COVAD COMMUNICATIONS GROUP INC, POS AM, 2001-01-10

COVAD COMMUNICATIONS GROUP INC
POS AM, 2001-01-10
TELEPHONE & TELEGRAPH APPARATUS

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<PAGE>

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 9, 2001

Registration No. 333-38688
================================================================================
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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

POST EFFECTIVE AMENDMENT NO. 3

FORM S-1/A

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

--------------
COVAD COMMUNICATIONS GROUP, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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

DELAWARE 4813 77-0461529
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>

4250 BURTON DRIVE
SANTA CLARA, CALIFORNIA 95054
(408) 987-1000

(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

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

FRANK MARSHALL

INTERIM CHIEF EXECUTIVE OFFICER AND DIRECTOR

COVAD COMMUNICATIONS GROUP, INC.
4250 BURTON DRIVE
SANTA CLARA, CALIFORNIA 95054
(408) 987-1000
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)

COPIES TO:
Meredith S. Jackson, Esq.
Ashok W. Mukhey, Esq.
Geoffrey M. Trachtenberg, Esq.
Irell & Manella LLP
1800 Avenue of the Stars
Los Angeles, California 90067
(310) 277-1010

APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, check the following box. |X|

If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. |_|

If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. |_|

If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. |_|

If delivery of the prospectus is expected to be made pursuant to Rule
434, please check the following box. |_|

The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933, as amended, or until the Registration Statement
shall become effective on such date as the Securities Exchange Commission,
acting pursuant to said Section 8(a), may determine.

================================================================================
<PAGE>

5,013,466 SHARES

[COVAD GRAPHIC]

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 January 8, 2001, the last reported sale price for our common stock on
the Nasdaq National Market was $1.625 per share.

SEE "RISK FACTORS" BEGINNING ON PAGE 7 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, 2001.

<PAGE>

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains "forward-looking statements" within the meaning of
the securities laws. These forward-looking statements are subject to a number of
risks and uncertainties, many of which are beyond our control. All statements
other than statements of historical facts included in this prospectus, including
the statements under "Prospectus Summary," "Management's Discussion and Analysis
of Financial Condition and Results of Operations," and "Business," and elsewhere
in this prospectus regarding our strategy, future operations, financial
position, estimated revenues, projected costs, prospects, plans and objectives
of management are forward-looking statements. When used in this prospectus, the
words "will," "believe," "anticipate," "intend," "estimate," "expect," "project"
and similar expressions are intended to identify forward-looking statements,
although not all forward-looking statements contain such identifying words. All
forward-looking statements speak only as of the date of this prospectus. We
undertake no obligation to update or revise publicly any forward-looking
statements, whether as a result of new information, future events or otherwise.
Although we believe that our plans, intentions and expectations reflected in or
suggested by the forward-looking statements we make in this prospectus are
reasonable, we can give no assurance that such plans, intentions or expectations
will be achieved.

We disclose important factors that could cause our actual results to differ
materially from our expectations ("cautionary statements") under "Risk Factors"
and elsewhere in this prospectus. Such factors include, among others, the
following: difficulties we may face in accessing the capital markets to fund
capital expenditures, the bankruptcy or other financial difficulties experienced
by our Internet service provider customers and our ability to retain end-users
that are serviced by delinquent Internet service provider customers, receipt of
timely payment from our Internet service provider and other customers, and
successfully reducing our costs and overhead while continuing to provide good
service, and our ability to successfully market our services to current and new
customers, generate customer demand for our services in the particular regions
where we plan to market services, achieve acceptable pricing for our services,
respond to increasing competition, manage growth of our operations, access
regions and negotiate suitable interconnection agreements with the incumbent
local exchange carriers, all in a timely manner, at reasonable costs and on
satisfactory terms and conditions, as well as regulatory, legislative and
judicial developments and general economic conditions. The cautionary statements
qualify all forward-looking statements attributable to us or persons acting on
our behalf.

i
<PAGE>

PROSPECTUS SUMMARY

COVAD COMMUNICATIONS GROUP, INC.

THIS SUMMARY HIGHLIGHTS INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS.
YOU SHOULD READ THE ENTIRE PROSPECTUS, INCLUDING "RISK FACTORS" BEGINNING ON
PAGE 7, CAREFULLY BEFORE INVESTING IN THESE SECURITIES.

OUR COMPANY

We believe we are a leading provider of high-speed Internet access and
related communications services which we sell to businesses and consumers
directly or indirectly through Internet service providers, telecommunications
carriers and other Internet resellers. These services include a range of
high-speed, high-capacity gateways for connecting end-users to the Internet and
corporate networks using traditional 2-wire copper telephone wiring. The
technology that makes this possible is commonly referred to as "digital
subscriber line" or "DSL."

We sell our services directly to business and consumer end-users through
our direct and telephone sales force and our website. We also sell our services
to Internet service providers and telecommunications carriers, who resell our
services to their business and consumer end-users. Our other customers are large
companies with established brand names or other organizations that resell our
Internet access services.

We have a relatively short operating history because we were incorporated
in October 1996. We introduced our services commercially in the San Francisco
Bay Area in December 1997. As of December 31, 2000, we believe we have one of
the largest nationally deployed digital subscriber line networks based on our
2,000 operational central offices which pass more than 47 million homes and
businesses. We have announced plans to close approximately 250 central offices
and when these closings are completed, our network will pass more than 40
million homes and businesses.

As of December 31, 2000, we had 274,000 high-speed Internet access lines in
service using digital subscriber line technology. We have received orders for
our services from more than 250 Internet service provider and telecommunications
carrier customers.

As of December 31, 2000, we had deployed our network in a total of 120
targeted population centers in the United States, but we plan on reducing this
number to 109 targeted population centers in 2001. When we complete our
planned closure of approximately 250 central offices, we expect that our network
will pass 40% of homes and 45% of businesses in the United States. We are also
developing a variety of services that are enhanced or enabled by our high-speed
network and we are entering into business arrangements in order to bring a
variety of additional service offerings to our customers and their end-users.

Since our inception, we have generated significant net losses and we
continue to experience negative cash flow. As of September 30, 2000, we had an
accumulated deficit of approximately $680 million. We expect these losses and
negative cash flow to continue at least through 2002.

RECENT DEVELOPMENTS

On December 12, 2000, we announced our expected results for the quarter
ending December 31, 2000, as well as for 2001, in light of our restructuring and
other recent events. For the fourth quarter of 2000, we expect that revenue will
be between $60 and $65 million. We expect fourth quarter EBITDA losses to be in
the range of $180 to $190 million, which includes our projected restructuring
charge of up to $20 million. We announced that our estimated fourth quarter
capital expenses would be approximately $100 million and that we expected the
number of installed lines to be 270,000 at 2000 year end. For 2001, we announced
that we expect our aggregate installed lines will be 440,000 to 460,000 at 2001
year end and our expected revenue will be $380 to $390 million. We also
announced that our EBITDA losses in total for 2001 are expected to be $450 to
$470 million and that our total capital expenses are projected to be
approximately $250 million in 2001. These numbers do not give effect to Staff
Accounting Bulletin 101, which will be adopted in the fourth quarter of 2000.
Finally, we announced that we expect our monthly cash burn rate to decrease to
less than $60 million by the end of 2001. At this lowered cash burn rate, we
expect our current funding to last into 2002. This is based on the assumption
that there will not be an ultimate unfavorable outcome in the securities
litigation in which we are involved prior to January 2002.

1
<PAGE>

October 17, 2000, that we did not recognize the revenue generated by those
customers in the third quarter of 2000. The aggregate revenue associated with
such Internet service provider customers that was not recognized was
approximately $11.4 million. With respect to several other delinquent Internet
service provider customers, including Flashcom, partial payments were made
and/or payment schedules agreed to.

Subsequent to October 17, 2000, Flashcom, which had made a $1.25 million
payment shortly before October 17, 2000, and had agreed to a payment schedule at
that time, refused to adhere to their payment schedule. In light of these new
events, we did not recognize $7.5 million of revenue attributable to Flashcom
for the third quarter of 2000. Subsequent to November 1, 2000, we learned that
four additional Internet service provider customers did not appear to have
sufficient long-term financial resources (without the infusion of additional
capital) to assure us that they would be able to make timely payment for our
services. Accordingly, we did not recognize revenue earned from those four
Internet service providers during the third quarter of 2000, except for $3.8
million of cash payments that we received from those four Internet service
providers during this period. The total revenue for these Internet service
provider customers, including Flashcom, that we did not recognize in the third
quarter of 2000 is $10.4 million. As a result, the revenue for the quarter ended
September 30, 2000, was reduced to $56.3 million compared to the $66.7 million
reported in our October 17, 2000 earnings release.

On January 8, 2001, we announced, in our fourth quarter and year-end
operating statistics, that a total of nineteen Internet service provider
customers had been placed on non-revenue recognition status by us because they
were unable to assure us that they would be able to make timely payment for our
services. As of December 31, 2000, these Internet service provider customers
account for approximately 92,000 of our total 274,000 installed lines. Although
we have stopped taking orders from some of these nineteen Internet service
provider customers, we are continuing to install previously accepted orders from
certain of these Internet service provider customers. As we continue to install
the previously accepted orders from certain of these Internet service provider
customers, we expect the number of installed lines served by these nineteen
Internet service providers will continue to grow.

We have terminated our contracts with some of these Internet service
provider customers who have become delinquent in their payments to us. We may
also decide to disconnect end-users that are purchasing our services from
delinquent Internet service provider customers. If this occurs, there can be no
assurance that these end-users will continue to purchase our services from us or
from another one of our Internet service provider customers. Even if we are able
to move these end-users to other Internet service provider customers or to our
network, it will require a significant amount of our resources, which may impair
our ability to install new lines as they are ordered. Any of these circumstances
could adversely affect our business.

Four of these nineteen Internet service provider customers, Flashcom, Zyan
Communications, Relay Point and Fastpoint, have filed for bankruptcy protection.
As of December 31, 2000, these four Internet service provider customers
represent more than half of the lines served through these nineteen Internet
service provider customers. We also expect to see more bankruptcies among
our Internet service provider customers. These bankruptcies will make it more
difficult to migrate lines away from bankrupt Internet service provider
customers. It is also possible that the bankruptcy courts will require that we
continue providing our services to bankrupt Internet service provider customers
or that we continue installing new orders for lines served by bankrupt Internet
service providers during the bankruptcy proceedings. In addition, Zyan
Communications was recently ordered by the bankruptcy court to pay us in advance
for future services, on a weekly basis, beginning in January 2001.

We expect that we will not be able to recognize some or all of the revenue
associated with one or more additional Internet service provider customers in
the future. We are in the process of exploring a variety of alternatives with
respect to delinquent Internet service provider customers, including sending
notices of termination of service and arranging for the direct transfer of lines
to our network or to our other Internet service provider customers. However, in
light of the financial position of many of these Internet service provider
customers, should the particular Internet service provider customer become
subject to reorganization or bankruptcy proceedings, no assurance can be given
that we will be able to retain payments or other consideration (including lines)
received by us.

On October 31, 2000, at the regularly-scheduled meeting of our Board of
Directors, Mr. Robert Knowling Jr., our then Chairman of the Board, President
and Chief Executive Officer, presented his business plan to address the business
challenges facing us. Mr. Knowling told the Board that if it wished to pursue a
different course or wanted new leadership, he would tender his resignation.
After consideration of our needs, the Board decided that we should

2
<PAGE>

follow a business plan different from the one proposed by Mr. Knowling. In light
of the Board's decision, the Board and Mr. Knowling agreed that he should
resign.

After our October 17, 2000 earnings release, several of our shareholders
have filed class action lawsuits against the Company and its officers alleging
violations of federal securities laws. Several other shareholders have filed
similar lawsuits since that time. In addition, some of the purchasers of our
$500 million aggregate principal amount of convertible senior notes that we sold
in September 2000 have filed complaints in California Superior Court alleging
fraud and deceit and violations of State securities laws. The relief sought in
these lawsuits includes rescission of their purchases of the convertible notes
and unspecified damages.

These lawsuits, the financial difficulties faced by some of our Internet
service provider customers and the limited availability of additional capital
funding pose significant challenges to management and the success of our
business. In response to these challenges, we recently announced a new top level
business plan for our company for 2001, which includes the following steps:

o we plan on closing underproductive or not fully built-out central
offices and holding the size of our network at approximately 1,750
central offices, which will significantly reduce our capital
expenditures;

o we are reducing our workforce by 800 positions, approximately 25
percent of our workforce;

o we are closing a facility in Alpharetta, Georgia and consolidating
offices in Manassas, Virginia, Santa Clara, California and Denver,
Colorado;

o we are restructuring our Covad Business Solutions division, formerly
BlueStar.net, to streamline our direct sales and marketing channel;
and

o we are evaluating and intend to implement other reductions in
operating costs.

In connection with this restructuring, we announced that we will report a
charge of up to $20 million in the quarter ending December 31, 2000,
substantially all of which will require the future expenditure of cash.

We are currently aware of Staff Accounting Bulletin 101. "Revenue
Recognition in Financial Statements," which was issued in December 1999 by the
Securities and Exchange Commission. SAB 101 provides that, in certain
circumstances, revenues received at the inception of a service arrangement have
to be deferred and recognized on a straight-line basis over the term of the
contract or the expected term of the customer relationship, whichever is longer,
provided that all other criteria for revenue recognition have been met. SAB 101
also limits, if necessary, the deferral of incremental direct costs associated
with the origination of a customer arrangement to an amount that is no greater
than the amount of up-front revenues that have been deferred. Due to the
complexities of implementing SAB 101, the SEC has deferred the implementation
date of SAB 101 until the quarter ending December 31, 2000, with retroactive
application to January 1, 2000, which will require adjustments consistent with
SAB 101 with respect to our quarterly financial information for each of the
three quarters in the period ended September 30, 2000. In October 2000, the SEC
issued further interpretive guidance on the implementation of SAB 101. Our
analysis of the impact of implementing SAB 101 is still in process. However,
although SAB 101 will substantially alter the timing of recognition of certain
revenues and treatment of certain costs in our consolidated financial
statements, it will not affect our consolidated cash flows. Accordingly, we
believe that the implementation of SAB 101 for the year ending December 31, 2000
will have a material adverse effect on our consolidated financial position and
results of operations, but will not affect our consolidated cash flows.

3
<PAGE>

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

Common stock outstanding as of
December 31, 2000......................................... 178,855,807 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 62 million 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.

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

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.

SUMMARY CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>

NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
-------------------------------------- ----------------------------
1997 1998 1999 1999 2000 (2)(3)
---------- ------------ ------------- ------------ --------------
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
<S> <C> <C> <C> <C> <C>
Revenues.................................. $ 26 $ 5,326 $ 66,488 $ 35,570 $ 156,308
Operating expenses:
Network and product costs.............. 54 4,562 55,347 32,219 133,085
Sales, marketing, general and
administrative....................... 2,374 31,043 140,372 80,786 311,444
Depreciation and amortization.......... 70 3,406 37,602 23,911 74,600
Amortization of goodwill and other
intangible assets.................... -- -- -- -- 44,171
Amortization of deferred compensation.. 295 3,997 4,768 3,895 2,609
Write-off of in-process technology..... -- -- -- -- 3,726
---------- ------------ ------------- ------------ --------------
Total operating expenses............. 2,793 43,008 238,089 140,811 569,635
---------- ------------ ------------- ------------ --------------
Loss from operations...................... (2,767) (37,682) (171,601) (105,241) (413,327)
Net interest expense................... 155 (10,439) (23,796) (19,620) (35,980)
Other income........................... -- -- -- -- 15,768
---------- ------------ ------------- ------------ --------------
Net loss.................................. (2,612) (48,121) (195,397) (124,861) (433,539)
Preferred dividends....................... -- -- (1,146) (1,146) --
---------- ------------ ------------- ------------ --------------
Net loss attributable to common $ (2,612) $ (48,121) $ (196,543) $ (126,007) $ (433,539)
stockholders..............................
========== ============ ============= ============ ==============
Net loss per share--basic and diluted...... $ (.35) $ (3.75) $ (1.83) $ (1.27) $ (2.85)
========== ============ ============= ============ ==============
Weighted average shares used in
computing net loss per share--basic
and diluted.......................... 7,361 12,844 107,648 99,553 152,031
========== ============ ============= ============ ==============

OTHER FINANCIAL DATA:
EBITDA(1)................................. $ (2,402) $ (30,154) $ (129,231) $ (77,435) $ (288,221)

CONSOLIDATED CASH FLOW DATA:
Capital expenditures...................... $ 2,253 $ 59,503 $ 208,186 $ 145,607 $ 384,628
Net cash used in operating activities..... (1,895) (9,054) (102,767) (65,721) (273,614)
Net cash used in investing activities..... (2,494) (61,252) (736,096) (233,877) (92,158)
Net cash provided by financing activities. 8,767 130,378 990,451 416,951 912,632
</TABLE>
<TABLE>
<CAPTION>

AS OF DECEMBER 31, AS OF
----------------------------------- SEPTEMBER 30,
1997 1998 1999 2000
-------- ----------- ----------- ------------------
(UNAUDITED)
(DOLLARS IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
<S> <C> <C> <C> <C>
Cash and cash equivalents and short-term investments.... $ 4,378 $ 64,450 $ 767,357 $ 913,130
Net property and equipment.............................. 3,014 59,145 237,542 568,286
Total assets............................................ 8,074 139,419 1,147,606 2,241,793
Long-term obligations, including current portion........ 783 142,879 375,049 1,338,454
Total stockholders' equity (net capital deficiency)..... 6,498 (24,706) 690,291 667,440
</TABLE>
5

<PAGE>

<TABLE>
<CAPTION>
AS OF
SEPTEMBER 30,
AS OF DECEMBER 31, 2000
-------------------------------------
1997 1998 1999
---------- ------------ ------------- ------------------
OTHER OPERATING DATA:
<S> <C> <C> <C> <C>
Homes and businesses passed............................ 278,000 6,023,217 29,000,000 47,000,000
Lines installed........................................ 26 3,922 57,000 205,000
</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.

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

(3) In September 2000, we acquired BlueStar in a transaction accounted for as a
purchase. Accordingly, the summary consolidated statement of operations data
for the nine months ended September 30, 2000 include the results of
operations of BlueStar from the date of acquisition (September 22, 2000)
through September 30, 2000. The summary consolidated financial data for the
nine months ended September 30, 2000 are not necessarily indicative of the
results that may be expected for the entire fiscal year or further periods.

<PAGE>

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," "ESTIMATES," "PROJECTS" 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.

WE ARE CURRENTLY FACING SIGNIFICANT CHALLENGES TO OUR BUSINESS THAT MAY
CAUSE US TO DELAY OR LIMIT OUR CONTINUED GROWTH OR OPERATIONS.

We recently announced a new top level organization-wide business plan for
2001 because we believe that, due to the financial difficulties facing our
Internet service provider customers and the resulting adjustments to our revenue
that resulted from their inability to pay for our services, the shareholder and
noteholder lawsuits against us, the fact that we have generated significant net
losses and that we continue to experience negative cash flow, it may be
difficult for us to access the capital markets on reasonable terms or at all.
These challenges that we are facing, combined with this potential for continuing
lack of access to capital on reasonable terms or at all, may cause us to make
further revisions to our business plan, or delay, curtail, reduce the scope of,
or eliminate our marketing and sales efforts, the scope of our network, and our
other operations. If we must further revise our business plan, because of the
continued negative impact of the financial difficulties of our Internet service
provider customers or adverse results from resolving existing lawsuits we may
not achieve positive cash-flow or turn profitable as planned, expected or
announced.

OUR BUSINESS WILL SUFFER IF OUR INTERNET SERVICE PROVIDERS AND
TELECOMMUNICATIONS CARRIERS AND OTHER THIRD PARTIES ARE NOT SUCCESSFUL IN
MARKETING AND SELLING OUR SERVICES OR CONTINUE TO HAVE PROBLEMS PAYING FOR 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. For
example, in the months of August, September and October of 2000, one of our
Internet service providers provided approximately 40% of our orders. 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 including revenues and line-growth 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. Market or other conditions that adversely affect our Internet
service provider customers could result in slower 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, future relationships we may establish with
other third parties may not result in significant line orders or revenues.

Due to difficulty accessing the capital markets and, in some cases,
inability to generate sufficient revenues to be self-funding, several of our
Internet service provider customers have experienced financial difficulties and
are not current in their payments for our services. As a result, we did not
record revenue from certain Internet service provider customers during the third
and fourth quarters of 2000. As of December 31, 2000, 19 Internet service
provider customers, which account for approximately 92,000 of our 274,000
installed lines were experiencing severe shortfalls in operating capital and
were not able to stay current in their payments. Four of these nineteen Internet
service provider customers, Flashcom, Zyan Communications, Relay Point and
Fastpoint, have filed for bankruptcy protection. As of December 31, 2000, these
four Internet service provider customers represented more than half of the
92,000 lines served through these nineteen Internet service provider customers.
With respect to the 19 Internet service provider customers, approximately 50% of
their lines are business lines and approximately 50% are consumer lines.
Business lines carry a higher profit margin than consumer lines. Although we
will continue to try to obtain payments from these customers, it is likely that
we will not be able to obtain payments from one or more of these customers. With
respect to the four Internet service provider customers that are in bankruptcy
proceedings, as

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well as any additional Internet service provider customers that seek bankruptcy
protection, there can be no assurance that we will ultimately collect sums owed
to us by these customers and it remains uncertain what consequence, if any,
bankruptcy proceedings would have on lines installed for such customers.
Moreover, to the extent that we receive payments from customers that
subsequently seek bankruptcy protection, we may be required to return some or
all of these payments to the bankruptcy trustee. The inability of our Internet
service provider customers to pay these past due amounts, and to make timely
payments for our services in the future, has adversely affected our financial
condition and results of operations and may continue to do so in the future.

We expect that additional Internet service provider customers may be unable
to pay for our services in the future if they are unable to obtain additional
funding which means that we will not recognize the revenue associated with these
additional Internet service provider customers. We have terminated our contracts
with some of these Internet service provider customers and we have and may
continue to disconnect end-users that are purchasing our services from
delinquent Internet service providers. There can be no assurance that these
end-users will continue to purchase our services from us or from another one of
our Internet service provider customers. Even if we are able to transition these
end-users to another Internet service provider or to ourselves, such migrations
will require a significant amount of our resources and cause disruptions in our
processes and operations, which may impair our ability to install new lines as
they are ordered. Any of these circumstances could adversely affect our
business.

WE ARE A PARTY TO LITIGATION AND ADVERSE RESULTS OF SUCH LITIGATION MATTERS
COULD NEGATIVELY IMPACT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Three purchasers of our convertible notes have filed complaints in
California Superior Court for the County of Santa Clara. These complaints allege
fraud and deceit, negligence and violations of state securities laws in
connection with our sale of the convertible notes. The relief sought includes
rescission of their aggregate purchases of approximately $90 million in
aggregate principal amount of convertible notes and unspecified damages,
including punitive damages. The plaintiff in one of these matters has requested
a trial date in August 2001, but we intend to oppose this request. One of the
plaintiffs in these matters has also sought a writ of attachment for the full
amount of their rescission claim for their purchases of convertible notes. On
December 11, 2000, this request for a writ of attachment of $46 million in
aggregate principal amount of our convertible notes was denied. Three additional
purchasers have indicated that they intend to file similar lawsuits.

In addition, a former LaserLink.net shareholder has filed a complaint
against us in the Supreme Court for the State of New York. He is seeking damages
arising out of our alleged failure to register Covad shares that he received in
exchange for his Laser Link.net shares. We do not believe that his claims have
any merit, but we cannot assure you that we will prevail in this matter.

While we believe we have strong defenses to and are vigorously defending
these lawsuits, the total outcome of these litigation matters is inherently
unpredictable and there is no guarantee we will prevail. Moreover, we cannot
guarantee the successful resolution of these actions and an adverse result in
these actions, including settlement of these actions, could negatively impact
our financial condition and results of operations. In addition, defending such
actions could result in substantial costs and diversion of resources that could
adversely affect our financial condition, results of operations and cash flows.

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

After consideration of the distressed financial condition of our Internet
service provider customer channel and after discussion with our legal counsel
regarding the current status and the potential impact of the various lawsuits
filed against us by certain shareholders and purchasers of our convertible
notes, we believe our current cash, cash-equivalents and short-term investments,
including proceeds received from our recently completed stock

8
<PAGE>

purchase agreement with SBC, will be sufficient to meet our anticipated cash
needs for working capital and capital expenditures into the first quarter of
2002. This is based on the assumption that there will not be an ultimate
unfavorable outcome in the securities litigation in which we are involved prior
to January 2002, and, if necessary, we will develop a contingency plan to
address any material adverse developments in the securities litigation.
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. Moreover, we believe that current capital
market conditions, particularly for our industry, may severely restrict our
ability to obtain such additional financing. In addition, we expect that the
revenue recognition issues that we reported with our third quarter results, and
the legal proceedings against us which followed the announcement of our earnings
results for the third quarter, will make it particularly difficult for us to
access capital markets. 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 further delay the expansion of our business or take or forego
actions, any or all of which could harm our business and hinder our ability to
repay our indebtedness or respond to competitive industry developments.

