1999............................... -- --
================== ===============

COMMON STOCK ADDITIONAL
------------------------------------ PAID-IN
SHARES AMOUNT CAPITAL
----------------- ---------------- --------------
<S> <C> <C> <C>
Initial issuance of Common Stock............................ 27,000,000 $ 12 $ 38
Repurchase of Common Stock.................................. (5,423,166) (3) (7)
Issuance of Common Stock.................................... 3,985,875 2 66
Issuance of Series A Preferred Stock ....................... -- -- 249
Issuance of Series B Preferred Stock
(net of $43 of financing costs)......................... -- -- 8,440

Deferred compensation ...................................... -- -- 906
Amortization of deferred.................................... -- -- --
Net loss.................................................... -- -- --
----------------- ---------------- --------------
Balances at December 31, 1997 .............................. 25,562,709 11 9,692
Issuance of Common Stock.................................... 928,785 1 570
Issuance of Series B Preferred Stock........................ -- -- 100
Issuance of Series C Preferred Stock........................ -- -- 1,100
Issuance of Common Stock warrants as part of debt offering
issuance costs......................................... -- -- 2,928
Issuance of Common Stock warrants
Pursuant to debt offering............................... -- -- 8,221
Deferred compensation ...................................... -- -- 8,074
Amortization of deferred compensation....................... -- -- --
Net loss.................................................... -- -- --
----------------- ---------------- --------------
Balances at December 31, 1998............................... 26,491,494 12 30,685
Issuance of Common Stock ................................... 48,999,989 33 725,708
Issuance of Common Stock upon exercise of warrants.......... 15,652,382 10 (5)
Issuance of Series C and D Preferred Stock.................. -- -- 59,994
Deferred charge related to issuance of
Series C and D Preferred Stock ......................... -- -- 28,700
Conversion of Series A, Series B and Series C Preferred
Stock to Common Stock................................... 41,053,864 27 (9)
Conversion of Series C1 and D1
Preferred stock......................................... 6,379,177 6 --
Preferred dividends ........................................ 133,587 -- (77)
Conversion of convertible Preferred Stock................... -- -- --
Deferred compensation....................................... -- -- 6,593
Amortization of deferred compensation....................... -- -- --
Unrealized gains (losses) on investments.................... -- -- --
Net loss.................................................... -- -- --
----------------- ---------------- --------------
Balances at December 31, 1999............................... 138,710,493 $ 88 $ 851,589
================= ================ ==============

DEFERRED ACCUMULATED OTHER ACCUMULATED
COMPENSATION COMPREHENSIVE INCOME DEFICIT
------------------- -------------------------- -----------------
<S> <C> <C> <C>
Initial issuance of Common Stock............................ $ -- $ -- $ --
Repurchase of Common Stock.................................. -- -- --
Issuance of Common Stock.................................... -- -- --
Issuance of Series A Preferred Stock ....................... -- -- --
Issuance of Series B Preferred Stock
(net of $43 of financing costs)......................... -- --

Deferred compensation ...................................... (906) --
Amortization of deferred.................................... 295 --
Net loss.................................................... -- -- (2,612)
------------------- -------------------------- -----------------
Balances at December 31, 1997 .............................. (611) -- (2,612)
Issuance of Common Stock.................................... -- -- --
Issuance of Series B Preferred Stock........................ -- -- --
Issuance of Series C Preferred Stock........................ -- -- --
Issuance of Common Stock warrants as part of debt offering
issuance costs......................................... -- -- --
Issuance of Common Stock warrants
Pursuant to debt offering............................... -- -- --
Deferred compensation ...................................... (8,074) -- --
Amortization of deferred compensation....................... 3,997 -- --
Net loss.................................................... -- -- (48,121)
------------------- -------------------------- -----------------
Balances at December 31, 1998............................... (4,688) -- (50,733)
Issuance of Common Stock ................................... -- -- --
Issuance of Common Stock upon exercise of warrants.......... -- -- --
Issuance of Series C and D Preferred Stock.................. -- -- --
Deferred charge related to issuance of
Series C and D Preferred Stock ......................... -- -- --
Conversion of Series A, Series B and Series C Preferred
Stock to Common Stock................................... -- -- --
Conversion of Series C1 and D1
Preferred stock......................................... -- -- --
Preferred dividends ........................................ -- -- --
Conversion of convertible Preferred Stock................... -- -- --
Deferred compensation....................................... (6,593) -- --
Amortization of deferred compensation....................... 4,768 -- --
Unrealized gains (losses) on investments.................... -- 91,257 --
Net loss.................................................... -- -- (195,397)
------------------- -------------------------- -----------------
Balances at December 31, 1999............................... $ (6,513) $ 91,257 $ (246,130)
=================== ========================== =================

TOTAL STOCKHOLDERS'
EQUITY (NET CAPITAL
DEFICIENCY)
-------------------------
<S> <C>
Initial issuance of Common Stock............................ $ 50
Repurchase of Common Stock.................................. (10)
Issuance of Common Stock.................................... 68
Issuance of Series A Preferred Stock ....................... 250
Issuance of Series B Preferred Stock
(net of $43 of financing costs)......................... 8,457

Deferred compensation ...................................... --
Amortization of deferred.................................... (295)
Net loss.................................................... (2,612)
-------------------------
Balances at December 31, 1997 .............................. 6,498
Issuance of Common Stock.................................... 571
Issuance of Series B Preferred Stock........................ 100
Issuance of Series C Preferred Stock........................ 1,100
Issuance of Common Stock warrants as part of debt offering
issuance costs......................................... 2,928
Issuance of Common Stock warrants
Pursuant to debt offering............................... 8,221
Deferred compensation ...................................... --
Amortization of deferred compensation....................... 3,997
Net loss.................................................... (48,121)
-------------------------
Balances at December 31, 1998............................... (24,706)
Issuance of Common Stock ................................... 725,741
Issuance of Common Stock upon exercise of warrants.......... 5
Issuance of Series C and D Preferred Stock.................. 60,000
Deferred charge related to issuance of
Series C and D Preferred Stock ......................... 28,700
Conversion of Series A, Series B and Series C Preferred
Stock to Common Stock................................... --
Conversion of Series C1 and D1
Preferred stock......................................... --
Preferred dividends ........................................ (77)
Conversion of convertible Preferred Stock................... --
Deferred compensation....................................... --
Amortization of deferred compensation....................... 4,768
Unrealized gains (losses) on investments.................... 91,257
Net loss.................................................... (195,397)
-------------------------
Balances at December 31, 1999............................... $ 690,291
=========================
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

F-5
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN 000'S)

<TABLE>
<CAPTION>
YEAR ENDED DCEMBER 31,
---------------------------------
1997 1998 1999
--------- ---------- ----------
OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net loss........................................................................ $ (2,612) $ (48,121) $ (195,397)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization................................................ 70 3,406 37,602
Loss on disposition of equipment............................................. -- -- 358
Amortization of deferred compensation........................................ 295 3,997 4,768
Accreted interest and amortization of debt discount and deferred debt
issuance costs.............................................................
-- 16,009 20,269
Net changes in operating assets and liabilities:
Accounts receivable........................................................ (25) (1,908) (13,460)
Unbilled revenue........................................................... (4) (659) (4,756)
Inventories................................................................ (43) (903) (7,601)
Prepaid expenses and other current assets.................................. (369) (1,328) (5,570)
Accounts payable........................................................... 651 14,324 26,151
Unearned revenue........................................................... 7 544 4,687
Other current liabilities.................................................. 135 5,585 30,182
--------- ---------- ----------
Net cash used in operating activities.................................... (1,895) (9,054) (102,767)

INVESTING ACTIVITIES:
Purchase of restricted investment............................................... (210) (15) (73,435)
Redemption of restricted investments............................................ -- -- 13,214
Purchase of investments......................................................... -- (460,062)
Deposits........................................................................ (31) (306) (794)
Long-term assets................................................................ -- (1,428) (6,833)
Purchase of property and equipment.............................................. (2,253) (59,503) (208,186)
--------- --------- ----------
Net cash used in investing activities.................................... (2,494) (61,252) (736,096)

FINANCING ACTIVITIES:
Net proceeds from issuance of long-term debt and warrants....................... -- 129,328 205,049
Principal payments under capital lease obligations.............................. (48) (238) (267)
Proceeds from Common Stock issuance, net of repurchase.......................... 108 571 725,746
Proceeds from preferred stock issuance.......................................... 8,707 1,200 60,000
Offering costs related to Common Stock offering................................. -- (483) (77)
--------- --------- ----------
Net cash provided by financing activities................................ 8,767 130,378 990,451
--------- --------- ----------
Net increase in cash and cash equivalents................................ 4,378 60,072 151,588
Cash and cash equivalents at beginning of year.................................. -- 4,378 64,450
--------- ---------- ----------
Cash and cash equivalents at end of year........................................ $ 4,378 $ 64,450 $ 216,038
========= ========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for interest.......................................... $ 9 $ 99 $ 13,257
========= ========== ==========
SUPPLEMENTAL SCHEDULE ON NON-CASH INVESTING AND FINANCING ACTIVITIES:
Equipment purchased through capital lease....................................... $ 831 $ 34 $ --
========= ========== ==========
Warrants issued for equity commitment........................................... $ -- $ 2,928 $ --
========= ========== ==========
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

F-6
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND NATURE OF OPERATIONS

Covad Communications Group, Inc. (the "Company") is a high-speed Internet
and network access provider offering digital subscriber line ("DSL") services to
Internet Service Provider ("ISP") and enterprise customers. ISPs purchase the
Company's services in order to provide high-speed Internet access to their
business and consumer end-users. Enterprise customers purchase the Company's
services to provide employees with remote access to their Local Area Networks to
improve employee productivity and reduce operating costs. The Company's services
are provided over standard copper telephone lines at considerably faster speeds
than available through a standard modem.

The Company's operations are subject to significant risks and uncertainties
including competitive, financial, developmental, operational, growth and
expansion, technological, regulatory, and other risks associated with an
emerging business.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The consolidated financial statements of the Company include the accounts
of all of its wholly-owned subsidiaries. There were no intercompany accounts and
transactions which required elimination.

USE OF ESTIMATES

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

INITIAL PUBLIC OFFERING

In January 1999, the Company completed an initial public offering of
20,182,500 shares of Common Stock at a purchase price of $8 per share. Net
proceeds to the Company aggregated approximately $150.2 million. In connection
with the offering, all of the preferred stock outstanding automatically
converted into 41,053,864 shares of Common Stock and 6,379,177 shares of Class B
Common Stock (which are convertible into 14,353,148 shares of Common Stock). The
Company's Board of Directors and stockholders also approved an amendment to the
Company's Articles of Incorporation to increase the total number of shares which
the Company is authorized to issue to 205,000,000 shares, of which 200,000,000
is Common Stock and 5,000,000 is preferred stock.

REVENUE RECOGNITION

Revenue related to installation of service and sale of customer premise
equipment is recognized when equipment is delivered and installation is
completed. Revenue from monthly recurring service is recognized in the month the
service is provided. Revenue recognized for which the customer has not been
billed is recorded as unbilled revenue until the period such billings are made.
Amounts billed in advance of providing services are recorded as unearned revenue
until the period such services are provided. For the year ended December 31,
1998, one customer accounted for approximately 17% of the Company's revenue. For
the year ended December 31, 1999, two customers accounted for 15% and 14%
percent of the Company's revenues.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments, with a maturity of
three months or less from the date of original issuance, to be cash equivalents.

F-7
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

RESTRICTED CASH

As of December 31, 1998, the Company had $225,000, in commercial deposits
held in the Company's name but restricted as security for certain of the
Company's capital lease financing arrangements. As of December 31, 1999, the
Company had $63,308,000 (net of an unrealized loss of $918,000) in U.S. Treasury
investments and commercial deposits for the payment of interest on the Company's
1999 notes and as security for certain lease financing arrangements.

CONCENTRATION OF CREDIT RISK AND CREDIT RISK EVALUATIONS

Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash and cash equivalents,
restricted cash, short-term investments and accounts receivable. The Company's
cash and investment policies limit cash equivalents, restricted cash and
short-term investments to short-term, investment grade instruments. Cash and
cash equivalents, restricted cash and short-term investments are held with
various domestic financial institutions with high credit standing. The Company
has not experienced any significant losses on its cash and cash equivalents,
restricted cash or short-term investments. The company conducts business with
companies in various industries, primarily in the United States. Concentrations
of credit risk with respect to accounts receivable are limited due to the large
number of customers comprising the Company's customer base. In addition, the
Company typically offers its customers credit terms. The Company performs
ongoing credit evaluations of its customers' financial condition and generally
does not require collateral. Allowances are maintained for potential credit
issues and such losses to date have been within management's expectations.

INVENTORIES

Inventories are stated at the lower of cost or market and consist primarily
of customer premise equipment. Costs are based on the "first-in, first-out"
method.

PROPERTY AND EQUIPMENT

Property and equipment are recorded at cost and depreciated using the
straight-line method over the following estimated useful lives:

Leasehold improvements..................... 15 years or life of the lease
Electronic communication equipment......... 2 to 5 years
Furniture and fixtures..................... 3 to 7 years
Computer equipment......................... 3 years
Office equipment........................... 2 to 5 years
Computer software.......................... 2 to 7 years

SOFTWARE DEVELOPMENT COSTS

The Company capitalizes costs associated with the design, deployment and
expansion of the Company's network including internally and externally developed
software in accordance with Financial Accounting Standard Board No. 86 "Software
Development Costs" ("FAS 86") and Statement of Position 98-1 "Accounting for
Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"),
respectively. Costs incurred subsequent to the establishment of technological
feasibility are capitalized and amortized over the estimated lives of the
related products. Technological feasibility is established upon completion of a
working model. Capitalized external software costs include the actual costs to
purchase software from vendors. Capitalized internal software costs generally
include personnel and related costs incurred in the enhancement and
implementation of purchased software packages. Capitalized internal labor costs
for the years ending December 31, 1997, 1998 and 1999 were $139,000, $3,063,000
and $15,733,000, respectively. Capitalized interest cost for the years ending
December 31, 1997, 1998 and 1999 were none, $908,000 and $2,756,000,
respectively.

F-8
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

EQUIPMENT UNDER CAPITAL LEASES

The Company leases certain of its equipment and other fixed assets under
capital lease agreements. The assets and liabilities under capital leases are
recorded at the lesser of the present value of aggregate future minimum lease
payments, including estimated bargain purchase options, or the fair value of the
assets under lease, whichever is less. Assets under capital lease are amortized
over the lease term or useful life of the assets.

ACCOUNTING FOR STOCK-BASED COMPENSATION

The Company accounts for employee stock options using the intrinsic value
method in accordance with Accounting Principles Board Opinion No. 25 ("APB 25")
and makes the pro forma disclosures required by Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation"
("FAS123").

ADVERTISING COSTS

The Company expenses the costs of advertising as incurred. Advertising
expense for the years ended December 31, 1997, 1998 and 1999 was $120,000,
$1,500,000 and $25,798,000, respectively.

INCOME TAXES

Due to the Company's overall loss position, there is no provision for
income taxes for 1997, 1998 or 1999.

The reconciliation of income tax computed at the US federal statutory rate
to income tax expense is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------
1997 1998 1999
--------------- --------------- ---------------
<S> <C> <C> <C>
Federal at 34%, statutory...................... $ (757,000) $ (16,363,000) $ (66,435,000)
Nondeductible interest......................... -- 911,000 2,050,000
Losses with no current benefits................ 757,000 15,436,000 64,306,000
Other.......................................... -- 16,000 79,000
--------------- --------------- ---------------
Provision...................................... $ -- $ -- $ --
=============== =============== ===============
</TABLE>

Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and amounts used for income tax purposes. Significant components of the
Company's deferred tax assets and liabilities for federal and state income taxes
are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------
1998 1999
--------------- ---------------
Deferred tax assets:
---------------
<S> <C> <C>
Net operating loss carryforwards............................ $ 16,000,000 45,462,000
Accrued interest............................................ -- 15,977,000
Other....................................................... 2,500,000 1,846,000
--------------- ---------------
Total Net deferred tax assets............................. 18,500,000 63,285,000
Valuation allowance............................................ (18,500,000) (26,782,000)
--------------- ---------------
Total tax deferred assets................................. -- 36,503,000
Unrealized gain on investments................................. -- (36,503,000)
--------------- ---------------
Net deferred tax assets................................... $ -- --
=============== ===============
</TABLE>

Realization of the Company's deferred tax assets is dependent upon future
earnings, if any, the timing and amount of which are uncertain. Accordingly, the
net deferred tax assets have been fully offset by a valuation allowance. The
valuation allowance increased by $8,282,000 during 1999.

F-9
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

As of December 31, 1999, the Company had federal net operating loss
carryforwards for federal tax purposes of approximately $219.5 million which
expire in the years 2012 through 2019, if not utilized. The Company also had net
operating losses carryforwards for state income tax purposes of approximately
$122.3 million expiring in year 2004, if not utilized.

The tax benefits associated with employee stock options provide a deferred
tax benefit of $14.5 million for the year-ended December 31, 1999. The deferred
tax benefit has been offset by a valuation allowance and will be credited to
additional paid-in capital when realized.

The utilization of the net operating loss is subject to a substantial
annual limitation due to the "change in ownership" provisions of the Internal
Revenue Code of 1986, as amended, and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The following methods and assumptions were used to estimate the fair value
for financial instruments:

CASH, CASH EQUIVALENTS AND RESTRICTED CASH. The carrying amount
approximates fair value.

SHORT TERM INVESTMENT. The fair values of short-term investments were
estimated based on quoted market prices.

BORROWINGS. The fair values of borrowings, including long-term debt,
capital lease obligations and other obligations, were estimated based on quoted
market prices, where available, or by discounting the future cash flows using
estimated borrowing rates at which similar types of borrowing arrangements with
the same remaining maturities could be obtained by the Company. For all
borrowings outstanding at December 31, 1998 and 1999, fair value approximates
recorded value.

LOSS PER SHARE

Basic loss per share is computed by dividing income or loss applicable to
common shareholders by the weighted average number of shares of the Company's
Common Stock, after giving consideration to shares subject to repurchase,
outstanding during the period.

Diluted loss per share is determined in the same manner as basic loss per
share except that the number of shares is increased assuming exercise of
dilutive stock options and warrants using the treasury stock method. The diluted
loss per share amount is the same as basic loss per share which has not been
reported because the Company has a net loss and the impact of the assumed
exercise of the stock options and warrants and the assumed is not dilutive.

The consolidated financial statements applicable to the prior periods have
been restated to reflect a three-for-two stock split effective May 1999.

F-10
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The following table presents the calculation of basic and diluted net
income (loss) per share (in thousands, except share and per share amounts):

YEAR ENDED DECEMBER 31,
----------------------------------------------
1997 1998 1999
-------------- -------------- --------------
(IN 000'S, EXCEPT SHARE AND PER SHARE
AMOUNTS)
<S> <C> <C> <C>
Net loss........................................ $ (2,612) $ (48,121) $ (195,397)
Preferred dividends............................. -- -- (1,146)
-------------- -------------- --------------
Net loss attributable to common stockholders.... $ (2,612) $ (48,121) $ (196,543)
============== ============== ==============
Basic and diluted:
Weighted average shares of Common Stock
outstanding................................ 24,797,854 25,886,940 115,675,656
Less: Weighted average shares subject to
repurchase................................. 17,436,876 13,042,737 8,027,844
-------------- -------------- --------------
Weighted average shares used in computing basic
and diluted net loss per share............... 7,360,978 12,844,203 107,647,812
============== ============== ==============
Basic and diluted net loss per share............ $ (0.35) $ (3.75) $ (1.83)
============== ============== ==============

</TABLE>

If the Company had reported net income, the calculation of historical
diluted earnings per share would have included an additional 8,574,189,
43,282,296 and 26,517,674 common equivalent shares related to the outstanding
stock options and warrants not included above (determined using the treasury
stock method) for the years ended December 31, 1997, 1998 and 1999,
respectively.

KEY SUPPLIERS

The Company is dependent on limited source suppliers for certain equipment
used to provide its services. The Company has generally been able to obtain an
adequate supply of equipment. In addition, the Company believes that there are
alternative suppliers for the equipment used to provide its services. However,
an extended interruption in the supply of equipment currently obtained from
limited source suppliers could adversely affect the Company's business and
results of operations.

ACCOUNTS RECEIVABLE ALLOWANCE

The Company's reserve for uncollectible accounts receivable was $220,000
and $2,857,000 at December 31, 1998 and 1999, respectively. No significant
charges were made against this reserve as of December 31, 1999.

BUSINESS SEGMENTS

For management purposes, the Company is viewed as one entity with a Chief
Executive Officer ("CEO"), who is the Chief Operating Decision Maker. Financial
position and results of operations for the entity are provided to the CEO in a
format similar to the accompanying financial statements. The Company's
management makes financial decisions and allocates resources based on these
financial statements.

SHORT-TERM INVESTMENTS

At December 31, 1999, all of the Company's investments were classified as
available for sale. Investments were also classified as short-term, as their
maturing date was less than one year from the balance sheet date. Management
determines the appropriate classification of investments at the time of purchase
and reevaluates such designation at the end of each period. Unrealized gains and
losses on short-term investments as of December 31, 1999, are included as a
separate component of stockholders' equity, net of any related tax effect. The
amount of realized gains or losses for the years ended December 31, 1997, 1998
and 1999 was not significant.