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 to seek to amend
our indentures, which we may be unable to do on acceptable terms.

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 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.

Our future success also depends on our continuing ability to identify,
hire, train and retain other highly qualified technical, sales, marketing, and
managerial personnel as we add end-users to our network. Competition for such
qualified personnel is intense. The recent significant drop in our stock price
has eliminated the value of stock options held by our employees, making it more
difficult to retain employees in this competitive market. 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.

The resignation of Robert E. Knowling, Jr. as our President, Chief
Executive Officer and Chairman of the Board of Directors and other related
organizational changes may also cause significant disruption to our business.
His resignation also may impair our ability to retain and attract other key
personnel.

9
<PAGE>

WE MAY BE ADVERSELY AFFECTED BY OUR DIFFICULTY ACCESSING CAPITAL MARKETS AND
SUCH CAPITAL CONSTRAINTS MAY CAUSE US TO REVISE OUR BUSINESS STRATEGIES AND/OR
DELAY OR LIMIT CONTINUED GROWTH OR OPERATIONS

In order to fund continued development, deployment and expansion of our
networks and fund operating losses, we will need continued access to the capital
markets on terms we believe are reasonable. If adequate funds are unavailable or
not available on acceptable terms, we may further revise our business strategies
and/or further delay, curtail, reduce the scope of, or eliminate the expansion
of our networks, operations and/or our marketing and sales efforts. Should we
revise our business strategies, we may not achieve break even on a cash-flow
basis or EBITDA basis or turn to profitability as planned, expected or
announced.

We believe that current capital market conditions, particularly for our
industry, will significantly reduce our ability to obtain additional financing
on reasonable terms or at all. In addition, we expect that the revenue
recognition issues that we reported with our third quarter results, and the
legal proceedings against us which followed such announcements, will make it
particularly difficult for us to access capital markets. We have already made
significant reductions in our capital expenditures in response to these events.
If we experience continued or prolonged barriers to raising additional financing
through the capital markets, we may need to make additional significant
reductions in our capital expenditures. Such reductions could have a material
adverse effect on our financial condition and business operations and prevent us
from effectively implementing our business plan. Such reductions may also
adversely affect the relationships with our customers and/or their end-users
that may in turn adversely affect our growth and financial results.

We have no commitments for any future financing and there can be no
assurance that we will be able to obtain additional financing in the future from
either debt or equity financings, bank loans, collaborative arrangements or
other sources on terms acceptable to us, or at all. Any additional equity
financing may be dilutive to our stockholders. Collaborative arrangements, if
necessary to raise additional funds, may require us to relinquish rights to,
among other things, market our services in certain territories.

IT MAY BE NECESSARY FOR US OR OUR INTERNET SERVICE PROVIDER CUSTOMERS TO REDUCE
CAPITAL EXPENDITURES WHICH MAY ADVERSELY AFFECT OUR FINANCIAL RESULTS

We are in the process of making significant reductions in our capital
expenditures, which may adversely affect our financial results. We have never
previously reduced our capital expenditures and it is uncertain what affect such
a reduction will have on our operations, customer and/or end-user relationships,
growth prospects and financial results. Even with these capital reductions that
we are making, we may not be able to break even on a cash-flow basis or EBITDA
basis or turn to profitability as planned, expected or announced.

Likewise, we expect that many of our Internet service provider customers
will make significant cutbacks in their capital expenditures, which would in
turn adversely affect our financial results. Since our Internet service provider
customers face many of the same challenges that we face, we may be adversely
affected by these reductions since it is uncertain what effect such reductions
will have on their operations, customer and/or end-user relationships, growth
prospects and financial results. Any significant adverse effect on our Internet
service provider customers may adversely affect us.

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 ROLLOUT 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's "Project Pronto"). For us to provide copper based DSL services to
these end-users, we need 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

10
<PAGE>

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 fail to 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 or 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
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. In February of 2000, SBC
sought a waiver from the FCC of certain merger conditions that it had agreed to
as part of its merger with Ameritech. Specifically, SBC sought permission from
the FCC to put ownership of certain advanced services equipment in the SBC
ILECs, rather than in SBC's advanced services affiliate as required by those
merger conditions. SBC sought the waiver in order to facilitate deployment of a
new remote terminal architecture throughout its network (called "Project
Pronto"). On September 7, 2000, the FCC adopted an order granting SBC's waiver
request, subject to numerous conditions designed to ensure that competitive
LEC's, such as us, have nondiscriminatory access to all of the features,
functions and capabilities of the Pronto architecture.

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<PAGE>

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.

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. Although the FCC has
appealed the Eighth Circuit's decision, it may also adopt new rules to reflect
the cost methodology that was approved by the Eighth Circuit. 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.

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, in August 2000, employees of Verizon
Communications conducted a work stoppage that impaired 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

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<PAGE>

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 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. Beginning in 2001, we will
generally provision new orders for consumer-grade services over line-shared
telephone wires. If the traditional telephone companies fail to deliver
line-shared telephone wires in sufficient quantities or to deliver functioning
line-shared telephone wires in an acceptable period of time, the growth of our
consumer business will be adversely affected.

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. We are experiencing ongoing
difficulties with the traditional local telephone companies as they attempt to
provide us with line sharing which has resulted in disruption and dislocation to
our ability to provide our services. The performance of the various traditional
telephone companies varies widely. The efforts of the traditional phone
companies have adversely affected our ability to scale our consumer-grade
services and to make those services profitable.

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.

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
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 unbundling and
collocation, we generally have to renegotiate our 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 our ability to
provide services, we 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

<PAGE>

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 adapt to regulatory changes;

o rapidly install high-speed access lines and/or implement line sharing;

o grow our revenue and increase our margins to cover our sizable network
costs;

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 September 30, 2000, we had an
accumulated deficit of approximately $679.7 million. To date, we have increased
our capital expenditures and operating expenses each quarter in order to expand
our business. Although we are in the process of reducing our capital
expenditures, 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 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 financial condition of our customers;

o the level of marketing required to acquire 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;

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<PAGE>

o pending litigation;

o 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 convertible
notes, and the amortization charges related to our issuance of preferred stock
to AT&T Ventures and two affiliated funds ("AT&T Ventures"), XO Communications
(formerly NEXTLINK Communications, Inc. ("NEXTLINK") and Concentric Network
Corporation) 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 Interest and amortization charges relating to the convertible notes
will be approximately $8.9 million during the year ending December 31,
2000, assuming no conversion prior to year end, and will be
approximately $33.1 million each following year until the convertible
notes are converted or, if not converted, until maturity of the
convertible notes in September 2005.

o We recorded intangible assets of $28.7 million associated with the
issuance of our preferred stock to AT&T Ventures, NEXTLINK (now XO
Communications) 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.

o We recorded goodwill and other intangible assets of $398.6 million
resulting from the acquisition of Laser Link. Amortization charges
relating to this acquisition will be approximately $61.0 million
during the year ending December 31, 2000 and approximately $79.7
million annually from 2001 through 2004 and $17.7 million in 2005.

o We recorded goodwill and other intangible assets of $123.1 million
resulting from the acquisition of BlueStar. Amortization charges
relating to this acquisition will be approximately $7.6 million during
the year ending December 31, 2000, approximately $27.5 million during
the years ending December 31, 2001 and 2002, approximately $25.6
million during the year ending December 31, 2003, approximately $20.3
million during the year ending December 31, 2004, and approximately
$14.9 million during the year ending December 31, 2005.

Any future financing we are able to obtain may be on terms less favorable
to us than the terms of our existing financings, and charges related to any such
future financing may be proportionately greater.

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 effect of our revised business plan on our relationship with our
customers;

15
<PAGE>

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 difficulties we may face in accessing the capital markets to fund such
capital expenditures;

o the bankruptcy or other financial difficulties experienced by our
Internet service provider customers;

o our ability to collect "past-due" receivables from certain key
customers;

o receipt of timely payment from our Internet service provider and other
customers;

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 the necessity of decreasing 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 our ability to successfully defend our company against certain pending
litigation;

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 our ability to reduce our capital expenditures and other expenses
without jeopardizing our relationships with key customers and
suppliers;

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

o our ability to integrate the businesses we acquire into our business
efficiently; 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

16
<PAGE>

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 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. Since we are currently selling most of our services to
end-users through third parties, our ability to retain these end-users is
largely dependent on the performance of these resellers. If these resellers fail
to satisfy their obligations to their end-users, or if they do not pay us for
our services, we may lose end-users or we may be forced to disconnect end-users.
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 (now XO Communications)--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 materially adversely affect our
business, no assurance can be given that such combinations will not ultimately
have such a material 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 acquisition of BlueStar, which sells its services
directly to end-users, may cause our existing Internet service provider
customers to view us as a competitor. Such Internet service providers may
therefore 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 MARGINS ON THE SALE OF 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 and significantly lower profit margins than our business-grade services.
In recent months, the number of orders that we have received for consumer-grade
services have been greater than the number of orders we have received for
business-grade services.

SEPTEMBER 30, 1999 DECEMBER 31, 1999 MARCH 31, 2000 JUNE 30, 2000 SEPTEMBER 30, 2000
------------------ ----------------- --------------- -------------- ------------------
<S> <C> <C> <C> <C> <C>
Total Installed 26,387 44,840 67,912 93,301 112,367
Business-Grade Lines....
Total Installed Consumer
Lines................... 4,613 12,160 25,088 44,699 92,633
Total Installed Lines...... 31,000 57,000 93,000 138,000 205,000
</TABLE>

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<PAGE>

We expect that the percentage of our revenues which we derive from our
consumer services will continue to increase and 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 increase the number of end-users on our
network within our existing metropolitan statistical areas. The execution of
this strategy involves:

o obtaining and maintaining 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.

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, operational and capital resources. We 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 Covad 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

18
<PAGE>

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.

Although we are continuing to grow our business, we are also exploring
various strategies for reducing our costs. As we implement these strategies, we
may cause disruption to our business if we do not manage this cost cutting
effort properly. For example, we recently announced that we are closing
approximately 250 of our central offices. We expect that these closings will
result in significantly reduced service to customers that have end-users served
out of those central offices. Those customers may choose to seek services from
our competitors. We are strategically selecting central offices for closure that
service the fewest end-users or are otherwise least productive. However, there
can be no assurance that closing these central offices will not result in
significant loss of our customers' confidence, and otherwise disrupt our
business.

We have recently experienced a significant increase in the volume of orders
for our line-shared consumer-grade services. We continue to encounter
difficulties with our internal operations and with the traditional telephone
companies that are providing the line-shared telephone wires. We are improving
the processes involved in line-sharing, but we currently have a significant
backlog of uninstalled orders for line-shared services because of ongoing
difficulties with our operational processes and the traditional telephone
companies.

Beginning in 2001, we are seeking to provision new orders for
consumer-grade services over line-shared telephone wires whenever possible. We
have not yet proven our ability to efficiently scale our line-shared
consumer-grade operations and business, so this widespread implementation of
line-sharing may cause disruption and dislocation to our business, which could
jeopardize our relationships with our customers and with end-users of our
services. We also may not be able to respond to increasing demand for
consumer-grade services. This may lead to reduced demand for our services and
may adversely affect our operating results. Our inability to improve our process
for installing line-shared orders continues to adversely affect our ability to
reduce our costs and improve our efficiency. In addition, this lack of success
will impair further cost reduction efforts, such as our planned implementation
of self-installation of line-shared services.

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 acquisitions of Laser Link.Net, Inc., BlueStar
Communications Group, Inc. and of preferred stock representing 70% of Loop
Telecom (a 50% voting interest), 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 acquisition,
including the Laser Link, BlueStar and Loop Holdings acquisitions, may not
provide the benefits originally anticipated, and there may be difficulty in
integrating the service offerings and networks gained through acquisitions and
strategic investments with our own. In a strategic investment where we acquire a
minority interest in a company, we may lack control over the operations and
strategy of the business, and we cannot guarantee that such lack of control will
not interfere with the integration of services and distribution channels of the
business with our own. Although we attempt to minimize the risk of unexpected
liabilities and contingencies associated with acquired businesses through
planning, investigation and negotiation, such unexpected liabilities
nevertheless may accompany such strategic investments and acquisitions. We
cannot guarantee that we successfully will:

o identify attractive acquisition and strategic investment candidates;

o complete and finance additional acquisitions on favorable terms; or

o integrate the acquired businesses or assets into our own.

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<PAGE>

We cannot guarantee that the integration of our business with any acquired
company's business, including the businesses of Laser Link, BlueStar and Loop
Holdings, will be accomplished smoothly or successfully, if at all. Any of these
factors could materially harm our business or our operating results in a given
period.

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 remote
network 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. Our ability to stay competitive may be reduced
if our new business plan is not successful, or if we are unable to obtain
additional financing as and when needed. 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 $29 per month and their business
DSL services as low as $39 per month, placing pricing pressure on our services.
While we are allowed to provide our data services over the same telephone wires
that they provide analog voice services, we have experienced difficulties in
implementing this ability. There is no assurance that we can 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, consolidations
involving the traditional telephone companies 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

20
<PAGE>

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.

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

As of September 30, 2000, we have approximately $1.3 billion of long-term
obligations, which consists primarily of the 1998 notes, the 1999 notes, the
2000 notes and the convertible 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, the 2000 notes, and
the convertible 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, the 2000
notes and the convertible 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 will require additional capital
infusions in the future in addition to our cash flow from operations to permit
us to grow our business and pay the principal and interest on our current
indebtedness and the convertible notes, 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 we began paying cash interest on
the 2000 notes in August 2000. We will begin paying cash interest on the
convertible notes on March 15, 2001.

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 receipt of timely payment from our customers;

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.

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

21
<PAGE>

respect to the 1998 notes, the 1999 notes, the 2000 notes, or the convertible
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.

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 Verizon (formerly Bell
Atlantic) for an alleged infringement of a patent issued to them in September
1998 entitled "Variable Rate and Variable Mode Transmission System." Although
the court recently held that we do not infringe Verizon's patent, Verizon 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.

A manufacturer of telecommunications hardware named "COVID" has filed an
opposition to our trademark application for the mark "COVAD and design". Covid
has also filed a complaint in the United States District Court for the District
of Arizona, alleging claims for false designation of origin, infringement and
unfair competition. We do not believe that this lawsuit on the opposition to our
trademark application have merit, but these legal proceedings are unpredictable
and there is no guarantee we will prevail. If we do not succeed, it could limit
our ability to provide our services under the "COVAD" name.

THE SCALABILITY AND SPEED OF OUR NETWORK REMAIN LARGELY UNPROVEN

As of September 30, 2000, we have deployed our network in a total of 120
targeted population centers, 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;

22
<PAGE>

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.

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.

23
<PAGE>

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.

CONTINUING ECONOMIC DOWNTURN OR VOLATILITY COULD ADVERSELY IMPACT DEMAND FOR OUR
SERVICES

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. Since March, 2000, the general economic health of the
United States or of California has been less robust than recent historically
high levels, and individuals and companies may seek to reduce expenses and
reduce, in the near term, expenditures, such as those for our services. Concern
about continuing economic 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.

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

24
<PAGE>

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 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 us 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.

25
<PAGE>

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 us. 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 designed to work on the same line as analog telephone service.
Most traditional telephone companies provide ADSL service exclusively 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.

THE PRICE OF OUR COMMON STOCK MAY FLUCTUATE SIGNIFICANTLY, WHICH MAY RESULT IN
LOSSES FOR INVESTORS

The market price for our common stock has been and is likely to continue to
be highly volatile. We expect our common stock to be subject to fluctuations as
a result of a variety of factors, including factors beyond our control. These
include:

o changes in market valuations of Internet and telecommunications
related companies;

o our ability to recognize revenue;

26
<PAGE>

o any loss of major customers, or inability of major customers to make
payments;

o any deviations in net revenues or in losses from levels expected by
securities analysts;

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 including our failure to meet the expectations of our
stockholders or of 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 or our competitors 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;

o general market and general economic conditions;

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

o volume fluctuations, which are particularly common among highly
volatile securities of Internet related companies.

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 received at the inception of a service
arrangement have to be deferred and recognized on a straight-line basis over the
term of the contract or the expected term of the customer relationship,
whichever is longer, provided that all other criteria for revenue recognition
have been met. SAB 101 also limits, if necessary, the deferral of incremental
direct costs associated with the origination of a customer arrangement to an
amount that is no greater than the amount of up-front revenues that have been
deferred. Due to the complexities of implementing SAB 101, the SEC has deferred
the implementation date of SAB 101 until the quarter ended December 31, 2000
with retroactive application to January 1, 2000, which will require adjustments
consistent with SAB 101 with respect to our quarterly financial information for
each of the three quarters in the period ended September 30 2000. In October
2000, the SEC issued further interpretive guidance on the implementation of SAB
101. Our analysis of the import of implementing SAB 101 is still in process.
However, although SAB 101 will substantially alter the timing of recognition of
certain revenues and treatment of certain costs in our consolidated financial
statements, it will not affect our consolidated cash flows. Accordingly, we
believe that the implementation of SAB 101 for the year ending December 31, 2000
will have a material adverse effect on our consolidated financial position and
results of operations, but will not affect our consolidated cash flows.

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 are available for sale, could
adversely affect the market price for our common stock. As of December 31, 2000,
we had 178,855,807 shares of common stock outstanding. A significant number of
these shares are not publicly traded but are available for immediate resale to
the public, subject to certain volume limitations under the securities laws and
lock-up arrangements. We also have 31,218,424 shares of our common stock
reserved for issuance pursuant to options under our 1997 Stock Plan, of which
25,807,746 shares were subject to outstanding options as of December 31, 2000.
As of December 31, 2000, we have approximately 2.1 million shares that are
subject to options that we assumed in connection with our acquisitions of Laser
Link.Net and BlueStar. We have

27
<PAGE>

also reserved approximately 1.1 million shares of common stock for issuance
under our 1998 Employee Stock Purchase Plan as of December 31, 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.

In addition, in connection with our acquisition of BlueStar Communications
Group, Inc., we issued 8.0 million shares of our common stock to BlueStar's
shareholders, some of which are freely tradable by the new shareholders. Up to
5.0 million additional shares may be issued to the BlueStar shareholders if
certain performance targets are met by our BlueStar subsidiary in fiscal year
2001. A significant number of these BlueStar shareholders entered into lock-up
agreements, pursuant to which such shareholders promised not to sell their
shares until either 6 months or 12 months after the closing of the acquisition.
We may, in our sole discretion and at any time without notice, release all or
any portion of the securities subject to lock-up agreements entered into as part
of the BlueStar acquisition. If BlueStar shareholders were to sell their shares
of our common stock, it could adversely affect our stock price.

In connection with our acquisition of Laser Link, the former shareholders
of Laser Link agreed that 10% of the shares issued in the transaction would be
held in escrow until March 2001. Moreover, two shareholders holding an aggregate
of approximately 3,000,000 shares, have agreed that 30% of their shares will be
held in escrow. Approximately 17% of these escrowed shares were released on
September 20, 2000 and October 31, 2000, the remaining 66% of the escrowed
shares were released in November 2000. The sale of these shares could adversely
affect the price of our stock.

In connection with the $500 million of convertible notes due 2005, we may
issue up to 28,129,395 shares of our common stock. If the convertible notes are
converted into shares of our common stock, the sale of these shares could
adversely affect the price of our stock.

We recently sold 9,373,169 shares of our common stock to SBC
Communications, Inc. SBC has agreed not to transfer any of these shares until
September 11, 2001, and, after that period, SBC agreed to offer us the first
opportunity to purchase shares that it intends to sell. Sales of shares of our
common stock by SBC after this lock-up period could adversely affect the price
of our stock.

ANTI-TAKEOVER EFFECTS OF CERTAIN CHARTER AND BYLAW PROVISIONS, DELAWARE LAW, OUR
INDENTURES, OUR STOCKHOLDER PROTECTION RIGHTS PLAN AND OUR CHANGE IN CONTROL
SEVERANCE ARRANGEMENTS COULD PREVENT A CHANGE IN OUR CONTROL

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 of 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, 2000 notes and
convertible notes provide that, in the event of certain changes in control, each
holder of these 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 our capital stock. 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 and our change in control severance arrangements with
certain key executives 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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<PAGE>

USE OF PROCEEDS

The proceeds from the resale 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 on our common stock 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..................................... 23.06 13.38
Fourth Quarter.................................... 12.00 1.31

On January 8, 2001 the last reported sale price for our common stock on the
NASDAQ National Market was $1.625 per share. As of January 2, 2001, there were
847 holders of record of our common stock, and there were no holders of record
of our class B common stock.

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<PAGE>

SELECTED CONSOLIDATED FINANCIAL DATA
OF COVAD COMMUNICATIONS GROUP, INC.

The following selected consolidated balance sheet data as of December 31,
1997 was derived from our audited consolidated financial statements, which are
not included in this prospectus and are qualified by reference to those
financial statements and the related notes. The following selected consolidated
statement of operations and balance sheet data as of December 31, 1998 and 1999
and for each of the three years in the period ended December 31, 1999 have been
derived from our audited consolidated financial statements and the related
notes, which are included elsewhere in this prospectus. The following selected
consolidated statement of operations and balance sheet data as of September 30,
2000 and for the nine months ended September 30, 1999 and 2000 have been derived
from our unaudited condensed consolidated financial statements and the related
notes, which are also 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
the 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. In September 2000, we acquired BlueStar
Communications Group, Inc. in a transaction accounted for as a purchase.
Accordingly, the selected consolidated statement of operations data for the nine
months ended September 30, 2000 include the results of operations of Laser Link
and BlueStar from the dates of acquisition through September 30, 2000. The
historical results are not necessarily indicative of the results that may be
expected for the entire fiscal year or future periods.

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------------------- ----------------------------
1997 1998 1999 1999 2000
----------- ------------ ------------- ------------ --------------
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues.................................. $ 26 $ 5,326 $ 66,488 $ 35,570 $ 156,308
Operating expenses:
Network and product costs.............. 54 4,562 55,347 32,219 133,085
Sales, marketing, general and
administrative....................... 2,374 31,043 140,372 80,786 311,444
Depreciation and amortization.......... 70 3,406 37,602 23,911 74,600
Amortization of goodwill and other
intangible assets.................... -- -- -- -- 44,171
Amortization of deferred compensation.. 295 3,997 4,768 3,895 2,609
Write-off of in-process technology..... -- -- -- -- 3,726
---------- ------------ -------------- ------------ --------------
Total operating expenses............. 2,793 43,008 238,089 140,811 569,635
---------- ------------ -------------- ------------ --------------
Loss from operations...................... (2,767) (37,682) (171,601) (105,241) (413,327)
Net interest expense................... 155 (10,439) (23,796) (19,620) (35,980)
Other income........................... -- -- -- -- 15,768
---------- ------------ -------------- ------------ --------------
Net loss.................................. (2,612) (48,121) (195,397) (124,861) (433,539)
Preferred dividends....................... -- -- (1,146) (1,146) --
---------- ------------ -------------- ------------ --------------
Net loss attributable to common $ (2,612) $ (48,121) $ (196,543) $ (126,007) $ (433,539)
stockholders...........................
========== ============ ============== ============ ==============
Net loss per share--basic and diluted...... $ (0.35) $ (3.75) $ (1.83) $ (1.27) $ (2.85)
========== ============ ============== ============ ==============
Weighted average shares used in
computing net loss per share--basic
and diluted.......................... 7,361 12,844 107,648 99,553 152,031
========== ============ ============== ============ ==============

OTHER FINANCIAL DATA:
EBITDA(1)................................. $ (2,402) $ (30,154) $ (129,231) $ (77,435) $ (288,221)

</TABLE>

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<PAGE>

AS OF DECEMBER 31,
----------------------------------- AS OF SEPTEMBER 30,
1997 1998 1999 2000
--------- ----------- ------------ -------------------
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents and short-term investments. $ 4,378 $ 64,450 $ 767,357 $ 913,130
Net property and equipment........................... 3,014 59,145 237,542 568,286
Total assets......................................... 8,074 139,419 1,147,606 2,241,793
Long-term obligations, including current portion..... 783 142,879 375,049 1,338,454
Total stockholders' equity (net capital deficiency).. 6,498 (24,706) 690,291 667,440
</TABLE>

AS OF DECEMBER 31,
----------------------------------- AS OF SEPTEMBER 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 47,000,000
Lines installed...................................... 26 3,922 57,000 205,000
</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.

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<PAGE>

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 have a relatively short operating history because we were incorporated
in October 1996. We introduced our services commercially in the San Francisco
Bay Area in December 1997. As of December 31, 2000, we believe we have one of
the largest nationally deployed digital subscriber line networks based on our
2,000 operational central offices which pass more than 47 million homes and
businesses. We have also announced plans to close approximately 250 central
offices. When these closings are completed, our network will pass more than 40
million homes and businesses.

RECENT DEVELOPMENTS

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<PAGE>

In mid-October, 2000, shortly before our quarterly earnings release, we
learned that nine of our Internet service provider customers were unable to give
us reasonable assurances of payment. As a result, we announced on October 17,
2000, that we did not recognize the revenue generated by those customers in the
third quarter of 2000. The aggregate revenue associated with such Internet
service provider customers that was not recognized was approximately $11.4
million. With respect to several other delinquent Internet service provider
customers, including Flashcom, partial payments were made and/or payment
schedules agreed to.

Four of these nineteen Internet service provider customers, Flashcom, Zyan
Communications, Relay Point and Fastpoint, have filed for bankruptcy protection.
As of December 31, 2000, these four Internet service provider customers
represent more than half of the lines served through these nineteen Internet
service provider customers. We also expect to see more bankruptcies among our
Internet service provider customers. These bankruptcies will make it more
difficult to migrate lines away from bankrupt Internet service provider
customers. It is also possible that the bankruptcy courts will require that we
continue providing our services to bankrupt Internet service provider customers
or that we continue installing new orders for lines served by bankrupt Internet
service providers during the bankruptcy proceedings.

We expect that we will not be able to recognize some or all of the revenue
associated with one or more additional Internet service provider customers in
the future. We are in the process of exploring a variety of alternatives with
respect to delinquent Internet service provider customers, including sending
notices of termination of service and arranging for the direct transfer of lines
to our network or to our other Internet service provider customers. However, in
light of the financial position of many of these Internet service provider
customers, should the particular Internet service provider customer become
subject to reorganization or bankruptcy proceedings, no assurance can be given
that we will be able to collect payments owed by us or retain payments or other
consideration (including lines) already received by us.

33
<PAGE>

follow a business plan different from the one proposed by Mr. Knowling. In light
of the Board's decision, the Board and Mr. Knowling agreed that he should
resign.

These lawsuits, the financial difficulties faced by some of our Internet
service provider customers and the limited availability of additional capital
funding pose significant challenges to management and the success of our
business. In response to these challenges, we recently announced a new top
level, organization-wide business plan for our company for 2001, which includes
the following steps:

o we plan on closing 250 underproductive or not fully built-out central
offices and holding the size of our network at approximately 1,750
central offices, which will significantly reduce our capital
expenditures;

o we are reducing our workforce by 800 positions, approximately 25
percent of our workforce;

o we are closing a facility in Alpharetta, Georgia and consolidating
offices in Manassas, Virginia, Santa Clara, California and Denver,
Colorado;

o we are restructuring our Covad Business Solutions division, formerly
BlueStar.net, to streamline our direct sales and marketing channel;
and

o we are evaluating and intend to implement other reductions in
operating costs.

In connection with this restructuring, we estimate that we will report a
charge of up to $20 million in the quarter ending December 31, 2000,
substantially all of which will require the future expenditure of cash.
In addition, due to this restructuring plan and our current operating
environment, we are currently performing an analysis to determine if any of our
long-lived assets, including intangibles, might be impaired. This analysis may
ultimately result in the recognition of non-cash impairment losses in our
financial statements for periods ending after September 30, 2000.

RESULTS OF OPERATIONS

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999

REVENUES

We recorded revenues of $56.3 million for the three months ended September
30, 2000 compared to $19.1 million for the three months ended September 30,
1999. Revenues were $156.3 million for the nine months ended September 30, 2000,
compared to $35.6 million for the nine months ended September 30, 1999. These
increases are attributable to growth in the number of customers and end-users
resulting from our increased sales and

34
<PAGE>

marketing efforts and the expansion of our national network, offset by $21.8
million of revenues associated with delinquent Internet service provider
customers that were not recognized during the third quarter of 2000, as
described above. 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.

Our consumer-grade services have lower profit margins than our
business-grade services. In recent months, the number of orders that we have
received for consumer-grade services have been greater than the number of orders
we have received for business-grade services.

SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
1999 1999 2000 2000 2000
------------- -------------- -------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Total Installed Business Lines....... 26,387 44,840 67,912 93,301 112,367
------------- -------------- -------------- ------------- -------------
Total Installed Consumer Lines....... 4,613 12,160 25,088 44,699 92,633
------------- -------------- -------------- ------------- -------------
Total Installed Lines................ 31,000 57,000 93,000 138,000 205,000
</TABLE>

Due to the recent deterioration in the financial condition of several of
our Internet service provider customers, we did not recognize revenue from
transactions with 19 Internet service provider customers that occurred during
the third and fourth quarters of 2000. As of December 31, 2000, these nineteen
Internet service provider customers accounted for approximately 92,000 of our
274,000 total installed lines. The amount of revenue we did not recognize
attributable to transactions with Internet service provider customers for which
we are not recognizing revenue is $21.8 million in the third quarter of 2000.
Revenue from these transactions will be recognized when cash is received and
after all previously recorded accounts receivable have been paid.

NETWORK AND PRODUCT COSTS

We recorded network and product costs of $58.1 million for the three months
ended September 30, 2000 and $16.7 million for the three months ended September
30, 1999. Network and product costs were $133.1 million for the nine months
ended September 30, 2000 and $32.2 million for the nine months ended September
30, 1999. These increases are 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, and sales
commissions. Sales, marketing, general and administrative expenses were $123.5
million for the three months ended September 30, 2000 and $37.7 million for the
three months ended September 30, 1999. Sales, marketing, general and
administrative expenses were $311.4 million for the nine months ended September
30, 2000 and $80.8 million for the nine months ended September 30, 1999. These
increases are 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 infrastructure, offset by SBC's $20.0
million reimbursement to us for general and administrative expenses. 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, network operations center facilities and corporate
facilities;

35
<PAGE>

o amortization of capitalized software costs; and

o amortization of intangible assets.

Depreciation and amortization was approximately $32.9 million for the three
months ended September 30, 2000 and $10.6 million for the three months ended
September 30, 1999. Depreciation and amortization was approximately $74.6
million for the nine months ended September 30, 2000 and $23.9 million for the
nine months ended September 30, 1999. These increases were due to the increase
in equipment and facilities placed in service throughout the periods. We expect
depreciation and amortization to increase as we increase our capital
expenditures to expand our networks.

GOODWILL AND OTHER 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 $6.3 million during the three and nine months ended
September 30, 2000, respectively. Annual amortization of these assets will be
approximately $8.4 million in each of the years through the year ending December
31, 2001, decreasing to approximately $1.2 million per year for each subsequent
year through the year ending December 31, 2004.

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 consolidated balance sheet a total of
approximately $398.6 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.

In connection with the BlueStar acquisition completed in the third quarter
of 2000 (as discussed in Note 4 to the Unaudited Condensed Consolidated
Financial Statements), we recorded on our consolidated balance sheet a total of
approximately $123.1 million of goodwill and other intangible assets in
September 2000. Goodwill was determined based on the residual difference between
the amount paid for BlueStar and the values assigned to identified tangible and
intangible assets.

We are amortizing goodwill and other intangible assets on a straight-line
basis over their estimated useful lives which range from three to five years.
For the three and nine months ended September 30, 2000, amortization of goodwill
and other intangible assets was $20.7 million and $44.2 million, respectively.

DEFERRED COMPENSATION

Through September 30, 2000, we recorded a total of approximately $19.2
million of deferred compensation, with an unamortized balance of approximately
$7.6 million on our September 30, 2000 consolidated balance sheet. This deferred
compensation is the result of us granting stock options and other awards to our
employees, certain of our directors, and certain contractors with exercise
prices per share below the fair values per share at the dates of grant. We are
amortizing the deferred compensation over the vesting period of the applicable
option using a graded vesting method. Amortization of deferred compensation was
$0.7 million for the three months ended September 30, 2000 and $1.0 million for
the three months ended September 30, 1999. Amortization of deferred compensation
was $2.6 million for the nine months ended September 30, 2000 and $3.9 million
for the nine months ended September 30, 1999.

INTEREST INCOME AND EXPENSE

Interest income and expense, net consists primarily of interest income on
our cash, cash equivalent and short term investment balances and interest
expense associated with our debt. Net interest expense for the three and nine
months ended September 30, 2000, was $16.2 million and $36.0 million,
respectively. Net interest expense during this period consisted primarily of
interest expense on the 1998 notes, the 1999 notes, 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. Net interest expense for the three and nine months
ended September 30, 1999, was $7.3 million and $19.6 million, respectively. Net
interest expense during this period consisted primarily of interest expense on
the 1998 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. We expect net interest expense to increase
significantly in future periods.

<PAGE>

INCOME TAXES

We made no provision for taxes because we operated at a loss for the three
and the nine months ended September 30, 2000 and 1999.

THREE YEARS ENDED DECEMBER 31, 1999

REVENUES

We 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. 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 $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 our network and increased orders
resulting from 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 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 our 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 our continued expansion of
our sales and marketing efforts, deployment of its network, expansion of our
facilities and building of our operating infrastructure. In addition, in 1999,
sales, marketing, general and administrative increased over 1998 due to our
advertising campaign initiated in 1999. Sales, marketing, general and
administrative expenses are expected to increase significantly as we continue to
expand our business.

DEFERRED COMPENSATION

Through December 31, 1999, we 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 our 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 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;

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.

37
<PAGE>

In January 1999, we recorded intangible assets of $28.7 million from the
issuance of preferred stock to AT&T Ventures, NEXTLINK (now XO Communications)
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. We expect
depreciation and amortization to increase significantly as we increase our
capital expenditures to expand our 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 our 13
1/2% senior discount notes due 2008 issued in March 1998 and our 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 our initial public offering and our issuance of
preferred stock to AT&T Ventures, NEXTLINK (now XO Communications) and Qwest. We
expect interest expense to increase significantly over time, primarily because
the 1998 notes and 1999 notes mature in 2008 and 2009, respectively, because we
issued $425.0 million of new long-term debt in January 2000 and because of the
interest expense which will be attributable to the convertible notes.

INCOME TAXES

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

38
<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 audited and unaudited consolidated financial statements. In our
opinion, this 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>
DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30,
1998 1999 1999 1999 1999 2000 2000 2000
--------- --------- --------- --------- --------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues.................. $ 2,766 $ 5,596 $ 10,833 $ 19,141 $ 30,918 $ 41,807 $ 58,160 $ 56,341
Operating Expenses:
Network and products costs 2,246 4,960 10,565 16,694 23,128 31,349 43,614 58,122
Sales, marketing, general
and administrative..... 13,812 18,113 24,976 37,697 59,586 85,445 102,462 123,538
Depreciation and
amortization........... 2,058 4,647 8,671 10,593 13,691 17,432 24,285 32,883
Amortization of goodwill
and other intangible
assets................. -- -- -- -- -- 3,350 20,103 20,718
Amortization of deferred
compensation........... 1,302 1,653 1,234 1,008 873 1,186 725 697
Write-off of in-process
technology............. -- -- -- -- -- 3,726 -- --
--------- --------- --------- --------- --------- ---------- ---------- ----------
Total operating expenses.. 19,418 29,373 45,446 65,992 97,278 142,488 191,189 235,958
Loss from operations...... (16,652) (23,777) (34,613) (46,851) (66,360) (100,681) (133,029) (179,617)
Net interest income
(expense).............. (3,208) (5,127) (7,239) (7,254) (4,176) (7,543) (12,237) (16,200)
Other income.............. -- -- -- -- -- 999 13,788 981
--------- --------- --------- --------- --------- ---------- ---------- ----------
Net loss.................. $(19,860) $(28,904) $(41,852) $(54,105) $(70,536) $(107,225) $(131,478) $(194,836)
Preferred dividends....... -- (1,146) -- -- -- -- -- --
--------- --------- --------- --------- --------- ---------- ---------- ----------
Net loss attributable to $(19,860) $(30,050) $(41,852) $(54,105) $(70,536) $(107,225) $(131,478) ($194,836)
common stockholders....
Net loss per share........ $ (1.22) $ (0.37) $ (0.41) $ (0.47) $ (0.53) $ (0.73) $ (0.86) $ (1.25)
========= ========= ========= ========= ========= ========== ========== ==========
</TABLE>

We have generated increasing revenues in most 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 bankruptcy or other financial difficulties experienced by our
Internet service provider customers;

o our ability to collect "past-due" receivables from certain key
customers;

o receipt of timely payment from our Internet service provider and other
customers;

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;

39
<PAGE>

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 financial condition of our customers;

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

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 $384.6 million for the nine months ended
September 30, 2000. We expect that our capital expenditures related to the
purchase of infrastructure equipment necessary for the development and expansion
of our networks and the development of new regions will be less in future
periods while capital expenditures related to the addition of subscribers in
existing regions will increase.

From our inception through September 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, $413.3 million in
net proceeds from the issuance of the 2000 notes and $484.5 million in net
proceeds from the issuance of the convertible notes in September 2000. As of
September 30, 2000, we had an accumulated deficit of $679.7 million, and cash,
cash equivalents, and short-term investments of $913.1 million. Subsequent to
September 30, 2000, we received cash of $150.0 million in connection with our
agreement with SBC to take a minority ownership position in us.

Net cash used in our operating activities was $273.6 million for the nine
months ended September 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 $92.2 million for the nine
months ended September 30, 2000. The net cash used for investing activities
during this period was primarily due to purchases of property and equipment, the
acquisition of businesses and equity investments, and the net proceeds received
from the sale of investments.

40
<PAGE>

Net cash provided by financing activities for the nine months ended
September 30, 2000 was $912.6 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 and $484.5 million from the issuance of the
convertible notes with an aggregate principal amount of $500.0 million.

We expect to experience substantial negative cash flow from operating
activities and negative cash flow before financing activities for at least the
next two years due to continued development, commercial deployment and addition
of new end-user to 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 and pay for our
services and the pricing of such services;

o the financial condition of our customers;

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 pending litigation;

o existing and future technology; and

o unanticipated opportunities.

We will be required to raise additional capital, the timing and amount of
which is uncertain. 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 take advantage of unanticipated opportunities. We believe
that current capital market conditions, particularly for our industry, reduce
our ability to obtain such additional financing. In addition, the distressed
financial condition of our Internet service provider customer channel that we
reported with our third quarter results, and the legal proceedings against us
which followed the announcement of our earnings results for the third quarter,
may make it more difficult for us to access capital markets. 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.

After consideration of the distressed financial condition of our Internet
service provider customer channel and after discussion with our legal counsel
regarding the potential impact of the various lawsuits filed against us by
certain shareholders and purchasers of our convertible notes, as described
above, we believe that our current cash, cash equivalents and short-term
investments, including the proceeds received from our recently completed Stock
purchase agreement with SBC, will be sufficient to meet our anticipated cash
needs for working capital and capital expenditures into the first quarter of
2002. This is based on the assumption that there will not be an ultimate
unfavorable outcome in the securities litigation in which we are involved prior
to January 2002. If necessary, we will develop a contingency plan to address any
material adverse developments arising in the securities litigation.

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,"

41
<PAGE>

"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;

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 and expectations of future operating results, including
expectations regarding our monthly cash burn rate and the number of
installed lines;

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;

o the effect of other litigation currently pending; 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 collect receivables from certain key customers;

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

o successfully defend our company against certain pending litigation;

o retain end-users that are serviced by delinquent Internet service
provider customers;

o successfully reduce our operating costs and overhead in light of the
financial circumstances of many of our Internet service provider
customers while continuing to provide good customer service;

o successfully continue to increase the number of business-grade lines;

o achieve favorable pricing for our services;

o respond to increasing competition;

o manage growth of our operations; and

42
<PAGE>

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 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, our 2000 notes and our convertible
notes, is fixed-rate debt.

<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 MANAGEMENT'S "DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--FORWARD LOOKING STATEMENTS."

OVERVIEW

We believe we are a leading provider of broadband communications services,
which we sell to businesses and consumers directly or through Internet service
providers, enterprises, telecommunications carriers 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. We sell these services directly to business and consumer
end-users through our sales force, telesales and our website. Internet service
providers purchase our services in order to provide high-speed Internet access
to their business and consumer end-users. Branded virtual service providers
purchase turnkey broadband or dial-up services from us and sell these services
to their existing customers or affinity groups. 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 December 31, 2000, we believe we have one of the nation's largest DSL
networks based on our 2,000 operational central offices which pass more than 47
million homes and businesses. We also plan to close approximately 250 central
offices. When these closings are completed, our network will pass more than 40
million homes and businesses. As of December 31, 2000, we had 274,000 DSL based
high-speed access lines in service and we had received orders for our services
from more than 250 Internet service provider, enterprise, and telecommunications
carrier customers, including AT&T Corporation, XO Communications (formerly
NEXTLINK Communications, Inc. and Concentric Network Corporation), EarthLink,
Inc., UUNET Technologies (an MCI WorldCom company) and Verio, Inc., which was
acquired by Nippon Telephone and Telegraph.

As of December 31, 2000, we have deployed our network in a total of 120
metropolitan statistical areas, but we plan on reducing this number to 109
metropolitan statistical areas in 2001. When we complete our planned closure of
central offices, we expect that our network will pass 40% of homes and 45% of
businesses in the United States.

We are also developing a variety of services that are enhanced or enabled
by our network and 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.

<PAGE>

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 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. At the beginning of the year 2000, only 3.7% of these users
accessed 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.

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

<PAGE>

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 that
our 1,750 central offices will be one of the nation's largest DSL networks and
will pass over more than 40 million homes and businesses. As of December 31,
2000, we had 274,000 lines in service nationwide.

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

<PAGE>

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 Frank Marshall, Interim Chief Executive Officer
and Director (former Vice President at Cisco Systems); 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, Inc.); Robert
Davenport, III, President and Chief Executive Officer, Covad Communications
International, B.V. (former Senior Vice President and Chief Operating Officer of
Tele-Communications, Inc.'s Internet Services subsidiary TCI.NET); Frank Thomas,
Chief Information Officer (former Managing Partner at Olive, LLP and Vice
President, Network Operations for U S West Communications, Inc.); Dhruv Khanna,
Executive Vice President, General Counsel and Secretary (Covad founder and
former in-house counsel for Intel Corporation); 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.); and Michael Lach, Executive Vice President, Corporate
Development and Business Integration (former Vice President, Customer
Provisioning and Maintenance of Ameritech Corporation).

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:

COST CONTAINMENT INITIATIVES. We have adopted a new business plan that
includes the following steps:

o closing approximately 250 underproductive or not fully built-out central
offices and holding the size of our network at approximately 1,750
central offices, which will significantly reduce our capital
expenditures;

o reducing our workforce by approximately 800 employees, which represents
approximately 25 percent of our workforce;

o closing a facility in Alpharetta, Georgia and consolidating offices in
Manassas, Virginia, Santa Clara, California and Denver, Colorado;

o restructuring our Covad Business Solutions division, formerly
BlueStar.net, to streamline our direct sales and marketing channel; and

o evaluating and implementing other cost reduction strategies.

ROLL OUT SERVICE RAPIDLY IN OUR TARGETED METROPOLITAN STATISTICAL AREAS. As
of September 30, 2000, we had introduced our services in 120 of the top
metropolitan statistical areas nationwide but we plan on reducing this number to
109 metropolitan statistical areas in 2001. When we complete our planned closure
of 250 central offices, we expect that our network will pass 40% of
homes and 45% of businesses in the United States.

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 then offer high-speed Internet
access using our network. In other cases, we provide wholesale DSL and Internet
access services for resale by our customers. 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;

<PAGE>

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.

SELL DIRECTLY TO BUSINESS AND CONSUMER END-USERS. We also provide
high-speed access, Internet access and virtual private networks directly to
business and consumer end-users. We started selling directly to business
end-users upon the closing of the BlueStar acquisition in September of 2000. Our
strategy is to initially sell in our smaller markets, utilizing a combination of
direct salespeople, telesales and websales. We plan to expand our direct sales
efforts into other markets over time.

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. We have announced
agreements to sell a complete ISP solution through Avon Products and Sony
Electronics.

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. ("Laser Link"). 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
acquisition of BlueStar Communications Group, Inc. ("BlueStar") will expand our
selling capabilities in smaller cities and rural areas, increase our
distribution methods, and will improve 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 SBC Communications,
Inc./Ameritech Corp. 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 services. Currently, we provide almost
all of our DSL services over a separate additional telephone wire. Beginning in
2001, we will generally provision new orders for our consumer-grade services
over line-shared telephone wires. 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 important opportunity for us for three primary
reasons. First, line sharing should significantly reduce the monthly recurring
charges we incur for telephone loops. Second, line sharing should reduce the
time it takes traditional telephone companies to deliver telephone loops because
the telephone loop will already exist. Third, line sharing should resolve lack
of telephone loop problems that we have encountered when ordering telephone
loops in some areas of the country. We began implementing line sharing in almost
all of the states, and we have entered into interim line sharing agreements with
Qwest Communications International, Inc., BellSouth Corporation and Verizon
Communications (other than Texas). In connection with the agreements that we
announced with SBC Communications, Inc. on September 11, 2000, we also agreed to
the terms and conditions for line sharing with SBC. We recently received a
decision from the Texas Public Utilities Commission implementing line sharing in
Texas.

<PAGE>

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:

MAXIMUM MAXIMUM ANGE*
INTRAREGIONAL SPEED TO SPEED FROM (FEET)
SERVICES END-USER END-USER R MARKET USAGE
------------------ ---------- ------------ -------- ------------------------
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 Mbps 15,000 High-speed Web access
--------------
* 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 margins on sales of 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.

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

<PAGE>

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 T1
data 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 at 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

MAXIMUM MAXIMUM ANGE*
INTRAREGIONAL SPEED TO SPEED FROM (FEET)
SERVICES END-USER END-USER R MARKET/USAGE
--------------------- ------------ ------------- ---------- --------------
TeleSurfer ADSL....... 608 Kbps 128 Kbps 12,000 Consumer
TeleSurfer Pro ADSL... 1.5 Mbps 384 Kbps 12,000 Consumer
--------------
* 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

This additional service 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.

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.

<PAGE>

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, branded virtual
service providers, enterprises, telecommunications carriers and other DSL
resellers. As of December 31, 2000, we had more than 274,000 DSL lines in
service and we had received orders for our services from more than 250 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 BRANDED VSPS SELECTED TELECOMMUNICATIONS CARRIERS
-------------------------------------------- --------------------- ------------------------------------
<S> <C> <C>
Earthlink, Inc., Avon Products AT&T Corporation
Prodigy Communications Corporation Sony Corp. Qwest Communications
International, Inc. SBC Communications, Inc.
UUNET Technologies
Verio, Inc.
XO Communications

</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 services
on a wholesale basis and sell such services under their own brand.

We have recently started to sign agreements with branded virtual service
providers. In these agreements a well branded company would utilize Covad as the
underlying ISP by which it may provide service to an existing base of customers
who are potential purchasers of high-speed internet service is complementary. We
expect that the rollout of these services will require several months of work
before they are marketed and sold to the branded company's incumbent customer
base.

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

<PAGE>

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 a 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, 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.

<PAGE>

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 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
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.

<PAGE>

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). 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 September 30, 2000, we had
2,000 central office spaces operational. We plan to close approximately 250
underproductive or not fully built-out central offices. In addition, we have a
significant number of additional spaces under construction as well as other
spaces on order from various traditional telephone companies.

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. 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;

o network security;

o ease of access and use;

o service bundling;

<PAGE>

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 XO 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 (now XO Communications), 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 UUNET Technologies in California
and New York 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.

<PAGE>

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 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, 39 Ghz and 50 Ghz
point-to-point and point-to-multi-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 September 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
companies. 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

<PAGE>

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 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

<PAGE>

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, SBC 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.

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.

<PAGE>

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. Although the FCC has
appealed the Eighth Circuit's decision, it may also adopt new rules to reflect
the cost methodology that was approved by the Eighth Circuit. 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.

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

<PAGE>

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 Verizon (formerly 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 judgment ruling in the Verizon lawsuit. The
court ruled that we had not infringed on Verizon'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.

A manufacturer of telecommunications hardware named "COVID" has filed an
opposition to our trademark application for the mark "COVAD and design". Covid
has also filed a complaint in the United States District Court for the District
of Arizona, alleging claims for false designation of origin, infringement and
unfair competition. We do not believe that this lawsuit or the opposition to our
trademark application have merit, but these legal proceedings are unpredictable
and there is no guarantee we will prevail. If we do not succeed, it could limit
our ability to provide our services under the "COVAD" name.

EMPLOYEES

As of September 30, 2000, we had approximately 3,000 employees, excluding
temporary personnel and consultants. In connection with our recently-announced
restructuring, we are reducing our workforce by approximately 400 employees.
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,

<PAGE>

we could incur higher ongoing labor costs and disruptions in our operations in
the event of a strike or other work stoppage.

PROPERTIES

We are headquartered in Santa Clara, California in facilities under 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 are in the process of consolidating our office space in Santa Clara as
well as our office spaces in Denver, Colorado and Virginia. In connection with
our recently-announced restructuring, we are closing a facility in Alpharetta,
Georgia.