F-11
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The following table summarizes the Company's investments:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
----------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
----------- ------------- ------------ ----------
(AMOUNT IN $000'S)
<S> <C> <C> <C> <C>
Commercial paper................................. $ 373,007 $ 125 -- $ 373,132
Corporate notes.................................. 53,767 -- (596) 53,171
Equity securities................................ 32,200 92,816 -- 125,016
---------- ------------- ------------ ----------
Total available for sale securities.............. $ 458,974 $ 92,941 $ (596) $ 551,319
========== ============= ============ ==========
</TABLE>

The company also had a net unrealized loss of $168,000 on cash and cash
equivalents and an unrealized loss of $920,000 on long term U.S. Treasury
investments, classified as Restricted Cash on the Company's balance sheet.

2. DEBT

On March 11, 1998, the Company completed a private placement (the "1998
Private Offering") through the issuance of 260,000 units (the "Units"), each
unit consisting of $1,000 in principal amount at maturity of 13 1/2% Senior
Discount Notes due 2008 (the "1998 notes") and one warrant, initially
exercisable to purchase 43.7346 shares of Common Stock, $0.001 par value, of the
Company (the "Unit Warrants"). Net proceeds from the 1998 Private Offering were
approximately $129.6 million, after transaction costs of approximately $5.5
million.

The principal amount of the 1998 notes will accrete from the date of
issuance at the rate of 13 1/2% per annum through March 15, 2003, compounded
semi-annually, and thereafter bear interest at the rate of 13 1/2% per annum,
payable semi-annually, in arrears on March 15 and September 15 of each year,
commencing on September 15, 2003. The 1998 notes are unsecured senior
obligations of the Company that will mature on March 15, 2008. The 1998 notes
will be redeemable at the option of the Company at any time after March 15, 2003
plus accrued and unpaid interest thereon, if any, to the redemption date.

The 1998 notes were originally recorded at approximately $126.9 million,
which represents the $135.1 million in gross proceeds less the approximate $8.2
million value assigned to the Unit Warrants, which is included in additional
paid-in capital. The value assigned to the Unit Warrants, representing debt
discount, is being amortized over the life of the 1998 notes. Debt issuance
costs were incurred through the issuance of additional warrants associated with
the commitment of equity by certain investors. The debt issuance costs are also
being amortized over the life of the 1998 notes. For the years ended December
31, 1998 and 1999, the accretion of the 1998 notes and the amortization of debt
discount and debt issuance costs was $16.0 million and $22.3 million,
respectively, of which $15.1 million and $21.0 million, respectively, is
included in interest expense and $900,000 and $1.3 million, respectively, is
capitalized in property, plant and equipment.

The Unit Warrants have ten year terms, have exercise prices of $0.0022 per
share (subject to adjustment in certain events), contain net exercise provisions
and are currently exercisable.

On February 18, 1999, the Company completed the issuance of $215.0 million
senior debt notes (the "1999 notes"). Net proceeds from the 1999 notes were
approximately $205.0 million after transaction costs of approximately $9.9
million, which are being amortized over the life of the notes. Amortization
expense related to the transaction cost was $827,000 for year ended December
31,1999. The principal amount of the 1999 notes bears interest at the rate of 12
1/2% per annum through February 15, 2009, compounded semi-annually, and
thereafter bears interest at the rate of 12 1/2% per annum, payable
semi-annually, in arrears on February 15 and August 15 of each year, commencing
on August 15, 1999. The 1999 notes are unsecured senior obligations of the
Company that will mature on February 15, 2009. The notes will be redeemable at
the option of the Company at any time after February 15, 2004 at stated
redemption prices plus accrued and unpaid interest thereon.

F-12
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The Company purchased approximately $74.1 million of government securities
from the net proceeds, representing sufficient funds to pay the first six
scheduled interest payments on the 1999 notes. These government securities are
pledged as security for repayment of interest on the 1999 notes.

On June 1, 1999, the Company completed an offer to exchange all outstanding
12 1/2% senior notes due February 15, 2009 for 12 1/2% senior notes due
February15, 2009, which have been registered under the Securities Act of 1933.

3. CAPITAL LEASES

The Company has entered into capital lease arrangements to finance the
acquisition of certain operating assets, two of which have bargain purchase
options. The original principal value of these leases totaled $865,000 as of
December 31, 1999, and was equivalent to the fair value of the assets leased.

Future minimum lease payments under capital leases are as follows:

YEAR ENDING DECEMBER 31,
-------------------------
2000.......................................................... $ 294,000
2001.......................................................... 44,000
2002.......................................................... 4,000
Thereafter.................................................... --
--------------
342,000

Less amount representing interest............................. (30,000)
Less current portion.......................................... (268,000)
--------------
Total long-term portion.................................. $ 44,000
==============

Accumulated amortization for equipment under capital leases is reflected in
accumulated depreciation and amortization for property and equipment.

4. OPERATING LEASES

The Company leases vehicles, equipment, and office space under various
operating leases. Future minimum lease payments by year under operating leases
are as follows:

YEAR ENDING DECEMBER 31,
-------------------------
2000......................................................... 5,852,000
2001......................................................... 5,713,000
2002......................................................... 5,023,000
2003......................................................... 3,875,000
2004......................................................... 3,292,000
Thereafter................................................... 2,326,000
---------------
Total................................................... $ 26,081,000
===============

Rental expense on operating leases totaled $131,000, $1,507,000 and
$4,302,000 for the years ended December 31, 1997, 1998, and 1999, respectively.

5. STOCKHOLDERS' EQUITY

STRATEGIC INVESTMENT

F-13
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

recorded intangible assets of $28.7 million associated with these transactions
which will be amortized over periods of three to six years. For the year ended
December 31, 1999, amortization expense totaled $8.2 million.

INITIAL PUBLIC OFFERING

On January 27, 1999, the Company completed the initial public offering
(IPO) of 20,182,500 shares of the Company's Common Stock at a price of $8.00 per
share. Net proceeds to the Company from the offering were $150.2 million after
deducting underwriting discounts and commissions and offering expenses payable
by the Company. As a result of the offering, 41,053,864 shares of the Common
Stock and 6,379,177 shares of the Class B Common Stock (which are convertible
into 14,353,148 shares of Common Stock) were issued upon the conversion of
Preferred Stock, 133,587 shares of Common Stock were issued for cumulative but
unpaid dividends on Series A and Series B Preferred Stock and 4,049,439 shares
of Common Stock were issued upon the exercise of common warrants.

SECONDARY OFFERING

On June 23, 1999, the Company completed a public offering of 12,937,500
shares of Common Stock sold by certain stockholders of the Company. The Company
did not sell any shares in this offering. Accordingly, there were no net
proceeds to the Company from this offering. The Company incurred offering
expenses of approximately $600,000.

SECOND PUBLIC OFFERING

On November 3, 1999 the Company completed a public offering of 22,425,000
shares of Common Stock sold by the Company and certain stockholders of the
Company. The net proceeds to the Company from this offering were $568.8 million
after deducting underwriting discounts and commissions and offering expenses.

COMMON STOCK

Shares of Common Stock outstanding at December 31, 1998 and December
31,1999 were 26,491,494 and 132,331,316 shares, respectively, of which
10,739,437 and 6,679,313 shares, respectively, remain subject to repurchase
provisions which generally lapse over a four-year period from the date of
issuance. Shares of Class B Common Stock outstanding at December 31, 1998 and
December 31, 1999 were 0 and 6,379,177, respectively, of which no shares remain
subject to repurchase.

Common Stock reserved for future issuance as of December 31, 1999 is as
follows:

Outstanding options.............................................. 24,522,633
Options available for grant...................................... 1,905,080
Employee stock purchase plan..................................... 2,872,836
Warrants outstanding............................................. 1,995,041
------------
Total....................................................... 31,295,590
===========

PREFERRED STOCK DIVIDENDS

The holders of Series A, Series B and Series C were entitled to receive in
any fiscal year, dividends at the rate of $0.0111 per share, $0.0267 per share
and $0.1487 per share, respectively, payable in preference and priority to any
payment of dividends on Common Stock. The rights to such dividends were
cumulative and accrue to the holders to the extent they were not declared or
paid and were payable, in cash or Common Stock, only in the event of a
liquidation, dissolution or winding up of the Company, or other liquidity event
(as defined in the Certificate of Incorporation). The cumulative dividends at
December 31, 1998 and December 31,1999 for Preferred Stock were approximately
$1,085,000 and $ 1,146,000, respectively, which were converted into 133,587
shares of Common Stock in connection with the IPO.

F-14
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

6. EMPLOYEE BENEFIT PLANS

DEFINED CONTRIBUTION PLAN

Effective September 1, 1997, the Company adopted a defined contribution
retirement plan under Section 401(k) of the Internal Revenue Code which covers
substantially all employees. Eligible employees may contribute amounts to the
plan, via payroll withholding, subject to certain limitations. The Company does
not match contributions by plan participants.

1998 EMPLOYEE STOCK PURCHASE PLAN

In January 1999, the Company adopted the 1998 Employee Stock Purchase Plan.
The Company has reserved a total of 3,375,000 shares of Common Stock for
issuance under the plan. Eligible employees may purchase Common Stock at 85% of
the lesser of the fair market value of the Company's Common Stock on the first
day of the applicable twenty-four month offering period or the last day of the
applicable six month purchase period.

STOCK OPTION PLANS

In 1997, the Company adopted the Covad Communications Group, Inc. 1997
Stock Plan (the "Plan"). The Plan provides for the grant of stock purchase
rights and options to purchase shares of Common Stock to employees and
consultants from time to time as determined by the Board of Directors. The
options expire from two to eight years after the date of grant. As of December
31, 1999 the Plan has reserved 34,920,770 shares of the Company's Common Stock
for sale and issuance under the Plan at prices to be determined by the Board of
Directors.

The following table summarizes stock option activity for the year ended
December 31, 1997, 1998 and December 31, 1999:

<TABLE>
<CAPTION>
NUMBER OF
SHARES OF OPTION PRICE
COMMON STOCK PER SHARE
---------------- -------------------
<S> <C> <C> <C>
Granted.................................................... 8,648,438 $ 0.022 - $ 0.03
Exercised.................................................. (13,500) -- - $ 0.02
Cancelled.................................................. (60,750) $ 0.022 - $ 0.03
-------------- --------------------
Balance as of December 31, 1997............................ 8,574,188 $ 0.022 - $ 0.03

Granted.................................................... 21,077,955 $ 0.067 - $ 5.44
Exercised.................................................. (466,863) $ 0.022 - $ 0.45
Cancelled.................................................. (1,627,730) $ 0.022 - $ 5.29
-------------- --------------------
Balance as of December 31, 1998............................ 27,557,550 $ 0.022 - $ 5.44

Granted.................................................... 8,774,658 $ 0.007 - $44.67
Exercised.................................................. (8,012,683) $ 0.007 - $38.17
Cancelled.................................................. (3,796,892) $ 0.147 - $43.42
-------------- -------------------
Balance as of December 31, 1999............................ 24,522,633 $ 0.0007 - $44.67
============== ===================
</TABLE>

F-15
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The following is a summary of the status of stock options outstanding at
December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------- -------------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
EXERCISE NUMBER OF AVERAGE LIFE AVERAGE NUMBER OF AVERAGE EXERCISE
PRICE RANGE SHARES REMAINING EXERCISE PRICE SHARES PRICE
------------------------ -------------- ------------- ----------------- -------------- ----------------
<S> <C> <C> <C> <C> <C>
$ .007 - $ 6.33 16,509,627 6.1 $ 1.14 3,592,692 $ 1.05
$ 1.33 - $12.67 1,704,315 7.0 $ 7.55 326,487 $ 7.55
$12.67 - $19.00 25,614 7.1 $ 18.61 2,757 $ 18.61
$19.00 - $25.33 34,500 7.1 $ 20.96 5,502 $ 20.91
$25.33 - $31.67 2,944,256 7.4 $ 28.41 166,840 $ 28.38
$31.67 - $38.00 1,754,922 7.5 $ 34.50 65,499 $ 36.21
$38.00 - $44.33 1,534,774 7.3 $ 40.69 151,818 $ 40.23
$44.33 - $50.67 14,625 5.6 $ 44.67 2,432 $ 44.67
-------------- ------------- ----------------- -------------- ----------------
24,522,633 6.5 $ 9.79 4,314,027 $ 4.57
============== ============= ================= ============== ================
</TABLE>

During the year ended December 31, 1997, the Company recorded deferred
compensation of $906,000 as a result of granting stock options and issuing
restricted stock with exercise or issue prices per share below the revised fair
value per share of the Company's Common Stock at the date of grant or issuance.
This amount was recorded as a reduction of stockholders' equity and is being
amortized as a charge to operations over the vesting period of the applicable
options using a graded vesting method. Such amortization was $295,000 for the
year ended December 31, 1997. During the year ended December 31, 1998, the
company recorded additional deferred compensation of approximately $8.1 million.
Amortization of deferred compensation during this same period was approximately
$4.0 million. During the year ended December 31, 1999, the Company recorded
additional deferred compensation of approximately $6.6 million. Amortization of
deferred compensation during this same period was approximately $4.8 million.

STOCK-BASED COMPENSATION

Pro forma information regarding the results of operations and net loss per
share is required by FAS 123, which also requires that the information be
determined as if the Company had accounted for its employee stock options using
the fair value method of FAS 123. The fair value of each option granted is
estimated on the date of grant using the Black Scholes valuation model.

The Company has elected to follow APB 25 and related interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FAS 123 requires the use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, when the exercised price of the Company's employee
stock options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized.

The option valuation models were developed for use in estimating the fair
value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected life of the option. Because the
Company's employee stock options have characteristics significantly different
from those of traded options and because changes in the subjective input
assumptions can materially affect the fair value of the estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

For the years ended December 31, 1997, 1998 and 1999, the fair value of the
Company's stock-based awards to employees was estimated using the following
weighted average assumptions:

1997 1998 1999
------- -------- -------
Expected life of options in years............... 4.0 4.0 4.0
Volatility...................................... 123.5% 123.5% 123.5%
Risk-free interest rate......................... 7.0% 7.0% 7.0%
Expected dividend yield......................... 0.00% 0.00% 0.00%

F-16
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The weighted average fair value of stock options granted during the years
ended December 31, 1997, 1998 and 1999 was $0.11, $0.91 and $9.79 per share,
respectively. For pro forma purposes, the estimated fair value of the Company's
stock-based awards to employees is amortized over the options' vesting period
which would result in an increase in net loss of approximately $12,000, $1.7
million and $35.2 million for the years ended December 31, 1997, 1998 and 1999,
respectively. The result of applying FAS 123 to the Company's option grants was
not material to the results of operations or loss per share for the year ended
December 31, 1997 and would have increased the net loss per share by $0.13 per
share and $0.33 per share for the year ended December 31, 1998 and 1999,
respectively.

The pro forma impact of options on the net loss for the years ended
December 31, 1997, 1998, and 1999 is not representative of the effects on net
loss for future years, as future years will include the effects of additional
years of stock option grants.

7. RELATED PARTY TRANSACTIONS

The Company purchases equipment from a supplier which is partially owned by
an investor in the Company. Purchases from this supplier totaled $85,000,
$5,844,000 and $45,695,000 for the years ending December 31, 1997, 1998 and
1999, respectively. During 1999, an unrelated party acquired this supplier, as
such, the Company had no financial interest in them by year end December
31,1999. In addition, the Company acquired an interest in a new supplier.
Purchases from this new supplier totaled $3,401,000 for the year ended December
31, 1999.

8. LEGAL PROCEEDINGS

The Company is engaged in a variety of negotiations, arbitrations and
regulatory and court proceedings with multiple traditional telephone companies.
These negotiations, arbitrations and proceedings concern the traditional
telephone companies' denial of physical central office space to the Company in
certain central offices, the cost and delivery of central office spaces, the
delivery of transmission facilities and telephone lines, billing issues and
other operational issues. For example, the Company is currently involved in
commercial arbitration proceedings with Pacific Bell over these issues. The
Company has also filed a lawsuit against Pacific Bell and certain of its
affiliates, including SBC Communications, in federal court. The Company is
pursuing a variety of contract, tort, and antitrust and other claims, such as
violations of the Telecommunications Act, in these proceedings. In November
1998, the Company prevailed in its commercial arbitration proceeding against
Pacific Bell. The arbitration panel found that Pacific Bell breached its
interconnection agreement with the Company and failed to act in good faith on
multiple counts. The arbitration panel ruled in favor of awarding the Company
direct damages, as well as attorneys fees and costs of the arbitration. Pacific
Bell is currently attempting to have the decisions vacated. Meanwhile, the
arbitration panel is evaluating the Company's claim.

The Company also filed a lawsuit against Bell Atlantic and its affiliates
in federal court and is pursuing antitrust and other claims in this lawsuit. In
addition, Bell Atlantic has separately filed suit against the Company asserting
infringement of a patent issued to them in September 1998 entitled "Variable
Rate and Variable Mode Transmission System." However, on February 18, 2000 the
court issued a summary judgement ruling holding that the Company had not
infringed Bell Atlantic's patent. Bell Atlantic has filed a notice of appeal
with respect to the court's ruling. While the Company expects that it would
prevail on an appeal, the outcome of such an appeal is uncertain.

A former employee of the Company has filed a complaint against the Company
in California Superior Court, alleging that he was terminated wrongfully and is
entitled to commissions and other amounts arising from his employment. The
Company believes that this employee resigned and that it does not owe him any
money, but litigation is unpredictable and there is no guarantee the Company
will prevail. Another group of former employees of the Company have filed a
Complaint against the Company in California Superior Court alleging that they
were terminated wrongfully and are entitled to other amounts arising from their
employment. The Company believes it has valid defenses and does not own them any
money. Another employee has filed a complaint against the Company in California
Superior Court, alleging that he was terminated wrongfully based on his age. The
Company also believes that it does not owe this employee any money. Litigation
is unpredictable and there is no guarantee the

F-17
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Company will prevail. Failure to resolve these various legal disputes and
controversies without excessive delay and cost and in a manner that is
favorable, could significantly harm the business.

The Company is not currently engaged in any other legal proceedings that it
believes could have a material adverse effect on the Company's business,
prospects, operating results and financial condition. The Company is subject to
state commission, FCC and court decisions as they relate to the interpretation
and implementation of the 1996 Telecommunications Act, the interpretation of
competitive telecommunications company interconnection agreements in general and
the Company's interconnection agreements in particular. In some cases, the
Company may be deemed to be bound by the results of ongoing proceedings of these
bodies or the legal outcomes of other contested interconnection agreements that
are similar to our agreements. The results of any of these proceedings could
harm the business.

9. SUBSEQUENT EVENTS

On January 28, 2000, the Company completed a private placement of $425.0
million aggregate principal amount of the Company's 12% senior notes (the "2000
notes") due 2010. The 2000 notes are unsecured senior obligations of the Company
maturing on February 15, 2010 and are redeemable at the option of the Company
any time after February 15, 2005 at stated redemption prices plus accrued and
unpaid interest thereon. Net proceeds from the 2000 notes were approximately
$413.3 million, after discounts, commissions and other transaction costs of
approximately $11.7 million. The discount and debt issuance costs are being
amortized over the life of the 2000 notes. These notes were sold in a private
placement under Rule 144A and Regulation S under the Securities Act of 1933, as
amended.

The Company has filed a registration statement covering an offer to
exchange new registered 12% senior notes due February 15, 2010 for all
outstanding 12% senior notes due February 15, 2010.

On February 15, 2000 the Company's Board of Directors adopted a Stockholder
Protection Rights Plan under which stockholders received one right for each
share of the Company's Common Stock or Class B Common Stock owned by them. The
rights become exercisable, in most circumstances, upon the accumulation by a
person or group of 15% or more of the Company's outstanding shares of Common
Stock. Each right entitles the holder to purchase from the Company, as provided
by the Stockholder protection Rights Agreement, one one-thousandth of a share of
Participating Preferred Stock, par value $.001 per share, for $400.00, subject
to adjustment.

On March 7, 2000, the Company announced a 3-for-2 stock split, which was
effectuated through a stock dividend. The Company's Common Stock began trading
on a split adjusted basis on April 3, 2000. All share and per share numbers in
the accompanying consolidated financial statements have been retroactively
adjusted to reflect this split.

On March 20, 2000 the Company completed the acquisition of Laser Link.Net,
a leading provider of branded internet access, based in Media, Pennsylvania in a
transaction to be accounted for as a purchase. Under the acquisition agreement,
the Company issued 6.45 million shares of common stock and stock options for all
Laser Link.Net outstanding, common shares and stock options, plus assumption of
all outstanding debt. The Company anticipates that this acquisition will allow
the Company to provide a turnkey broadband access solution to companies and
affinity groups who want to offer broadband internet services to their
customers, members, or affiliates. Laser Link.Net currently provides a similar
service using dial-up access. The total consideration related to the
acquisition, was approximately $411.1 million.