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 if we chose to 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. In connection with the agreements with SBC Communications,
Inc that we announced on September 11, 2000, we settled all of our pending
litigation against SBC affiliates Southwestern Bell and Pacific Bell. This
settlement also resolves our commercial arbitration proceeding against Pacific
Bell.

Several of our shareholders have filed class action lawsuits against us,
our former president and Chief Executive Officer, Robert E. Knowling, and our
current executive vice president and Chief Financial Officer, Mark H. Perry.
These lawsuits were filed in the United States District Court for the Northern
District of California. The complaints in these matters allege violations of
federal securities laws on behalf of persons who purchased our securities,
including those who purchased common stock and those who purchased convertible
notes, during the periods from September 7, 2000 to October 17, 2000 or
September 7, 2000 to November 14, 2000. The relief sought includes monetary
damages and equitable relief. In addition, three purchasers of the convertible
notes have filed complaints in California Superior Court for the County of Santa
Clara. These complaints allege fraud and deceit, negligence and violations of
state securities laws in connection with our sale of the convertible notes. The
relief sought includes rescission of their purchases of approximately $90
million in aggregate principal amount of convertible notes and unspecified
damages, including punitive damages. The plaintiff in one of these matters has
requested a trial date in August 2001, but we intend to oppose this request. One
of the plaintiffs in these matters has also sought a writ of attachment for the
full amount of its rescission claims for its purchases of convertible notes. On
December 11, 2000, this request for a writ of attachment was denied. Three
additional purchasers have indicated that they intend to file similar lawsuits.
Although we do believe that we have strong defenses in these lawsuits, the
ultimate outcome of these litigation matters is inherently unpredictable and
there is no guarantee we will prevail.

We recently filed a lawsuit against BellSouth TeleCommunications and its
subsidiaries in federal court. We are pursuing antitrust and other claims in
this lawsuit arising out of BellSouth's conduct as a supplier of central office
space, transmission facilities and telephone lines.

We have also filed a lawsuit against Verizon and its affiliates in federal
court. We are pursuing antitrust and other claims in this lawsuit. In addition,
Verizon 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 Verizon's patent. Verizon 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.

A 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

<PAGE>

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.
Another 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.

A manufacturer of telecommunications hardware named "COVID" has filed an
opposition to our trademark application for the mark "COVAD and design" and is
seeking to cancel our registration of the COVAD trademark. We do not believe
that this opposition has merit, but trademark proceedings are unpredictable and
there is no guarantee we will prevail. If we do not succeed, it could limit our
ability to provide our services under the "COVAD" name. COVID has also filed a
complaint in the United States District Court for the District of Arizona,
alleging claims for false designation of origin, infringement and unfair
competition. COVID is seeking an injunction to stop us from using the COVAD
trademark, as well as an award of monetary damages. We do not believe that these
claims have any merit, but the outcome of litigation is unpredictable and we
cannot guarantee that we will prevail.

A former LaserLink.net shareholder has filed a complaint against us in the
Supreme Court for the State of New York. He is seeking damages arising out of
our alleged failure to register the Covad shares that he received in exchange
for his LaserLink.net shares. We do not believe that his claims have any merit,
but we cannot assure you that we will prevail in this matter.

Four of our nineteen distressed Internet service provider customers have
filed for bankruptcy protection. It is likely that these bankruptcies will
impair our ability to collect the amounts owed to us and to migrate these lines
to other Internet service provider customers or to our own network. One
bankruptcy court has ordered Zyan Communications to prepay us for our future
services on a weekly basis beginning in January 2001. It is possible that
additional bankruptcy courts will require that we continue providing services to
bankrupt Internet service provider customers during the bankruptcy proceedings.

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 or we may otherwise be significantly
impacted 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.

BLUESTAR ACQUISITION

On September 25, 2000, we completed our acquisition of 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 issued approximately 6.1 million shares of
our common stock and assumed approximately 226,000 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 5.0 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 and
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 access to BlueStar's customer base; and

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

62
<PAGE>

SBC COMMUNICATIONS, INC. AGREEMENTS

On September 11, 2000, we announced various agreements with SBC
Communications, Inc. ("SBC"):

o We announced a commercial agreement in which SBC will provide $600
million in resale revenue to us over six years starting October 1, 2000,
with approximately $23 million of revenue in the first year and
increasing revenue commitments each year during the life of the contract.
Upon a change of control as defined in the contract, SBC's aggregate
revenue commitment is reduced to $100 million during an initial period of
the contract, and is terminated after the initial period. This agreement
also provides incentives for SBC to sell business lines provided by us,
and we announced that SBC will begin marketing both symmetric business
service DSL and asymmetric consumer service DSL provided by us throughout
the United States.

o We announced SBC's plans to take a minority ownership position in us for
$150 million, pending regulatory approval. Under this agreement, SBC
acquired 9,373,169 shares or approximately six percent of our outstanding
shares and is not permitted to sell such shares until November 3, 2001,
unless we experience a change of control.

o We announced that, regarding pending legal matters, our antitrust suit
against SBC and Pacific Bell and our arbitrations against SBC affiliates,
Southwestern Bell and Pacific Bell, were settled, including Pacific
Bell's claim for alleged past due service fees. In addition, we announced
the resolution of several critical issues in line sharing disputes in
Texas, Kansas, Illinois, Michigan, Ohio, Wisconsin, Indiana, Connecticut
and California, plus key issues in pending interconnection arbitrations
in Texas and Kansas.

o We announced that performance standards in all 13 SBC states were agreed
upon, which we expect will further reduce regulatory disputes. Standards
for SBC performance were agreed upon so that both companies will operate
under a standard set of measures and remedies in all SBC states, which
include California, Nevada, Texas, Oklahoma, Arkansas, Kansas, Missouri,
Ohio, Indiana, Michigan, Wisconsin, Illinois and part of Connecticut.
These standards include stand-alone and line-shared loop provisioning
intervals, collocation intervals, repair and maintenance, and access to
loop plant data. In addition, we agreed upon a 13-state line sharing
price consisting of a $10 non-recurring charge and a $5.75 monthly
recurring charge for all physical elements of the line sharing UNE,
including installation.

o We announced the agreement to continue joint OSS development to support
SBC's resale of our products, including the fully automatic loop ordering
provisioning process pioneered by us. By working closely with SBC, we
intend to simplify the ordering process and improve DSL provisioning
times. Our OSS system currently is integrated with Pacific Bell and has
shown improved installation rates of 25 percent and higher.

o We also announced in-region agreements that include continued access to
neighborhood gateways utilized in SBC's recently announced "Project
Pronto," competitively neutral terms and conditions for spectrum
management and agreements regarding the collocation of equipment in SBC
central offices.

LOOP HOLDINGS EUROPE ASP

On September 8, 2000 we entered into an acquisition agreement with Loop
Holdings Europe AsP, a Danish entity which owns preferred shares representing
70% of Loop Telecom, S.A. (a 50% voting interest), a Spanish full-service
broadband service provider for small and medium-sized businesses. Loop Holdings
was acquired for $15 million in cash, a note for $15 million payable six months
after the closing and a note for $20 million payable one year after closing.
This acquisition closed on September 21, 2000.

CONVERTIBLE NOTE OFFERING

On September 25, 2000, we consummated the private placement of $500 million
principal amount of five year 6% convertible senior notes. The convertible notes
were sold to initial purchasers at a price of 100% for resale under Rule 144A of
the Securities Act of 1933, as amended. Net proceeds from the convertible notes
were approximately $484.5 million after discounts, commissions, and other
transaction costs of approximately $15.5 million. The convertible notes are
convertible into our common stock at a conversion price of $17.775, subject to
certain adjustments, and were issued pursuant to an indenture dated as of
September 25, 2000, between us and the United States Trust Company of New York.

<PAGE>

MANAGEMENT

DIRECTORS AND EXECUTIVE OFFICERS

Our directors and executive officers, and their respective ages as of
January 1, 2001, are as follows:

NAME AGE POSITION
Frank Marshall........... 53 Interim Chief Executive Officer and Director
Mark H. 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
Frank Thomas............. 42 Chief Information Officer

John McDevitt............ 48 Executive Vice President, Sales and Marketing

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

Robert E. Dupuis......... 46 Executive Vice President
Chuck Haas............... 40 Executive Vice President

Charles McMinn........... 48 Chairman of the Board of Directors
Robert Hawk.............. 60 Director
Hellene Runtagh.......... 51 Director
Daniel Lynch............. 58 Director
Rich Shapero............. 51 Director
Larry Irving............. 43 Director

FRANK MARSHALL has served as a member of our board of directors since
October 1997 and has served as our Interim Chief Executive Officer since October
2000. 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.

MARK H. 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
Records Division, where he served in several management positions.

ROBERT DAVENPORT, III joined us in January 1999. He served as our Vice
President, Business Development until February 1999 and served as our Executive
Vice President, Business Development from February 1999 to August 2000, at which
time he began serving as President and Chief Executive Officer, Covad
Communications International, B.V. 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

<PAGE>

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.

FRANK THOMAS joined us in March 2000. He served as a Vice President, ILEC
Relations from March 2000 to June 2000. He served as our acting Chief
Information Officer from June 2000 to August 2000 and has served as our Chief
Information Officer since August 2000. Prior to joining us, he was the Managing
Partner, Consulting for Olive, LLP from 1998 to March of 2000. From 1996 to
1998, he served as Vice President, Network Operations for U S WEST
Communications, Inc. From 1991 to 1996, he served as a Director and Senior
Director, Information Systems and as a Network Operations Manager, Information
Systems with Eli Lilly & Company.

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 Executive 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 Executive Vice President, External
Affairs. Prior to joining us, from January 1999 to July 1999, Terry served as
Vice President & Chief Financial Officer, Capital Management, 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,
Business Integration and in August 2000 he began serving 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

<PAGE>

implementation of new products 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.

ROBERT E. DUPUIS has served as our Executive Vice President since December
2000. He previously served President, Chief Executive Officer and as Chairman of
the Board of Directors of BlueStar Communications Group, Inc. From August 1998
to April 1999, Mr. Dupuis was an executive on staff with Crosspoint Venture
Partners, a venture capital firm with substantial investments in us and in the
telecommunications industry. In August 1998, Mr. Dupuis was the President and
Chief Executive Officer of Able Telecom, a construction company specializing in
telecommunications. From May 1996 to January 1998, Mr. Dupuis served as Chief
Executive Officer and President of RMD Americas, a wireless communications
company with international operations. From June 1992 through April 1996, Mr.
Dupuis served as Vice President and General Manager of Comsat International and
as Vice President of Sales and Marketing of Comsat World Systems.

CHARLES HAAS is a founder of the Company and has been serving as our
Executive Vice President since December 2000. He served as the Company's Vice
President, Sales and Marketing from May 1997 until November 1998 and served in
various other roles. Mr. Haas has over fourteen years of sales and business
development experience with Intel where he held various positions from July 1982
to April 1997. At Intel, Mr., Haas served as manager of corporate business
development, focusing on opportunities in the broadband computer communications
area, and played a principal role in the development of the Company's
Residential Broadband strategy for telephone and satellite companies (DSL,
Fiber-to-the-Curb and satellite modems).

CHARLES MCMINN is a founder of the Company and has been the Chairman of the
Board of Directors since October 2000. Mr. McMinn previously served as our
Chairman of the Board of Directors from July 1998 to September 1999. He served
as the Company's President, Chief Executive Officer and as a member of its Board
of Directors from October 1996 to July 1998. Mr. McMinn has over 20 years of
experience in creating, financing, operating and advising high technology
companies. From November of 1999 to October 2000, Mr. McMinn served as Chief
Executive Officer and founder of Certive Corporation and he is still a member of
Certive's board of directors. From July 1995 to October 1996, and from August
1993 to June 1994, Mr. McMinn managed his own consulting firm, Cefac Consulting,
which focused on strategic development for information technology and
communications businesses. From June 1994 to November 1995, he served as
Principal, Strategy Discipline, at Gemini Consulting. From August 1992 to June
1993, he served as President and Chief Executive Officer of Visioneer
Communications, Inc. and from October 1985 to June 1992 was a general partner at
InterWest Partners, a venture capital firm. Mr. McMinn began his Silicon Valley
career as the product manager for the 8086 microprocessor at Intel.

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.

<PAGE>

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 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.

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
Charles McMinn stockholders in 2002 and at each third
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.

<PAGE>

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 consists of two of our outside directors, Ms.
Runtagh and Mr. Shapero. 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 two outside directors, Messrs. Shapero
and Irving. 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.
Marshall, 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.

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." Mr. McMinn is a member of the Board of Directors of
DishnetDSL, a DSL provider in India, and Certive Corporation. We are a minority
investor in both of these companies.

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 during the fiscal year ended December 31, 2000 as well as two
individuals who would have been one of our most highly compensated executive
officers but for the fact that the individuals were not serving as an executive
officer at the end of the fiscal year ended December 31, 2000 (collectively, the
"Named Executive Officers"). 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.

<PAGE>

SUMMARY COMPENSATION TABLE

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>
Frank Marshall.................. 2000 $ 1 -- -- 60,000 --
Interim Chief Executive
Officer and Director

Robert Knowling, Jr............. 2000 $ 500,000 $ 250,000 -- 450,000(25) $ 250,810(21)
Former Chairman, Board of 1999 $ 399,996 $ 500,000 -- -- $ 750,420(8)
Directors, President and 1998 $ 180,768(2) $ 250,000 -- 4,725,000 $ 750,343(9)
Chief Executive Officer(1)

Robert Davenport, III........... 2000 $ 350,000 -- -- 152,500 $ 150,360(15)
Executive Vice President, 1999 $ 183,077(6) $ 91,667 -- 450,001 $ 171(19)
Business Development 1998 -- -- -- -- --

Catherine Hemmer................ 2000 $ 350,000 -- -- 175,000 $ 87,860(16)
Chief Operating Officer 1999 $ 180,769 $ 109,500 $ 882,500(17) -- $ 240(19)
1998 $ 58,359(4) $ 56,000 -- 437,713 $ 84,363(11)

Robert E. Dupuis................ 2000 $ 82,192(3) -- -- 250,000 $ 94(19)
Executive Vice President 1999 -- -- -- -- --
1998 -- -- -- -- --

Mark H. Perry................... 2000 $ 122,808(5) -- $ 194,400(22) 275,000 $ 276(19)
Executive Vice President and 1999 -- -- -- -- --
Chief Financial Officer 1998 -- -- -- -- --

John McDevitt................... 2000 $ 134,863(7) -- -- 250,000 $ 198(19)
Executive Vice President, 1999 -- -- -- -- --
Sales and Marketing 1998 -- -- -- -- --

Dhruv Khanna.................... 2000 $ 275,000 -- -- 52,501 $ 270(19)
Executive Vice President, 1999 $ 176,923 $ 80,000 -- -- 180(19)
General Counsel and Secretary 1998 $ 147,835 -- -- -- 145(19)

Robert Roblin................... 2000 $ 126,575(23) -- -- 75,000 $ 405(19)
Former Executive, Vice 1999 $ 232,692 $ 140,250 $ 882,500(17) -- $ 405(19)
President 1998 21,154(18) $ 9,493 -- 562,500 $ 74(19)
Sales and Marketing(13)

Joseph Devich................... 2000 $ 278,630(24) -- -- 75,000 $ 150,210(10)
Former Executive Vice 1999 $ 167,308 $ 101,250 $ 882,500(17) -- $ 210(19)
President, 1998 $ 52,981(20) $ 20,137 -- 380,622 $ 76,961(12)
Corporate Services(14)
</TABLE>
--------------
(1) On November 1, 2000, we announced the resignation of Mr. Knowling. Frank
Marshall has been appointed to replace Mr. Knowling on an interim basis
and Mr. Knowling received compensation provided for by his employment
agreement.
(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 $300,000 from hiring date of
September 22, 2000.
(4) Pro rated based on an annual salary of $160,000 from hiring date of August
10, 1998.
(5) Pro rated based on an annual salary of $275,000 from hiring date of July
21, 2000.
(6) Pro rated based on an annual salary of $200,000 from hiring date of January
20, 1999.
(7) Pro rated based on an annual salary of $275,000 from hiring date of July 5,
2000.
(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) Includes the outstanding balance of $150,000 on a note which was forgiven
in connection with Mr. Devich's resignation as well as $210 for term life
insurance premium.
(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 Mr. Roblin. John McDevitt
has been appointed to replace Mr. Roblin.
(14) Mr. Devich resigned from the Company in December 2000.

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<PAGE>

(15) Includes the balance of $150,000 on a $600,000 note which is forgivable
over four years as well as premium payments for Mr. Davenport's term life
insurance.
(16) Includes the balance of $87,500 on a $350,000 note which is forgivable over
four years as well as premium payments for Ms. Hemmer's term life
insurance.
(17) This value is based upon the closing price of $29.416 for 30,000 shares
granted on 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 closing price of $37.29. Twenty-five percent of these
shares will vest on the four consecutive anniversaries of the grant date.
(18) Pro rated based on an annual salary of $220,000 from hiring date of
November 16, 1998.
(19) The dollar amount in this column represents premium payments the Company
made for executive's term life insurance policies.
(20) Pro rated based on an annual salary of $150,000 from hiring date of August
13, 1998.
(21) Includes the outstanding balance of $250,000 on a note which was forgiven
in connection with Mr. Knowling's resignation and premium payments for Mr.
Knowling's term life insurance.
(22) This value is based upon the closing price of $19.44 for 10,000 shares
granted on July 21, 2000 to Mr. Perry.
(23) Pro rated based on an annual salary of $350,000 through resignation in May
2000.
(24) Pro rated based on an annual salary of $300,000 through resignation in
December 2000.
(25) Includes 450,000 options to purchase common stock which were granted in
February 2000 and voluntarily rescinded in September 2000.

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) 2000(%)(2) PER SHARE DATE TERM($)(3)
------- ------------- ------------ ---------- ---------- ----------------------------
5% 10%
<S> <C> <C> <C> <C> <C> <C>
Frank Marshal, II............. 60,000 0.4371% $ 56.625 2/15/08 $ 1,622,155 $ 3,885,343
Robert Davenport, III......... 52,500 0.3825% $ 56.63 2/15/08 $ 1,419,511 $ 3,399,975
100,000 0.7285% $ 15.69 8/11/08 $ 749,128 $ 1,794,291
Catherine Hemmer.............. 75,000 0.5464% $ 56.63 2/15/08 $ 2,027,873 $ 4,857,108
100,000 0.7285% $ 1.59 12/08/08 $ 76,097 $ 182,265
Robert E. Dupuis.............. 250,000 1.8213% $ 15.130 9/22/10 $ 1,805,975 $ 4,325,625
Mark H. Perry................. 200,000 1.4570% $ 19.44 7/21/08 $ 1,856,347 $ 4,446,273
75,000 0.5464% $ 1.5938 12/08/08 $ 57,073 $ 136,699
John McDevitt................. 150,000 1.0928% $ 18.50 7/5/08 $ 1,324,939 $ 13,173,459
100,000 0.7285% $ 1.5938 12/8/08 $ 76,097 $ 182,265
Dhruv Khanna.................. 52,501 0.3825% $ 56.63 2/15/08 $ 1,419,538 $ 3,400,040
Robert Roblin................. 75,000 0.5464% $ 56.63 7/11/00 $ 2,027,873 $ 4,857,108
Joseph Devich................. 75,000 0.5464% $ 56.63 1/03/01 $ 2,027,873 $ 4,857,108
Robert Knowling(4)............ 450,000 3.2783% $ 56.63 2/15/08 $ 12,167,236 $ 29,142,645
</TABLE>
--------------
(1) The material terms of the option grants are 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 13,726,759 shares we granted
during 2000 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.
(4) Includes 450,000 options to purchase common stock which were granted in
February 2000 and voluntarily rescinded in September 2000.

70
<PAGE>

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, 2000 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,
2000. 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.

OPTIONS EXERCISED DURING
2000 NUMBER OF SECURITIES
--------------------------- UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
SHARE OPTIONS AT IN-THE-MONEY OPTIONS AT
ACQUIRED DECEMBER 31, 2000 DECEMBER 31, 2000($)(2)
ON VALUE -------------------------- -------------------------------
NAME EXERCISE(#) REALIZED($)(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
------- ----------- -------------- ----------- ------------- -------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Robert Knowling (4)...... 318,913 $11,704,610.12 2,338,275 -- $2,833,521.65 --
Robert Davenport, III.... 52,500 $ 2,988,519.15 182,394 367,608 -- --
Catherine Hemmer......... -- -- 200,956 324,258 -- --
Robert E. Dupuis......... -- -- 24,338 277,022 -- --
Mark H. Perry............ -- -- -- 275,000 -- --
Frank Marshall........... -- -- 62,373 68,127 $ 56,915 --
John McDevitt............ -- -- -- 250,000 -- --
Dhruv Khanna............. -- -- 10,937 41,564 -- --
Robert Roblin............ 119,973 $ 3,066,806.98 -- -- -- --
Joseph Devich............ 78,375 $ 2,094,213.39 46,744 237,244 $2,833,521.65 --
</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., closing price) of common stock of $1.656 on December 29, 2000.
An option is "in-the-money" if the market value of the common stock exceeds
the exercise price.

EMPLOYMENT AGREEMENTS AND CHANGE IN CONTROL ARRANGEMENTS

All twelve of our Section 16 officers, except our Interim Chief Executive
Officer, have entered into severance agreements with us under which the benefits
would be triggered by a change of control. In general, a change of control for
the purposes of these agreements, is defined as either (i) the acquisition of
20% of outstanding common stock of the Company; (ii) an unapproved 25% change in
the composition of the board; or (iii) stockholder approval of a merger without
80% continuity of interest or of sale or other disposition of substantially all
of our assets.

These agreements provide for a one-year employment term for these
officers upon a qualifying "change in control" and provide that such officer's
compensation and benefits cannot be reduced during the one-year term. In
addition, these contracts provide a basic severance benefit equal to two times
the sum of such officer's base salary and target bonus. Should an officer be
terminated within one year of a change in control, without cause or should the
officer terminate employment for "good reason" within that period, in addition
to the severance payment described above, such officer shall be entitled to (i)
a pro rata bonus for the year of termination; (ii) distribution of deferred
compensation; (iii) cash in lieu of any forfeited retirement/401(k) benefits;
and (iv) two years medical and other insurance benefits. Moreover, under certain
circumstances, such officer may defer severance and deferred compensation
payment upon six months advance notice. These agreements may also provide
additional rights including, but not limited to, legal fee reimbursement,
interest on delinquent payments, a board hearing if terminated "for cause," and
no obligation to mitigate damages.

In 1998, we entered into a written employment agreement with Robert
Knowling, Jr., the former Chairman of the Board of Directors, President and
Chief Executive Officer, who resigned on November 1, 2000. In connection with
his resignation, Mr. Knowling will continue to receive compensation in the form
of a $500,000 annual base salary for a period of two years and a $250,000 annual
bonus for two years, so long as Mr. Knowling does not become employed by one of
our direct competitors. 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 shares of our common stock at an exercise
price of $0.45 per share. 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 been

71
<PAGE>

forgiven in connection with his resignation. 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
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.

72
<PAGE>

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 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 shares for the Year 2000 and Year 2001, respectively. As of January
1, 2000, there were 11,478,826 shares available for issuance under the Plan,
which includes the 3% annual increase of 4,400,533 shares and 5,000,000
additional 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 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.

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<PAGE>

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
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.

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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.

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

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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. 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.

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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.

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 December 31, 2000, 25,807,746 shares of common stock were subject
to outstanding options and SPRs under the Plan, 39,160,366 options had been
issued under the Plan (net of cancelled options), and 5,332,802 shares of common
stock remained available for future issuance.

The actual benefits, if any, to the holders of stock options issued under
the 1997 Plan are not determinable as all grants to be made under the 1997 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

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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 8,774,658
shares of common stock were issued pursuant to the 1997 Plan; (ii) options to
purchase 163,500 shares of common stock were issued pursuant to the 1997 Plan to
the current directors who are not executive officers, as a group (5 persons);
(iii) options to purchase 1,060,500 shares of common stock were issued to
current executive officers, as a group (9 persons); and (iv) options to purchase
7,526,826 shares of common stock were issued pursuant to the 1997 Plan to all
other employees and consultants, including current officers who are not
executive officers, as a group (approximately 800 persons). The closing price of
the common stock on December 31, 1999 was $37.29 per share.

The 1997 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 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, 1,119,796 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 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

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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 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.

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 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

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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.

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

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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 (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 us
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

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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
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. 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."

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."

BLUESTAR COMMUNICATIONS GROUP, INC. 2000 STOCK INCENTIVE PLAN

On September 25, 2000, pursuant to the Agreement and Plan of Merger dated
as of June 15, 2000, BlueStar Communications Group, Inc. ("BlueStar") was
acquired in a merger of Covad Acquisition Corp. ("CAC"), our wholly owned
subsidiary, with BlueStar in which CAC was the surviving entity (the "Merger").
As part of the Merger, we agreed to assume the BlueStar Communications Group,
Inc. 2000 Stock Incentive Plan (the "BlueStar Plan") and each outstanding option
under the BlueStar 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 BlueStar
Plan. In the Merger, each share of BlueStar common stock was converted into .053
share of our common stock (the "Exchange Ratio"). In light of the Exchange
Ratio, there are 207,146 shares of our common stock subject to the BlueStar
Plan.

In general, the BlueStar Plan consists of five types of equity incentive
programs: (i) the Discretionary Option Grant Program under which eligible
persons may, at the discretion of the Plan Administrator, be granted options to
purchase shares of common stock; (ii) the Salary Investment Option Grant Program
under which eligible employees may elect to have a portion of their base salary
invested each year in special options; (iii) the Stock Issuance Program under
which eligible persons may, at the discretion of the Plan Administrator, be
issued shares of common stock directly, either through the immediate purchase of
such shares or as a bonus for services rendered the Company (or any parent or
subsidiary); (iv) the Automatic Option Grant Program under which eligible
non-employee Board members shall automatically receive options at periodic
intervals to purchase shares of common stock; and (v) the Director Fee Option
Grant Program under which non-employee Board members may elect to have all or
any portion of their annual retainer fee otherwise payable in cash applied to a
special option grant.

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The persons eligible to participate in the Discretionary Option Grant and
Stock Issuance Programs include (i) employees; (ii) non-employee members of the
Board or the board of directors of any parent or subsidiary; and (iii)
consultants and other independent advisors who provide services to the Company
(or any parent or subsidiary). Only employees who are Section 16 Insiders or
other highly compensated individuals participate in the Salary Investment Option
Grant Program. Only non-employee Board members may participate in the Automatic
Option Grant and Director Fee Option Grant Programs.

No one person participating in the BlueStar Plan may receive options,
separately exercisable stock appreciation rights and direct stock issuances for
more than 53,000 shares of common stock (in the aggregate) per calendar year.
The stock issuable under the BlueStar Plan includes shares of authorized but
unissued or reacquired common stock. The maximum number of shares of common
stock initially reserved for issuance over the term of the BlueStar Plan shall
not exceed 452,541 shares.

As of the date of the Merger, 7,027,077 shares of BlueStar's common
stock, par value $0.01, were reserved for issuance under existing options
granted under the BlueStar Plan. It is anticipated that no further options will
be granted or shares will be issued under the BlueStar Plan. After the Merger,
based on the Exchange Ratio, a maximum of 1,251,182 shares of the Company's
common stock will be issuable pursuant to existing options granted under the
BlueStar Plan.

While the BlueStar Plan provides for automatic share increase each year
through 2005 based on the outstanding common stock, the Company does not intend
to avail itself of this increased availability since it anticipates that no
further options will be granted under the BlueStar Plan.

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.

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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 $1.8511 and 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 shares of our common stock at a purchase price of $0.0022 per share.
The parties agreed that the stock purchases by AT&T Ventures and NEXTLINK
Communications Inc. (now XO Communications) 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 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 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 shares of our common stock at a
purchase price of $0.0015 per share. Prior to our initial public offering, Intel
exercised its warrants for 238,167 shares of our common stock.

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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, Mr. McMinn, our Chairman of the
Board of Directors, and two of our current officers, Mr. Khanna and Mr. Haas,
each exchanged 6,750,000 shares of common stock of Covad California, originally
purchased for $.0019 per share, for a like number of our 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 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 shares of our common stock to Mr. Rex
Cardinale, one of our former officers, for a purchase price of $0.148 per share.
On August 30,1997, we issued 776,250 shares of our common stock to Mr. Laehy,
one of our former officers, for a purchase price of $0.0222 per share. On
October 14, 1997, we issued 324,000 shares of our common stock to Mr. Marshall,
our Chief Executive Officer and one of our directors, for a purchase price of
$0.0222 per share. On April 24, 1998, we issued 216,000 shares of our common
stock to Mr. Hawk, one of our directors, for a purchase price of $0.296 per
share. On August 28, 1998, we issued 90,000 shares of our common stock to Mr.
Hawk for a 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.

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THE STRATEGIC INVESTMENTS AND RELATIONSHIPS

In January 1999, we received equity investments from AT&T Ventures,
NEXTLINK Communications Inc.(now XO Communications) 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. (now XO Communications) 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. (now XO
Communications) 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. (now XO
Communications) 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. (now XO Communications) or Qwest
Communications International, Inc. or whether AT&T Corp., NEXTLINK
Communications Inc. (now XO Communications) or Qwest Communications
International, Inc. will discontinue selling our services entirely.

On September 11, 2000, we entered into an agreement with SBC
Communications, Inc. in which SBC purchased 9,373,169 shares of our common stock
for $150 million. SBC has agreed not to transfer any of our common stock until
September 11, 2001, and, after that period, SBC agreed to offer us the first
opportunity to purchase shares that it intends to sell. SBC also agreed for a
period of five years to vote its shares for the nominees to our Board of
Directors either as recommended by the Board of Directors or in the proportion
to the votes cast by our other shareholders, at SBCs choice. SBC also agreed
that it would not acquire any material number of additional shares of our common
stock for a period of five years without our prior consent.

Concurrently with this equity investment, we entered into the following
other agreements with SBC:

o A commercial agreement in which SBC will provide $600 million in
resale revenue to us over six years starting October 1, 2000, with
approximately $23 million of revenue in the first year and increasing
revenue commitments each year during the life of the contract. Upon a
change of control as defined in the contract, SBC's aggregate revenue
commitment is reduced to $100 million during an initial period of the
contract, and is terminated after the initial period. This agreement
also provides incentives for SBC to sell business lines provided by
us, and we announced that SBC will begin marketing both symmetric
business service DSL and asymmetric consumer service DSL provided by
Covad throughout the United States.

o A settlement of pending legal matters, our antitrust suit against SBC
and Pacific Bell and our arbitrations against SBC affiliates,
Southwestern Bell and Pacific Bell, including Pacific Bell's claim for
alleged past due service fees. The settlement also resolves of several
critical issues in line sharing disputes in Texas, Kansas, Illinois,
Michigan, Ohio, Wisconsin, Indiana, Connecticut and California, plus
key issues in pending interconnection arbitration in Texas and Kansas.

o An agreement to continue joint OSS development to support SBC's resale
of our products, including the fully automatic loop ordering
provisioning process pioneered by us.

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o In region agreements that include continued access to neighborhood
gateways utilized in SBC's recently announced "Project Pronto,"
competitively neutral terms and conditions for spectrum management and
agreements regarding the collocation of equipment in SBC central
offices.

BLUESTAR ACQUISITION

On September 25, 2000, we completed our acquisition of BlueStar
Communications Group, Inc. Our current Chairman of the Board of Directors,
Charles McMinn, was a member of BlueStar's Board of Directors and a BlueStar
shareholder when this acquisition occurred, however, he was not a member of our
Board of Directors at that time. Two of our directors, Robert Hawk and Richard
Shapero, were also shareholders of BlueStar when this acquisition took place and
Mr. Shapero was also a member of BlueStar's Board of Directors. Both Mr. Shapero
and Mr. Hawk did not participate in meetings of our Board of Directors
concerning the review and approval of the BlueStar acquisition.

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 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 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

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will continue to receive compensation in the form of a $500,000 annual base
salary for a period of two years and a $250,000 annual bonus for two years, so
long as Mr. Knowling does not become employed by one of our direct competitors.
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 shares of our common stock at an exercise price of $0.45 per
share. 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 been forgiven in connection with his
resignation. See "Certain Relationships and Related Transactions--Employee
Loans."

In December 2000, we entered into written employment agreements with Mark
Perry, our Executive Vice President and Chief Financial Officer, John McDevitt,
our Executive Vice President, Sales and Marketing, Michael Lach, our Executive
Vice President, Corporate Development and Business Integration, Terry Moya, our
Executive Vice President, External Affairs, Jane Marvin, our Executive Vice
President, Human Resources, and Catherine Hemmer, our Executive Vice President
and Chief Operating Officer. These agreements have a 12-month term, except for
Ms. Hemmer's agreement, which has an 18-month term. If we terminate any of these
officers without cause (as that term is defined in the agreement), or if an
officer resigns for good reason (as that term is defined in the agreement), we
must continue to pay their annual salary through the term of the agreement, plus
a pro rated portion of their bonus. In the event of a change of control (as that
term is defined in the agreement), these employment agreements are null and
void.

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 former 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. As of
November 1, 2000, the outstanding balance of $250,000 on this note was forgiven
in connection with Mr. Knowling's resignation from his position with the
Company.

In August 1998, we loaned Joseph Devich, one of our former 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. Half of the principal amount
of this note was forgiven on Mr. Devich's first anniversary with the Company and
the other half was forgiven in connection with Mr. Devich's resignation from the
Company.

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

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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.

In October 2000, we loaned Terry Moya, one of our officers, the principal
amount of $35,000 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 on the
earlier to occur of October 2005 or the sale of the pledged shares. Interest is
payable at a rate of 6.60% per annum, compounded semiannually.

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PRINCIPAL AND SELLING SHAREHOLDERS

The following table sets forth certain information regarding ownership of
our common stock as of December 31, 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 December
31, 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.

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SHARES BENEFICIALLY
OWNED PRIOR TO THE SHARES SHARES BENEFICIALLY
OFFERING ELIGIBLE OWNED AFTER THE OFFERING
BENEFICIAL ------------------------- TO -------------------------
OWNER NUMBER PERCENTAGE BE SOLD NUMBER PERCENTAGE
---------------- ------------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Donald Guinan................................. 38,176 * 38,176 0 *
Andrew Guinan (19)............................ 83,825 * 12,147 72,718 *
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 (13)............................... 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 (14)........................... 53,784 * 19,629 34,255 *
Daniel Malcolm (15)........................... 55,214 * 2,775 52,439 *
Malcolm Family Ltd. Partnership............... 11,106 * 11,106 0 *
Mike Breslin (16)............................. 9,770 * 2,276 7,494 *
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 (17)............................ 57,457 * 12,840 22,925 *
Paul Hondros.................................. 3,469 * 3,469 0 *
</TABLE>

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------------------------
* Represents beneficial ownership of less than 1% of our outstanding stock.

(1) Based on a Form 13G filed November 6, 2000 with the Securities and Exchange
Commission by SBC Communications, Inc.
(2) Includes 357,592 shares of common stock subject to options exercisable
within 60 days of December 31, 2000. Includes 130,319 shares of our common
stock owned by Ms. Hemmer's husband which may be attributable to Ms.
Hemmer.
(3) Includes 211,357 shares of common stock subject to options exercisable
within 60 days of December 31, 2000.
(4) Includes 45,873 shares of common stock subject to options exercisable
within 60 days of December 31, 2000.
(5) Includes 66,123 shares of common stock subject to options exercisable
within 60 days of December 31, 2000.
(6) Includes 66,123 shares of common stock subject to options exercisable
within 60 days of December 31, 2000.
(7) Includes 25,623 shares of common stock subject to options exercisable
within 60 days of December 31, 2000.
(8) Includes 24,373 shares of common stock subject to options exercisable
within 60 days of December 31, 2000.
(9) Includes 2,114,530 shares of common stock subject to options exercisable
within 60 days of December 31, 2000.
(10) Includes 11,249 shares of common stock subject to options exercisable
within 60days of December 31, 2000.
(11) Includes 51,728 shares of common stock subject to options exercisable
within 60 days of December 31, 2000. Mr. McGovern is employed by us as CEO,
Covad Integrated Services Division.
(12) Includes 17,187 shares of common stock subject to options exercisable
within 60 days of December 31, 2000. Mr. Sullivan is employed by us as our
Senior Vice President, Technical Marketing.
(13) Includes 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.
(14) Includes 34,255 shares of common stock subject to options exercisable
within 60 days of December 31, 2000. Mr. McGovern is employed by us as a
Regional Sales Manager.
(15) Includes 52,439 shares of common stock subject to options exercisable
within 60 days of December 31, 2000. Mr. Malcolm is employed by us Senior
Vice President, Sales Development.
(16) Includes 7,494 shares of common stock subject to options exercisable within
60 days of December 31, 2000. Mr. Breslin is employed by us as an Account
Manager.
(17) Includes 22,925 shares of common stock subject to options exercisable
within 60 days of December 31, 2000. Mr. Copeland is employed by us as a
Director of Project Management.
(18) Consists of 34,379 shares of common stock subject to options exercisable
within 60 days of December 31, 2000. Mr. Sullivan is employed by us as a
Database Administrator.
(19) Includes 72,718 shares of common stock subject to options exercisable
within 60 days of December 31, 2000. Mr. Guinan is employed by us as our
Vice President, Business Integration.
(20) Includes 52,060 shares of common stock subject to options exercisable
within 60 days of December 31, 2000. Mr. Stakias was formerly a director of
Laser Link.Net.
(21) Includes 52,060 shares of common stock subject to options exercisable
within 60 days of December 31, 2000. Mr. Copeland was formerly a director
of Laser Link.Net.
(22) Includes 52,060 shares of common stock subject to options exercisable
within 60 days of December 31, 2000. Mr. Dulaney was formerly a director of
Laser Link.Net.
(23) Includes 52,060 shares of common stock subject to options exercisable
within 60 days of December 31, 2000. Mr. Fromholzer was formerly a director
of Laser Link.Net.
(24) Includes 52,060 shares of common stock subject to options exercisable
within 60 days of December 31, 2000. Mr. Lynch was formerly a director of
Laser Link.Net.

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(25) 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.
(26) Includes 28,661 shares subject to options exercisable within 60 days of
December 31, 2000.
(27) Includes 23,957 shares subject to options exercisable within 60 days of
December 31, 2000.
(28) Includes 32,282 shares subject to options exercisable within 60 days of
December 31, 2000.
(29) Includes 13,124 shares subject to options exercisable within 60 days of
December 31, 2000.

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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 December 31, 2000 our authorized capital stock currently consists of
600,000,000 shares of common stock (including 10,000,000 shares of class B
common stock) and 5,000,000 shares of preferred stock. As of December 31, 2000,
there were 847 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 December 31, 2000, there were 178,855,807 shares of
common stock outstanding. As of December 31, 2000, options to purchase
27,872,447 shares of common stock at a weighted average exercise price of $18.81
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 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 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

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<PAGE>

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.

Pursuant to the Stock Purchase Agreement dated September 11, 2000 between
us and SBC Communications, Inc., SBC is entitled to a single demand and
unlimited "piggyback" registration rights, subject to certain limitations and
conditions. The number of securities requested to be included in a registration
are subject to a pro rata reduction based on the number of shares of common
stock that SBC wishes to include in the registration statement and any other
shares to be included in the offering to the extent that the managing
underwriter advises that the total number of securities requested to be included
in the underwriting would materially and adversely affect the success of the
offering. These registration rights terminate six years after the closing of the
Stock Purchase Agreement.

Pursuant to the Resale Registration Rights Agreement dated September 25,
2000, among us, Bear Stearns & Co., Inc., Morgan Stanley & Co., Incorporated,
Credit Suisse First Boston Corporation, Deutsche Bank Securities Inc. and
Goldman Sachs & Co., we agreed to do the following, at our expense:

o file with the SEC not later than the date 90 days after the earliest
date of original issuance of any of the convertible notes a
registration statement on such form as we deem appropriate covering
resales by holders of all convertible notes and the common stock
issuable upon conversion of the convertible notes;

o use our reasonable best efforts to cause such registration statement
to become effective as promptly as is practicable, but in no event
later than 180 days after the earliest date of original issuance of
any of the convertible notes; and

o use our reasonable best efforts to keep the registration statement
effective until the earliest of:

o two years after the last date of original issuance of any of the
convertible notes;

o the date when the holders of the convertible notes and the common
stock issuable upon conversion of the convertible notes are able
to sell all such securities immediately without restriction
pursuant to the volume limitation provisions of Rule 144 under
the Securities Act; and

o the date when all of the convertible notes and the common stock
issuable upon conversion of the convertible notes of those
holders that complete and deliver in a timely manner the selling

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securityholder election and questionnaire described below are
registered under the shelf registration statement and disposed of
in accordance with the shelf registration statement.

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

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.

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 662/3% 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

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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.

CHANGE IN CONTROL AGREEMENTS. Twelve of our officers have entered into
severance agreements with us under which the benefits would be triggered by a
change of control. In general, a change of control for the purposes of these
agreements, is defined as either (i) the acquisition of 20% of outstanding
common stock of the Company; (ii) an unapproved 25% change in the composition of
the board; or (iii) stockholder approval of a merger without 80% continuity of
interest or of sale or other disposition of substantially all of our assets.

These agreements provide for a one-year employment term for these officers
upon a qualifying "change in control" and provide that such officer's
compensation and benefits cannot be reduced during the one-year term. In
addition, these contracts provide a basic severance benefit equal to two times
the sum of such officer's base salary and target bonus. Should an officer be
terminated within one year of a change in control, without cause or should the
officer terminate employment for "good reason" within that period, in addition
to the severance payment described above, such officer shall be entitled to (i)
a pro rata bonus for the year of termination; (ii) distribution of deferred
compensation; (iii) cash in lieu of any forfeited retirement/401(k) benefits;
and (iv) two years medical and other insurance benefits. Moreover, under certain
circumstances, such officer may defer severance and deferred compensation
payment upon six months advance notice. These agreements may also provide
additional rights including, but not limited to, legal fee reimbursement,
interest on delinquent payments, a board hearing if terminated "for cause," and
no obligation to mitigate damages.

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for the common stock is Boston Equiserve.

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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 December 31, 2000 we had 178,855,807 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 tradable
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 December 31, 2000 we have 31,218,424
shares of our common stock reserved for issuance pursuant to options under our
1997 Stock Plan, of which 25,807,746 shares were subject to outstanding options
as of December 31, 2000, and we have approximately 1.1 million shares of our
common stock reserved for issuance pursuant to our 1998 Employee Stock Purchase
Plan. As of December 31, 2000, we have approximately 2.1 million shares that are
subject to options that we assumed in connection with our acquisitions of Laser
Link.Net and BlueStar. 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.

CONVERTIBLE NOTES. Pursuant to the $500 million of convertible notes due
2005, we may issue up to 28,129,395 shares of our common stock. After
registration and conversion, these shares will be eligible for resale in the
public market.

SBC COMMUNICATIONS. We sold 9,373,169 shares of our common stock to SBC
Communications, Inc. SBC has agreed not to transfer any of these shares until
September 11, 2001, and, after that period, SBC agreed to offer us the first
opportunity to purchase shares that it intends to sell. After September 11,
2001, these shares will be eligible for resale in the public market.

BLUESTAR. In connection with our acquisition of BlueStar Communications
Group, Inc., we issued 8.0 million shares of our common stock to BlueStar's
shareholders, some of which are freely tradable by the new shareholders. Up to
5.0 million additional shares may be issued to the BlueStar shareholders if
certain performance targets are met by our BlueStar subsidiary in fiscal year
2001. A significant number of these BlueStar shareholders entered into lock-up
agreements, pursuant to which such shareholders promised not to sell their
shares until either 6 months or 12 months after the closing of the acquisition.
We may, in our sole discretion and at any time without notice, release all or
any portion of the securities subject to lock-up agreements entered into as part
of the BlueStar acquisition. If BlueStar shareholders were to sell their shares
of our common stock, it could adversely affect our stock price.

LASER LINK. In connection with our acquisition of Laser Link, the former
shareholders of Laser Link agreed that 10% of the shares issued in the
transaction would be held in escrow until March 2001. Moreover, two shareholders
holding an aggregate of approximately 3,000,000 shares, have agreed that 30% of
their shares will be held in escrow. Approximately 17% of these escrowed shares
were released on September 20, 2000 and October 31, 2000, the remaining 66% of
the escrowed shares were released in November 2000. The sale of these shares
could adversely affect the price of our stock.

REGISTRATION RIGHTS

98
<PAGE>

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.

In connection with our acquisition of LaserLink.net, we agreed to
register 5,013,466 shares of our common stock that were issued to the former
shareholders of LaserLink.net. There is currently an S-1 registration statement
in effect covering those shares and we intend to keep that registration
statement in effect until March 20, 2001.

o use our reasonable best efforts to keep the registration statement
effective until the earliest of:

o two years after the last date of original issuance of any of the
convertible notes;

o the date when the holders of the convertible notes and the
common stock issuable upon conversion of the convertible notes
are able to sell all such securities immediately without
restriction pursuant to the volume limitation provisions of Rule
144 under the Securities Act; and

o the date when all of the convertible notes and the common
stock issuable upon conversion of the convertible notes of those
holders that complete and deliver in a timely manner the selling
securityholder election and questionnaire described below are
registered under the shelf registration statement and disposed
of in accordance with the shelf registration statement.

99
<PAGE>

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

(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.

100
<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.

101
<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 Covad Communications Group, 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 Ernst & Young LLP, independent auditors, as set forth in
their report thereon (which contains an emphasis paragraph describing conditions
that adversely affect the Company's consolidated results of operations and
liquidity subsequent to December 31, 1999 as described in Note 10 to the
consolidated financial statements) 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 said 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.

102
<PAGE>

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
<S> <C>
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 September 30, 2000.......................................... F-19
Condensed Consolidated Statements of Operations for the three and nine months ended September 30,
2000 and 1999..................................................................................... F-20
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2000 and 1999 F-21
Notes to Condensed Consolidated Financial Statements................................................ F-22

UNAUDITED PRO FORMA CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS
Overview............................................................................................ F-30
Unaudited Pro Forma Condensed Combined Consolidated Statements of Operations for the year ended
December 31, 1999................................................................................. F-31
Unaudited Pro Forma Condensed Combined Consolidated Statements of Operations for the nine months
ended September 30, 2000.......................................................................... F-32
Notes to Unaudited Pro Forma Condensed Combined Consolidated Financial Information.................. F-33

LASER LINK.NET, INC.
ANNUAL FINANCIAL STATEMENTS
Report of Independent Accountants................................................................... F-37
Balance Sheets at December 31, 1999 and 1998........................................................ F-38
Statements of Operations for the years ended December 31, 1997, 1998 and 1999....................... F-39
Statements of Stockholders' Equity for the years ended December 31, 1997, 1998 and 1999............. F-40
Statements of Cash Flows for the years ended December 31, 1997, 1998 and 1999....................... F-41
Notes to Financial Statements....................................................................... F-42

BLUESTAR COMMUNICATIONS GROUP, INC.
ANNUAL FINANCIAL STATEMENTS
Report of Independent Public Accountants............................................................ F-49
Consolidated Balance Sheets at December 31, 1998 and December 31, 1999.............................. F-50
Consolidated Statements of Operations for the years ended December 31, 1998 and 1999................ F-51
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998 and 1999...... F-52
Consolidated Statements of Cash Flows for the years ended December 31, 1998 and 1999................ F-53
Notes to Consolidated Financial Statements.......................................................... F-54

INTERIM FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets at December 31,1999 and June 30, 2000......................... F-64
Condensed Consolidated Statements of Operations for the three and six months ended
June 30, 1999 and 2000............................................................................ F-65
Condensed Consolidated Statements of Stockholders' Equity for the six months ended
June 30, 2000..................................................................................... F-66
Condensed Consolidated Statements of Cash Flows for the six months ended
June 30, 1999 and 2000............................................................................ F-67
Notes to Condensed Consolidated Financial Statements................................................ F-68
</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.

Since the date of completion of our audit of the accompanying
consolidated financial statements and initial issuance of our report thereon
dated January 21, 2000, except for Note 9, as to which the date is April 3,
2000, as discussed in Note 10, a substantial number of the Company's Internet
service provider customers have experienced financial difficulties and certain
of them have filed for bankruptcy protection. Furthermore, several of the
Company's shareholders and purchasers of its convertible notes have filed
lawsuits against the Company and certain of its current and former officers
alleging violations of federal and state securities laws. The relief sought in
these lawsuits includes rescission of certain convertible note sales completed
by the Company in September 2000 and unspecified damages. The distressed
financial condition of the Company's Internet service provider customer channel
has adversely affected, and may continue to adversely affect, the Company's
consolidated results of operations and liquidity subsequent to December 31,
1999. In addition, the ultimate outcome, if unfavorable, of the aforementioned
securities litigation may exacerbate this situation in the future. Note 10 also
describes management's plans to address certain of these issues.