F-18
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>

JUNE 30,
2000
------------
<S> <C>
Current assets:
Cash and cash equivalents....................................................................... $ 422,820
Accounts receivable, net........................................................................ 32,054
Short-term investments.......................................................................... 340,334
Unbilled revenue................................................................................ 7,555
Inventories..................................................................................... 18,362
Prepaid expenses and other current assets....................................................... 19,500
------------
Total current assets........................................................................ 840,625
Property and equipment, net........................................................................ 466,137
Restricted cash.................................................................................... 52,078
Goodwill and other intangible assets, net.......................................................... 375,172
Other assets, net.................................................................................. 49,868
------------
Total assets................................................................................ $ 1,783,880
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................................ $ 70,188
Unearned revenue................................................................................ 11,253
Accrued network costs........................................................................... 10,190
Other accrued liabilities....................................................................... 69,020
Current portion of capital lease obligations.................................................... 146
------------
Total current liabilities................................................................... 160,797
Long-term debt, net................................................................................ 811,820
Long-term capital lease obligations................................................................ 25
Other long-term liabilities........................................................................ 16,919
------------
Total liabilities........................................................................... 989,561
Stockholders' equity:
Common stock.................................................................................... 138
Common stock--Class B........................................................................... 6
Additional paid-in capital...................................................................... 1,260,089
Deferred compensation........................................................................... (8,361)
Accumulated other comprehensive income.......................................................... 27,280
Accumulated deficit............................................................................. (484,833)
------------
Total stockholders' equity.................................................................. 794,319
------------
Total liabilities and stockholders' equity.................................................. $ 1,783,880
============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

F-19
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>

THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------------- ------------------------
2000 1999 2000 1999
------------ ---------- ------------ -----------
<S> <C> <C> <C> <C>
Revenues.................................................. $ 58,160 $ 10,833 $ 99,967 $ 16,429
Operating expenses:
Network and product costs.............................. 43,614 10,565 74,963 15,525
Sales, marketing, general and administrative........... 102,462 24,976 187,907 43,089
Depreciation and amortization.......................... 24,285 8,671 41,717 13,318
Amortization of goodwill and other intangible assets... 20,103 -- 23,453 --
Amortization of deferred compensation ................. 725 1,234 1,911 2,887
Write-off of in-process technology..................... -- -- 3,726 --
------------ ---------- ------------ -----------
Total operating expenses........................... 191,189 45,446 333,677 74,819
------------ ---------- ------------ -----------
Income (loss) from operations............................. (133,029) (34,613) (233,710) (58,390)
Interest income (expense):
Interest income........................................ 13,353 4,585 27,180 8,094
Interest expense....................................... (25,590) (11,824) (46,960) (20,460)
------------ ---------- ------------ -----------
Net interest income (expense).......................... (12,237) (7,239) (19,780) (12,366)
Other income.............................................. 13,788 -- 14,787 --
------------ ---------- ------------ -----------
Net loss.................................................. (131,478) (41,852) (238,703) (70,756)
Preferred dividends.................................... -- -- -- (1,146)
------------ ---------- ------------ -----------
Net loss attributable to common stockholders.............. $ (131,478) $ (41,852) $ (238,703) $ (71,902)
============ ========== ============ ===========
Basic and diluted net loss per common share............... $ (0.86) $ (0.41) $ (1.59) $ (0.79)
============ ========== ============ ===========
Weighted average shares used in computing basic and
diluted net loss per share............................. 153,403 102,235 150,060 91,396
============ ========== ============ ===========
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

F-20
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>

SIX MONTHS ENDED
JUNE 30,
------------------------
2000 1999
------------ -----------
<S> <C> <C>
Net cash used in operating activities................................................... $ (105,643) $ (27,721)

INVESTING ACTIVITIES:

Cash acquired through acquisitions...................................................... 3,948 --
Acquisition of business, net of cash acquired........................................... (14,930) --
Net sale (purchase) of investments...................................................... 147,008 (20,000)
Purchase of restricted cash............................................................. -- (74,103)
Redemption of restricted cash........................................................... 13,438 --
Purchase of property and equipment...................................................... (262,914) (93,748)
Deposits................................................................................ (1,124) (291)
Other assets............................................................................ (631) (6,304)
------------ -----------

Net cash used in investing activities................................................... (115,205) (194,446)

FINANCING ACTIVITIES:

Net proceeds from issuance of long-term debt............................................ 413,269 205,076
Principal payments under capital lease obligations...................................... (141) (129)
Proceeds from common stock issuance, net of offering costs.............................. 14,502 150,318
Proceeds from preferred stock issuance.................................................. -- 60,000
Payment of preferred dividends.......................................................... -- (77)
------------ -----------

Net cash provided by financing activities............................................... 427,630 415,188
------------ -----------

Net increase in cash and cash equivalents............................................... 206,782 193,021
Cash and cash equivalents at beginning of period........................................ 216,038 64,450
------------ -----------

Cash and cash equivalents at end of period.............................................. $ 422,820 $ 257,471
============ ===========

Supplemental disclosures of cash flow information:......................................
Cash paid during the period for interest............................................. $ 13,257 $ 43
------------ -----------

Issuance of common stock for acquisition of business.................................... $ 391,968 --
============ ===========
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

F-21
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF PRESENTATION

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements. Actual results could differ materially from those estimates. The
unaudited condensed consolidated financial statements of the Company include the
accounts of all of its wholly-owned subsidiaries. There were no intercompany
accounts or transactions which required elimination.

The unaudited condensed consolidated financial statements at June 30, 2000
and for the three and six months ended June 30, 2000 and 1999 are unaudited, but
include all normal recurring adjustments and accruals which are necessary to
fairly state the Company's consolidated financial position, results of
operations and cash flows for the periods presented. Operating results for the
three and six month periods ended June 30, 2000 and 1999 are not necessarily
indicative of results that may be expected for any future periods.

The information included in this report should be read in conjunction with
the Company's audited consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1999.

The unaudited condensed consolidated financial statements applicable to the
prior periods have been restated to reflect a three-for-two stock split
effective April 2000.

Certain June 30, 1999 amounts have been reclassified to conform to the
current year presentation.

NET LOSS PER SHARE

Basic net loss per share is computed by dividing net loss attributable to
common stockholders by the weighted average number of shares of the Company's
common stock, after giving consideration to shares subject to repurchase,
outstanding during the period.

Diluted net loss per share is determined in the same manner as basic net
loss per share except that the number of shares is increased assuming the
exercise of dilutive stock options and warrants using the treasury stock method.
Diluted net loss per share is the same as basic net loss per share, which has
not been reported because the Company has a net loss and the impact of the
assumed exercise of the stock options and warrants is not dilutive.

The following table presents the calculation of basic and diluted net loss
per share for the three and six months ended June 30, 2000 and 1999 (in
thousands, except per share amounts):

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------- --------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net loss....................................................... $ (131,478) $ (41,852) $ (238,703) $ (70,756)
Preferred dividends....................................... -- -- -- (1,146)
------------ ------------ ------------ ------------
Net loss attributable to common stockholders................... $ (131,478) $ (41,852) $ (238,703) $ (71,902)
Basic and diluted:
Weighted average shares of common stock outstanding....... 157,635 110,712 154,895 100,548
Less: Weighted average shares subject to repurchase.. (4,232) (8,477) (4,835) (9,152)
------------ ------------ ------------ ------------
Weighted average shares used in computing basic and diluted
net loss per share........................................ 153,403 102,235 150,060 91,396
============ ============ ============ ============
Basic and diluted net loss per share........................... $ (0.86) $ (0.41) $ (1.59) $ (0.79)
============ ============ ============ ============
</TABLE>

F-22
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)

2. COMPREHENSIVE INCOME

Comprehensive income for the three and six months ended June 30, 2000 and
1999 is as follows (in thousands):

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------------- --------------------------
2000 1999 2000 1999
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
Net loss.................................................... $ (131,478) $ (41,852) $ (238,703) $ (70,756)
Unrealized holding gains (losses), net of tax effect... (65,383) 25,638 (63,977) 25,638
------------ ------------ ------------ -------------
Comprehensive income........................................ $ (196,861) $ (16,214) $ (302,680) $ (45,118)
============ ============ ============ =============
</TABLE>

3. SHORT-TERM INVESTMENTS

At June 30, 2000, all of the Company's investments were classified as
available for sale. Investments were also classified as short-term, as their
maturity date was less than one year from the balance sheet date. Management
determines the appropriate classification of investments at the time of purchase
and re-evaluates such designation at the end of each period. Unrealized gains
and losses on short-term investments as of June 30, 2000 are included as a
separate component of stockholders' equity, net of any related tax effect. The
amount of net realized gains for the three and six months ended June 30, 2000
was $12.8 million and $13.4 million, respectively.

The following table summarizes the Company's short-term investments.

<TABLE>
<CAPTION>
JUNE 30, 2000
------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ----------- -----------
(AMOUNT IN $000'S)
<S> <C> <C> <C> <C>
Commercial paper.............................................. $ 2,984 $ -- $ (2) $ 2,982
Corporate notes............................................... 5,754 -- (5) 5,759
U.S. Treasury & Agency notes.................................. 253,628 -- (42) 253,586
Equity securities............................................. 50,738 27,279 -- 78,017
----------- ---------- ----------- -----------
Total available for sale securities........................... $ 313,104 $ 27,279 $ (49) $ 340,334
</TABLE>

The Company had a net unrealized loss of $576,000 on long term U.S.
Treasury investments at June 30, 2000 classified as restricted cash on the
accompanying unaudited condensed consolidated balance sheet. The Company also
had a net unrealized gain of $626,000 on cash and cash equivalents at June 30,
2000.

4. ACQUISITIONS

LASER LINK.NET, INC.

On March 20, 2000, Covad Communications Group, Inc. completed its
combination with Laser Link.Net, Inc. by issuing approximately 5.0 million
common shares for all of the outstanding Laser Link common shares. The Covad
common shares were valued for accounting purposes using the average market price
of $61.53 per share which is based on the average closing price for a range of
seven trading days around the announcement date (March 9, 2000) of the
transaction. In addition, the outstanding Laser Link stock options were
converted into approximately 1.4 million options to purchase Covad common shares
at an average fair value of $58.61 per share. The value of the options, as well
as direct transaction expenses have been included as a part of the total
purchase cost.

The Unaudited Condensed Consolidated Statements of Operations for the three
and six months ended June 30, 2000 include the results for Laser Link subsequent
to the March 20, 2000 acquisition date, which were not significant to the
Company's consolidated results of operations.

The Unaudited Condensed Consolidated Financial Statements at June 30, 2000
and for the three and six months then ended have been prepared on the basis of
assumptions relating to the allocation of the total purchase

F-23
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)

cost to the assets and liabilities of Laser Link based upon estimates of their
fair value. Following is a table of the total purchase cost and annual
amortization of the intangible assets acquired (in thousands):

<TABLE>
<CAPTION>
<S> <C>
Total purchase cost:
Value of common shares issued.................................................... $ 307,869
Assumption of Laser Link.Net, Inc. options....................................... 84,100
------------
391,969
Acquisition costs................................................................ 15,485
------------
Total purchase costs.................................................................. $ 407,454
============
</TABLE>

<TABLE>
<CAPTION>
LIFE ANNUAL
(YRS) AMORTIZATION
------ -------------
<S> <C> <C> <C>
Purchase price allocation:
Tangible net assets acquired.............................. $ 5,132
Intangible assets acquired:
Developed and core technology........................... 13,023 5 2,605
Customer base........................................... 28,552 5 5,710
Acquired workforce...................................... 1,141 5 228
In-process research and development..................... 3,726 --
Goodwill................................................ 355,880 5 71,176
------------ -------------
Total purchase price allocation.............................. $ 407,454 $ 79,719
============ =============
</TABLE>

Tangible net assets of Laser Link principally include cash and cash
equivalents, short-term investments, accounts receivable and fixed assets.
Liabilities assumed principally include a line of credit, accounts payable,
accrued compensation and other accrued expenses.

The customer based was valued using an Income Approach which projects the
associated revenue, expenses and cash flows attributable to the customer base
over its estimated life (five years). These cash flows are discounted to their
present value using a rate of return (20%) that reflects an appropriate level of
risk. The value attributed to the customer base is being amortized on a straight
line basis over its estimated useful life of five years.

The value of the assembled workforce was derived by estimating the costs to
replace the existing employees, including recruiting, hiring and training costs
for each category of employee. The value of the assembled workforce is being
amortized on a straight line basis over its estimated useful life of five years.

A portion of the purchase price has been allocated to developed and core
technology and in-process research and development (IPRD). Developed and core
technology and IPRD were identified and valued through extensive interviews,
analysis of data provided by Laser Link concerning developmental products, their
stage of development, the time and resources needed to complete them, if
applicable, their expected income generating ability, target markets and
associated risks. The relief from royalty method, which assumes that the value
of an asset equals the amount a third party would pay to use the asset and
capitalize on the related benefits of the assets, was the primary technique
utilized in valuing the developed technology and IPRD.

The nature of the efforts required to develop the purchased IPRD into
commercially viable products principally relate to the completion of all
planning, designing, prototyping, verification and testing activities that are
necessary to establish that the products can be produced to meet their design
specifications, including functions, features and technical performance
requirements.

F-24
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)

In valuing the IPRD, Covad considered, among other factors, the importance
of each project to the overall development plan, the projected incremental cash
flows from the projects when completed and any associated risks. The projected
incremental cash flows were discounted back to their present value using a
discount rate of 30%. This discount rate was determined after consideration of
Covad's weighted average cost of capital and the weighted average return on
assets. Associated risks include the inherent difficulties and uncertainties in
completing each project and thereby achieving technological feasibility,
anticipated levels of market acceptance and penetration, market growth rates and
risks related to the impact of potential changes in future target markets.

The IPRD relates to internally developed proprietary software used in its
VISP business. This software has been designed with enhancements and upgrades
continually underway. With respect to the acquired in-process technologies, the
calculations of value were adjusted to reflect the value creation efforts of
Laser Link prior to the closing date. The percent complete for the in-process
technology is estimated to be 75%.

Goodwill is determined based on the residual difference between the amount
paid and the values assigned to identified tangible and intangible assets.
Goodwill is being amortized on a straight line basis over its estimated useful
life of five years.

BLUESTAR COMMUNICATIONS GROUP, INC.

Under the terms of the of the merger agreement, Covad will issue to the
BlueStar stockholders and other equity owners of BlueStar at the effective time
of the merger, 8 million shares of Covad common stock minus shares (priced at
the closing market price of Covad common stock on the third business day prior
to closing) with a value equal to:

o BlueStar's transaction costs for the merger; and

o the principal, interest and expenses associated with the interim
financing extended to BlueStar prior to the merger.

This consideration will be divided among BlueStar stockholders and other
equity owners of BlueStar at the effective time of the merger according to an
exchange ratio calculated as follows:

o First, for the purpose of satisfying the liquidation preferences of
BlueStar preferred stockholders, shares of Covad common stock (priced
at the average closing market price for Covad common stock over the 20
days ending on the fourth business day prior to closing) will be set
aside with a value equal to $71,121,771, the total amount of those
preferences, and divided among the BlueStar preferred stockholders pro
rata according to their share ownership; and

o Second, each share of BlueStar stock, including the BlueStar preferred
stock, will be converted into a number of shares of Covad common stock
to be calculated by dividing the remaining shares of Covad common
stock to be issued in the merger, by the total number of BlueStar
shares (calculated on a fully diluted basis, excluding certain options
that have been forfeited by their owners and are incapable of
exercise.)

In addition, up to 5 million additional Covad common shares will be issued
which depends on BlueStar reaching certain specified levels of revenue and
earnings before interest, taxes, depreciation and amortization (EBITDA) in
fiscal 2000.

The table below assumes 7,140,411 Covad common shares would be issued for
the BlueStar common and preferred shares outstanding at June 30, 2000. For
purposes of the table below, the Covad common shares have been valued at the
closing market price on August 18, 2000 of $15 5/8 per share. The actual value
will be determined based on the average closing price of Covad common shares for
a few days before and after the actual closing date. As of June 30, 2000, Blue
Star's outstanding options and warrants would be converted into options and
warrants to purchase 633,669 shares of Covad common stock and have an average
fair value of $9.59 per share. The value of the options and warrants, as well
as estimated direct transaction expenses have been included as part of the total
estimated purchase cost. The table below does not give effect to the potential
issuance of the additional 5 million shares which depends on results in fiscal
2001. Since any outstanding loans at the closing date will become a part of

F-25
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)

the purchase cost, the reduction in shares to be issued for any outstanding
loans will not have a significant effect on Covad's total purchase cost.

The information provided below has been prepared on the basis of
assumptions relating to the allocation of the total purchase cost to the assets
and liabilities of BlueStar based upon preliminary estimates of their fair
value. The actual allocation of the total purchase cost may differ from those
assumptions after finalization of the valuation and other procedures are
completed after the closing of the transaction and BlueStar's transaction costs
and the principal, interest and expense associated with interim financing
extended by Covad to BlueStar are finalized and reduced the number of shares to
be issued. Following is a table of the estimated total purchase cost and annual
amortization of the intangible assets acquired (in thousands):

<TABLE>
<S> <C>
Estimated purchase cost
Value of common shares issued......................................................... $ 111,569
Assumption of BlueStar Inc. options and warrants...................................... 6,075
-----------
117,644
Estimated acquisition costs.............................................................. 9,346
-----------
Total estimated purchase costs........................................................... $ 126,990
===========
</TABLE>

<TABLE>
<CAPTION>
LIFE ANNUAL
(YRS) AMORTIZATION
---------- -------------
<S> <C> <C> <C>
Purchase price allocation:..................................
Tangible net assets at June 30, 2000..................... $ 2,919
Intangible assets acquired:
Customer base.......................................... 10,500 3 3,500
Acquired workforce..................................... 11,300 3 3,767
Deferred stock compensation............................ 2,293 2.5 917
Goodwill.................................................... 99,978 5 19,996
------------ -------------
Total estimated purchase price allocation................... $ 126,990 $ 28,180
============ =============
</TABLE>

Tangible net assets of BlueStar principally include cash and cash
equivalents, deferred charges and fixed assets. Liabilities assumed principally
include accounts payable, accrued expenses and a note payable.

The customer base was valued using an Income Approach which projects the
associated revenue, expenses and cash flows attributable to the customer base
over its estimated life. These cash flows are discounted to their present value
using a rate of return that reflects the appropriate level of risk. The value
attributed to the customer base is being amortized on a straight line basis over
its estimated useful life of three years.

Deferred stock compensation represents the excess intrinsic value of the
outstanding unvested common stock options on the date the acquisition is
finalized versus the weighted average intrinsic value on the date the shares
were originally granted. The price of the Company's common stock on August 18,
2000 of 15 5/8 was used as the acquisition price for purposes of calculating the
purchase consideration. Deferred stock compensation will be amortized over the
weighted average remaining vesting period of the options or 2.5 years.

Goodwill is determined based on the residual difference between the amount
paid and the values assigned to identified tangible and intangible assets.
Goodwill will be amortized on a straight line basis over its estimated useful
life of five years.

F-26

<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)

5. DEBT

On January 28, 2000, the Company completed a private placement of $425.0
million aggregate principal amount of the Company's 12% senior notes (the "2000
Notes') due 2010 which are redeemable at the option of the Company any time
after February 15, 2005 at stated redemption prices plus accrued and unpaid
interest thereon.

Net proceeds from the 2000 Notes were approximately $413.3 million, after
discounts, commissions and other transaction costs of approximately $11.7
million. The discount and debt issuance costs are being amortized over the life
of the 2000 Notes. For the three months ended June 30, 2000, the amortization of
debt discount and debt issuance costs was $205,000.

6. STOCKHOLDERS' EQUITY

COVAD COMMUNICATIONS GROUP, INC.

STRATEGIC INVESTMENT:

In January 1999, the Company entered into strategic relationships with AT&T
Corp. ("AT&T"), NEXTLINK Communications, Inc. ("NEXTLINK") and Qwest
Communications Corporation ("Qwest"). As part of these strategic relationships,
the Company received equity investments totaling approximately $60 million. The
Company recorded intangible assets of $28.7 million associated with these
transactions which will be amortized over periods of three to six years.

INITIAL PUBLIC OFFERING:

On January 27, 1999, the Company completed an Initial Public Offering
("IPO") of 20,182,500 shares of the Company's common stock at a price of $8.00
per share. Net proceeds to the Company from the IPO were $150.2 million after
deducting underwriting discounts and commissions and offering expenses payable
by the Company. As a result of the IPO, 41,053,865 shares of common stock and
6,379,177 shares of Class B common stock (which are convertible into 14,353,148
shares of common stock) were issued upon the conversion of preferred stock,
133,587 shares of common stock were issued for cumulative but unpaid dividends
on series A and series B preferred stock and 4,049,039 shares of common stock
were issued upon the exercise of common warrants.

SECONDARY OFFERING:

SECOND PUBLIC OFFERING:

On November 3, 1999 the Company completed a public offering of 22,425,000
shares of common stock sold by the Company and certain stockholders of the
Company. The net proceeds to the Company from this offering were approximately
$568.8 million after deducting underwriting discounts and commissions and
offering expenses.

F-27
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS

The Covad Communications Group, Inc. Unaudited Pro Forma Condensed Combined
Consolidated Financial Statements give effect to the combination of Covad
Communications Group, Inc., Laser Link.Net Inc., and BlueStar Communications
Group, Inc. through the issuance of Covad common shares and stock options for
the outstanding Laser Link.Net and BlueStar Communications Group, Inc. common
shares and stock options and, in the case of BlueStar, the outstanding preferred
shares and warrants. The combination with Laser Link was completed on March 20,
2000, and the combination with BlueStar Communications Group, Inc. is expected
to be completed in the third quarter of 2000.