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 Notes 9 and 10,
as to which the dates are April 3, 2000,
and January 9, 2001, respectively

F-2
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>

DECEMBER 31,
-------------------------
ASSETS 1998 1999
---------- -------------
<S> <C> <C>
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
========== =============
</TABLE>

LIABILITIES AND STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)

<TABLE>
<CAPTION>
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable.................................................................. $ 14,975 $ 20,790
Unearned revenue.................................................................. 551 5,238
Accrued network costs............................................................. 1,866 8,798
Other accrued liabilities......................................................... 3,854 47,440
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)

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 COMMON STOCK ADDITIONAL
------------------------------ ------------------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
-------------- ------------- --------------- ------------- ------------
<S> <C> <C> <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 ............. 1,125,000 1 -- -- 249
Issuance of Series B Preferred Stock
(net of $43 of financing costs)................ 25,500,002 17 -- -- 8,440

Deferred compensation ............................ -- -- -- -- 906
Amortization of deferred.......................... -- -- -- -- --
Net loss.......................................... -- -- -- -- --
-------------- ------------- --------------- ------------- ------------
Balances at December 31, 1997 .................... 26,625,002 18 25,562,709 11 9,692
Issuance of Common Stock.......................... -- -- 928,785 1 570
Issuance of Series B Preferred Stock.............. 150,003 -- -- -- 100
Issuance of Series C Preferred Stock.............. 594,238 -- -- -- 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..................... (27,369,243) 18 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........ 9,568,766 6 -- -- 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................ (27,369,243) (18) 41,053,864 27 (9)
Conversion of Series C1 and D1
Preferred stock................................ (9,568,766) (6) 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
============== ============= =============== ============= ============

TOTAL STOCKHOLDERS'
DEFERRED ACCUMULATED OTHER ACCUMULATED EQUITY (NET CAPITAL
COMPENSATION COMPREHENSIVE INCOME DEFICIT DEFICIENCY)
---------------- ---------------------- --------------- ---------------------
<S> <C> <C> <C> <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 ............................ (906) -- --
Amortization of deferred.......................... 295 -- 295
Net loss.......................................... -- -- (2,612) (2,612)
---------------- ---------------------- --------------- ---------------------
Balances at December 31, 1997 .................... (611) -- (2,612) 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 ............................ (8,074) -- -- --
Amortization of deferred compensation............. 3,997 -- -- 3,997
Net loss.......................................... -- -- (48,121) (48,121)
---------------- ---------------------- --------------- ---------------------
Balances at December 31, 1998..................... (4,688) -- (50,733) (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............................. (6,593) -- -- --
Amortization of deferred compensation............. 4,768 -- -- 4,768
Unrealized gains (losses) on investments.......... -- 91,257 -- 91,257
Net loss.......................................... -- -- (195,397) (195,397)
---------------- ---------------------- --------------- ---------------------
Balances at December 31, 1999..................... $ (6,513) $ 91,257 $ (246,130) $ 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 DECEMBER 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 5,815
Unearned revenue.......................................................... 7 544 4,687
Other current liabilities................................................. 135 5,585 50,518
---------- --------- -----------
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.......................................... $ -- $ 2,9280 $ --
========== ========= ===========
</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" ("FAS
123").

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.

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

F-9

<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

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 7,360,978 12,844,203 107,647,812
and diluted net loss per share.................
============== ============== ==============
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:

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 $ 92,914 $ (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 $0.0015
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.

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.

F-12
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

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 February 15, 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

In January 1999, the Company entered into strategic relationships with
AT&T Corp. ("AT&T"), NEXTLINK Communications, Inc. (now XO Communications) 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. 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

F-13
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

$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.

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.

F-14
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

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><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>

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

F-15
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

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%

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 $0.20 per
share and $0.49 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.

F-16
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

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 Verizon (formerly Bell Atlantic)
and its affiliates in federal court and is pursuing antitrust and other claims
in this lawsuit. In addition, Verizon 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 judgment ruling holding that the
Company had not infringed Verizon's patent. Verizon 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. This suit
has been settled for a nominal amount.

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 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.

F-17
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

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 $407.5 million.

10. RECENT DEVELOPMENTS

As disclosed in Note 7 to the Company's unaudited condensed consolidated
financial statements as of September 30, 2000 and for the three and nine month
periods ended September 30, 1999 and 2000, appearing in this Prospectus and
Registration Statement, a substantial number of the Company's Internet service
provider customers have experienced financial difficulties and certain of them
have filed for bankruptcy protection during 2000. Furthermore, as disclosed in
Note 7 to such unaudited condensed consolidated financial statements, several of
the Company's shareholders and purchasers of its convertible notes have filed
lawsuits against the Company and certain of its current and former officers in
2000 alleging violations of federal and state securities laws. The relief sought
in these lawsuits includes rescission of certain convertible note sales
completed by the Company in September 2000 and unspecified damages. The
distressed financial condition of the Company's Internet service provider
customer channel has adversely affected, and may continue to adversely affect,
the Company's consolidated results of operations and liquidity subsequent to
December 31, 1999. In addition, the ultimate outcome, if unfavorable, of the
aforementioned securities litigation may exacerbate this situation in the
future. Accordingly, if necessary, the Company will develop a contingency plan
to address any material adverse developments in this litigation.

As disclosed in Note 8 to the Company's unaudited condensed consolidated
financial statements as of September 30, 2000, and for the three and nine month
periods ended September 30, 1999 and 2000, appearing in this Prospectus and
Registration Statement, the Company announced a comprehensive restructuring plan
during the fourth quarter of 2000 that involves a curtailment of network
expansion plans, the closing of certain facilities, the consolidation of various
offices, a significant workforce reduction and other cost reduction strategies.

F-18
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
(UNAUDITED)

SEPTEMBER 30,
2000
-------------
ASSETS

Current assets:
Cash and cash equivalents.................................... $ 762,898
Accounts receivable, net..................................... 29,585
Short-term investments....................................... 150,232
Unbilled revenue............................................. 13,170
Inventories.................................................. 20,132
Prepaid expenses and other current assets.................... 33,114
-----------
Total current assets.................................... 1,009,131
Property and equipment, net........................................ 568,286
Restricted cash.................................................... 39,178
Investment in unconsolidated investees............................. 85,065
Goodwill and other intangible assets, net.......................... 477,519
Other assets, net.................................................. 62,614
-----------
Total assets............................................ $2,241,793
===========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable............................................. $ 50,032
Unearned revenue............................................. 10,393
Accrued network costs........................................ 17,022
Other accrued liabilities.................................... 123,452
Note payable................................................. 35,000
Current portion of capital lease obligations................. 910
-----------
Total current liabilities............................... 236,809
Long-term debt, net................................................ 1,319,592
Long-term capital lease obligations................................ 14
Other long-term liabilities........................................ 17,938
-----------
Total liabilities....................................... 1,574,353

Stockholders' equity:
Common stock................................................. 145
Common stock--Class B........................................ --
Additional paid-in capital................................... 1,348,394
Deferred compensation........................................ (7,553)
Accumulated other comprehensive income....................... 6,123
Accumulated deficit......................................... (679,669)
-----------
Total stockholders' equity............................... 667,440
-----------
Total liabilities and stockholders' equity.............. $2,241,793
===========

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)

Revenues.................................................. $ 56,341 $ 19,141 $ 156,308 $ 35,570
Operating expenses:
Network and product costs.......................... 58,122 16,694 133,085 32,219
Sales, marketing, general and administrative....... 123,538 37,697 311,444 80,786
Depreciation and amortization...................... 32,883 10,593 74,600 23,911
Amortization of goodwill and other intangible
assets........................................... 20,718 -- 44,171 --
Amortization of deferred compensation.............. 697 1,008 2,609 3,895
Write-off of in-process technology................. -- -- 3,726 --
----------- ---------- ---------- -----------
Total operating expenses..................... 235,958 65,992 569,635 140,811
----------- ---------- ---------- -----------
Loss from operations...................................... (179,617) (46,851) (413,327) (105,241)
Interest income (expense):
Interest income.................................... 10,136 4,770 37,316 12,864
Interest expense................................... (26,336) (12,024) (73,296) (32,484)
----------- ---------- ---------- -----------
Net interest expense............................... (16,200) (7,254) (35,980) (19,620)

Other income.............................................. 981 -- 15,768 --
----------- ---------- ---------- -----------
Net loss.................................................. $ (194,836) $ (54,105) $ (433,539) $ (124,861)

Preferred dividends................................ -- -- -- (1,146)
----------- ---------- ---------- -----------
Net loss attributable to common stockholders.............. $ (194,836) $ (54,105) $ (433,539) $ (126,007)
=========== ========== ========== ===========
Basic and diluted net loss per common share............... $ (1.25) $ (0.47) $ (2.85) $ (1.27)
=========== ========== ========== ===========
Weighted average shares used in computing basic and 155,931 115,624 152,031 99,553
diluted net loss per share.............................
=========== ========== ========== ===========
</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>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
2000 1999
------------ ----------
<S> <C> <C>
OPERATING ACTIVITIES:

Net cash used in operating activities.................................................. $ (273,614) $ (65,721)

INVESTING ACTIVITIES:

Cash acquired through acquisitions..................................................... 4,040 --
Acquisition of businesses and equity investments, net of cash acquired................. (29,929) --
Net sale (purchase) of investments..................................................... 315,953 (20,000)
Purchase of restricted cash............................................................ -- (74,353)
Redemption of restricted cash.......................................................... 13,438 13,214
Purchase of property and equipment..................................................... (384,628) (145,607)
Increase in other assets............................................................... (11,032) (7,131)
------------ ----------
Net cash used in investing activities.................................................. (92,158) (233,877)

FINANCING ACTIVITIES:

Net proceeds from issuance of long-term debt........................................... 898,017 205,049
Principal payments under capital lease obligations..................................... (224) (197)
Proceeds from common stock issuance, net of offering costs............................. 14,839 152,176
Proceeds from preferred stock issuance................................................. -- 60,000
Payment of preferred dividends......................................................... -- (77)
------------ ----------
Net cash provided by financing activities.............................................. 912,632 416,951
------------ ----------
Net increase in cash and cash equivalents.............................................. 546,860 117,353
Cash and cash equivalents at beginning of period....................................... 216,038 64,450
------------ ----------
Cash and cash equivalents at end of period............................................. $ 762,898 $ 181,803
============ ==========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

Cash paid for interest.......................................................... $ 54,788 $ 13,257
============ ==========
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

Common stock issued for preferred dividends..................................... $ -- $ 1,069
============ ==========
Issuance of common stock for acquisition of businesses.......................... $ 480,301 $ --
============ ==========
Issuance of notes payable in exchange for equity interest in
Loop Holdings Europe AsP...................................................... $ 35,000 $ --
============ ==========
</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 AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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 its wholly-owned subsidiaries. All intercompany accounts and
transactions have been eliminated.

The unaudited condensed consolidated financial statements as of September
30, 2000 and for the three and nine months ended September 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 nine months ended September 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 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 September 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 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 nine months ended September 30, 2000 and 1999
(in thousands, except per share amounts):

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -------------------------
2000 1999 2000 1999
----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Net loss................................................... $ (194,836) $ (54,105) $ (433,539) $ (124,861)
Preferred dividends..................................... -- -- -- (1,146)
----------- ----------- ----------- ------------
Net loss attributable to common stockholders............... $ (194,836) $ (54,105) $ (433,539) $ (126,007)
Basic and diluted:
Weighted average shares of common stock outstanding..... 158,524 122,753 156,119 108,031
Less: Weighted average shares subject to repurchase... (2,593) (7,129) (4,088) (8,478)
----------- ----------- ----------- ------------
Weighted average shares used in computing basic and
diluted net loss per share................................. 155,931 115,624 152,031 99,553
=========== =========== =========== ============
Basic and diluted net loss per share....................... $ (1.25) $ (0.47) $ (2.85) $ (1.27)
=========== =========== =========== ============
</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 nine months ended September 30,
2000 and 1999 is as follows (in thousands):

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2000 1999 2000 1999
------------ ----------- ------------ ------------
<S> <C> <C> <C> <C>
Net loss.................................................. $ (194,836) $ (54,105) $ (433,539) $ (124,861)
Unrealized holding gains (losses)...................... (21,157) (8,940) (85,134) 16,698
------------ ----------- ------------ ------------
Comprehensive income...................................... $ (215,993) $ (63,045) $ (518,673) $ (108,163)
============ =========== ============ ============
</TABLE>

3. SHORT-TERM INVESTMENTS

At September 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 September 30, 2000, are included as a
separate component of stockholders' equity. The amount of net realized gains for
both the three and nine months ended September 30, 2000 was $13.4 million.

The following table summarizes the Company's short-term investments (in
thousands):

SEPTEMBER 30, 2000
----------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
----------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
Commercial paper......................................... $ 14,685 $ -- $ (3) $ 14,682
U.S. agency notes........................................ 101,398 24 (3) 101,419
Equity securities........................................ 51,038 13,539 (7,416) 57,161
----------- ------------ ------------ -----------
Total available for sale securities................... $ 167,121 $ 13,563 $ (7,422) $ 173,262
=========== ============ ============ ===========
</TABLE>

The company had a net unrealized loss of $219,000 on long-term U.S.
Treasury securities, at September 30, 2000, classified as restricted cash in the
accompanying consolidated balance sheet. The Company also had a net unrealized
gain of $17,000 on cash and cash equivalents at September 30, 2000.

4. ACQUISITIONS

LASER LINK.NET, INC.

F-23
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)

The Unaudited Condensed Consolidated Financial Statements at September
30, 2000 and for the three and nine months then ended 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 preliminary estimates of
their fair value. The actual allocation of the total purchase cost may differ
from the preliminary estimates. The 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 options................... 84,100
------------
391,969

Acquisition costs.................................. 15,485
------------
Total purchase costs.................................... $ 407,454
============

LIFE ANNUAL
(YRS) AMORTIZATION
------- -------------
<S> <C> <C> <C>
Purchase price allocation:
Tangible net assets acquired................................. $ 5,132 N/A $ --
Intangible assets acquired:
Developed and core technology............................ 13,023 5 2,605
Customer base............................................ 28,552 5 5,710
Assembled 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 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 of five years. These cash flows are discounted to their
present value using a 20% rate of return 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.

F-24
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)

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.

In valuing the IPRD, the Company 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 the Company'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
Laser Link's 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% as of March 22, 2000.

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.

The following unaudited pro forma financial information presents the
consolidated results of operations of the Company, excluding the charge for
IPRD, as if the acquisition of Laser Link had occurred at January 1, 1999 and
does not purport to be indicative of what would have occurred had the
acquisition been made as of January 1, 1999 or of the results that may occur in
the future. The pro forma 1999 results of operations combines the consolidated
results of operations of the Company, excluding the charge for in-process
research and development, for the nine months ended September 30, 1999 with the
historical results of operations of Laser Link for the nine months ended
September 30, 1999 (in thousands, except per share data).

NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------
2000 1999
--------------- -------------
Revenue..................................... $ 158,925 $ 38,987
Net loss.................................... $ (493,946) $ (188,753)
Loss per share.............................. $ (3.22) $ (1.81)

BLUESTAR COMMUNICATIONS GROUP, INC.

On September 22, 2000, the Company completed its combination with
BlueStar Communications Group, Inc. ("BlueStar") by issuing approximately 6.1
million shares of common stock (including 800,000 shares to be held in escrow
for a one year period) for all of the outstanding BlueStar preferred and common
shares. The common shares issued were valued for accounting purposes using the
average market price of $14.23 per share, which is based on the average closing
price for a range of seven trading days around the closing of the transaction.
In addition, the outstanding BlueStar stock options and warrants were converted
into approximately 226,000 options to purchase the Company's common shares at a
fair value averaging approximately $7.70 per share. Up to 5 million additional
common shares of the Company will be issued if BlueStar reaches certain
specified levels of revenue and earnings before interest, taxes, depreciation
and amortization (EBITDA) in fiscal 2000.

F-25
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)

The Unaudited Condensed Consolidated Financial Statements at September
30, 2000 and for the three and nine months then ended 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 estimates of their fair value.
The actual allocation of the total purchase cost may differ from the preliminary
estimates. The 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................................. $ 86,593
Assumption of BlueStar options and warrants................... 1,742
-----------
88,335

Interim financing costs............................................ 26,152
-----------
Acquisition costs.................................................. 9,346
-----------
Total purchase costs............................................ $ 123,833
===========

LIFE ANNUAL
(YRS) AMORTIZATION
------ -------------
Purchase price allocation:
Tangible net assets acquired......... $ 400 N/A $ --
Intangible assets acquired:
Customer base...................... 10,500 3 3,500
Assembled workforce................ 11,300 3 3,767
Deferred stock compensation........ 364 2.5 146
Goodwill........................... 101,269 5 20,254
---------- -------------
Total purchase price allocation...... $ 123,833 $ 27,667
========== =============

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 five years.

The following unaudited pro forma financial information presents the
consolidated results of operations of the Company, as if the acquisition of
BlueStar had occurred at January 1, 1999 and does not purport to be indicative
of what would have occurred had the acquisition been made as of January 1, 1999
or of the results that may occur in the future. The pro forma 1999 results of
operations combines the consolidated results of operations of the Company, for
the nine months ended September 30, 1999 with the historical results of
operations of BlueStar for the nine months ended September 30, 1999 (in
thousands, except per share data).

NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------
2000 1999
--------------- -------------
Revenue.......................... $ 163,944 $ 35,915
Net loss......................... $ (530,184) (153,029)
Loss per share................... $ (3.36) (1.45)

F-26
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)

On September 8, 2000, the Company entered into an acquisition agreement
with Loop Holdings Europe AsP, which owns preferred shares representing 70% of
Loop Telecom S.A., (a 50% voting interest) a Spanish full-service broadband
service provider for small and medium-sized businesses, for $15 million in cash,
a note for $15 million payable six months after the closing and a note for $20
million payable one year after closing. The acquisition closed on September 21,
2000 and has been accounted for using the equity method of accounting.

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 notes. For the three and nine months ended September 30, 2000, the
amortization of debt discount and debt issuance costs was $294,000 and $793,000,
respectively.

On September 25, 2000, the Company completed a private placement of
$500.0 million five year 6% convertible senior notes, which are convertible into
our common stock at a conversion price of $17.775, subject to certain
adjustments.

Net proceeds from the convertible notes were approximately $484.5 million
after discounts, commissions, and other transaction costs of approximately $15.5
million. The discount and debt issuance costs are being amortized over the life
of the convertible notes. For the three months ended September 30, 2000, the
amortization of debt discount and debt issuance costs was $43,000.

6. RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for
Derivative Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the balance sheet and measure those instruments at fair value.
Management does not expect the adoption of SFAS 133 to have a material effect on
the Company's consolidated financial position or results of operations. The
Company is required to adopt SFAS 133 in the first quarter of 2001.

The Company is 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 received at the inception of a
service arrangement have to be deferred and recognized on a straight-line basis
over the term of the contract or the expected term of the customer relationship,
whichever is longer, provided that all other criteria for revenue recognition
have been met. SAB 101 also limits, if necessary, the deferral of incremental
direct costs associated with the origination of a customer arrangement to an
amount that is no greater than the amount of up-front revenues that have been
deferred. Due to the complexities of implementing SAB 101, the SEC deferred the
implementation date of SAB 101 until the quarter ending December 31, 2000, with
retroactive application to January 1, 2000, which will require adjustments
consistent with SAB 101 with respect to the Company's quarterly financial
information for each of the three quarters in the period ended September 30,
2000. In October 2000, the SEC issued further interpretive guidance on the
implementation of SAB 101. The Company's analysis of the impact of implementing
SAB 101 is still in process. However although SAB 101 will substantially alter
the timing of recognition of certain revenues and treatment of certain costs in
the Company's consolidated financial statements, it will not affect the
Company's consolidated cash flows. Accordingly, the Company believes that the
implementation of SAB 101 for the year ending December 31, 2000 will have a
material adverse effect on its consolidated financial position and results of
operations, but will not affect its consolidated cash flows.

F-27
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)

7. LEGAL PROCEEDINGS AND OTHER MATTERS

On September 11, 2000, the Company announced various agreements with SBC
Communications, Inc. ("SBC") including, (i) a resale and marketing agreement for
up to $600 million in revenue over a six year period for SBC to market and
resell the Company's DSL services (including an arrangement whereby SBC
reimbursed the Company for $20.0 million in general and administrative expenses
during the third quarter of 2000), (ii) a stock purchase agreement whereby SBC
took, on November 6, 2000, a minority ownership position of approximately 6% of
the Company in exchange for $150 million, and (iii) a settlement agreement of
the Company's pending legal matters with SBC and its affiliates including
performance standards and line-sharing arrangements governing the future
commercial relationship between the two entities in all 13 SBC states.

Several of our shareholders have filed class action lawsuits against us,
our former president and Chief Executive Officer, Robert E. Knowling, and our
current executive vice president and Chief Financial Officer, Mark H. Perry.
These lawsuits were filed in the United States District Court for the Northern
District of California. The complaints in these matters allege violations of
federal securities laws on behalf of persons who purchased our securities,
including those who purchased common stock and those who purchased convertible
notes, during the periods from September 7, 2000 to October 17, 2000 or
September 7, 2000 to November 14, 2000. The relief sought includes monetary
damages and equitable relief. In addition, three purchasers of the convertible
notes have filed complaints in California Superior Court for the County of Santa
Clara. These complaints allege fraud and deceit, negligence and violations of
state securities laws in connection with our sale of the convertible notes. The
relief sought includes rescission of their purchases of approximately $90
million in aggregate principal amount of convertible notes and unspecified
damages, including punitive damages. The plaintiff in one of these matters has
also requested a trial date in August 2001, but the Company intends to oppose
this request. One of the plaintiffs in these matters has also sought a writ of
attachment for the full amount of its rescission claims for its purchases of
convertible notes. On December 11, 2000, this request for a writ of attachment
was denied. Three additional purchasers of the Company's convertible notes have
indicated that they intend to file similar lawsuits. Although the Company
believes that it has strong defenses in these pending and threatened lawsuits,
the ultimate outcome of these litigation matters is inherently unpredictable and
there is no guarantee the Company will prevail.

A manufacturer of telecommunications hardware has filed a complaint
against the Company in the United States District Court for the District of
Arizona, alleging claims for false designation of origin, infringement and
unfair competition. The plaintiff is seeking an injunction to stop the Company
from using the COVAD trademark, as well as an award of monetary damages. We do
not believe that these claims have any merit, but the outcome of litigation is
unpredictable and the Company cannot guarantee that it will prevail.

An unfavorable outcome in any of the proceedings described above could
have a material adverse effect on the Company's consolidated financial position
and results of operations.

As of December 31, 2000, nineteen of the Company's Internet service
provider customers, which account for approximately 92,000 of the Company's
274,000 total installed lines, are experiencing financial difficulties due in
part to weakness in the capital markets, and are not current in their payment
for the Company's services. Based on this information, the Company determined
that the collectibility of revenues from those customers was not reasonably
assured and, therefore, did not recognize any of the approximately $21.8 million
of revenue earned from financially distressed Internet service provider
customers during the third quarter of 2000. Revenue related to customers that do
not demonstrate the ability to pay for services in a timely manner will be
recorded as revenue when cash for those services is received, after the
collection of all previous accounts receivable balances.

Four of these nineteen Internet service provider customers, Flashcom,
Zyan Communications, Relay Point and Fastpoint, have subsequently filed for
bankruptcy protection. As of December 31, 2000, these four Internet service
provider customers represent over half of the approximately 89,000 lines served
through these nineteen Internet service

F-28
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)

provider customers. Zyan Communications has been ordered by the court to prepay
the Companyfor services on a weekly basis. The Company may also obtain similar
relief with respect to other Internet service provider customers in bankruptcy
proceedings. In addition, the Company has completed the migration of certain end
users from certain of the financially distressed Internet service provider
customers.

8. RECENT DEVELOPMENTS

The distressed financial condition of the Company's Internet service
provider customer channel (Note 7), the lawsuits filed against the Company and
certain of its current and former officers alleging violations of federal and
state securities laws (Note 7) and the limited availability of additional
capital funding in the Company's industry sector pose significant challenges to
management and the success of the Company's business. Therefore, during the
fourth quarter of 2000, the Company announced a comprehensive restructuring plan
that involves the following steps:

o Closing 250 underproductive or not fully-built out central offices and
holding the size of the Company's network at approximately 1,750
central offices, which will significantly reduce the Company's capital
expenditures;

o Reducing the Company's workforce by approximately 800 positions, which
represents approximately 25% of the Company's workforce;

o Closing a facility in Alpharetta, Georgia and consolidated offices in
Manassas, Virginia, Santa Clara, California and Denver, Colorado;

o Restructuring the Covad Business Solutions division, formerly
BlueStar.net, to streamline the Company's direct sales and marketing
channel; and

o Evaluating and implementing other cost reduction strategies.

Management estimates that the Company will report a charge of up to $20
million in the fourth quarter of 2000 in connection with this restructuring
plan, substantially all of which will require the future expenditure of cash.
In addition, due to this restructuring plan and the Company's current operating
environment, the Company is currently performing an analysis to determine if any
of its long-lived assets, including intangibles, might be impaired. This
analysis may ultimately result in the recognition of non-cash impairment losses
in the Company's consolidated financial statements for periods ending after
September 30, 2000.