The Unaudited Pro Forma Condensed Combined Consolidated Statements of
Operations for the year ended December 31, 1999 and for the six months ended
June 30, 2000 reflect the combinations as if they had taken place on January 1,
1999 and January 1, 2000, respectively. The Unaudited Pro Forma Condensed
Combined Consolidated Balance Sheets give effect to the combination with
BlueStar as if it had taken place on June 30, 2000. Covad's historical balance
sheet as of June 30, 2000 includes the financial position of Laser Link. The
Unaudited Pro Forma Condensed Combined Consolidated Statements of Operations
combine Covad's historical results of operations for the year ended December 31,
1999 and the six months ended June 30, 2000 with BlueStar's historical results
of operations for those same periods and Laser Link's historical results of
operations for the year ended December 31, 1999 and the period from January 1,
2000 to March 20, 2000 (the closing date of the transaction), respectively.

The Covad Communications Group, Inc. Unaudited Pro Forma Condensed Combined
Consolidated Financial Statements reflect the combinations using the purchase
method of accounting and have been prepared on the basis of assumptions
described in the notes thereto, including assumptions relating to the allocation
of the total purchase cost to the assets and liabilities of Laser Link and
BlueStar based upon estimates of their fair value. The allocation of the total
purchase cost for BlueStar is preliminary. The actual BlueStar allocation may
differ from those assumptions after the transaction is closed and the valuation
is finalized.

The Covad Communications Group, Inc. Unaudited Pro Forma Condensed Combined
Consolidated Financial Statements should be read in conjunction with the Covad
audited and unaudited financial statements, the Laser Link audited financial
statements, and the BlueStar audited and unaudited financial statements,
included elsewhere in this document. The Covad Communications Group, Inc.
Unaudited Pro Forma Condensed Combined Consolidated Financial Statements are not
necessarily indicative of what the actual operating results would have been had
the combinations actually taken place on January 1, 1999 or January 1, 2000 or
what the financial position would have been had the combination with BlueStar
taken place as of June 30, 2000 and do not purport to indicate Covad's future
results of operations or financial position.

F-28
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN 000'S)

<TABLE>
<CAPTION>
JUNE 30, 2000
------------------------------------------------------------
PRO FORMA
BUSINESS
COMBINATIONS PRO FORMA
COVAD BLUESTAR TOTAL ADJUSTMENTS COMBINED
---------- --------- ----------- ------------- ----------
ASSETS
Current Assets
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents..................... $ 422,820 921 423,741 $ (9,346) $ 414,395
Accounts receivable, net...................... 32,054 1,304 33,358 -- 33,358
Short-term investments........................ 340,334 -- 340,334 -- 340,334
Unbilled revenue.............................. 7,555 -- 7,555 -- 7,555
Inventories................................... 18,362 18 18,380 -- 18,380
Prepaid expenses and other current assets..... 19,500 1,476 20,976 -- 20,976
---------- --------- ----------- ------------- ----------
Total current assets........................ 840,625 3,719 844,344 (9,346) 834,998
Property and equipment, net................... 466,137 23,775 489,912 -- 489,912
Other Assets:
Restricted cash............................... 52,078 -- 52,078 -- 52,078
Goodwill and other intangible assets, net..... 375,172 -- 375,172 121,778 496,950
Other assets, net............................. 49,868 4,156 54,024 -- 54,024
---------- --------- ----------- ------------- ----------
Total other assets.......................... 477,118 4,156 481,274 121,778 603,052
---------- --------- ----------- ------------- ----------
Total assets..................................... $1,783,880 $ 31,650 $1,815,530 $ 112,432 $1,927,962
========== ========= =========== ============= ==========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities
Accounts payable.............................. $ 70,188 $ 8,171 $ 78,359 $ -- $ 78,359
Unearned revenue.............................. 11,253 -- 11,253 -- 11,253
Accrued network costs......................... 10,190 -- 10,190 -- 10,190
Other accrued liabilities..................... 69,020 12,623 81,643 -- 81,643
Current portion of long term obligations...... 146 334 480 -- 480
Note payable.................................. -- 7,271 7,271 -- 7,271
---------- --------- ----------- ------------- ----------
Total current liabilities................... 160,797 28,399 189,196 -- 189,196
Long-term debt, net.............................. 811,820 332 812,152 -- 812,152
Long-term capital lease obligations.............. 25 -- 25 -- 25
Other long-term liabilities...................... 16,919 -- 16,919 -- 16,919
---------- --------- ----------- ------------- ----------
Total liabilities........................... 989,561 28,731 1,018,292 -- 1,018,292

Stockholders' Equity:
Preferred stock............................... -- 70,992 70,992 (70,992) --
Common stock and additional paid-in capital... 1,260,233 6,234 1,266,467 117,644 1,377,877
(6,234)

Restricted stock loan receivable.............. -- (728) (728) 728 --
Deferred stock compensation................... (8,361) (3,077) (11,438) (2,293) (10,654)
3,077

Accumulated other comprehensive income ....... 27,280 -- 27,280 -- 27,280
Accumulated deficit .......................... (484,833) (70,502) 555,335 70,502 (484,833)
---------- --------- ----------- ------------- ----------
Total stockholders' equity ................. 794,319 2,919 797,238 112,432 909,670
---------- --------- ----------- ------------- ----------
Total liabilities and stockholders' equity....... $1,783,880 $ 31,650 $1,815,530 $ 112,432 $1,927,962
========== ========= =========== ============= ==========
</TABLE>

SEE ACCOMPANYING NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED
CONSOLIDATED FINANCIAL STATEMENTS.

F-29
<PAGE>

COVAD COMMUNCATIONS GROUP, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)

YEAR ENDED DECEMBER 31, 1999
----------------------------------------------------------------------------
PRO FORMA
BUSINESS
COMBINATION PRO FORMA
COVAD LASER LINK BLUESTAR TOTAL ADJUSTMENTS COMBINED
------------ ----------- ---------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Revenues............................ $ 66,488 $ 6,044 $ 771 $ 73,303 $ -- $ 73,303
Operating expenses:
Network and product costs........ 55,347 5,451 8,083 68,881 2,605 71,486
Sales, marketing, general and
administrative................. 140,372 2,855 11,759 154,986 -- 154,986
Depreciation and amortization.... 37,602 1,313 264 39,179 -- 39,179
Amortization of goodwill and
other intangible assets........ -- -- -- -- 104,377 104,377
Amortization of deferred
compensation................... 4,768 -- 426 5,194 917 6,111
------------ ----------- ---------- ---------- ------------ ------------
Total operating expenses....... 238,089 9,619 20,532 268,240 107,899 376,139
------------ ----------- ---------- ---------- ------------ ------------
Loss from operations................ (171,601) (3,575) (19,761) (194,937) (107,899) (302,836)
Interest income (expense):
Interest income.................. 20,676 14 607 21,297 -- 21,297
Interest expense................. (44,472) (181) (65) (44,718) -- (44,718)
------------ ----------- ---------- ---------- ------------ ------------
Net interest income (expense).... (23,796) (167) 542 (23,421) -- (23,421)
------------ ----------- ---------- ---------- ------------ ------------
Net loss............................ (195,397) (3,742) (19,219) (218,358) (107,899) (326,257)
Preferred dividends................. (1,146) (490) -- (1,636) -- (1,636)
------------ ----------- ---------- ---------- ------------ ------------
Net loss attributable to common
stockholders..................... $ (196,543) $ (4,232) $ (19,219) $(219,994) $ (107,899) $ (327,893)
============ =========== ========== ========== ============ ============
Basic and diluted net loss per share $ (1.83) $ (0.16) $ (2.15) $ (2.74)
============ =========== ========== ============
Weighted average shares outstanding
used in computing basic and
diluted net loss per share....... 107,647,812 26,074,860 8,953,153 119,792,282
============ =========== ========== ============
</TABLE>

SEE ACCOMPANYING NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED
CONSOLIDATED FINANCIAL STATEMENTS.

F-30
<PAGE>

COVAD COMMUNCATIONS GROUP, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>

SIX MONTHS ENDED JUNE 30, 2000
-----------------------------------------------------
PRO FORMA
LASER LINK BUSINESS
(1/1/00- COMBINATIONS PRO FORMA
COVAD 3/20/00) BLUESTAR TOTAL ADJUSTMENTS COMBINED
-------------- ----------- ------------ ------------ ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Revenues............................ $ 99,967 $ 5,440 $ 3,625 $ 109,032 $ -- $ 109,032
Operating expenses:
Network and product costs......... 74,963 2,823 20,612 98,398 651 99,049
Sales, marketing, general and
administrative.................. 187,907 2,745 29,585 220,237 -- 220,237
Depreciation and amortization.... 41,717 353 1,935 44,005 -- 44,005
Amortization of goodwill and
other intangible assets......... 23,453 -- -- 23,453 29,560 53,013
Amortization of deferred
compensation.................... 1,911 -- 1,096 3,007 459 3,466
Write-off of in-process technology 3,726 -- -- 3,726 (3,726) --
-------------- ----------- ------------ ------------ ------------- --------------
Total operating expenses........ 333,677 5,921 53,228 392,826 26,944 419,770
-------------- ----------- ------------ ------------ ------------- --------------
Loss from operations................ (233,710) (481) (49,603) (283,794) (26,944) (310,738)
Interest income (expense):
Interest income................... 27,180 -- 499 27,679 -- 27,679
Interest expense.................. (46,960) (137) (96) (47,193) -- (47,193)
-------------- ----------- ------------ ------------ ------------- --------------
Net interest income (expense).... (19,780) (137) 403 (19,514) -- (19,514)
Other income (expense).............. 14,787 -- (1,454) 13,333 -- 13,333
-------------- ----------- ------------ ------------ ------------- --------------
Net loss............................ $ (238,703) $ (618) $ (50,654) $ (289,975) $ (26,944) $ (316,919)
============== =========== ============ ============ ============= ==============
Basic and diluted net loss per share $ (1.59) $ (5.31) $ (1.99)
============== ============ ==============
Weighted average shares outstanding
used in computing basic and
diluted net loss per share....... 150,060,418 9,539,643 159,400,415
============== ============ ==============
</TABLE>

SEE ACCOMPANYING NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED
CONSOLIDATED FINANCIAL STATEMENTS.

F-31
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRO FORMA PRESENTATION

LASER LINK.NET, INC.

On March 20, 2000, Covad Communications Group, Inc. completed its
combination with Laser Link.Net, Inc. by issuing approximately 5.0 million
common shares for all of the outstanding Laser Link common shares. The Covad
common shares were valued for accounting purposes using the average market price
of $61.53 per share which is based on the average closing price for a range of
seven trading days around the announcement date (March 9, 2000) of the
transaction. The Covad Communications Group, Inc. Unaudited Pro Forma Condensed
Combined Consolidated Statements of Operations for the six months ended June 30,
2000 and for the year ended December 31, 1999, reflect the issuance of these
shares as if the transaction had closed on January 1, 2000 and January 1, 1999,
respectively. In addition, the outstanding Laser Link stock options were
converted into approximately 1.4 million options to purchase Covad common shares
at an average fair value of $58.61 per share. The value of the options, as well
as direct transaction expenses have been included as a part of the total
purchase cost.

The Covad Communications Group, Inc. Unaudited Pro Forma Financial
Statements have been prepared on the basis of assumptions relating to the
allocation of the total purchase cost to the assets and liabilities of Laser
Link based upon estimates of their fair value. Following is a table of the total
purchase cost and annual amortization of the intangible assets acquired (in
thousands):

Total purchase cost:
Value of common shares issued............................... $ 307,869
Assumption of Laser Link.Net, Inc. options.................. 84,100
-----------
391,969
Acquisition costs........................................ 15,485
-----------
Total purchase costs................................. $ 407,454
===========

LIFE ANNUAL
(YRS) AMORTIZATION
------ --------------
Purchase price allocation:
Tangible net assets acquired........... $ 5,132
Intangible assets acquired:
Developed and core technology........ 13,023 5 2,605
Customer base........................ 28,552 5 5,710
Acquired workforce................... 1,141 5 228
In-process research and development.. 3,726
Goodwill............................. 355,880 5 71,176
-------- --------------
Total purchase price allocation.... $407,454 $ 79,719
======== ==============

F-32
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

Where developmental projects had reached technological feasibility, they
were classified as developed and core technology and the value assigned to
developed technology was capitalized. The developed and core technology is being
amortized on the straight-line basis over its estimated useful life of five
years. Where the developmental projects had not reached technological
feasibility and had no future alternative uses, they were classified as IPRD.
The value allocated to projects identified as IPRD were charged to expense
during the quarter ended March 31, 2000, the quarter in which the transaction
closed. Such amount has, therefore, been reflected in Covad's historical
financial statements for the six months ended June 30, 2000 but has been
excluded from the Unaudited Pro Forma Condensed Combined Consolidated Statements
of Operations since such amount is non-recurring in nature.

BLUESTAR COMMUNICATIONS GROUP, INC.

o BlueStar's transaction costs for the merger; and

o the principal, interest and expenses associated with the interim
financing extended to BlueStar prior to the merger.

F-33
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

This consideration will be divided among BlueStar stockholders and other
equity owners of BlueStar at the effective time of the merger according to an
exchange ratio calculated as follows:

The following table calculates the exchange ratio under three sets of
assumptions described further below. For each calculation, the closing market
price of Covad's common stock on August 18, 2000 of $15 5/8 per share and the
outstanding common and preferred shares, options and warrants of BlueStar at
June 30, 2000 were used. The actual shares to be issued will depend on the
closing market price of Covad common stock for the periods preceding the closing
date as described above and the actual shares of BlueStar common and preferred
shares and options and warrants outstanding at the closing date.

The calculation below as of June 30, 2000 was used for purposes of
preparing the Covad Communications Group, Inc. Unaudited Pro Forma Condensed
Combined Consolidated Financial Statements. There were no amounts outstanding or
costs incurred under the interim financing arrangements at that date. The
Unaudited Pro Forma Condensed Combined Consolidated Financial Statements assume
7,140,411 of Covad common shares would be issued for the outstanding BlueStar
common and preferred shares outstanding at June 30, 2000. For purposes of the
Unaudited Pro Forma Condensed Combined Consolidated Financial Statements, the
Covad common shares have been valued at the closing market price on August 18,
2000 of $15 5/8 per share. The actual value will be determined based on the
average closing price per share of Covad common shares for a few days before and
after the actual closing date. As of June 30, 2000, BlueStar's outstanding
options and warrants would be converted into options and warrants to purchase
633,669 shares of Covad common stock and have an average fair value of $9.59 per
share. The value of the options and warrants, as well as estimated direct
transaction expenses have been included as part of the total estimated purchase
cost. The Unaudited Pro Forma Condensed Combined Consolidated Financial
Statements do not give effect to the potential issuance of the additional 5
million shares which depends on results in fiscal 2001.

The calculation as of August 18, 2000 is based on the balance outstanding
under the interim financing arrangement of $20.9 million at that date and the
related interest and financing costs of $700,000 incurred to that date. The
actual shares to be issued will depend on the balance outstanding and the costs
incurred under the interim financing arrangement at the closing date. Since any
outstanding loans at the closing date will become a part of the purchase cost,
the reduction in shares to be issued for any outstanding loans will not have a
significant effect on Covad's total purchase cost.

F-34
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

The calculation as of September 30, 2000 assumes that September 30, 2000 is
the closing date and reflects the amount which BlueStar expects to be
outstanding under the interim financing arrangement at the closing date of $27.9
million. If BlueStar's borrowings at the closing date exceed $27.9 million or
the closing date occurs subsequent to September 30, 2000, the shares available
to the stockholders and other equity owners will be reduced.

<TABLE>
<CAPTION>
JUNE 30, 2000 AUGUST 18, 2000 SEPTEMBER 30, 2000
------------------------- -------------------------- -------------------------
<S> <C> <C> <C> <C> <C> <C>
Maximum Covad common shares
to be issued............... 8,000,000 8,000,000 8,000,000
Estimated transaction costs
for BlueStar............... $ 3,530,000 (225,920) $ 3,530,000 (225,920) $ 3,530,000 (225,920)
Interim financing and related
costs...................... -- -- $ 21,600,000 (1,382,400) $29,138,000 (1,864,832)
----------- ------------ -----------
Net shares to be issued to
BlueStar stockholders and
other equity holders....... 7,774,080 6,391,680 5,909,248

Shares to be issued to
preferred stockholders for
liquidation preferences.... $71,121,771 (4,551,793) $ 71,121,771 (4,551,793) $71,121,771 (4,551,793)
----------- ------------ -----------
Net shares remaining for
BlueStar stockholders and
other equity holders....... 3,222,287 1,839,887 1,357,455
=========== ============ ===========

BLUESTAR SHS COVAD SHS BLUESTAR SHS COVAD SHS BLUESTAR SHS COVAD SHS
------------ ----------- ------------- ------------ ------------ -----------
Number of common and
preferred shares of
BlueStar outstanding at
June 30, 2000 and
allocation of Covad common
shares..................... 35,864,420 2,588,618 35,864,420 1,478,069 35,864,420 1,090,509
BlueStar options and warrants
outstanding at June 30,
2000 and Covad common
shares reserved for
issuance................... 8,779,273 633,669 8,779,273 361,818 8,779,273 266,946
------------ ----------- ------------- ------------ ------------ -----------
44,643,693 3,222,287 44,643,693 1,839,887 44,643,693 1,357,455
============ =========== ============= ============ ============ ===========
Exchange ratio................ 0.0722 0.0412 0.0304
============ ============= ============
</TABLE>

F-35
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

The Covad Communications Group, Inc. Unaudited Pro Forma Financial
Condensed Combined Consolidated Statements have been prepared on the basis of
assumptions relating to the allocation of the total purchase cost to the assets
and liabilities of BlueStar based upon preliminary estimates of their fair
value. The actual allocation of the total purchase cost may differ from those
assumptions after finalization of the valuation and other procedures are
completed after the closing of the transaction. Following is a table of the
estimated total purchase cost and annual amortization of the intangible assets
acquired (in thousands):

Estimated purchase cost

Value of common shares issued ........................... $ 111,569
Assumption of BlueStar Inc options and warrants.......... 6,075
--------------
117,644
Estimated acquisition costs.............................. 9,346
--------------
Total estimated purchase costs........................ $ 126,990

==============

LIFE ANNUAL
(YRS) AMORTIZATION
---------- ------------
Purchase price allocation:
Tangible net assets at June 30, 2000... $ 2,919
Intangible assets acquired:
Customer base...................... 10,500 3 3,500
Acquired workforce................. 11,300 3 3,767
Deferred stock compensation........ 2,293 2.5 917
Goodwill........................... 99,978 5 19,996
------- ------------
Total estimated purchase
price allocation.............. $126,990 $ 28,180
============ ============

Tangible net assets of BlueStar principally include deferred charges
and fixed assets. Liabilities assumed principally include accounts payable,
accrued expenses and a note payable.

2. PRO FORMA NET LOSS PER SHARE

The Covad Communications Group, Inc. Unaudited Pro Forma Condensed Combined
Consolidated Statements of Operations have been prepared as if the combination
of Covad, Laser Link and BlueStar had occurred on January 1, 1999 for the year
ended December 31, 1999 and January 1, 2000 for the six months ended June 30,
2000. The pro forma basic and diluted net loss per share are based on the
weighted average number of

F-36

<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

Covad common shares outstanding during each period,
the actual number of Covad shares issued to acquire the outstanding Laser Link
common shares and the assumed 7.1 million shares to acquire the outstanding
preferred and common shares of BlueStar. Outstanding stock options for Covad,
Laser Link and BlueStar are not included in the computation of pro forma diluted
net loss per share as their effect would be antidilutive.

3. PRO FORMA ADJUSTMENTS

The Covad Communications Group, Inc. Unaudited Pro Forma Condensed Combined
Consolidated Financial Statements give effect to the allocation of the total
purchase cost to the assets and liabilities of Laser Link and BlueStar based on
their relative fair values and to the amortization over the respective useful
lives of amounts allocated to intangible assets. The allocation of the total
purchase cost for BlueStar is preliminary. The actual BlueStar allocation may
differ after the transaction is closed and the valuation is finalized.

Intercompany transactions between Covad, Laser Link, and BlueStar were
insignificant.

No pro forma adjustments were required to conform the accounting principles
used by Laser Link and BlueStar to the accounting principles used by Covad.

F-37
<PAGE>

REPORT OF INDEPENDENT ACCOUNTANTS

The Board of Directors and Stockholders of
Laser Link.Net, Inc.:

In our opinion, the accompanying balance sheets and the related
statements of operations, stockholders' equity and redeemable preferred stock
and of cash flows present fairly, in all material respects, the financial
position of Laser Link.Net, Inc. at December 31, 1999 and 1998, and the results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1999 in conformity with accounting principles generally
accepted in the United States. 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 of these
statements in accordance with auditing standards generally accepted in the
United States, which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.

/s/ PricewaterhouseCoopers LLP

January 21, 2000, except for Note 9 as
to which the date is March 8, 2000

F-38
<PAGE>

LASER LINK.NET, INC.
BALANCE SHEETS
(DOLLARS IN THOUSANDS)

DECEMBER 31,
-------------------
1998 1999
--------- --------
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents............................................................... $ 4,586 $ 3,514
--------- --------
Accounts receivable, net of allowance for doubtful accounts of $339 at December 31, 1999 12 2,588
Prepaid expenses and other current assets............................................... -- 230
--------- --------
Total current assets.................................................................... 4,598 6,332
Property and equipment, at cost............................................................ 759 4,516
Less accumulated depreciation and amortization............................................. (157) (1,470)
--------- --------
Property and equipment, net............................................................. 602 3,046
--------- --------
Total assets............................................................................ $ 5,200 $ 9,378
========= ========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit.......................................................................... $ -- $ 3,750
--------- --------
Accounts payable........................................................................ 447 3,974
Accrued payroll and other expenses...................................................... 65 776
Deferred revenue........................................................................ -- 349
Loans from officers..................................................................... 417 --
--------- --------
Total liabilities..................................................................... 929 8,849
--------- --------
--------- --------
Commitments and contingent liabilities:
Class A Redeemable Preferred Stock, no par value, 20,000 shares authorized, issued and
outstanding at December 31, 1999 and 1998, respectively Liquidation value: $2,000 at
December 31, 1999 and 1998............................................................ 352 842
Stockholders' (deficit) equity:
Preferred Stock, no par value, 10,000,000 shares authorized, 20,000 issued and
outstanding as redeemable preferred stock.............................................
Class A Common Stock, no par value, 200,000,000 shares authorized, 7,474,860
and 7,562,480 shares issued and outstanding at December 31,
1998 and 1999, respectively........................................................... 4,253 4,255
Class B Common Stock, no par value, 200,000,000 shares authorized, 18,600,000 and
18,512,380 shares issued and outstanding at December 31,
1998 and 1999, respectively........................................................... 350 348
Additional paid-in capital.............................................................. 1,672 1,182
Accumulated deficit..................................................................... (2,356) (6,098)
--------- --------
Total stockholders' (deficit) equity.................................................. 3,919 (313)
--------- --------
Total liabilities and stockholders' (deficit) equity.................................. $ 5,200 $ 9,378
========= ========

</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
FINANCIAL STATEMENTS.

F-39
<PAGE>

LASER LINK.NET, INC.

STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)

FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------
1997 1998 1999
------------- -------------- --------------
<S> <C> <C> <C>
Revenues........................................................... $ 138 $ 30 $ 14,288
Cost of services provided.......................................... -- -- 8,244
------------- -------------- --------------
Net revenues ...................................................... 138 30 6,044
Costs and expenses:
Cost of internet services ...................................... 263 1,109 5,451
Sales and marketing ............................................ 7 120 807
General and administrative...................................... 74 520 2,048
Depreciation and amortization................................... 26 130 1,313
------------- -------------- --------------
Total costs and expenses ..................................... 370 1,879 9,619
------------- -------------- --------------
Loss from operations............................................ (232) (1,849) (3,575)
Interest income.................................................... -- 2 14
Interest expense................................................... 14 68 181
------------- -------------- --------------
Net loss ..................................................... (246) (1,915) (3,742)
Preferred stock dividends and accretion of preferred stock to
redemption value ............................................... -- -- (490)
------------- -------------- --------------
Net loss attributable to common shareholders........................ $ (246) $ (1,915) $ (4,232)
============= ============== ==============
Basic and diluted net loss per common share........................ $ (0.01) $ (0.09) $ (0.16)
============= ============== ==============
Basic and diluted weighted average shares outstanding.............. 18,629,918 21,335,443 26,074,860
============= ============== ==============

</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
FINANCIAL STATEMENTS.

F-40
<PAGE>

LASER LINK.NET, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY AND REDEEMABLE PREFERRED STOCK
(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
REDEEMABLE CLASS A
PREFERRED STOCK COMMON STOCK CLASS B COMMON STOCK
-------------------- --------------------- -----------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------- --------- ----------- -------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996................... 4,020

Sale of Class A Common Stock................... 1,640,000 $ 410
Redemption of Class B Common stock............. (4,020)
Purchase of Class B Common Stock............... 18,600,000 $ 350
Net loss for the year..........................
--------- --------- ----------- -------- ------------ ---------
Balance at December 31, 1997................... 1,640,000 410 18,600,000 350
--------- --------- ----------- -------- ------------ ---------
Sale of Class A Common Stock................... 5,834,860 3,843
Non-employee stock option compensation expense.
Warrants issued for Class B Common stock.......
Sale of Class A Preferred Stock, net of
expenses.................................... 20,000 352
Net loss for the year..........................
--------- --------- ----------- -------- ------------ ---------
Balance at December 31,1998 ................... 20,000 352 7,474,860 4,253 18,600,000 350
--------- --------- ----------- -------- ------------ ---------
Amortization of discount on Class A Preferred
Stock....................................... 330
Accretion of dividends on Class A Preferred
Stock....................................... 160
Exchange of stock.............................. 87,620 2 (87,620) (2)
Net loss for the year..........................
--------- --------- ----------- -------- ------------ ---------
Balance at December 31, 1999................... 20,000 $ 842 7,562,480 $ 4,255 18,512,380 $ 348
========= ========= =========== ======== ============ =========
<CAPTION>

ADDITIONAL TOTAL
PAID-IN ACCUMULATED STOCKHOLDERS'
CAPITAL DEFICIT DEFICIT
----------- ------------ -------------
<S> <C> <C> <C>
Balance at December 31, 1996...................
$ (195) $ (195)
Sale of Class A Common Stock................... 410
Redemption of Class B Common stock............. --
Purchase of Class B Common Stock............... 350
Net loss for the year.......................... (246) (246)
----------- ------------ -------------
Balance at December 31, 1997................... (441) 319
----------- ------------ -------------
Sale of Class A Common Stock................... 3,843
Non-employee stock option compensation expense. $ 13 13
Warrants issued for Class B Common stock....... 59 59
Sale of Class A Preferred Stock, net of
expenses.................................... 1,600 1,600
Net loss for the year.......................... (1,915) (1,915)
----------- ------------ -------------
Balance at December 31,1998 ................... 1,672 (2,356) 3,919
----------- ------------ -------------
Amortization of discount on Class A Preferred
Stock....................................... (330) (330)
Accretion of dividends on Class A Preferred
Stock....................................... (160) (160)
Exchange of stock.............................. --
Net loss for the year.......................... (3,742) (3,742)
----------- ------------ -------------
Balance at December 31, 1999................... $ 1,182 $ (6,098) $ (313)
=========== ============ =============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

F-41
<PAGE>

LASER LINK.NET, INC.
STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>

FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1998 1999
----------- ----------- ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss .......................................................... $ (246) $ (1,915) $ (3,742)
Adjustments to reconcile net loss to cash used in operating
activities:
Depreciation and amortization.................................... 26 130 1,313
Amortization of debt discount.................................... -- 59 --
Allowance for doubtful accounts.................................. -- -- 339
Non-employee stock option compensation expense................... -- 13 --
Changes in operating assets and liabilities:
Accounts receivable............................................ (150) 150 (2,915)
Other assets................................................... (8) -- (230)
Accounts payable............................................... 24 409 3,527
Accrued payroll and other expenses............................. -- 57 711
Deferred revenues.............................................. -- -- 349
----------- ----------- ------------
Net cash used in operating activities........................ (354) (1,097) (648)
----------- ----------- ------------

Cash flows from investing activities:
Capital expenditures............................................... (275) (475) (3,757)
----------- ----------- ------------
Net cash used in investing activities........................ (275) (475) (3,757)
----------- ----------- ------------

Cash flows from financing activities:
Proceeds from borrowings under line of credit...................... -- -- 3,750
Proceeds from issuance of common stock............................. 760 3,843 --
Proceeds from issuance of preferred stock.......................... -- 2,000 --
Stock issuance costs............................................... -- (48) --
(Repayments of) proceeds from loans from officers.................. (85) 317 (417)
----------- ----------- ------------
Net cash provided by financing activities.................... 675 6,112 3,333
----------- ----------- ------------
Net (decrease) increase in cash and cash equivalents......... 46 4,540 (1,072)
Cash and cash equivalents, beginning
of period.......................................................... -- 46 4,586
----------- ----------- ------------
Cash and cash equivalents, end of period.............................. $ 46 $ 4,586 $ 3,514
=========== =========== ============

Supplemental disclosure of cash flow:
Cash paid for interest............................................. 14 9 181
=========== =========== ============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

F-42
<PAGE>

LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND LIQUIDITY:

Laser Link.Net, Inc. ("Laser Link" or the "Company") which was incorporated
in Pennsylvania on February 22, 1996 is engaged in the business of providing a
full-service dial-up based Internet access service to corporations and other
organizations. The Company has incurred losses since its inception as it has
devoted substantially all of its efforts toward building network infrastructure
and internal staffing, developing systems, expanding into new markets, and
raising capital.

The Company has funded its operations since inception through contributions
from shareholders and the sale of common and preferred stock to investors.

Effective August 13, 1999, the Company changed its name from Laser Link
Communications, Inc. to Laser Link.Net, Inc.

The Company operates in a single segment.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

CASH AND CASH EQUIVALENTS:

The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. Cash and cash
equivalents are stated at cost, which approximates fair value.

PROPERTY AND EQUIPMENT:

Property and equipment are stated at cost. Depreciation and amortization
are provided for using the straight-line method over the estimated useful lives
of the related assets, which is generally three years for computers, computer
related equipment, and purchased software and five years for furniture and other
equipment. Leasehold improvements are amortized over the life of the lease.

LONG-LIVED ASSETS:

In accordance with Statement of Financial Accounting Standard No. 121
("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of", the Company reviews assets for impairment
whenever events or changes in circumstances indicate the carrying value of the
asset may not be recoverable. A determination of impairment (if any) is made
based on estimates of undiscounted future cash flows. The Company believes that
no such impairment existed at December 31, 1999.

REVENUE RECOGNITION:

The Company recognizes revenue when services are provided. Certain services
are generally billed one month in advance while others are billed one month in
arrears. Advance billings including prepaid services and collections relating to
future access services are recorded as deferred revenue and recognized as
revenue when earned.

COSTS OF SERVICES PROVIDED:

Costs of revenues include costs related to the production of software as
well as costs incurred for Internet services provided to the Company.

RESEARCH AND DEVELOPMENT COSTS:

Research and development costs incurred to develop software products are
charged to operations as incurred.

F-43
<PAGE>
LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

ADVERTISING COSTS:

Advertising costs, included in sales and marketing expenses, are expensed
as incurred. Advertising expenses were $51,000 and $10,000 for the years ended
December 31, 1998 and 1999, respectively.

INCOME TAXES:

From inception through December 28, 1998, the Company, with consent of its
stockholders, elected to have its income taxed under the S Corporation
provisions of the Internal Revenue Code (the "Code"), which provide that, in
lieu of corporate income taxes, the stockholder is taxed on the Company's
taxable income. Accordingly, there was no provision for federal or state income
taxes in the Company's statement of operations. Effective December 29, 1998, the
Company terminated its S Corporation status and began operation as a C
Corporation. The Company has incurred losses from operations in the period from
December 29, 1998 through December 31, 1999; therefore, there was no provision
for income taxes in the Company's statement of operations at December 31, 1999.

The Company uses the liability method of accounting for income taxes. Under
this method, deferred income tax assets and liabilities are recorded based on
the differences between the tax bases of assets and liabilities and their
carrying amounts for financial reporting purposes. Deferred tax liabilities or
assets at the end of each period are determined using the tax rate enacted under
the current tax law. The measurement of net deferred tax assets is reduced by
the amount of any tax benefits that, based on available evidence, are not
expected to be realized, and a corresponding valuation allowance is established.

CONCENTRATION OF CREDIT RISK:

Financial instruments which potentially subject the Company to a
concentration of credit risk principally consist of cash and cash equivalents
and short-term investments. Short-term investments are stated at cost, which
approximates fair market value. The Company has its cash and cash equivalents
placed with high quality, creditworthy financial institutions. The balances at
such institutions at December 31, 1999 and periodically throughout the year are
in excess of federally insured limits. As part of its cash management process,
the Company performs periodic evaluations of the relative credit standings of
these institutions.

The Company's accounts receivable potentially subject the Company to credit
risk, as collateral is generally not required. For certain customers, the
Company's risk of loss is limited due to advance billings for services, the use
of preapproved charges to customer credit cards, and the ability to terminate
access on delinquent accounts. In addition, the concentration of credit risk to
these customers is mitigated by the large number of customers comprising the
customer base. Where services are billed in arrears, the Company performs
ongoing credit evaluations of its customers' financial condition. The carrying
amount of the Company's receivables approximates their fair value.

VULNERABILITY DUE TO CERTAIN CONCENTRATIONS:

The Company's growth and future success is substantially dependent upon its
ability to convince corporations and other organizations to adopt the Laser Link
service for their constituents. Although a number of corporations and
organizations have entered into discussions regarding the service, only two have
entered into written agreements with the Company obligating them to offer the
service to their subscribers.

The Company has signed a Virtual Internet Provider agreement with UUNet
Technologies, Inc. ("UUNet") that provides the Company with access to UUNet's
points of presence capacity.

The Company continues to seek additional capital resources to complete the
development of its service and expand and improve its product line.

F-44
<PAGE>
LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS

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

STOCK-BASED COMPENSATION:

Stock based compensation is recognized using the intrinsic value method
prescribed in Accounting Principles Board Option No. 25, "Accounting for Stock
Issued to Employees", and related interpretations. Accordingly, compensation
cost for stock options is measured as the excess, if any, of the fair market
value of the Company's stock at the date of grant over the amount an individual
must pay to acquire the stock and amortized over the vesting period. All
transactions in which goods and services are the consideration received for the
issuance of equity instruments, such as stock options, are expensed based on the
fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more reliably measured. The Company has adopted
the disclosure only provisions of Statements of Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (SFAS 123) (see Note 5).

HISTORICAL NET LOSS PER SHARE:

The Company calculates net loss per common share in accordance with
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per
Share." Basic Earnings Per Share ("EPS") is a per share measure of an entity's
performance computed by dividing net income (loss) available to common
shareholders (the numerator) by the weighted-average number of shares of common
stock outstanding during the period (the denominator). Diluted EPS measures the
entity's performance taking into consideration common shares outstanding (as
computed under basic EPS) and dilutive potential common shares, such as stock
options. However, entities with a net loss do not include common stock
equivalents in the computation of diluted EPS as the effect would be
anti-dilutive. Therefore, the Company's basic and diluted EPS are equal as
common stock equivalents are not included as inclusion of such shares would have
an anti-dilutive effect.

3. PROPERTY AND EQUIPMENT:

A summary of property and equipment at December 31, 1999 is as follows:

1998 1999
----------- -------------
Computer equipment.................................. $ 681,000 $ 2,410,000
Purchased software.................................. 78,000 1,658,000
Furniture........................................... -- 324,000
Leasehold improvements.............................. -- 124,000
----------- -------------
Less: accumulated depreciation and amortization..... 759,000 4,516,000
(157,000) (1,470,000)
----------- -------------
Property and equipment, net......................... $ 602,000 $ 3,046,000
=========== =============

Depreciation expense was approximately $21,000, $109,000, and $791,000 in
1997, 1998 and 1999, respectively. Amortization expense was approximately
$5,000, $21,000 and $522,000,in 1997, 1998 and 1999, respectively.

F-45
<PAGE>

LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

4. INCOME TAXES:

The significant components of deferred tax assets at December 31, 1999 are
as follows:

1999
------------
Loss carryforwards........................................ $ 1,410,000
Bad debt expense.......................................... 132,000
------------
Total deferred tax assets.............................. 1,542,000
Less: valuation allowance................................. (1,542,000)
------------
Net deferred tax assets................................ $ --
============

As of December 31, 1999, the Company had net operating loss carryforwards
for federal income tax purposes of approximately $3,526,000. The federal loss
carryforwards, which expire between 2018 and 2019, are available to offset
future federal taxable income, if any. The Company also had state net operating
loss carryforwards as of December 31, 1999 of $3,526,000. The state loss
carryforwards, which expire between 2008 and 2009, are limited to a maximum
utilization of $1,000,000 per year.

Management has determined that realization of these tax benefits is
uncertain and therefore has provided a full valuation allowance. The utilization
of tax credit carryforwards may be limited by changes in ownership under Section
382 of the Internal Revenue Code and similar statutes.

5. STOCKHOLDERS' EQUITY:

COMMON STOCK:

Class A Common stockholders have the right to one vote for each share of
Class A Common Stock held. Class B Common stockholders have the right to one
vote for each share of Class B Common Stock held. Class B Common stockholders
have the right to elect a majority of the Board of Directors.

On April 1, 1999 the Company effected a twenty-for-one stock split of the
outstanding shares of common stock in the form of a stock dividend. Accordingly,
all common stock data shown in the accompanying financial statements and notes
have been retroactively adjusted to reflect the stock split.

PREFERRED STOCK:

The Board of Directors has the authority to issue shares and to fix voting
privileges, dividend rates, conversion privileges and any other rights of the
preferred stock.

REDEEMABLE PREFERRED STOCK:

On December 29, 1998, the Company issued 20,000 shares of its Class A
Redeemable Preferred Stock to an investor for $2,000,000. Stock issuance costs
of $48,000 have been charged to the redeemable preferred stock. The Class A
Redeemable Preferred Stock has no voting privileges and accrues quarterly
dividends at 8% of the liquidation preference (defined by the agreement to be $5
per share) per annum. The Class A Redeemable Preferred stockholders are entitled
to distribution of $5 per share in preference to holders of Common Stock plus
all accrued and unpaid dividends on December 31, 2003 or earlier upon the
occurrence of certain events such as an initial public offering. Upon
liquidation, dissolution or winding up of the Company, Class A Redeemable
Preferred stockholders are entitled to a distribution equal to the liquidation
preference amount. This offering included a warrant to purchase 2,099,900
additional shares of Class A Common Stock at less than $.01 per share. The
warrant expires on December 29, 2008.

F-46
<PAGE>

LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

STOCK OPTION PLAN:

The Company established the 1997 Stock Option Plan (the "Plan") that
provides for the grant of stock options and warrants to officers, directors and
other key employees of the Company to purchase a maximum of 10,000,000 shares of
Class A Common Stock. The Plan provides for granting of both incentive stock
options, as defined in Section 422 of the Code, and options that do not qualify
under Section 422 of the Code ("nonqualified options"). The Plan expires ten
years from the date of adoption of the Plan, subject to the right of the Board
of Directors to terminate the Plan at any time prior thereto. Grants under the
Plan expire five or ten years from the date of the grant and generally vest over
a four year period. The exercise price of all options granted under the Plan
must be at least 100% of the fair market value on the date of grant. As of
December 31, 1999, no options have been exercised, and 1,885,500 options remain
available for issuance under the Plan.

NON-QUALIFIED OPTION GRANTS:

In addition to the options granted under the Plan, the Company granted
20,000 nonqualified stock options to a consultant during 1998. Nonqualified
options generally have a maximum term of 10 years and generally vest in equal
annual increments over a three- year period.

If compensation cost had been determined based on the fair value of the
options at the grant dates for those options for which no compensation cost has
been recognized, consistent with the method of SFAS 123, the Company's net loss
and loss per share would have been:

1997 1998 1999
------------ ------------- --------------
Net loss:
As reported................... $ (246,000) $ (1,915,000) $ (3,742,000)
Pro forma..................... (248,000) (1,961,000) (4,204,000)
Net loss:
As reported................... (0.01) (0.09) (0.14)
Pro forma..................... (0.01) (0.09) (0.16)

Such pro forma disclosures may not be representative of future compensation
expense because options vest over several years and additional grants are made
each year.

The weighted-average fair value of stock options granted was $0.02 per
option in 1997, $0.05 in 1998 and $0.25 in 1999. The fair value of each option
grant was estimated at the date of grant using the Black-Scholes option-pricing
model. The following weighted average assumptions were used for grants in 1997,
1998 and 1999, respectively: risk-free interest rates of 5.8%, 5.6% and 5.3%;
dividend yields and volatility factors of 0%; and expected lives of three years.

The following table summarizes stock option activity in 1998 and 1999:

<TABLE>
<CAPTION>
EXERCISE WEIGHTED-AVERAGE
NUMBER OF PRICE RANGE PER WEIGHTED-AVERAGE REMAINING
SHARES SHARE EXERCISE PRICE CONTRACTUAL LIFE
------------ --------------- ------------------- -------------------
<S> <C> <C> <C> <C>
Outstanding as of December 31, 1997 2,000,000 $ 0.05-$0.25 $0.11 7.95 years
Granted............................... 1,870,000 $ 0.05-$0.50 $0.31 8.32 years
Exercised............................. -- -- -- --
Cancelled/forfeited................... (80,000) $ 0.25 $0.25 8.94 years
------------ --------------- ------------------- -------------------
Outstanding as of December 31, 1998 3,790,000 $ 0.05-$0.50 $0.20 8.13 years
Granted............................... 4,499,500 $ 0.76-$3.38 $1.39 9.39 years
Exercised............................. -- -- -- --
Canceled/forfeited.................... (75,000) $ 0.76 $0.76 9.75 years
------------ --------------- ------------------- -------------------
Outstanding as of December 31, 1999 8,214,500 $ 0.05-$3.38 $0.84 8.80 years
============ =============== =================== ===================
</TABLE>

F-47
<PAGE>

LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The following table summarizes the number of options outstanding by year of
grant:

NUMBER OF EXERCISE
YEAR OF GRANT SHARES PRICE RANGE
-------------- ------------- ----------------
1997.......................... 2,000,000 $ 0.05 - $0.25
1998.......................... 1,790,000 $ 0.05 - $0.50
1999.......................... 4,424,500 $ 0.76 - $3.38

As of December 31, 1998, 549,800 shares were exercisable at a
weighted-average price per share of $0.12. As of December 31, 1999 1,994,300
shares were exercisable at a weighted average price per share of $0.29. No
options were exercised during 1997, 1998 or 1999.