The distressed financial condition of the Company's Internet service
provider customer channel described in Note 7 has adversely affected, and may
continue to adversely affect, the Company's consolidated results of operations
and liquidity. In addition, the ultimate outcome, if unfavorable, of the
securities litigation described in Note 7 may exacerbate this situation in the
future. Accordingly, if necessary, the Company will develop a contingency plan
to address any material adverse developments in this litigation.

F-29
<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. ("Covad" or the "Company"), Laser Link.Net Inc.
("Laser Link"), and BlueStar Communications Group, Inc. ("BlueStar") through the
issuance of Covad common shares and stock options for the outstanding Laser Link
and BlueStar 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 was completed on
September 22, 2000.

The Unaudited Pro Forma Condensed Combined Consolidated Statements of
Operations for the year ended December 31, 1999 and for the nine months ended
September 30, 2000 reflect the combinations as if they had taken place on
January 1, 1999 and January 1, 2000, respectively. Unaudited Pro Forma Condensed
Combined Consolidated Balance Sheets are not presented as the Company's
historical balance sheet as of September 30, 2000 includes the financial
position of Laser Link and BlueStar, and is included elsewhere in this document.
The Unaudited Pro Forma Condensed Combined Consolidated Statements of Operations
combine the Company's historical results of operations for the year ended
December 31, 1999 and the nine months ended September 30, 2000 with BlueStar's
historical results of operations for the year ended December 31, 1999 and the
period from January 1, 2000 to September 22, 2000 (the closing date of the
transaction) 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 preliminary estimates of their fair value. The actual
allocation of the total purchase cost may differ from the preliminary estimates.

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 and the Laser Link and
BlueStar audited 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 and do not purport to indicate the
Company's future results of operations or financial position.

F-30
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.

UNAUDITED PRO FORMA CONDENSED COMBINED
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN 000'S, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>

YEAR ENDED DECEMBER 31, 1999
------------------------------------------------------------------------------------
PRO FORMA
BUSINESS
COMBINATIONS 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.................... -- -- -- -- 104,635 104,635
Amortization of deferred
compensation.............. 4,768 -- 426 5,194 146 5,340
-------------- ------------- ----------- ------------ ------------- --------------
Total operating expenses.. 238,089 9,619 20,532 268,240 107,386 375,626
-------------- ------------- ----------- ------------ ------------- --------------
Loss from operations........... (171,601) (3,575) (19,761) (194,937) (107,386) (302,323)
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) (107,386) (325,744)
Preferred dividends............ (1,146) (490) -- (1,636) -- (1,636)
-------------- ------------- ----------- ------------ ------------- --------------
Net loss attributable to common
stockholders................ $ (196,543) $ (4,232) $ (19,219) $ (219,994) $ (107,386) $ (327,380)
============== ============= =========== ============ ============= ==============
Basic and diluted net loss per
share....................... $ (1.83) $ (0.16) $ (2.15) $ (2.76)
============== ============= =========== ==============
Weighted average shares
outstanding used in
computing basic and diluted
net loss per share.......... 107,648 26,075 8,953 118,736
============== ============= =========== ==============
</TABLE>

SEE ACCOMPANYING NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED
CONSOLIDATED FINANCIAL STATEMENTS.

F-31
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN 000'S, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 2000
-----------------------------------------------------
PRO FORMA
LASER LINK BLUESTAR BUSINESS
(1/1/00- (1/1/00- COMBINATIONS PRO FORMA
COVAD 3/20/00) 9/22/00) TOTAL ADJUSTMENTS COMBINED
-------------- ----------- ------------ ------------ ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Revenues............................ $ 156,308 $ 2,617 $ 7,636 $ 166,561 $ -- $ 166,561
Operating expenses:
Network and product costs......... 133,085 1,183 13,439 147,707 1,954 149,661
Sales, marketing, general and
administrative.................. 311,444 1,562 64,474 377,480 -- 377,480
Depreciation and amortization.... 74,600 353 3,219 78,172 -- 78,172
Amortization of goodwill and
other intangible assets......... 44,171 -- -- 44,171 35,882 80,053
Amortization of deferred
compensation.................... 2,609 -- -- 2,609 110 2,719
Write-off of in-process technology 3,726 -- -- 3,726 (3,726) --
-------------- ----------- ------------ ------------ ------------- --------------
Total operating expenses........ 569,635 3,098 81,132 653,865 34,220 688,085
-------------- ----------- ------------ ------------ ------------- --------------
Loss from operations................ (413,327) (481) (73,496) (487,304) (34,220) (521,524)
Interest income (expense):
Interest income................... 37,316 -- 528 37,844 -- 37,844
Interest expense.................. (73,296) (137) (155) (73,588) -- (73,588)
-------------- ----------- ------------ ------------ ------------- --------------
Net interest income (expense).... (35,980) (137) 373 (35,744) -- (35,744)
Other income........................ 15,768 -- (2,772) 12,996 -- 12,996
-------------- ----------- ------------ ------------ ------------- --------------
Net loss............................ $ (433,539) $ (618) $ (75,895) $ (510,052) $ (34,220) $ (544,272)
============== =========== ============ ============ ============= ==============
Basic and diluted net loss per share $ (2.85) $ (3.41)
============== ==============
Weighted average shares outstanding
used in computing basic and
diluted net loss per share....... 152,031 159,399
============== ==============
</TABLE>

SEE ACCOMPANYING NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED
CONSOLIDATED FINANCIAL STATEMENTS.

F-32
<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, the Company completed its combination with Laser
Link.Net, Inc. ("Laser Link") by issuing approximately 5.0 million common shares
for all of the outstanding Laser Link common shares. The Company's 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 nine months ended September 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 the Company's 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 preliminary estimates of their fair value. The actual allocation
of the total purchase cost may differ from the preliminary estimates. The
following is a table of the total purchase cost and annual amortization of the
intangible assets acquired (in thousands):

<TABLE>
<CAPTION>
Total purchase cost:
<S> <C>

Value of common shares issued..................................................... $ 307,869
Assumption of Laser Link 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 N/A $ --
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>

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 (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.

F-33
<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 the Company's historical
financial statements for the nine months ended September 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.

On September 22, 2000, the Company completed its combination with BlueStar
Communications Group, Inc. ("BlueStar") by issuing approximately 6.1 million
shares of common stock (including 800,000 shares to be held in escrow for a
one-year period) for all of the outstanding BlueStar common and preferred
shares. The Company's common shares were valued for accounting purposes using
the average market price of $14.23 per share which is based on the average
closing price for a range of seven trading days around the closing of the
transaction. The Covad Communications Group, Inc. Unaudited Pro Forma Condensed
Combined Consolidated Statements of Operations for the nine months ended June
30, 2000 and for the year ended September 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 BlueStar stock options and
warrants were converted into approximately 226,000 options to purchase the
Company's common shares at an average fair value of $7.70 per share. Up to 5
million additional common shares of

F-34
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

the Company 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 Covad Communications Group, Inc. Unaudited Pro Forma Condensed
Combined Consolidated 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 BlueStar based upon preliminary estimates of their fair
value. The actual allocation of the total purchase cost may differ from the
preliminary estimates. The following is a table of the estimated total purchase
cost and annual amortization of the intangible assets acquired (in thousands):

<TABLE>
<CAPTION>
Total purchase cost:
<S> <C>
Value of common shares issued ............................................ $ 86,593
Assumption of BlueStar options and warrants............................... 1,742
---------
88,335
Interim financing costs................................................... 26,152
Acquisition costs......................................................... 9,346
---------
Total purchase costs.................................................. $ 123,833
=========
</TABLE>

<TABLE>
<CAPTION>
Life Annual
(yrs) Amortization
----- ------------
<S> <C> <C> <C>
Purchase price allocation:
Tangible net assets acquired....................... $ 400 N/A $ --
Intangible assets acquired:
Customer base.................................... 10,500 3 3,500
Acquired workforce............................... 11,300 3 3,767
Deferred stock compensation...................... 364 2.5 146
Goodwill......................................... 101,269 5 20,254
---------- -----------
Total purchase price allocation................ $ 123,833 $ 27,667
========== ===========
</TABLE>

Deferred stock compensation represents the excess intrinsic value of the
outstanding unvested common stock options on the date the acquisition was
finalized versus the weighted average intrinsic value on the date the shares
were originally granted. The average market price of 14.23 per share, which is
based on the average closing price for a range of seven trading days around the
closing of the transaction, 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.

F-35
<PAGE>

COVAD COMMUNICATIONS GROUP, INC.
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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 nine months
ended September 30, 2000. The pro forma basic and diluted net loss per share are
based on the weighted average number of Covad common shares outstanding during
each period, the actual number of Covad shares issued to acquire the outstanding
Laser Link common shares and the actual number of Covad 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.

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-36
<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-37
<PAGE>

LASER LINK.NET, INC.
BALANCE SHEETS
(DOLLARS IN THOUSANDS)

DECEMBER 31,
-------------------
1998 1999
--------- --------
ASSETS
<S> <C> <C>
Current assets:
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-38
<PAGE>

LASER LINK.NET, INC.
STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
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-39
<PAGE>

LASER LINK.NET, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY AND REDEEMABLE PREFERRED STOCK
(DOLLARS IN THOUSANDS)

REDEEMABLE CLASS A
PREFERRED STOCK COMMON STOCK CLASS B COMMON STOCK ADDITIONAL
-------------------- --------------------- ----------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL
--------- --------- ----------- -------- ------------ --------- -----------
<S> <C> <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. $ 13
Warrants issued for Class B Common stock....... 59
Sale of Class A Preferred Stock, net of
expenses.................................... 20,000 352 1,600
Net loss for the year..........................
--------- --------- ----------- -------- ------------ --------- -----------
Balance at December 31,1998 ................... 20,000 352 7,474,860 4,253 18,600,000 350 1,672
--------- --------- ----------- -------- ------------ --------- -----------
Amortization of discount on Class A Preferred 330 (330)
Stock.......................................
Accretion of dividends on Class A Preferred
Stock....................................... 160 (160)
Exchange of stock..............................
Net loss for the year.......................... 87,620 2 (87,620) (2)
--------- --------- ----------- -------- ------------ --------- -----------
Balance at December 31, 1999................... 20,000 $ 842 7,562,480 $ 4,255 18,512,380 $ 348 $ 1,182
========= ========= =========== ======== ============ ========= ===========

TOTAL
ACCUMULATED STOCKHOLDERS'
DEFICIT DEFICIT
------------ -------------
<S> <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
Warrants issued for Class B Common stock....... 59
Sale of Class A Preferred Stock, net of
expenses.................................... 1,600
Net loss for the year.......................... (1,915) (1,915)
------------ -------------
Balance at December 31,1998 ................... (2,356) 3,919
------------ -------------
Amortization of discount on Class A Preferred
Stock....................................... (330)
Accretion of dividends on Class A Preferred
Stock....................................... (160)
Exchange of stock.............................. --
Net loss for the year.......................... (3,742) (3,742)
------------ -------------
Balance at December 31, 1999................... $ (6,098) $ (313)
============ =============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

F-40
<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-41
<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.

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.

F-42
<PAGE>

LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

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.

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.

F-43
<PAGE>

LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

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.

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

F-44
<PAGE>

LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

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.

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.

F-45
<PAGE>

LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

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 WEIGHTED-AVERAGE REMAINING
SHARES PER SHARE EXERCISE PRICE CONTRACTUAL LIFE
------------ --------------- ------------------- -------------------
<S> <C> <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>

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.

F-46
<PAGE>

LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

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:

FISCAL OPERATING
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
=============

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

F-47
<PAGE>

LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

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 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-48
<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-49
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1999
<TABLE>
<CAPTION>

1998 1999
---------------- ---------------
ASSETS
<S> <C> <C>
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, $0.01 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, $0.0025 and $0.01 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-50
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999

<TABLE>
<CAPTION>
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-51
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999

COMMON STOCK ADDITIONAL
---------------------- PAID-IN DEFERRED MEMBER ACCUMULATED
SHARES AMOUNT CAPITAL COMPENSATION CAPITAL DEFICIT TOTAL
----------- ---------- ----------- -------------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1998 . -- $ -- $ -- $ -- $ 100,808 $ -- $ 100,808
Member contributions .... -- -- -- -- 20,314 -- 20,314
Net loss of LLC.......... -- -- -- -- -- (236,754) (236,754)
Issuance of common stock
and reorganization
from LLC
to Corporation......... 9,855,000 24,637 (140,269) -- (121,122) 236,754 --
Common stock issued...... 2,332,281 5,831 575,524 -- -- -- 581,355
Common stock redemption.. (41,688) (104) (13,792) -- -- -- (13,896)
Net loss since
reorganization ........ -- -- -- -- -- (480,875) (480,875)
---------- ---------- ---------- ------------- --------- ------------ ------------
Balance at December 31, 1998 12,145,593 30,364 421,463 -- -- (480,875) (29,048)
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) -- -- 4,496
Deferred compensation on
stock option grants ... -- -- 3,601,347 (3,601,347) -- -- --
Amortization of deferred
compensation .......... -- -- -- 425,840 -- -- 425,840
Compensation expense
related to
non-employee warrant
and stock
options granted ....... -- -- 10,000 -- -- -- 10,000
Exercise of common stock
options................ 198,315 1,983 22,442 -- -- -- 24,425
Repurchase of common
stock ................. (2,021,025) (20,210) -- -- -- (78,820) (99,030)
Net loss................. -- -- -- -- -- (19,218,780) (19,218,780)
---------- ---------- ---------- ------------- --------- ------------- ------------
Balance at December 31,
1999 ....................... 11,712,900 $ 117,128 $4,018,372 $ (3,239,122) $ -- $(19,778,475) $(18,882,097)
========== ===================== ============= ========== ============ ============
</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 CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999

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-53
<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-54
<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-55
<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-56
<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
on a straight-line basis over the term of the contract or the expected term of
the customer relationship, whichever is longer, provided that all other criteria
for revenue recognition have been met. SAB 101 also limits the deferral of
incremental direct costs associated with the origination of a customer
arrangement to an amount that is less than or equal to the amount of up-front
revenues that have been deferred. 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.

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
============ ==============

F-57
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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 noncancelable 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).

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.

F-58
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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.

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

F-59
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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 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

F-60
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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 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,

F-61
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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
=========== ===========

The following table summarizes information about initial employee, Plan and
New Plan options outstanding at December 31, 1999:

<TABLE>
<CAPTION>
OPTIONS WEIGHTED WEIGHTED
REMAINING AVERAGE OPTIONS AVERAGE
OUTSTANDING AT CONTRACTUAL EXERCISE EXERCISABLE AT EXERCISE
EXERCISE PRICES 12/31/99 LIFE IN YEARS PRICE 12/31/99 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.

F-62
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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.

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-63
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND JUNE 30, 2000
<TABLE>
<CAPTION>
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, $0.01 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, $0.01 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-64
<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-65
<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 DEFERRED
SHARES AMOUNT CAPITAL RECEIVABLE COMPENSATION
------------- ------------ --------------- -------------- ----------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1999................ 11,712,900 $ 117,128 $ 4,018,372 $ -- $ (3,239,122)
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 -- (933,610)
Amortization of deferred compensation.... -- -- -- -- 1,095,963
Restricted stock loan receivable......... -- -- -- (728,150) --
Net loss................................. -- -- -- -- --
------------- ------------ --------------- -------------- ----------------
Balance at June 30, 2000.................... 13,176,774 $ 131,767 $ 6,101,976 $ (728,150) $ (3,076,769)
============= ============ =============== ============== ================

ACCUMULATED
DEFICIT TOTAL
--------------- -----------------
<S> <C> <C>
Balance at December 31, 1999................ $ (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.................... -- --
Amortization of deferred compensation.... -- 1,095,963
Restricted stock loan receivable......... -- (728,150)
Net loss................................. (50,654,241) (50,654,241)
--------------- -----------------
Balance at June 30, 2000.................... $ (70,502,329) $ (68,073,505)
=============== =================

</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

F-66
<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-67
<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

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.

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 (i.e. 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.

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<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)

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's shareholders 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. The
number of shares the Company receives at the close of the merger will be reduced
based upon the amount of unpaid principal and interest the Company has
outstanding under any loan agreements arranged by Covad on behalf of the
Company. The share reduction will be calculated by dividing any such amounts
outstanding by the closing price of one share of Covad common stock on the
National Nasdaq Market on the third business day prior to the closing date. Up
to five million additional shares of Covad common stock may be issued to the
Company shareholders if certain performance targets are met by the Company
during the 2001 fiscal year.

In June 2000, the Company entered into a $40.0 million demand loan
agreement with Bear Stearns Corporate Lending Inc. Under the terms of the loan
agreement, the Company 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 the Company'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

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<PAGE>

BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)

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 the Company 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 the Company or (5) December 15, 2000.

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<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, Verizon Communications, Qwest 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
----

Special Note Regarding Forward-Looking Statements.......................... i
Prospectus Summary......................................................... 1
The Offering............................................................... 4
Summary Consolidated Financial Data........................................ 5
Risk Factors............................................................... 7
Use of Proceeds............................................................ 29
Determination of Offering Price............................................ 29
Dividend Policy............................................................ 29
Price Range of Our Common Stock............................................ 29
Selected Consolidated Financial Data of
Covad Communications Group, Inc......................................... 30
Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................... 32
Business................................................................... 44
Management................................................................. 64
Certain Relationships and Related Transactions............................. 84
Principal and Selling Shareholders......................................... 90
Description of Capital Stock............................................... 94
Shares Eligible for Future Sale............................................ 98
Plan of Distribution....................................................... 101
Where You Can Find More Information........................................ 102
Legal Matters.............................................................. 102
Experts.................................................................... 102
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

[GRAPHIC OMITTED]

COVAD COMMUNICATIONS GROUP, INC.

COMMON STOCK
________________

, 2001

================================================================================

<PAGE>

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table sets forth the costs and expenses, payable by the
Company in connection with the sale of common stock being registered. All
amounts are estimates except for the SEC registration fee.

AMOUNT TO BE
PAID BY THE
COMPANY
-------------
SEC registration fee............................................ $ 42,882.31
Printing........................................................ 45,000.00
Legal fees and expenses......................................... 60,000.00
Accounting fees and expenses.................................... 50,000.00
Miscellaneous................................................... 5,000.00
-------------
Total....................................................... $ 197,882.31
=============

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS

Section 145 of the Delaware General Corporation Law ("DGCL") provides that
a corporation may indemnify such person who was or is a party or is threatened
to be made a party to any threatened, pending or completed action or proceeding,
whether civil, criminal, administrative or investigative, by reason of the fact
that such person is or was a director, officer, employee or agent of the
corporation or is or was serving at its request in such capacity in another
corporation or business association, against expenses (including attorneys'
fees), judgments, fines and amounts paid in settlement actually and reasonably
incurred by him in connection with such action, suit or proceeding if such
person acted in good faith and in a manner such person reasonably believed to be
in or not opposed to the best interests of the corporation, and, with respect to
any criminal action or proceeding, had no reasonable cause to believe his
conduct was unlawful.

Section 102(b)(7) of the DGCL permits a corporation to provide in its
certificate of incorporation that a director of the corporation shall not be
personally liable to the corporation or its stockholders for monetary damages
for breach of fiduciary duty as a director, except for liability (i) for any
breach of the director's duty of loyalty to the corporation or its stockholders,
(ii) for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law, (iii) under Section 174 of the DGCL,
or (iv) for any transaction from which the director derived an improper personal
benefit.

As permitted by Section 102(b)(7) of the DGCL, the Registrant's Amended
and Restated Certificate of Incorporation includes a provision that limits a
director's personal liability to the Registrant or its stockholders for monetary
damages for breaches of his or her fiduciary duty as a director. Article X of
the Registrant's Amended and Restated Certificate of Incorporation provides that
no director of the Registrant shall be personally liable to the Registrant or
its stockholders for monetary damages for breach of fiduciary duty to the
fullest extent permitted by the DGCL.

As permitted by Section 145 of the DGCL, the Registrant's Bylaws provide
that, to the fullest extent permitted by the DGCL, directors, officers and
certain other persons who are made, or are threatened to be made, parties to, or
are involved in, any action, suit or proceeding will be indemnified by the
Registrant with respect thereto. Article VI of the Registrant's Bylaws provides
for the indemnification of officers, directors, employees and agents of the
corporation if such person acted in good faith and in a manner reasonably
believed to be in and not opposed to the best interest of the corporation, and,
with respect to any criminal action or proceeding the indemnified party had no
reason to believe his conduct was unlawful.

The Registrant maintains insurance policies under which its directors and
officers are insured, within the limits and subject to the limitations of the
policies, against expenses in connection with the defense of actions, suits or
proceedings, and certain liabilities that might be imposed as a result of such
actions, suits or proceedings, to which they are parties by reason of being or
having been directors or officers of the Registrant. The Registrant also

II-1
<PAGE>

entered into agreements to indemnify the Registrant's directors and executive
officers, in addition to the indemnification provided for in the Registrant's
Amended and Restated Certificate of Incorporation and Bylaws.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES

Since our incorporation in October 1996, we have issued and sold
unregistered securities as follows:

(1) An aggregate of 18,216,000 shares of common stock was issued in a
private placement in November 1996 to Messrs. McMinn, Khanna, Haas, Davidson and
Lynch pursuant to Restricted Stock Purchase Agreements. The consideration
received for such shares was $50,600. We repurchased 3,615,444 shares of common
stock issued to Mr. Davidson in July 1997. See "Certain Transactions."

(2) An aggregate of 1,687,500 shares of common stock was issued in a
private placement in July 1997 to Mr. Cardinale pursuant to a Restricted Stock
Purchase Agreement. The consideration received for such shares was $37,500.

(3) An aggregate of 750,000 shares of series A preferred stock was issued
in a private placement in June 1997 to Messrs. McMinn, Khanna, Haas and Lynch.
The aggregate consideration received for such shares was $249,975.

(4) An aggregate of 17,000,001 shares of series B preferred stock was
issued in a private placement in July 1997 to Warburg, Crosspoint and Intel. The
aggregate consideration received for such shares was $8,500,000.50, a portion of
which was paid by cancellation of a $500,000 demand note issued to Warburg in
June 1997.

(5) An aggregate of 517,500 shares of common stock was issued in a private
placement in August 1997 to Mr. Laehy pursuant to a Restricted Stock Purchase
Agreement. The consideration received for such shares was $17,250.

(6) An aggregate of 216,000 shares of common stock was issued in a private
placement in October 1997 to Mr. Marshall pursuant to a Restricted Stock
Purchase Agreement. The consideration received for such shares was $7,200.

(7) An aggregate of 1,125 shares of common stock was issued in a private
placement in December 1997 to one investor pursuant to an Assignment, Transfer
and Sale Agreement and a Restricted Stock Purchase Agreement. The consideration
for such shares was receipt of a mark and domain name.

(8) An aggregate of 100,002 shares of series B preferred stock was issued
in a private placement in February 1998 to Mr. Marshall. The consideration
received for such shares was $100,002.

(9) Warrants for the purchase of an aggregate of 2,700,000 shares of
common stock with an exercise price of $0.0022 per share were issued in February
1998 to Warburg, Crosspoint and Intel in connection with a series C preferred
stock and Warrant Subscription Agreement.

(10) An aggregate of 360,144 shares of series C preferred stock was issued
in a private placement in March 1998 to Intel. The consideration received for
such shares was $999,999.84.

(11) In March 1998, we issued 260,000 units consisting of 131/2% senior
discount notes due 2008 and warrants to purchase 7,580,646 shares of common
stock with exercise prices of $0.0022 per share to Bear, Stearns & Co. Inc. and
BT Alex. Brown Incorporated, as initial purchasers, for resale to qualified
institutional buyers. Bear, Stearns & Co. Inc. and BT Alex. Brown Incorporated
received commissions of $4,728,542 for acting as initial purchasers in
connection with this transaction.

(12) An aggregate of 36,015 shares of series C preferred stock was issued
in a private placement in April 1998 to Mr. Hawk. The consideration received for
such shares was $100,001.65.

(13) An aggregate of 144,000 shares of common stock was issued in a
private placement pursuant to a Restricted Stock Purchase Agreement in April
1998 to Mr. Hawk. The consideration received for such shares was $64,000.

(14) A warrant for the purchase of an aggregate of 202,500 shares of
common stock with an exercise price of $.6666 per share was issued in July 1998
to a consultant in connection with services rendered.

(15) An aggregate of 60,000 shares of common stock was issued in a private
placement pursuant to a Restricted Stock Purchase Agreement in August 1998 to
Mr. Hawk. The consideration received for such shares was $230,000.

II-2
<PAGE>

(16) An aggregate of 13,500 shares of common stock was issued in a private
placement pursuant to a Restricted Stock Purchase Agreement in October 1998 to
one investor. The consideration received for such shares was services rendered.

(17) An aggregate of 13,167 shares of common stock was issued in a private
placement pursuant to a Restricted Stock Purchase Agreement in November 1998 to
two consultants. The consideration received for such shares was services
rendered.

(18) An aggregate of 12,000 shares of common stock was issued in a private
placement pursuant to a Restricted Stock Purchase Agreement in December 1998 to
a consultant. The consideration received for such shares was services rendered.