6. RELATED PARTY TRANSACTIONS:

Each nonmanagement member of the Board of Directors received an option to
purchase 300,000 shares of common stock at exercise prices ranging from $0.05 to
$0.50 per share (estimated fair market value at date of grant). These options
(totaling 1,500,000 shares) expire on April 20, 2003 and vest over a period of
three years, except that the options may vest immediately upon the occurrence of
certain events.

An officer of the Company has made advances to the Company for working
capital and equipment purchases. These loans had a term of one year and included
interest at the prime rate. These advances were repaid in full during 1999. In
connection with these loans, this officer was issued warrants to purchase
146,000 and 570,660 shares of Class B Common Stock at $0.38 and $0.76 per share,
respectively. These warrants expire five years from the date of issuance on
April 27, 2003 and December 9, 2003, respectively.

The Company may borrow up to $5,000,000 under a revolving credit agreement
with an investor group. The credit agreement will expire on June 30, 2000.
Borrowings under the agreement bear interest at prime plus 2% (10.5% at December
31, 1999) and are collateralized by substantially all of the assets of the
Company. The credit facility contains certain quarterly financial covenants. The
Company had borrowings outstanding under the credit facility of $0 and
$3,750,000 as of December 31, 1998 and 1999, respectively. As of December 31,
1999, the Company was in violation of certain financial covenants of the credit
facility.

7. COMMITMENTS AND CONTINGENCIES:

LEASES:

The Company leases three facilities for its operations and equipment
network. The equipment network facility is under a noncancelable operating lease
expiring November 15, 2003. One operations facility is leased on a
month-to-month basis with no formal agreement. The other facility agreement is a
noncancelable lease expiring March 15, 2004.

At December 31, 1999, the Company's minimum rental commitments under
non-cancelable operating leases for each fiscal year ended December 31 are as
follows:

OPERATING
FISCAL YEAR LEASES
----------- -------------
2000........................................ $ 278,000
2001........................................ 282,000
2002........................................ 210,000
2003........................................ 210,000
2004 and thereafter......................... 53,000
-------------
Total minimum lease payments.............. $ 1,033,000
=============

F-48
<PAGE>

LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Total rent expense for operating leases for the years ended December 31,
1997, 1998 and 1999 amounted to approximately $22,000, $39,000 and $184,000,
respectively.

EMPLOYMENT CONTRACTS:

The Company has entered into various employment contracts with key
employees. These agreements are consecutive one-year terms and entitle the
employees to a total of 1,320,000 options to purchase Class A common stock.

SIGNIFICANT AGREEMENTS:

Access to the Internet for subscribers is provided through points of
presence capacity leased from UUNet. The agreement with UUNet expires June 1,
2001 and automatically renews for consecutive one- year terms, unless terminated
prior to or at the end of its current term.

UUNet is also a competitor of the Company. UUNet's availability may be
limited in the future if other significant UUNet users increase capacity. The
Company pays UUNet a fee per network hour used.

The Company has licensed Netscape Communicator software ("Netscape") from
Netscape Communications Corporation, and Microsoft Internet Explorer Software
("Explorer") from Microsoft Corporation. These licenses permit the Company to
distribute Netscape and Explorer in the Company's Network Operations Center
access packages. Management believes that contract renewal of both of the
licenses under conditions acceptable to the Company is probable.

The Company has entered into an agreement with a company to provide
customer service and technical support to the Company's customer base. The
Company is subject to charges by the service provider on a fixed fee basis per
subscriber.

LEGAL PROCEEDINGS:

The Company is subject to legal proceedings and claims that arise in the
ordinary course of business. As of December 31, 1999, management is not aware of
any asserted or pending litigation or claims against the Company that would have
a material adverse effect on the Company's financial condition, results of
operations or liquidity.

8. EMPLOYEE BENEFIT PLAN:

In 1999, the Company established a defined contribution 401(k) retirement
plan covering substantially all its employees. Under this plan, eligible
employees may contribute a portion of their salary until retirement and the
Company, at its discretion, may match a portion of the employee's contribution
up to 15% of an employee's annual compensation. The Company contributed $31,000
in 1999.

9. SUBSEQUENT EVENTS:

On March 8, 2000, the Company signed an Agreement and Plan of Merger (the
"Agreement") with Covad Communications Group, Inc. ("Covad"). Under the terms of
the Agreement, Covad will exchange approximately 4,300,000 shares (6,450,000
split-adjusted shares) of its common stock for all outstanding Company common
stock and all unexpired and unexercised outstanding Company options and
warrants.

F-49
<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To BlueStar Communications Group, Inc.:

We have audited the accompanying consolidated balance sheets of BlueStar
Communications Group, Inc. (a Delaware corporation) and subsidiaries as of
December 31, 1998 and 1999, and the related consolidated statements of
operations, stockholders' equity and cash flows each of the two years in the
period ended December 31, 1999. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of BlueStar
Communications Group, Inc. and subsidiaries as of December 31, 1998 and 1999,
and the consolidated results of their operations and their cash flows for each
of the two years in the period ended December 31, 1999 in conformity with
accounting principles generally accepted in the United States.

/s/ Arthur Andersen LLP

Nashville, Tennessee
January 14, 2000, except for the fifth
and eighth paragraphs of Note 9, as to
which the date is July 14, 2000

F-50
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1999

1998 1999
------------- ---------------
ASSETS

<S> <C> <C>
Current Assets:
Cash and cash equivalents..................................................... $ 501,611 $ 12,901,707
Accounts receivable........................................................... 1,142 140,115
Inventories................................................................... -- 108,051
Prepaid expenses and other current assets..................................... 6,531 325,643
------------- ---------------
Total current assets........................................................ 509,284 13,475,516
------------- ---------------

------------- ---------------
Property and equipment, net...................................................... 142,712 5,017,500
Collocation fees, net............................................................ 19,250 7,445,674
Other assets..................................................................... -- 567,677
------------- ---------------
Total assets................................................................ $ 671,246 $ 26,506,367
============= ===============

LIABILITIES AND STOCKHOLDERS' DEFICIT

Current Liabilities:
Accounts payable.............................................................. $ 30,978 $ 2,360,369
Accrued liabilities........................................................... 169,316 4,645,776
Note payable.................................................................. --- 541,526
Current portion of long-term debt............................................. 155,000 320,922
------------- ---------------
Total current liabilities................................................... 355,294 7,868,593
------------- ---------------
Long-term debt, net of current portion........................................... 345,000 503,174
------------- ---------------
Total liabilities........................................................... 700,294 8,371,767

Commitments and Contingencies:
Redeemable Convertible Preferred Stock, $01 par value;
25,000,000 shares authorized
Series A, 12,345,003 shares outstanding....................................... -- 5,936,688
Series B, 8,177,040 shares outstanding........................................ -- 31,080,009

Stockholders' Deficit:
Common stock, $0025 and $01 par value at December 31, 1998 and 1999,
respectively; 50,000,000 and 60,000,000 shares authorized at December 31,
1998 and 1999, respectively; 12,145,593 and 11,712,900 shares issued and
outstanding at December 31, 1998 and 1999, respectively..................... 30,364 117,128
Additional paid-in capital.................................................... 421,463 4,018,372
Deferred compensation......................................................... -- (3,239,122)
Accumulated deficit........................................................... (480,875) (19,778,475)
------------- ---------------
Total stockholders' deficit................................................. (29,048) (18,882,097)
------------- ---------------
Total liabilities, redeemable convertible preferred stock and
stockholders' deficit..................................................... $ 671,246 $ 26,506,367
============= ===============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.

F-51
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999

1998 1999
-------------- -----------------
<S> <C> <C>
Revenues.................................................................... $ 12,101 $ 771,109
Operating Expenses:
Network and product costs................................................ 199,973 8,082,759
Selling and marketing.................................................... 75,572 4,809,590
General and administrative............................................... 426,250 6,949,442
Amortization of deferred compensation.................................... -- 425,840
Depreciation and amortization............................................ 28,402 263,972
-------------- -----------------
Total Operating Expenses............................................... 730,197 20,531,603
-------------- -----------------

Loss from Operations........................................................ (718,096) (19,760,494)

Interest Income (Expense):
Interest income.......................................................... 14,633 607,200
Interest expense......................................................... (14,166) (65,486)
-------------- -----------------
Net interest income.................................................... 467 541,714
Net loss.................................................................... $ (717,629) $ (19,218,780)
============== =================
Net loss per common share, basic and diluted................................ $ (0.07) $ (2.15)
============== =================
Weighted average number of common shares outstanding........................ 10,154,010 8,953,153
============== =================
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THESE CONSOLIDATED FINANCIAL STATEMENTS.

F-52
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999
<TABLE>
<CAPTION>

COMMON STOCK ADDITIONAL
------------------------------ PAID-IN DEFERRED MEMBER
SHARES AMOUNT CAPITAL COMPENSATION CAPITAL
--------------- ------------- -------------- ------------------ -------------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1998 ........... -- $ -- $ -- $ -- $ 100,808
Member contributions .............. -- -- -- -- 20,314
Net loss of LLC.................... -- -- -- -- --
Issuance of common stock
and reorganization from LLC
to Corporation.................. 9,855,000 24,637 (140,269) -- (121,122)
Common stock issued................ 2,332,281 5,831 575,524 -- --
Common stock redemption............ (41,688) (104) (13,792) -- --
Net loss since reorganization ..... -- -- -- -- --
--------------- ------------- -------------- ------------------ -------------
Balance at December 31, 1998 12,145,593 30,364 421,463 -- --
Change of par value of
common stock from $.0025
to $.01 per share .............. -- 91,091 (91,091) -- --
Shares issued to employee
(1,298,244 shares restricted
and deferred compensation at
$.049 per share)................ 1,390,017 13,900 54,211 (63,615) --
Deferred compensation on
stock option grants ............ -- -- 3,601,347 (3,601,347) --
Amortization of deferred
compensation ................... -- -- -- 425,840 --
Compensation expense
related to non-employee
warrant and stock
options granted ................ -- -- 10,000 -- --
Exercise of common stock options... 198,315 1,983 22,442 -- --
Repurchase of common stock ........... (2,021,025) (20,210) -- -- --
Net loss.............................. -- -- -- -- --
--------------- ------------- -------------- ------------------ -------------
Balance at December 31, 1999 ......... 11,712,900 $ 117,128 $ 4,018,372 $ (3,239,122) $ --
=============== ============= ============== ================== =============

ACCUMULATED
DEFICIT TOTAL
----------------- ------------------
<S> <C> <C>
Balance at January 1, 1998 ........... $ -- $ 100,808
Member contributions .............. -- 20,314
Net loss of LLC.................... (236,754) (236,754)
Issuance of common stock
and reorganization from LLC
to Corporation.................. 236,754 --
Common stock issued................ -- 581,355
Common stock redemption............ -- (13,896)
Net loss since reorganization ..... (480,875) (480,875)
----------------- ------------------
Balance at December 31, 1998 (480,875) (29,048)
Change of par value of
common stock from $.0025
to $.01 per share .............. -- --
Shares issued to employee
(1,298,244 shares restricted
and deferred compensation at
$.049 per share)................ -- 4,496
Deferred compensation on
stock option grants ............ -- --
Amortization of deferred
compensation ................... -- 425,840
Compensation expense
related to non-employee
warrant and stock
options granted ................ -- 10,000
Exercise of common stock options... -- 24,425
Repurchase of common stock ........... (78,820) (99,030)
Net loss.............................. (19,218,780) (19,218,780)
----------------- ------------------
Balance at December 31, 1999 ......... $ (19,778,475) $ (18,882,097)
================= ==================
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.

F-53
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999
<TABLE>
<CAPTION>

1998 1999
------------- --------------
<S> <C> <C>
Cash Flows From Operating Activities:
Net loss....................................................................... $ (717,629) $ (19,218,780)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation of property and equipment....................................... 28,402 224,548
Amortization of collocation fees............................................. -- 39,424
Amortization of deferred compensation........................................ -- 425,840
Non-cash compensation expense................................................ 6,073 14,496
Changes in operating assets and liabilities:
Accounts receivable........................................................ (1,142) (138,973)
Inventories................................................................ -- (108,051)
Prepaid expenses and other current assets.................................. (6,531) (319,112)
Other assets............................................................... -- (567,677)
Accounts payable........................................................... 30,978 2,329,391
Accrued liabilities........................................................ 163,243 4,476,460
------------- --------------
Net cash used in operating activities.................................... (496,606) (12,842,434)
------------- --------------

Cash Flows From Investing Activities:
Purchase of property and equipment............................................. (70,306) (4,557,810)
Payments of collocation fees................................................... (19,250) (7,465,848)
------------- --------------
Net cash used in investing activities.................................... (89,556) (12,023,658)
------------- --------------

Cash Flows From Financing Activities:
Proceeds from issuance of common stock......................................... 575,000 24,425
Repurchase of common stock..................................................... -- (99,030)
Proceeds from issuance of preferred stock...................................... -- 37,016,697
Proceeds from long-term debt................................................... 500,000 500,000
Repayments on long-term debt (175,904)
Other equity transactions, net................................................. 12,773 --
------------- --------------
Net cash provided by financing activities................................ 1,087,773 37,266,188
------------- --------------
Net Increase in Cash and Cash Equivalents......................................... 501,611 12,400,096
Cash and Cash Equivalents, beginning of year...................................... -- 501,611
------------- --------------
Cash and Cash Equivalents, end of year............................................ $ 501,611 $ 12,901,707
============= ==============

Supplemental Cash Flow Information:
Interest paid.................................................................. $ 14,166 $ 65,486
============= ==============

Supplemental Non-Cash Financing Activities:
Software purchased through short-term note payable............................. $ -- $ 541,526
============= ==============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED
FINANCIAL STATEMENTS.

F-54
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1999

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BlueStar Properties, Inc., a Tennessee corporation, was incorporated on
September 28, 1998. On the same date, subsequent to incorporation, all assets
and liabilities of BlueStar Communications, LLC, which was organized on March 7,
1997, were merged with and into BlueStar Properties, Inc., a Tennessee
corporation, in a common control reorganization. On June 21, 1999, we
reincorporated in Delaware by merging BlueStar Properties, Inc., a Tennessee
corporation, into BlueStar Properties, Inc., a Delaware corporation, with
BlueStar Properties, Inc., a Delaware corporation, surviving. The Delaware
corporation subsequently changed its name to BlueStar Communications Group, Inc.
(collectively, including all predecessors, the Company).

The Company has four wholly owned subsidiaries, BlueStar Communications,
Inc., the operating business, BlueStar Networks, Inc. and BlueStar Networks of
Virginia, Inc., both of which maintain certain regulatory licenses, and BlueStar
Communications of the Southeast, Inc.

The Company is a provider of broadband communications and Internet services
to small- and medium-sized businesses in Tier II and Tier III cities. Our
Internet services, which are packaged with Web hosting and e-mail, and our
high-speed real private networking services are primarily provided using DSL
technology. In addition to DSL technology, the Company also offers other
low-cost broadband solutions, including unbundled network element T1, or UNE T1,
in order to meet its customers' needs and maximize its network footprint.

The consolidated financial statements include the activity of BlueStar
Communications, LLC and BlueStar Properties, Inc., a Tennessee corporation, as
the predecessors to the Company. Revenue, expense and cash flow information for
the period from inception (March 7, 1997) to December 31, 1997 were all less
than $6,700, and, as a result, a full set of consolidated financial statements
for 1997 have not been included.

To date, the Company has incurred cash losses from operations and projects
that it will continue to incur losses in the near future, resulting in the need
for additional cash. The Company could incur additional losses as it continues
to expand its operating network. The Company intends to obtain cash from
strategic partners, existing and/or new stockholders or other resources. If such
resources are not obtained by the Company, then it could adversely affect the
Company's ability to operate at its current level.

(A) BASIS OF PRESENTATION

The consolidated financial statements of the Company include the accounts
of its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.

(B) REVENUE RECOGNITION

Revenue related to service, installation and sale of customer premise
equipment is recognized when equipment is delivered and installation is
completed. Revenue from monthly recurring service is recognized in the month the
service is provided. Although not material at December 31, 1998 or December 31,
1999, payments received in advance of providing services are recorded as
unearned revenue until such services are provided.

Selling costs in connection with lines that have been sold but not yet
installed are expensed as incurred. These selling costs are the only expenses
incurred prior to installation.

The Company considers highly liquid investments with initial maturities of
less than three months to be cash equivalents. The Company had $8,994 in cash
balance subject to withdrawal restrictions as a condition of its $75,000
equipment leasing line of credit with its bank at December 31, 1998 and no
restrictions at December 31, 1999.

F-55
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

(D) INVENTORIES

Inventories consist of telecommunications equipment that will be installed
at customer locations. Inventory is accounted for on a FIFO basis at the lower
of cost or market.

(E) PROPERTY AND EQUIPMENT

Property and equipment are recorded at cost and depreciated using the
straight-line method over the following estimated useful lives:

Furniture and fixtures ......................... 7 years
Network equipment .............................. 5 years
Software ....................................... 3 years
Leasehold improvements ......................... Life of the lease

Expenditures for maintenance and repairs are charged to expense as
incurred, whereas expenditures for renewals and betterments are capitalized. The
Company accounts for software costs in accordance with the American Institute of
Certified Public Accountants' Statement of Position 98- 1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." The
statement requires capitalization of certain costs incurred in the development
of internal-use software, including external direct material and service costs.

(F) COLLOCATION FEES

Collocation fees represent non-recurring (one-time) fees paid to
traditional telephone companies. Non-recurring fees are an investment paid to
the telephone carriers to make space in the phone carriers central office
available and ready for use and placement of certain Company equipment.
Non-recurring collocation fees are amortized over their estimated useful lives
of five years.

The Company also incurs recurring monthly fees to traditional telephone
companies. Recurring collocation fees compensate the traditional telephone
carrier for maintenance of the facilities and variable costs such as power.
These fees also provide Company employees unlimited access to collocation space
and enable local loops between the central office and the customer as well as
broadband transport facilities to transmit data among the Company's
collocations. These recurring fees are cancelable by the Company when it ceases
to occupy the space. However, should the Company move to another collocation
space in the same area in order to over our service, monthly fees would be
payable at approximately the same levels ($500 average per month per collocation
facility).

(G) LONG-LIVED ASSETS

Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of "
requires that companies consider whether indicators of impairment of long-lived
assets held for use are present. If such indicators are present, companies
determine whether the sum of the estimated undiscounted future cash flows
attributable to such assets are less than their carrying amount, and if so,
companies recognize an impairment loss based on the excess of the carrying
amount of the assets over fair value. Accordingly, management periodically
evaluates the ongoing value of property and equipment and has determined that
there were no indications of impairment as of December 31, 1998 and 1999.

(H) ADVERTISING

The Company expenses the cost of advertising as incurred. Advertising
expense was approximately $30,192 and $898,653 for the years ended December 31,
1998 and 1999, respectively.

(I) INCOME TAXES

Prior to becoming BlueStar Properties, Inc., a Tennessee C corporation, on
September 28, 1998, the Company operated as a limited liability company under
the provisions of the Internal Revenue Code. Under these provisions,

F-56
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

income or losses of BlueStar Communications, LLC were reported by the members on
their individual federal and state income tax returns, and BlueStar
Communications, LLC did not pay income taxes or receive income tax benefits. The
year-to-date loss of the LLC through September 28, 1998, of $236,754 was netted
against paid-in capital upon the dissolution of the LLC on that date.

The Company accounts for income taxes under Statements of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). Under
the asset and liability method of SFAS 109, deferred tax assets and liabilities
are determined based on differences between financial reporting and tax basis of
assets and liabilities and are measured using the enacted tax rates and laws
that are expected to be in effect when the differences are expected to reverse.
Under SFAS 109, the effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date.

(J) STOCK-BASED COMPENSATION

The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
interpretations, as permitted under Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation"(SFAS 123).

(K) NET LOSS PER SHARE

Net loss per share is presented in accordance with the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS
128). SFAS 128 requires the presentation of basic and diluted earnings per share
(EPS). Under the provisions of SFAS 128, basic net loss per share is computed by
dividing the net loss for the period by the weighted average number of shares of
common stock outstanding during the period.

Shares issued to employees subject to repurchase by the Company are not
included in the weighted average number of common shares outstanding for the
period.

Diluted EPS is the same as basic EPS as all potentially dilutive securities
are antidilutive Potential dilutive securities at December 31, 1999 include
common stock that would be issued for the exercise of stock options and warrants
6,854,450 shares the expiration of restrictions on shares 3,657,157 shares and
the conversion of preferred shares 20,522,043 common shares

(L) USE OF ESTIMATES

The preparation of the Company's financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates and such differences may be
material to the financial statements.