(19) From July 1997 through December 31, 1998, we granted stock options to
purchase an aggregate of 19,795,090 shares of common stock to employees,
consultants and directors with exercise prices ranging from $0.0222 to $5.44 per
share pursuant to our 1997 Stock Plan. To date, 320,248 shares of common stock
have been issued upon exercise of vested options.

(20) An aggregate of 2,701,049 shares of series C-1 preferred stock and
2,083,334 shares of series D-1 preferred stock were issued in a private
placement in January 1999 to four investors. The consideration received for such
shares was $45 million.

(21) An aggregate of 900,349 shares of series C-1 preferred stock and
694,445 shares of series D-1 preferred stock were issued in a private placement
in January 1999 to an investor. The consideration received for such shares was
$15 million.

(22) In February 1999, we issued $215 million aggregate principal amount
of 121/2% senior notes due 2009 to Bear, Stearns & Co. Inc., BT Alex. Brown
Incorporated, Donaldson, Lufkin & Jenrette Securities Corporation and Goldman,
Sachs & Co., as initial purchasers for resale to qualified institutional buyers.
The initial purchasers received commissions of $5,106,250 for acting as such in
connection with the transaction.

(23) In April 1999, we issued a warrant to purchase 450,000 split-adjusted
shares of 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.

(24) In January 2000, we issued $425 million aggregate principal amount
of 12% senior notes due 2010 to Bear, Stearns & Co., Inc. and Morgan Stanley &
Co., Inc., as initial purchasers for resale to qualified institutional buyers.
The initial purchasers received commissions of $10,306,250 for acting as such in
connection with the transaction.

(25) 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., our wholly-owned subsidiary, with Laser Link in which
Lightsaber was the surviving entity. As a result, in a transaction exempt under
Section 4(2) of the Securities Act, we issued shares of our common stock to
shareholders of Laser Link.Net in exchange for their Laser Link.Net stock.

(26) On September 25, 2000, we issued $500 million aggregate principal
amount 6% convertible senior notes due 2005 to Bear, Stearns & Co., Inc., Morgan
Stanley & Co. Inc., Credit Suisse First Boston, Deutsche Banc Alex, Brown and
Goldman, Sachs & Co., as initial purchasers for resale to qualified
institutional buyers. The initial purchasers received commissions totaling
$15,000,000 for acting as such in connection with the transaction.

(27) On November 3, 2000, 9,373,169 shares of our common stock were issued
in a private placement to SBC Communications pursuant to Section 4(2). The
consideration received for such shares was $150 million.

No underwriters were used in connection with these sales and issuances
except for the issuance of the 1998 notes and related warrants in (11) above,
the issuance of the 1999 notes in (22) above, the issuance of the 2000 notes in
(24) above and the issuance of the convertible notes in (26) above. The sales
and issuances of these securities except for those in note (11), note (22), note
(24) and note (26) were exempt from registration under the Securities Act
pursuant to Rule 701 promulgated thereunder on the basis that these options were
offered and sold either pursuant to a written compensatory benefit plan or
pursuant to written contracts relating to consideration, as provided by Rule
701, or pursuant to Section 4(2) thereof on the basis that the transactions did
not involve a public

II-3
<PAGE>

offering. The sales and issuance in note (11), note (22), note (24) and note
(26) were exempt from registration under the Securities Act pursuant to Section
4(2) and, in connection with the resale by the initial purchasers of the
securities described in note (11), note (22), note (24) and note (26), Rule 144A
thereunder.

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<PAGE>

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

EXHIBIT
NUMBER DESCRIPTION
------ -----------
1.1(9) Purchase Agreement, dated September 19, 2000, among the Company, Bear, Stearns & Co., Inc., Morgan Stanley & Co.
Incorporated, Credit Suisse First Boston Corporation, Deutsche Bank Securities, Inc. and Goldman, Sachs & Co.
2.1(3) Agreement and Plan of Merger Among Covad Communications Group, Inc., LightSaber Acquisition Co. and Laser Link.Net,
Inc., dated as of March 8, 2000.
2.2(8) Agreement and Plan of Merger and Registration among Covad Communications Group, Inc., Covad Acquisition Corp. and
BlueStar Communications Group, Inc., dated as of June 15, 2000.
2.3(10) Acquisition Agreement, dated as of September 8, 2000, among Covad Communications Group, Inc., Greenway Holdings Ltd.,
Loop Holdings Europe APS, Loop Telecom, S.A. and the shareholders of Loop Telecom, S.A.
2.4(10) Shareholders' Agreement, dated as of September 12, 2000, among Loop Holdings Europe APS, Loop Telecom, S.A., Covad
Communications Group, Inc. and the other shareholders of Loop Telecom, S.A.
3.2* Amended and Restated Certificate of Incorporation.
3.4* Bylaws, as currently in effect.
3.5(8) Certificate of Amendment of Certificate of Incorporation of the Registrant filed on July 14, 2000.
4.1(1) Indenture dated as of March 11, 1998 between the Registrant and The Bank of New York.
4.4(1) Warrant Registration Rights Agreement dated as of March 11, 1998 among the Registrant and Bear, Stearns & Co., Inc.
and BT Alex. Brown Incorporated.
4.5(1) Specimen 13 1/2% Senior Note Due 2008.
4.6(1) Amended and Restated Stockholders Rights Agreement dated January 19, 1999 among the Registrant and certain of its
stockholders.
4.7(2) Indenture dated as of February 18, 1999 among the Registrant and The Bank of New York.
4.8(2) Registration Rights Agreement dated as of February 18, 1999 among the Registrant and the Initial Purchasers.
4.9(2) Specimen 12 1/2% Senior Note Due 2009.
4.10(7) Indenture dated as of January 28, 2000, between the Registrant and United States Trust Company of New York.
4.11(7) Registration Rights Agreement dated as of January 28, 2000, between the Registrant and Bear, Stearns & Co., Inc.
4.12(7) Specimen 12% Senior Note Due 2010.
4.14(4) Stockholder Protection Rights Agreement dated February 15, 2000.
4.15(8) Stock Restriction Agreement among Covad Communications and certain stockholders of BlueStar, (included in Exhibit 2.2).
4.16(9) Indenture, dated as of September 25, 2000, between the Company and United States Trust Company of New York.
4.17(9) Specimen 6% Convertible Senior Note, incorporated by reference to Exhibit A included in Exhibit 4.1 above.
4.18(11) Stock Purchase Agreement between SBC Communications Inc. and Covad Communications Group, Inc., dated September 10,
2000.
4.19(11) Resale and Marketing Agreement between SBC Communications Inc. and Covad Communications Group, Inc., dated
September 10, 2000.
5.1* Opinion of Irell & Manella LLP.
9.1(8) Stockholders Agreement among Covad Communications and certain stockholders of BlueStar (included in Exhibit 2.2).
10.1(2) Form of Indemnification Agreement entered into between the Registrant and each of the Registrant's executive officers
and directors.
10.5(2) Series C Preferred Stock and Warrant Subscription Agreement dated as of February 20, 1998 among the Registrant,
Warburg, Pincus Ventures, L.P., Crosspoint Venture Partners 1996 and Intel Corporation, as amended by the Assignment
and Assumption Agreement and First Amendment to the Series C Preferred Stock and Warrant Subscription Agreement
dated as of April 24, 1998 among the Registrant, Warburg,
Crosspoint and Robert Hawk.
10.6(2) Employment Agreement dated June 21, 1999 between the Registrant and Robert E. Knowling, Jr.
</TABLE>

II-5
<PAGE>

<TABLE>
<S><C>
10.7(2) Sublease Agreement dated July 6, 1998 between Auspex Systems, Inc. and the Registrant with respect to Registrant's
facilities in Santa Clara, California.
10.8(2) 1998 Employee Stock Purchase Plan and related agreements, as currently in effect.
10.10(2) Form of Warrant to purchase Common Stock issued by the Registrant on February 20, 1998 to Warburg, Pincus Ventures,
L.P., Crosspoint Ventures Partners 1996 and Intel Corporation.
10.11(5) Note Secured by Deed of Trust dated October 7, 1998 issued by Catherine A. Hemmer and John J. Hemmer in favor of the
Registrant.
10.12(5) 1997 Stock Plan and related option agreement, as currently in effect.
10.13(5) Series C-1 Preferred Stock Purchase Agreement dated as of December 30, 1998 among the Registrant, AT&T Venture
Fund II, LP and two affiliated funds.
10.14(5) Series D-1 Preferred Stock Purchase Agreement dated as of December 30, 1998 among the Registrant, AT&T Venture
Fund II, LP and two affiliated funds.
10.15(5) Series C-1 Preferred Stock Purchase Agreement dated as of December 30, 1998 between the Registrant and NEXTLINK
Communications, Inc.
10.16(5) Series D-1 Preferred Stock Purchase Agreement dated as of December 30, 1998 between the Registrant and NEXTLINK
Communications, Inc.
10.17(5) Series C-1 Preferred Stock Purchase Agreement dated as of January 19, 1998 between the Registrant and U.S.
Telesource, Inc.
10.18(5) Series D-1 Preferred Stock Purchase Agreement dated as of January 19, 1998 between the Registrant and U.S.
Telesource, Inc.
10.21(9) Resale Registration Rights Agreement, among the Company, Bear, Stearns & Co., Inc., Morgan Stanley & Co. Incorporated,
Credit Suisse First Boston Corporation, Deutsche Bank Securities, Inc. and Goldman, Sachs & Co.
11.1(6) Statement of Computation of Per Share Earnings.
12.1(6) Statement of Computation of Ratios.
21.1(6) Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, independent auditors.
23.2* Consent of Irell & Manella LLP (Included in Exhibit 5.1).
23.3 Consent of PricewaterhouseCoopers LLP
23.4 Consent of Arthur Andersen LLP
24.1* Power of Attorney.
27.1(6) Financial Data Schedules.
</TABLE>
--------------
* Previously Filed
(1) Incorporated by reference to the exhibit of corresponding number filed
with our registration statement on Form S-4 (No. 333-51097) as originally
filed on April 27, 1998 and as subsequently amended.
(2) Incorporated by reference to the exhibit of corresponding number filed
with our registration statement on Form S-4 (No. 333-75955) as originally
filed on April 4, 1999 and as subsequently amended.
(3) Incorporated by reference to the exhibit of corresponding number filed
with our registration statement on Form 8-K as originally filed on March
23, 2000 and as subsequently amended.
(4) Incorporated by reference to Exhibit 4.1 filed with our registration
statement on Form 8-A as originally filed on February 22, 2000 and as
subsequently amended.
(5) Incorporated by reference to the exhibit of corresponding number filed
with our registration statement on Form S-1 (File No. 333-63899) as
originally filed on September 21, 1998 and as subsequently amended.
(6) Incorporated by reference to the exhibit of corresponding number filed
with our report on Form 10-K as originally filed on March 30, 2000 and as
subsequently amended.
(7) Incorporated by reference to the exhibit of corresponding number filed
with our registration statement on Form S-4 (No. 333-30360) as originally
filed on February 14, 2000 and as subsequently amended.
(8) Incorporated by reference to the exhibit of corresponding number filed
with our registration statement on Form S-4 (No. 333-43494)as originally
filed on August 10, 2000 and as subsequently amended.
(9) Incorporated by reference to exhibit of corresponding number filed with
our registration statement on Form 8-K as originally filed on September
27, 2000 and as subsequently amended.
(10) Incorporated by reference to exhibit of corresponding number filed with
our registration statement on Form

II-6
<PAGE>
8-K as originally filed on September 27, 2000 and as subsequently
amended.
(11) Incorporated by reference to the exhibit of corresponding number filed
with our registration statement on Form 8-K as originally filed on
September 12, 2000 and as subsequently amended.

(B) FINANCIAL STATEMENTS

None.

ITEM 17. UNDERTAKINGS

1. The undersigned registrant hereby undertakes:

(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this registration statement:

(i) To include any prospectus required by Section 10(a)(3) of
the Securities Act of 1933;

(ii) To reflect in the prospectus any facts or events arising
after the effective date of the registration statement (or the most
recent post-effective amendment thereof) which, individually or in
the aggregate, represent a fundamental change in the information set
forth in the registration statement. Notwithstanding the foregoing,
any increase or decrease in volume of securities offered (if the
total dollar value of securities offered would not exceed that which
was registered) and any deviation from the low or high end of the
estimated maximum offering range may be reflected in the form of
prospectus filed with the Commission pursuant to Rule 424(b) if, in
the aggregate, the changes in volume and price represent no more
than a 20 percent change in the maximum aggregate offering price set
forth in the "Calculation of Registration Fee" table in the
effective registration statement;

(iii) To include any material information with respect to
the plan of distribution not previously disclosed in the
registration statement or any material change to such information in
the registration statement;"

PROVIDED HOWEVER, that paragraphs (a)(1)(i) and (a)(1)(ii) do not apply if the
registration statement is on Form S-3, Form S-8, or Form F-3, and the
information required to be included in a post-effective amendment by those
paragraphs is contained in periodic reports filed with or furnished to the
Commission by the registrant pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 that are incorporated by reference in the registration
statement.

(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be
deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall
be deemed to be the initial BONA FIDE offering thereof.

(3) To remove from registrant by means of a post-effective
amendment any of the securities being registered which remain unsold at
the termination of the offering.

(4) If the registrant is a foreign private issuer, to file a
post-effective amendment to the registration statement to include any
financial statements required by Rule 3-19 of this chapter at the start
of any delayed offering or throughout a continuous offering. Financial
statements and information otherwise required by Section 10(a)(3) of the
Act need not be furnished, PROVIDED, that the registrant includes in the
prospectus, by means of a post-effective amendment, financial statements
required pursuant to this paragraph (a)(4) and other information
necessary to ensure that all other information in the prospectus is at
least as current as the date of those financial statements.
Notwithstanding the foregoing, with respect to registration statements on
Form F-3, a post-effective amendment need not be filed to include
financial statements and information required by Section 10(a)(3) of the
Act or Rule 3-19 of this chapter if such financial statements and
information are contained in periodic reports filed with or furnished to
the Commission by the registrant pursuant to Section 13 or Section 15(d)
of the Securities Exchange Act of 1934 that are incorporated by reference
in the Form F-3.

2. Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling persons
of the Registrant pursuant to the foregoing provisions, or otherwise, the
Registrant has been advised that in the opinion of the SEC such indemnification
is against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities

II-7
<PAGE>

(other than the payment by the Registrant of expenses incurred or paid by a
director, officer or controlling person of the Registrant in the successful
defense of any action, suit or proceeding) is asserted by such director, officer
or controlling person in connection with the securities being registered, the
Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of such issue.

3. The undersigned Registrant hereby undertakes:

(a) For purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the Registrant pursuant to Rule 424(b)(1), or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective; and

(b) For purposes of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.

II-8
<PAGE>

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED,
THE REGISTRANT HAS DULY CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS
BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF SANTA
CLARA, STATE OF CALIFORNIA, ON THE 9TH DAY OF JANUARY 2001.

COVAD COMMUNICATIONS GROUP, INC.
By: /S/ MARK H. PERRY
---------------------------------------
Mark H. Perry

EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Frank Marshall and/or Mark H. Perry and
each of them his attorney-in-fact, each with the power of substitution, for him
and in his name, place and stead, in any and all capacities, to sign any and all
amendments (including post-effective amendments) to this Registration Statement,
and to sign any registration statement for the same offering covered by this
Registration Statement that is to be effective upon filing pursuant to Rule
462(b) promulgated under the Securities Act, and all post-effective amendments
thereto, and to file the same, with all exhibits thereto in all documents in
connection therewith, with the SEC, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that such attorneys-in-fact and
agents or any of them, or his or their substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons on January 9,
2001 in the capacities indicated.

SIGNATURE TITLE
--------- -----

/S/ FRANK MARSHALL Interim Chief Executive Officer and Director
----------------------------------------------- (Principal Executive Officer)
(Frank Marshall)

/S/ MARK H. PERRY Executive Vice President and Chief Financial Officer
----------------------------------------------- (Principal Financial and Accounting Officer)
(Mark H. Perry)

/S/ CHARLES MCMINN Chairman of the Board of Directors
-----------------------------------------------
(Charles McMinn)

/S/ ROBERT HAWK Director
-----------------------------------------------
(Robert Hawk)

/S/ HELLENE RUNTAGH Director
-----------------------------------------------
(Hellene Runtagh)

/S/ LARRY IRVING Director
-----------------------------------------------
(Larry Irving)

/S/ DANIEL LYNCH Director
-----------------------------------------------
(Daniel Lynch)

/S/ RICH SHAPERO Director
-----------------------------------------------
(Rich Shapero)
</TABLE>

II-9
<PAGE>

EXHIBIT INDEX

EXHIBIT
NUMBER DESCRIPTION
------- -----------

<TABLE>
<CAPTION>
<S> <C>
1.1(9) Purchase Agreement, dated September 19, 2000, among the Company, Bear, Stearns & Co., Inc., Morgan
Stanley & Co. Incorporated, Credit Suisse First Boston Corporation,
Deutsche Bank Securities, Inc. and Goldman, Sachs & Co.
2.1(3) Agreement and Plan of Merger Among Covad Communications Group, Inc.,
LightSaber Acquisition Co. and Laser Link.Net, Inc., dated as of March 8, 2000.
2.2(8) Agreement and Plan of Merger and Registration among Covad Communications Group, Inc.,
Covad Acquisition Corp. and BlueStar Communications Group, Inc., dated as of June 15, 2000.
2.3(10) Acquisition Agreement, dated as of September 8, 2000, among Covad Communications Group, Inc.,
Greenway Holdings Ltd., Loop Holdings Europe APS, Loop Telecom, S.A. and the shareholders of Loop
Telecom, S.A.
2.4(10) Shareholders' Agreement, dated as of September 12, 2000, among Loop Holdings Europe APS, Loop
Telecom, S.A., Covad Communications Group, Inc. and the other shareholders of Loop Telecom, S.A.
3.2* Amended and Restated Certificate of Incorporation.
3.4* Bylaws, as currently in effect.
3.5(8) Certificate of Amendment of Certificate of Incorporation of the Registrant filed on July 14, 2000.
4.1(1) Indenture dated as of March 11, 1998 between the Registrant and The Bank of New York.
4.4(1) Warrant Registration Rights Agreement dated as of March 11, 1998 among the Registrant and
Bear, Stearns & Co., Inc. and BT Alex. Brown Incorporated.
4.5(1) Specimen 13 1/2% Senior Note Due 2008.
4.6(1) Amended and Restated Stockholders Rights Agreement dated January 19, 1999 among the Registrant and
certain of its stockholders.
4.7(2) Indenture dated as of February 18, 1999 among the Registrant and The Bank of New York.
4.8(2) Registration Rights Agreement dated as of February 18, 1999 among the Registrant and the Initial
Purchasers.
4.9(2) Specimen 12 1/2% Senior Note Due 2009.
4.10(7) Indenture dated as of January 28, 2000, between the Registrant and United States Trust Company of
New York.
4.11(7) Registration Rights Agreement dated as of January 28, 2000, between the Registrant and
Bear, Stearns & Co., Inc.
4.12(7) Specimen 12% Senior Note Due 2010.
4.14(4) Stockholder Protection Rights Agreement dated February 15, 2000.
4.15(8) Stock Restriction Agreement among Covad Communications and
certain stockholders of BlueStar, (included in Exhibit 2.2).
4.16(9) Indenture, dated as of September 25, 2000, between the Company and United States Trust Company of
New York.
4.17(9) Specimen 6% Convertible Senior Note, incorporated by reference to Exhibit A included in Exhibit 4.1
above.
4.18(11) Stock Purchase Agreement between SBC Communications Inc. and Covad Communications Group, Inc., dated
September 10, 2000.
4.19(11) Resale and Marketing Agreement between SBC Communications Inc. and Covad Communications Group, Inc.,
dated September 10, 2000.
5.1* Opinion of Irell & Manella LLP.
9.1(8) Stockholders Agreement among Covad Communications and certain stockholders of BlueStar (included in
Exhibit 2.2).
10.1(2) Form of Indemnification Agreement entered into between the
Registrant and each of the Registrant's executive officers and
directors.
10.5(2) Series C Preferred Stock and Warrant Subscription Agreement
dated as of February 20, 1998 among the Registrant, Warburg, Pincus
Ventures, L.P., Crosspoint Venture Partners 1996 and Intel
Corporation, as amended by the Assignment and Assumption Agreement
and First Amendment to the Series C Preferred Stock and Warrant
Subscription Agreement dated as of April 24, 1998 among the
Registrant, Warburg, Crosspoint and Robert Hawk.
10.6(2) Employment Agreement dated June 21, 1999 between the Registrant and Robert E. Knowling, Jr.
</TABLE>

<PAGE>
<TABLE>
<CAPTION>
<S> <C>
10.7(2) Sublease Agreement dated July 6, 1998 between Auspex Systems, Inc. and the Registrant with respect
to Registrant's facilities in Santa Clara, California.
10.8(2) 1998 Employee Stock Purchase Plan and related agreements, as currently in effect.
10.10(2) Form of Warrant to purchase Common Stock issued by the Registrant on February 20, 1998 to Warburg,
Pincus Ventures, L.P., Crosspoint Ventures Partners 1996 and Intel Corporation.
10.11(5) Note Secured by Deed of Trust dated October 7, 1998 issued by Catherine A. Hemmer and
John J. Hemmer in favor of the Registrant.
10.12(5) 1997 Stock Plan and related option agreement, as currently in effect.
10.13(5) Series C-1 Preferred Stock Purchase Agreement dated as of December 30, 1998 among the Registrant,
AT&T Venture Fund II, LP and two affiliated funds.
10.14(5) Series D-1 Preferred Stock Purchase Agreement dated as of December 30, 1998 among the Registrant,
AT&T Venture Fund II, LP and two affiliated funds.
10.15(5) Series C-1 Preferred Stock Purchase Agreement dated as of December 30, 1998 between the Registrant
and NEXTLINK Communications, Inc.
10.16(5) Series D-1 Preferred Stock Purchase Agreement dated as of December 30, 1998 between the Registrant
and NEXTLINK Communications, Inc.
10.17(5) Series C-1 Preferred Stock Purchase Agreement dated as of January 19, 1998 between the Registrant
and U.S. Telesource, Inc.
10.18(5) Series D-1 Preferred Stock Purchase Agreement dated as of January 19, 1998 between the Registrant
and U.S. Telesource, Inc.
10.21(9) Resale Registration Rights Agreement, among the Company, Bear, Stearns & Co., Inc.,
Morgan Stanley & Co. Incorporated, Credit Suisse First Boston Corporation, Deutsche Bank Securities,
Inc. and Goldman, Sachs & Co.
</TABLE>

11.1(6) Statement of Computation of Per Share Earnings.
12.1(6) Statement of Computation of Ratios.
21.1(6) Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, independent auditors.
23.2* Consent of Irell & Manella LLP (Included in Exhibit 5.1).
23.3 Consent of PricewaterhouseCoopers LLP
23.4 Consent of Arthur Andersen LLP
24.1* Power of Attorney.
27.1(6) Financial Data Schedules.
--------------
* Previously Filed

(1) Incorporated by reference to the exhibit of corresponding number filed
with our registration statement on Form S-4 (No. 333-51097) as originally
filed on April 27, 1998 and as subsequently amended.

(2) Incorporated by reference to the exhibit of corresponding number filed
with our registration statement on Form S-4 (No. 333-75955) as originally
filed on April 4, 1999 and as subsequently amended.

(3) Incorporated by reference to the exhibit of corresponding number filed
with our registration statement on Form 8-K as originally filed on March
23, 2000 and as subsequently amended.

(4) Incorporated by reference to Exhibit 4.1 filed with our registration
statement on Form 8-A as originally filed on February 22, 2000 and as
subsequently amended.

(5) Incorporated by reference to the exhibit of corresponding number filed
with our registration statement on Form S-1 (File No. 333-63899) as
originally filed on September 21, 1998 and as subsequently amended.

(6) Incorporated by reference to the exhibit of corresponding number filed
with our report on Form 10-K as originally filed on March 30, 2000 and as
subsequently amended.

(7) Incorporated by reference to the exhibit of corresponding number filed
with our registration statement on Form S-4 (No. 333-30360) as originally
filed on February 14, 2000 and as subsequently amended.

(8) Incorporated by reference to the exhibit of corresponding number filed
with our registration statement on Form S-4 (No. 333-43494)as originally
filed on August 10, 2000 and as subsequently amended.

(9) Incorporated by reference to exhibit of corresponding number filed with
our registration statement on Form 8-K as originally filed on September
27, 2000 and as subsequently amended.

(10) Incorporated by reference to exhibit of corresponding number filed with
our registration statement on Form

<PAGE>

8-K as originally filed on September 27, 2000 and as subsequently
amended.

(11) Incorporated by reference to the exhibit of corresponding number filed
with our registration statement on Form 8-K as originally filed on
September 12, 2000 and as subsequently amended.