(M) FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts reported in the balance sheet for cash and cash
equivalents, restricted cash, accounts receivable, accounts payable, and debt
approximate fair value.

(N) START-UP COSTS

In accordance with Statement of Position 98-5, "Reporting on the Costs of
Start-up Activities" (SOP 98-5), the Company has expensed all start-up costs to
date.

(O) COMPREHENSIVE LOSS

The Company's comprehensive loss as defined by Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" has been the same
as reported losses since inception.

F-57
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

(P) SEGMENT INFORMATION

The Company has adopted Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS
131). SFAS 131 supersedes SFAS 14, "Financial Reporting for Segments of a
Business Enterprise", replacing the "industry segment" approach with the
"management" approach. The management approach designates the internal
organization that is used by management for making operating decisions and
assessing performance as the source of the Company's reportable segments. The
Company operates in one segment: high-speed Internet access and data
communications services.

(Q) NEWLY ISSUED ACCOUNTING STANDARDS

In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS
133). SFAS 133 establishes accounting and reporting standards requiring that
every derivative instrument be recorded in the balance sheet as either an asset
or liability measured at its fair value. SFAS 133 requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. SFAS 133 is effective for fiscal quarters
beginning after June 15, 2000. The impact of the adoption of SFAS 133 is not
expected to have a material impact on the Company's results of operations or
financial position.

Staff Accounting Bulletin 101 "Revenue Recognition in Financial
Statements," ("SAB 101") was issued in December 31, 1999 by the Securities and
Exchange Commission. SAB 101 provides that, in certain circumstances, revenues
which are received in the first month of a contract might have to be recognized
over an extended period fo time, instead of in the first month of the contract.
Due to complications surrounding the implementation of SAB 101, the SEC has
deferred the implementation date of certain provisions of SAB 101 until no later
than the quarter ended December 31, 2000, with retroactive application to
transactions entered into during the quarter ended March 31, 2000. This
extension will allow the Company and other companies impacted by this Bulletin
adequate time to fully understand the broader implications of SAB 101 and to
respond accordingly.

(R) CONCENTRATION OF RISK

Under a master operating lease agreement with Ascend Communications, now
Lucent, the Company had leased equipment valued at $16,213,932 as of December
31, 1999. Lucent is the primary supplier of the Company's network equipment.
Lucent also provided the Company with a $1,000,000 line of working capital in a
transaction separate from the lease agreements.

Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of cash, cash equivalents and accounts
receivable. Concentrations of credit risk with respect to trade receivables are
limited due to the large number of customers comprising the Company's customer
base.

F-58
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

2. PROPERTY AND EQUIPMENT

Property and equipment, at cost, as of December 31, consisted of the
following:

1998 1999
----------- --------------
Furniture and Fixtures............... $ 2,815 $ 375,094
Network equipment.................... 166,493 2,358,357
Software............................. -- 2,434,854
Leasehold improvements............... 1,806 102,145
Less accumulated depreciation........ (28,402) (252,950)
----------- --------------
Property and equipment, net.......... $ 142,712 $ 5,017,500
=========== ==============

3. LEASE COMMITMENTS

The Company leases its office facilities and certain equipment from various
sources and leases its DSL equipment from Lucent as part of its $109.0 million
equipment lease line. The payment terms for each of the individual leases under
the Lucent Master Lease Agreement escalate during the first year and then remain
constant over the remaining life of the lease. Under the Lucent Master Lease
Agreement, the Company may lease equipment with a fair market value up to $30.0
million immediately. The Company may lease additional equipment up to the full
$109.0 million value so long as it maintains certain financial ratios and
covenants defined in the Lucent Master Lease Agreement. Once the Company has
leased equipment with a fair market value greater than $50.0 million, it must
maintain $10.0 million of restricted cash or cash equivalents on hand at all
times. The total amount of the base rent for all leases and subleases is being
charged to expense on the straight-line method over the terms of the leases.
Rental expense for all operating leases and subleases was $128,896 and
$3,566,838 for the years ended December 31, 1998 and 1999, respectively. Future
minimum commitments under noncancellable operating lease agreements and building
office space lease agreements outstanding at December 31, 1999 are as follows:

OPERATING
LEASE PAYMENTS
---------------
2000............................................... $ 9,219,241
2001............................................... 9,689,065
2002............................................... 5,427,773
2003............................................... 490,726
2004............................................... 205,572
---------------
Total minimum lease payments.................... $ 25,032,377
===============

4. ACCRUED LIABILITIES

At December 31, 1998 and 1999, accrued liabilities consisted of the
following:

1998 1999
------------- -------------
Accrued software payments.................. $ -- $ 995,537
Accrued compensation expenses.............. -- 764,482
Deferred lease payments.................... 80,251 1,824,962
Other accruals............................. 89,065 1,060,795
------------- --------------
Accrued liabilities........................ $ 169,316 $ 4,645,776
============= =============

Deferred lease payments, within accrued liabilities, are caused by the
difference between the recognition of lease expense under generally accepted
accounting principles and the payment terms required by the Lucent Master Lease
Agreement. The payment terms for each of the individual leases under the Lucent
Master Lease Agreement escalates during the first year and then remains constant
over the remaining life of the lease. Accordingly, the base rent for the lease
is being charged to expense using the straight line method over the life of the
lease (36 months).

F-59
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

5. NOTE PAYABLE

In December 1999, the Company entered into a short-term note payable to an
equipment vendor in the amount of $541,526. Interest accrues at an annual rate
of 15%. Principal and interest payments of $58,704 are due monthly for the first
10 months of the year ended December 31, 2000.

6. LONG-TERM DEBT

At December 31, 1998 and 1999, long-term debt consists of:

INTEREST
RATE 1998 1999
-------- ------------ -----------
Lucent loan dated August 1998........ 8.50% $ 500,000 $ 373,891
Lucent loan dated February 1999...... 7.75 -- 450,205
Less current portion................. (155,000) (320,922)
------------ -----------
Long-term debt....................... $ 345,000 $ 503,174
============ ===========

The Company has a working capital line of credit agreement (Credit Line)
with Lucent allowing for borrowings up to $1,000,000. The balance is secured by
all of the assets of the Company. The line of credit is available in two
tranches of $500,000 each. Each tranche is payable over thirty-six months with
interest only payments for the first six months and principal and interest due
over the remaining thirty months. The August 1998 tranche matures in August 2001
and the February 1999 tranche matures in February 2002. Amounts charged to
interest expense for both loans was $14,166 and $65,486 during the years ended
December 31, 1998 and 1999, respectively.

7. REDEEMABLE CONVERTIBLE PREFERRED STOCK

The Company's certificate of incorporation, as amended, authorizes the
issuance of up to 25,000,000 shares of Redeemable Convertible Preferred Stock
(Preferred Stock), of which 12,345,003 and 8,177,040 shares are designated
Series A and Series B, respectively. In March 1999, the Company issued
12,345,003 shares of redeemable convertible voting preferred stock designated as
Series A Preferred Stock at $0.49 per share. In August 1999 the Company issued
8,177,040 shares of redeemable convertible voting Preferred Stock designated as
Series B Preferred Stock at $3.80 per share.

The rights with respect to voting, dividends, liquidation and conversion of
the Preferred Stock are as follows:

Each share of Series A and B Preferred Stock has the same number of votes
as the number of shares of Common Stock into which that Series of Preferred
Stock is convertible.

Holders of Series A and B Preferred Stock are entitled to receive dividends
at the annual rate of $0.04 and $0.30 per share, respectively, when, as and if
declared by the Board of Directors. Such dividends are non-cumulative and are
payable prior and in preference to any dividends payable for Common Stock
declared by the Board of Directors. There have been no dividends declared to
date. As of December 31, 1999, the preferred stock holders have a priority right
on dividends of $1,296,000.

In the event of any liquidation or winding up of the Company, including a
merger or sale of significant assets, the holders of Series A and B Preferred
Stock shall be entitled to receive prior and in preference to any distribution
of any of the assets of the Company to the holders of Common Stock an amount of
$0.49, the original Series A liquidation amount, and $3.80, the original Series
B liquidation amount, per share for each share of Series A and B Preferred
Stock, respectively, plus all declared but unpaid dividends, if any. If assets
are insufficient to permit payment in full of a particular series, then
distribution would occur in proportion to the original issue price of the
respective series of Preferred Stock held by such holders.

F-60
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

After paying the amounts due the holders of shares of Preferred Stock, the
remaining assets available for distribution shall be distributed pro rata among
the holders of Common Stock and all Preferred Stock.

Each share of Preferred Stock is convertible into Common Stock at the
option of the holder or upon the consent of a majority of the aggregate votes of
the number of preferred shares then outstanding. The number of fully paid and
nonassessable shares of common stock into which each share of Series A and
Series B Preferred Stock may be converted shall be determined by dividing the
gross issue proceeds plus any declared but unpaid dividends by the original
issue price, adjusted for the effect of any stock splits, dividends or other
distribution payable that entitles a holder of Common Stock to receive
additional shares without payment of any consideration for the additional
shares. The conversion price was $0.49 and $3.80 for each share of Series A and
Series B Preferred Stock, respectfully, at December 31, 1999.

Such conversion is automatic upon the effective date of an initial public
offering of Common Stock for which the gross proceeds to the Company are at
least $20,000,000 and the offering price per share is at least $3.80 per share.
A total of 20,522,043 shares of Common Stock have been reserved for issuance
upon the conversion of the Series A and Series B Preferred Stock.

Each holder of Series A or Series B Preferred Stock may require the Company
to redeem on the dates specified below, by giving not less than 60 days written
notice, up to a cumulative total of that percentage of the shares held by such
requesting holder as set forth below.

CUMULATIVE
PERCENTAGE OF
SHARES WHICH
MAY BE
REDEMPTION DATE REDEEMED
--------------- --------------
March 17, 2006.................................. 25%
March 17, 2007.................................. 50
March 17, 2008.................................. 75
March 17, 2009.................................. 100

8. STOCKHOLDERS' DEFICIT

On October 29, 1999, the Company effected a 3-for-1 stock split in the form
of a stock dividend. The accompanying consolidated financial statements and all
references to Common Stock shares and per share amounts including options and
warrants to purchase Common Stock have been retroactively restated to reflect
the stock split. Membership units in the LLC were not effected by the stock
split as it was not an organized entity at the time of the stock dividend.
During 1999 the Company enacted a change in the par value of its common stock
from $0.0025 to $.01 per share.

As a condition of the Series A Preferred Stock agreement entered into on
March 17, 1999, three employees of the Company entered into Stock Restriction
and Special Payment Agreements with the Company. The agreements require tenure
conditions for the respective employees in order to fully vest in a portion of
their shares owned as of the date of the funding of the Series A Preferred
Stock. Restricted shares are subject to a right of repurchase by the Company, at
a price of $0.049 per share, if the employee leaves the Company or is terminated
prior to vesting. This right of repurchase lapses ratably over a 48-month period
and an additional 25% of the original amount of restricted shares automatically
accelerates vesting for termination without cause. In addition, the agreements
also include provisions which accelerate vesting upon a change in control of the
Company. In connection with the termination of employment of one of these
employees subject to such agreements, the Company exercised its right of
repurchase of 2,021,025 shares of Common Stock at a price of $.049 per share and
immediately retired these shares.

On September 22, 1998, the Company entered into a Personal Services
Agreement (PSA) with a consultant for the Company. Under the terms of the
agreement, the consultant was granted 3.5% stock ownership in the Company and
ultimately received additional ownership interest under the agreement. As of
December 31, 1998, the consultant had received ownership in 5% of the
outstanding Common Stock. Compensation expense was recorded

F-61
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

based on the 5% ownership for the year ending December 31, 1998. On March 18,
1999, the consultant received 1,390,017 additional shares per the terms of the
PSA. Immediately subsequent to receipt of the shares, the consultant became an
officer and employee of the Company and the PSA was terminated. As a condition
of the Series A Preferred Stock Purchase Agreement, a portion of his shares of
Common Stock are restricted and subject to repurchase by the Company.
Compensation expense related to the unrestricted shares was recognized upon
issuance. The value related to the 1,298,244 restricted shares was recorded as
deferred compensation and is being amortized over the 48-month vesting period.

On August 8, 1998, the Company entered into a Warrant Agreement with Lucent
in relation to the working capital note payable. In consideration of this
commitment with a ten-year term, a warrant was issued to purchase shares of
Common Stock at an exercise price of $0.33 per share. The number of shares
available to be exercised per the terms of the note equaled the total principal
amount advanced to the Company divided by ten, adjusted for any stock splits. At
December 31, 1998, the Company had borrowed $500,000 and thus 150,000 shares
were available to be issued under the warrant. In February 1999, the Company
borrowed an additional $500,000 on the note and the number of shares available
to be issued under the warrant was increased to 300,000. As of December 31,
1999, there have been no exercises under the warrant.

In July 1999, the Company entered into a Warrant Agreement with Boyle
Consolidated Communications, LLC (Boyle) as consideration for an exclusivity
license to install access equipment in certain Boyle properties. The Company
issued to Boyle a warrant to purchase 60,000 shares of Common Stock with an
exercise price of $1.67 per share. This warrant is immediately exercisable and
expires on the earlier of July 2004 or a breach of the agreement. The Company
may exercise the option to repurchase any unvested shares at a price of $1.67
per share. The shares vest ratably over a 36-month period. As of December 31,
1999, there have been no exercises under the warrant. The Company accounted for
the warrants based on their fair value at the grant date utilizing the Black
Scholes economic model. The value of the warrants was expensed.

9. STOCK OPTION PLAN

During 1998, the Company issued 360,000 non-qualified stock options to
certain initial employees and consultants of the Company From January 1999 to
March 1999, the Company issued an additional 366,000 non-qualified stock options
to certain employees and three consultants of the Company All initial employee
or consultant options were issued at exercise prices greater than market value
as determined by the Board of Directors of the Company The options expire in
2006 The Company recognized compensation expense for the value of the 360,000
options issued to non-employees.

WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
----------- -----------
Outstanding at January 1, 1998............. -- --
Granted................................. 360,000 0.33
Exercised............................... -- --
Cancelled............................... -- --
----------- -----------
Outstanding at December 31, 1998........... 360,000 0.33
Granted................................. 366,000 0.38
Exercised............................... (45,000) 0.33
Cancelled............................... (135,000) 0.33
----------- -----------
Outstanding at December 31, 1999........... 546,000 $ 0.37
=========== ===========
Exercisable at December 31, 1999........... 306,000 $ 0.36
=========== ===========

In March 1999, the Company's Board of Directors (Board) adopted the 1999
Incentive Stock Option Plan (Plan). The Plan provides for the granting of stock
options to employees, directors or consultants of the Company. The Plan is
administered by the Board and allows for the granting of non-qualified (NQOs)
and incentive stock

F-62
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

options (ISOs) for purchase up to an aggregate of 3,259,500 shares of Common
Stock. The options are exercisable at the discretion of the plan administrator,
but generally are exercisable upon vesting. Options generally vest over a four
year period at a rate of 25% after the first year of service, then ratably over
the next thirty-six months. Certain employees of the Company have been granted
ISOs which vest at a rate of 12.5% after the first six months of service and
then ratably over the next forty-two months. Options expire within 10 years
after the date of grant. In the event of a change of control of the Company, the
Plan provides for accelerated vesting based upon the terms evidenced in the
Option grant, generally 50.0% of the unvested options of the employee. All
options under the Plan have a ten year term.

In October 1999, the Board approved and adopted the 1999 Stock Option/Stock
Issuance Plan (New Plan). The New Plan provides for the granting of stock
options and stock purchase rights to employees, non-employee members of the
Board and consultants who provide services to the Company. At December 31, 1999,
7,615,500 shares of Common Stock were reserved for issuance under the Plan. The
Plan is administered by the Board and allows for the granting of non-statutory
options (NSOs) and incentive stock options (ISOs). The plan administrator
establishes exercise provisions for options, but generally options are
immediately exercisable upon grant. In the event that options are exercised
prior to vesting, the shares issued pursuant to unvested options will be subject
to repurchase by the Company. Options generally vest over a four year period at
a rate of 25% after the first year of service, then ratably over the next
thirty-six months. Certain employees of the Company have been granted options
which vest at a rate of 12.5% after the first six months of service and then
ratably over the next forty-two months. Options expire within 10 years after the
date of grant.

All grants under the Plan will be issued new certificates under the New
Plan. Grants issued above the amount authorized by the Plan have been approved
by the Board and are considered issued under the New Plan.

The Company accounts for options issued to employees under APB Opinion 25.
For the period ended December 31, 1999, the Company granted options with
exercise prices greater than, equal to and less than the market value of the
common stock as determined by the Board of Directors of the Company. As a result
of the Company's reassessment during 2000 of the fair value per share of its
common stock, the Company has restated its financial statements for the year
ended December 31, 1999 to recognize deferred compensation of $3,601,347 related
to options granted with exercise prices less than the market value of the common
stock. Stock compensation expense is recognized over the four year vesting
period and totaled $425,840 for the year ended December 31, 1999. The Company
recognized compensation expense related to non-qualified options issued to
consultants under the Plan.

Plan and New Plan activity is as follows:

WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
------------ -----------
Outstanding at January 1, 1999.............. -- --
Granted.................................. 6,134,265 $ 0.37
Exercised................................ (153,315) 0.06
Cancelled................................ (32,500) 0.57
------------ -----------
Outstanding at December 31, 1999............ 5,948,450 $ 0.38
============ ===========
Exercisable at December 31, 1999............ 308,543 $ 0.07
============ ===========

F-63
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The following table summarizes information about initial employee, Plan and
New Plan options outstanding at December 31, 1999:
<TABLE>
<CAPTION>

OPTIONS REMAINING WEIGHTED OPTIONS WEIGHTED
OUTSTANDING AT CONTRACTUAL AVERAGE EXERCISABLE AT AVERAGE
EXERCISE PRICES 12/31/99 LIFE IN YEARS EXERCISE PRICE 12/31/99 EXERCISE PRICE
----------------------- -------------- -------------- --------------- --------------- --------------
<S> <C> <C> <C> <C> <C>
$ 0.05-0.10 2,939,250 4.50 $ 0.07 299,043 $ 0.05
0.20-0.49 1,008,000 3.71 0.29 306,000 0.36
0.77 2,547,200 5.00 0.77 9,000 0.77
-------------- -------------- --------------- --------------- --------------
6,494,450 4.60 $ 0.38 614,043 $ 0.22
============== ============== =============== =============== ==============
</TABLE>

SFAS 123 established new financial and reporting standards for stock-based
compensation plans. As the Company has adopted the disclosure-only provision of
SFAS 123, no compensation cost has been recognized for the Company's option plan
based on the fair value method. If the Company had recognized compensation cost
for the option grants based on the fair value method prescribed by SFAS 123, the
effects for the year ended December 31, 1998 would have been immaterial and the
Company's net loss would have increased by approximately $44,000 or less than
$0.01 per share for the year ended December 31, 1999. The weighted average fair
value of options granted during 1999 was $0.61. The above tables include 37,500
non-qualified options issued under the plan that are subject to repurchase by
the Company. The Company did not repurchase any of these shares as of December
31, 1999.

The fair value for these options was estimated at the date of grant using
the minimum value method allowed under SFAS 123. Under this method, the expected
life of the options used in this calculation was 2, 3, 5 and 6 years for options
vesting in 1, 2, 3 and 4 years, respectively, from the date of grant; the risk
free interest rate used ranged from 4.62% to 6.38%; and a volatility factor of
nil.

10. INCOME TAXES

The components of the net deferred income tax asset (liability), at an
effective rate of 39%, as of December 31, 1998 and 1999 are as follows:

1998 1999
------------ --------------
Non-current asset (liability):............
Net operating loss carryforward........ $ 186,811 $ 7,906,389
Tax over book depreciation............. (9,008) (265,253)
Compensation accrual................... -- 77,728
Other nondeductible accruals........... -- 143,500
Capitalized start-up costs............. 9,576 7,912
Long-term accrued liability............ 34,735 --
------------ --------------
Total non-current asset.............. 222,114 7,870,276
Less valuation allowance............... (222,114) (7,870,276)
------------ --------------
Net deferred tax asset............... $ -- $ --
============ ==============

SFAS 109 requires the Company to record a valuation allowance when it is
"more likely than not that some portion or all of the deferred tax assets will
not be realized." It further states that "forming a conclusion that a valuation
allowance is not needed is difficult when there is negative evidence such as
cumulative losses in recent years." The ultimate realization of the deferred
income tax assets depends on the Company's ability to generate sufficient
taxable income in the future. The Company has provided a valuation allowance at
December 31, 1998 and December 31, 1999. If the Company achieves sufficient
profitability in future years to use all of the deferred income tax asset, the
valuation allowance will be reduced through a credit to expense (increasing
retained earnings).

As of December 31, 1999, the Company had federal net operating loss
carryforwards of approximately $479,002 which expire in 2013 and $18,804,874
which expire in 2014.

F-64
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

11. COMMITMENTS AND CONTINGENCIES

The Company is involved in various litigation that arise through the normal
course of business. Management believes that the resolution of these matters
will not have a material adverse effect on the Company's financial position or
results of operations.

On April 5, 1999, the Company entered into an agreement with the Chief
Executive Officer. The agreement provides for a monthly base salary and 12
months' salary and additional vesting of options if terminated.

F-65
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND JUNE 30, 2000

DECEMBER 31, JUNE 30,
1999 2000
--------------- ---------------
(UNAUDITED)
ASSETS
<S> <C> <C>
Current Assets:
Cash and cash equivalents................................................... $ 12,901,707 $ 920,669
Accounts receivable......................................................... 140,115 1,303,684
Inventories................................................................. 108,051 18,010
Prepaid expenses and other current assets................................... 325,643 1,476,466
--------------- ---------------
Total current assets...................................................... 13,475,516 3,718,829
--------------- ---------------

Property and equipment, net.................................................... 5,017,500 12,195,324
Collocation fees, net.......................................................... 7,445,674 11,579,176
Other assets................................................................... 567,677 4,156,331
--------------- ---------------
Total assets.............................................................. $ 26,506,367 $ 31,649,660
=============== ===============

LIABILITIES AND STOCKHOLDERS' DEFICIT

Current Liabilities:
Accounts payable............................................................ $ 2,360,369 $ 8,170,872
Accrued liabilities......................................................... 4,645,776 12,622,889
Note payable................................................................ 541,526 7,270,767
Current portion of long-term debt........................................... 320,922 334,520
--------------- ---------------
Total current liabilities................................................. 7,868,593 28,399,048
--------------- ---------------
Long-term debt, net of current portion......................................... 503,174 332,420
Total liabilities......................................................... 8,371,767 28,731,468

Commitments and contingencies:
Redeemable convertible preferred stock, $01 par value;
25,000,000 shares authorized
Series A, 12,345,003 shares outstanding .................................... 5,936,688 5,936,688
Series B, 8,177,040 shares outstanding ..................................... 31,080,009 31,080,009
Series C, 2,165,603 shares outstanding...................................... -- 33,975,000

Stockholders' Deficit:
Common stock, $01 par value at December 31, 1999 and June 30, 2000;
60,000,000 shares authorized at December 31, 1999 and June 30, 2000,
11,712,900 and 13,176,774 shares issued and outstanding at December 31,
1999 and June 30, 2000, respectively ..................................... 117,128 131,767
Additional paid-in capital ................................................. 4,018,372 6,101,976
Restricted stock loan receivable............................................ -- (728,150)
Deferred compensation ...................................................... (3,239,122) (3,076,769)
Accumulated deficit......................................................... (19,778,475) (70,502,329)
--------------- ---------------
Total stockholders' deficit .............................................. (18,882,097) (68,073,505)
--------------- ---------------
Total liabilities, redeemable convertible preferred stock and
stockholders' deficit................................................... $ 26,506,367 $ 31,649,660
=============== ===============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.

F-66
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000

(UNAUDITED)
<TABLE>
<CAPTION>

1999 2000
-------------- ----------------
<S> <C> <C>
Revenues.................................................................... $ 136,211 $ 3,625,031

Operating Expenses:.........................................................
Network and product costs ............................................... 950,659 20,612,551
Selling and marketing.................................................... 323,581 17,349,024
General and administrative............................................... 863,145 12,235,957
Amortization of deferred compensation.................................... 3,976 1,095,963
Depreciation and amortization ........................................... 24,493 1,934,852
-------------- ----------------
Total operating expenses ............................................ 2,165,854 53,228,347
-------------- ----------------
Loss From Operations ....................................................... (2,029,643) (49,603,316)

Interest Income (Expense):
Interest income ......................................................... 40,197 499,709
Interest expense ........................................................ (187) (96,390)
-------------- ----------------
Net interest income (expense)........................................ 40,010 403,319
-------------- ----------------
One time charges and debt fees........................................... -- (1,454,244)
============== ================
Net loss ................................................................... $ (1,989,633) $ (50,654,241)
============== ================

Net loss per common share, basic and diluted ............................... $ (0.19) $ (5.31)
============== ================
Weighted average number of common shares outstanding........................ 10,425,501 9,539,643
============== ================
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

F-67
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2000
(UNAUDITED)
<TABLE>
<CAPTION>

RESTRICTED
COMMON STOCK ADDITIONAL STOCK
--------------------------- PAID-IN LOAN
SHARES AMOUNT CAPITAL RECEIVABLE
------------- ------------ --------------- --------------
<S> <C> <C> <C> <C>
Balance at December 31, 1999................ 11,712,900 $ 117,128 $ 4,018,372 $ --
Exercise of common stock options......... 3,248,809 32,488 1,149,994 --
Repurchase of common stock............... (1,784,935) (17,849) -- --
Deferred compensation on
stock option grants.................... -- -- 933,610 --
Amortization of deferred compensation.... -- -- -- --
Restricted stock loan receivable......... -- -- -- (728,150)
Net loss................................. -- -- -- --
------------- ------------ --------------- --------------
Balance at June 30, 2000.................... 13,176,774 131,767 6,101,976 (728,150)
============= ============ =============== ==============

DEFERRED ACCUMULATED
COMPENSATION DEFICIT TOTAL
---------------- --------------- -----------------
<S> <C> <C> <C>
Balance at December 31, 1999................ $ (3,239,122) $ (19,778,475) $ (18,882,097)
Exercise of common stock options......... -- -- 1,182,482
Repurchase of common stock............... -- (69,613) (87,462)
Deferred compensation on
stock option grants.................... (933,610) -- --
Amortization of deferred compensation.... 1,095,963 -- 1,095,963
Restricted stock loan receivable......... -- -- (728,150)
Net loss................................. -- (50,654,241) (50,654,241)
---------------- --------------- -----------------
Balance at June 30, 2000.................... $ (3,076,769) $ (70,502,329) $ (68,073,505)
================ =============== =================
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

F-68
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000
(UNAUDITED)
<TABLE>
<CAPTION>

1999 2000
--------------- ---------------
<S> <C> <C>
Cash Flows From Operating Activities:
Net loss................................................................... $ (1,989,623) $ (50,654,241)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation of property and equipment................................... 24,493 1,412,374
Amortization of collocation fees......................................... -- 522,478
Amortization of deferred compensation.................................... -- 1,095,963
Interest on restricted stock receivable.................................. -- (22,580)
Changes in operating assets and liabilities:
Accounts receivable.................................................... (38,964) (1,163,569)
Inventories............................................................ -- 90,041
Prepaid expenses and other current assets.............................. (72,622) (1,150,823)
Other assets........................................................... -- (3,588,654)
Accounts payable....................................................... 268,330 5,810,503
Accrued liabilities.................................................... 337,151 7,977,113
--------------- ---------------
Short-term note payable................................................ 193,756 13,598
--------------- ---------------
Net cash used in operating activities................................ (1,277,479) (39,657,797)
--------------- ---------------
Cash Flows From Investing Activities:
Purchase of property and equipment......................................... (297,941) (8,590,198)
Payments of collocation fees............................................... (938,500) (4,655,980)
--------------- ---------------
Net cash used in investing activities................................ (1,236,441) (13,246,178)
--------------- ---------------
Cash Flows From Financing Activities:
Proceeds from issuance of common stock..................................... -- 476,912
Repurchase of common stock................................................. -- (87,462)
Proceeds from issuance of preferred stock.................................. 5,936,688 33,975,000
Proceeds from long-term debt............................................... 245,383 6,729,241
Repayments on long-term debt............................................... -- (170,754)
Other equity transactions, net............................................. 0 --
--------------- ---------------
Net cash provided by financing activities............................ 6,182,071 40,922,937
--------------- ---------------
Net Increase in Cash and Cash Equivalents..................................... 3,668,151 (11,981,038)
Cash and Cash Equivalents, beginning of period................................ 501,611 12,901,707
--------------- ---------------
Cash and Cash Equivalents, end of period...................................... $ 4,169,762 $ 920,669
=============== ===============
Supplemental Cash Flow Information:
Interest paid.............................................................. $ 33,663 $ 96,390
=============== ===============
Supplemental Non-Cash Investing Activities:
Restricted Stock Receivable................................................ $ -- $ 705,570
=============== ===============
Supplemental Non-Cash Financing Activities:
Software purchased through short-term note payable......................... $ -- $ 29,555
=============== ===============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

F-69
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The condensed consolidated balance sheet as of June 30, 2000 and the
condensed consolidated statements of operations and cash flows for the periods
ended June 30, 1999 and June 30, 2000 have been prepared by the Company in
accordance with the accounting policies described in its annual financial
statements for the year ended December 31, 1999 and should be read in
conjunction with the notes thereto.

In the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position at
June 30, 2000 and results of operations and changes in cash flows for all
periods presented have been made. The results of operations for the periods
ended June 30, 1999 and 2000 are not necessarily indicative of the operating
results for the full years.

2. NET LOSS PER SHARE

Shares issued to employees subject to repurchase by the Company are not
included in the weighted average number of common shares outstanding for the
period.

Diluted EPS is the same as basic EPS as all potentially dilutive securities
are antidilutive. Potential dilutive securities include common stock that would
be issued for the exercise of stock options and warrants 4,581,700 shares the
expiration of restrictions on shares 3,456,018 shares and the conversion of
preferred shares (22,687,641 common shares).

3. LEASE COMMITMENTS

In April of 2000, the Master Lease Agreement with Lucent was amended to
increase the maximum lease line from $109 million to $175 million. As of June
30, 2000, the Company has drawn a total of $50.5 million from the lease line.

In April, 2000, the Company executed an equipment leasing line with Cisco
Systems Capital, which allows the Company to lease equipment with a fair market
value up to $50.0 million.

4. REDEEMABLE CONVERTIBLE PREFERRED STOCK

On January 28, 2000, the Company issued 318,471 shares of Series C
Preferred Stock for a total consideration of $5,000,000. On February 14, 2000,
the Company issued an additional 1,847,132 shares of Series C Preferred Stock
for net proceeds of $28,984,968. The rights and preferences of the Series C
preferred stock are similar to Series A and B preferred stock, except that
Series C preferred stock contains antidilution provisions.

5. STOCKHOLDERS DEFICIT

In January 2000, one of the employees subject to a Stock Restriction and
Special Payment Agreement resigned. The Company exercised its right to
repurchase the related outstanding restricted shares of 1,784,935 at a purchase
price of $0.049 per share. The total cost of repurchased options and severance
to the Company under the resignation agreement was approximately $231,000.

F-70
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

6. STOCK OPTION PLAN

During 2000, the Company's Board of Directors (Board) adopted the 2000
Stock Incentive Plan (2000 Plan). The 2000 Plan provides for five separate
equity incentive programs for eligible employees, directors and consultants of
the Company, which are the Discretionary Option Grant Program, Salary Investment
Option Grant Program, Stock Issuance Program, Automatic Option Grant Program and
Director Fee Option Grant Program. A total of 8,538,500 shares of common stock
have been reserved for issuance under the 2000 Plan, which includes all option
grants under the predecessor option plans (ie. the initial employee Plan and New
Plan, and shares available for issuance under the predecessor plans) and
4,200,315 additional shares approved by the Board for issuance.

The Salary Investment Option Grant Program is restricted to certain highly
compensated employees and other insiders as defined in the 2000 Plan. The
Automatic Option Grant and Director Fee Option Grant programs are restricted to
non-employee Board members. All employees, non-employee members of the Board and
consultants and the independent advisors who provide services to the Company are
eligible under the Discretionary Option Grant and Stock Issuance Programs.

The Company granted an additional 2,265,000 incentive stock options under
the 2000 Plan to certain employees of the Company at exercise prices ranging
from $0.77 to $7.85 per share in the period from January 5, to June 30, 2000.
These option grants generally vest over a four year period at a rate of 25%
after the first year of service, then ratably over the next thirty-six months.

From January 1, 2000 to June 30, 2000, certain employees of the Company
exercised options for 3,248,809 shares at a weighted average exercise price of
$0.27 per share. Some of these employees were issued recourse loans by the
Company valued at $705,570 in order for the employees to purchase their
respective shares. The loans accrue interest at an annual rate of 7%. The loans
are also secured by a pledge of the Common Stock purchased by the loan proceeds.
Of the shares exercised through June 30, 2000, 1,544,375 shares have not vested
and are subject to repurchase by the Company at a weighted average exercise
price of $0.36 per share.

7. STOCK PURCHASE PLAN

On March 30, 2000, the Company's Board of Directors approved the BlueStar
Communications Group, Inc. Employee Stock Purchase Plans (the "ESPP"). As part
of the ESPP, 600,000 of common shares have been reserved for issuance under the
plan. The ESPP's adoption is subject to the Company's completion of its initial
public offering.

The ESPP, which is intended to qualify under Section 423 of the IRS Code,
will be implemented by a series of overlapping offering periods of 24 months'
duration, with new offering periods, other than the first offering period,
commencing on the first business day in February and August of each year.

The purchase price per share at which shares will be sold in an offering
under the ESPP will be the lower of 85% of the fair market value of a share of
the Company's common stock on the first day of an offering period or 85% of the
fair market value of a share of the Company's common stock on the semi-annual
purchase date. The fair market value of the Company's common stock on a given
date will be equal to the closing price of the Company's common stock on such
date as such price is reported by the National Association of Securities Dealers
on the Nasdaq national market.

8. SUBSEQUENT EVENTS

On June 16, 2000 an agreement was reached to merge with Covad
Communications, Group, Inc. ("Covad"), a provider of broadband and Internet
services. Under the merger agreement, the Company will receive 8 million shares
of Covad common stock for all of the Company's outstanding shares, plus
assumption of $55 million in debt and operating leases in a transaction
currently scheduled to close in the third quarter of 2000. Up to five million
additional shares of Covad common stock may be issued to the BlueStar
shareholders if certain performance targets are met by BlueStar over the 2001
fiscal year.

F-71
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

to exceed an aggregate of $40.0 million. Bear Stearns, however, is not obligated
to provide any portion of the requested amount. Any amounts borrowed under the
loan agreement bear interest, at BlueStar's discretion, at either (1) the prime
rate publicly announced by Citibank, N.A., plus 600 basis points or (2) the
interest rate which eurodollar deposits for one month are offered in the
interbank eurodollar market plus 700 basis points. Under either interest rate
election, the minimum interest rate is 13.0%. The loan agreement matures at the
earliest of (1) demand by Bear Stearns, (2) the date of commencement by or
against BlueStar or any of its subsidiaries of any bankruptcy proceeding, (3)
termination of the merger agreement in accordance with its terms (4)
consummation of the merger with Covad Communications or any other change in
control of BlueStar or (5) December 15, 2000.

F-72
<PAGE>
APPENDIX I
COVAD COMMUNICATIONS GROUP, INC.
GLOSSARY OF TERMS

ACCESS LINE--A circuit that connects a telephone end-user to the ILEC
Central Office.

ANALOG MODEM--A telecommunications device that allows the communication of
digital information over analog telephone lines and through the public switched
telephone network by translating such information in a way that simulates and
uses only the bandwidth of normal voice transmissions.

ASYNCHRONOUS TRANSFER MODE (ATM)--A standard packet-switching protocol that
segments digital information into 53-byte cells (each cell has a 5-byte standard
packet-switching header and 48 bytes of data) that are switched very quickly
throughout a network over virtual circuits. ATM is able to accommodate multiple
types of media (voice, video, data).

BANDWIDTH--Refers to the maximum amount of data that can be transferred
through a computer's backplane or communication channel in a given time. It is
usually measured in Hertz for analog communications and bits per second for
digital communication.

CENTRAL OFFICE--ILEC facility where subscriber lines are joined to
switching equipment.

CLEC (COMPETITIVE LOCAL EXCHANGE CARRIER)--Category of telephone service
provider (carrier) that offers services similar to those of the ILEC, as allowed
by recent changes in telecommunications law and regulation. A CLEC may also
provide other types of services such as long distance, Internet access and
entertainment.

COMMUNICATIONS ACT OF 1934--The federal legislation governing broadcast and
non-broadcast communications, including both wireless and wired telephone
service, and which established the FCC.

DSL--Digital Subscriber Line.

FCC (FEDERAL COMMUNICATIONS COMMISSION)--The U.S. government agency charged
with the oversight of communications originating in the U.S. and crossing state
lines.

FRAME-RELAY--A high-speed packet-switched data communications protocol.

HFC (HYBRID FIBER COAX)--A combination of fiber optic and coaxial cable,
which has become the primary architecture utilized by cable operators in recent
and ongoing upgrades of their systems. An HFC architecture generally utilizes
fiber optic wire between the headend and the nodes and coaxial wire from nodes
to individual end-users.

ILEC (INCUMBENT LOCAL EXCHANGE CARRIER)--The local exchange carrier that
was the monopoly carrier in a region, prior to the opening of local exchange
services to competition.

ILEC COLLOCATION--A location serving as the interface point for a CLEC
network's interconnection to that of the ILEC. Collocation can be (i) physical,
in which the CLEC places and directly maintains equipment in the ILEC Central
Office, or (ii) virtual, in which the CLEC leases a facility, similar to that
which it might build, to effect a presence in the ILEC Central Office.

INTERCONNECTION (CO-CARRIER) AGREEMENT--A contract between an ILEC and a
CLEC for the interconnection of the two networks and CLEC access to ILEC UNEs.
These agreements set out the financial and operational aspects of such
interconnection and access.

ISP (INTERNET SERVICE PROVIDER)--A vendor that provides subscribers access
to the Internet.

ISDN (INTEGRATED SERVICES DIGITAL NETWORK)--ISDN provides standard
interfaces for digital communication networks and is capable of carrying data,
voice, and video over digital circuits. ISDN protocols are used worldwide for
connections to public ISDN networks or to attach ISDN devices to ISDN-capable
PBX systems (ISPBXs). Developed by the International Telecommunications Union,
ISDN includes two user-to-network interfaces: basic rate interface (BRI) and
primary rate interface (PRI). An ISDN interface contains one signaling channel
(D-channel) and a number of information channels ("bearer" or B channels). The
D-channel is used for call setup, control, and

I-1
<PAGE>

call clearing on the B-channels. It also transports feature information while
calls are in progress. The B-channels carry the voice, data, or video
information.

IXC (INTEREXCHANGE CARRIER)--Facilities-based long distance/interLATA
carriers (e.g., AT&T, MCI WorldCom and Sprint), who also provide intraLATA toll
service and may operate as CLECs.

KBPS (KILOBITS PER SECOND)--One thousand bits per second.

LATA (LOCAL ACCESS AND TRANSPORT AREA)--A geographic area inside of which a
local telephone company can offer switched telecommunications services,
including long distance (known as toll). There are 196 LATAs in the U.S.

MBPS (MEGABITS PER SECOND)--One million bits per second.

RBOCS (REGIONAL BELL OPERATING COMPANIES)--ILECs created by AT&T's
divestiture of its local exchange business. The remaining RBOCs include
BellSouth, Bell Atlantic Corporation, Ameritech Corporation, U S WEST
Communications, Inc. and SBC Communications, Inc.

T1--This is a Bell system term for a digital transmission link with a
capacity of 1.544 Mbps.

UNES (UNBUNDLED NETWORK ELEMENTS)--The various portions of an ILEC's
network that a CLEC can lease for purposes of building a facilities-based
competitive network, including copper lines, Central Office collocation space,
inter-office transport, operational support systems, local switching and rights
of way.

I-2
<PAGE>

================================================================================

YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED OR INCORPORATED BY REFERENCE
IN THIS PROSPECTUS. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH DIFFERENT
OR ADDITIONAL INFORMATION. THIS PROSPECTUS IS NOT AN OFFER TO SELL NOR IS IT
SEEKING AN OFFER TO BUY SHARES OF OUR COMMON STOCK IN ANY JURISDICTION WHERE THE
OFFER OR SALE IS NOT PERMITTED. THE INFORMATION CONTAINED OR INCORPORATED BY
REFERENCE IN THIS PROSPECTUS IS CORRECT ONLY AS OF THE DATE OF THIS PROSPECTUS,
REGARDLESS OF THE TIME OF THE DELIVERY OF THIS PROSPECTUS OR ANY SALE OF OUR
COMMON STOCK.

TABLE OF CONTENTS

PAGE

Prospectus Summary................................. 1
Risk Factors....................................... 8
Use of Proceeds.................................... 26
Determination of Offering Price.................... 26
Dividend Policy.................................... 26
Price Range of Our Common Stock.................... 26
Selected Historical Consolidated Financial Data of
Covad Communications Group, Inc................. 27
Covad Management's Discussion and Analysis of
Financial Condition and Results of Operations... 29
Selected Historical Consolidated Financial Data of
Bluestar Communications Group, Inc.............. 40
Bluestar Management's Discussion and Analysis of
Financial Condition and Results of Operations... 41
Business........................................... 47
Management......................................... 66
Certain Relationships and Related Transactions..... 86
Principal and Selling Shareholders................. 91
Description of Capital Stock....................... 94
Shares Eligible for Future Sale.................... 97
Plan of Distribution............................... 99
Where You Can Find More Information................ 100
Legal Matters...................................... 100
Experts............................................ 100
Index to Financial Statements...................... F-1
Glossary........................................... I-1

DEALER PROSPECTUS DELIVERY OBLIGATION

DEALERS THAT EFFECT TRANSACTIONS IN THESE SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS
IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.

5, 013,466 SHARES

[COVAD LOGO]

COMMON STOCK
------------------

AUGUST 23, 2000